Monday, November 24, 2008

Why not simply cut the GST?

It's an idea that's occurred to Stephen Koukoulas of TD Securities:

"One very simply plan, which would not have a lasting impact on the Budget balance would be a 12 month cut in the GST to say 8%, perhaps lower. This injects money into the economy immediately, it is fairer in that is does not simply benefit borrowers; if implemented with a 12 month sunset clause, future budget balances would not be impacted and it could dampen inflation expectations. (There are issues of State financing, an effect on bringing forward spending with a hangover after that and the like, but these are small beer when policy makers are doing as much as possible to inspire economic growth.)"

Koukoulas continues...

"Howard and Costello’s Policy Failure

The current economy circumstances bring into focus the inept, short-sighted and hopelessly misguided handling of the economy in the final years of Howard and Costello government. In the period from about 2003 – 2004, Howard and Costello were continually surprised by the size of the budget surplus as the economy boomed on the back of a once in a century surge in national income from the staggering strength in commodity prices and remarkable growth in Australia’s major trading partners.

Instead of saving for a rainy day or building war chest of money for when this bubble burst (insert your own cliché!), they spent the windfall fiscal gains like drunken sailors, which fuelled a surge in inflation, which in turn caused the RBA to hike rates aggressively, which in turn is one reason why Australia is so vulnerable now to the global slow down. Right now, the near certain collapse of the terms of trade and the risk of a deep recession are not helped by this past profligacy.

These may be moot points at the moment, but there is a lesson for the Rudd and Swan government.

Had Howard and Costello managed the economy well and accumulated much of the windfall gain in large Budget surpluses in the period 2004 to 2007, inflation pressures would not have been as intense, the RBA would not have hiked as dramatically as the government would have somewhere between $50 billion and $75 billion is spare cash to support the economy at its time of need. Simply put, the government would now have greater flexibility to cut taxes and increase spending when the economy is cascading towards recession.

Rudd and Swan – Don’t Make the Same Mistake!

In this context, it is important for the current Rudd government to jettison the idea that the Budget must stay in surplus – even in a recession. As mentioned, the case for a substantial fiscal easing is strong, even if that means the Budget falls into deficit by 2 or even 3% of GDP.

It would be dumb to try to keep the Budget in surplus at a time of weak growth and rising unemployment. Postponing tax cuts and cutting spending in these circumstances is as foolhardy as the policy platform of Howard and Costello in their last few years in government, but in the opposite direction.

If indeed, the economy is as bad as it looks, embrace a Budget deficit, spend up to limit the inevitable human misery that a recession inevitably brings and manage fiscal policy in a counter cyclical way.

If this succeeds, of course this is great news. Just be aware that whenever the recovery comes, be prepared to slash spending, hike taxes to return the budget to surplus, but do it only when the economy is strong enough to stand it."  



Responses:

Nick Gruen writes:

Well, I'll be pleased if I'm wrong, but it seems barmy to me. Hard to see how you couldn't have stimulated consumption by foregoing a lot less revenue than that. A 1.5% cut in prices (some of which won't flow through from the menu costs one presumes.)

The economic textbook is a good thing, but not when used in such a mechanical way. Still, I guess we'll find a little bit out about how it turns out.


Crikey wrote:

Last night, ABC viewers were treated to the spectacle of Peter Costello banging on about "his" GST on the steadily more dreary Howard Years . A few hours later, Fairfax's Peter Martin quoted economist Stephen Kokoulas as advocating a cut in Costello's GST from 10% to 8%. Around the same time, the UK Government &resolved to temporarily slash its rate of VAT from 17.5% to 15% in a bid to stimulate its tanking economy. Could the Rudd Government be contemplating a similar move?Publish Post

The Kokoulas plan: "One very simple plan, which would not have a lasting impact on the Budget balance would be a 12 month cut in the GST to say 8%, perhaps lower. This injects money into the economy immediately, it is fairer in that is does not simply benefit borrowers; if implemented with a 12 month sunset clause, future budget balances would not be impacted and it could dampen inflation expectations. (There are issues of State financing, an effect on bringing forward spending with a hangover after that and the like, but these are small beer when policy makers are doing as much as possible to inspire economic growth.)"

Crikey asked a group of leading Australian economists if a cut in GST could be feasible:

Shane Oliver, AMP Capital Investors: It's quite a smart move actually and it's certainly possible. But there's an upside and a downside. The upside is that if you give a regular tax cut to people they may not spend it -- they may chose to save it or pay off their mortgage. The benefit of cutting the GST is that people only get the tax cut if they spend money. So it's certain to provide some form of stimulus. The downside is that it will result in more administrative complexity for business if you're changing the rate all the time. But overall, it's not inflationary and it makes sense and it's a smart way of ensuring an increase in spending.

Adam Carr, Senior Economist, ICAP Australia: It would definitely provide a stimulus for the economy but the main problem is I just don't think there'd be the political will. Governments around the world are certainly willing to try different things to kickstart the economy but locally you'd get the state governments, like NSW, kicking up a huge stink in relation to GST revenue. But yes, it would certainly make good economic sense.

Josh Williamson, TD Securities: I think this could arise as a policy option if we find ourselves in a deep recession in '09 or '10. The basic premise is that a cut in GST, if properly monitored by the ACCC, would result in downward pressure on prices and perhaps help revive growth rates. I think it's politically feasible and would prove popular with consumers, although the government would have to make a decision on how to make up losses on GST revenue, especially to compensate the states.

Assoc. Prof. Steve Keen, University of Western Sydney: I'm not particularly fussed. I'd rather see the GST actually increased and used to abolish stamp duty. In terms of a long term performance that's a much better thing to do. At the moment state governments use the GST as a major source of revenue and this encourages property speculation. So I'd rather see GST increased as a long term strategy rather than pursuing short term stimuli of cutting the rate of GST. We're not going to be able to spend our way out of this one. Consumers are massively in debt and they have to massively reduce their debt levels.



9 comments:

Marek said...

Sound like something Paul Keating would say! I recently heard him talk about the natural balancers in the budget and he made a lot of sense... in some ways it was a little scarry to find myself agreeing with him as he spoke

Anonymous said...

I don't entirely agree with that assessment. I agree that they could've maintained a higher surplus but they didn't need a budget surplus as high as $50-75 billion. If they had invested more in infrastructure (and spent more prudently in many other areas) then our economy would have had more capacity to grow, which would have eased some of the pressure on inflation.

Al

Anonymous said...

I agree with the gist of the last section. A deficit at a time of global economic downturn is not a bad thing at all. I think they will go into deficit but I can't imagine they'll allow it to go into deficit by 2% of GDP or more.

Al

Andos said...

Doesn't reducing the GST make more work for business holders? Repricing every item, and at tax time?

Anonymous said...

then we'd see prices stay the same and profits rise by 2%

Peter Martin said...

Not with consumer demand where it's heading

Michael S said...

Peter,

Don't the states have to agree on any changes to the GST?

Peter Martin said...

Every single state.

According to the Coalition document setting out the new tax system:

As GST revenue will be directed to the States, the Commonwealth Government would not only have to agree to introduce legislation to increase the GST rate, but the request for such a change would have to be unanimous among State Premiers and Territory Chief Ministers. Legislation would then need to be passed by both Houses of the Federal Parliament.

Although the Parliamentary Library expresses doubt about whether such approval would really be needed here:

http://pmgstrate.notlong.com

Marek said...

there are much "worse" taxes that should be lowered first lets just hope that is crisis dosen't go to waste

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