Tuesday, October 16, 2007

See a fire, add some petrol - economic management Costello-style

From Shane Wright, economics editor, The West Australian.

You don’t use a bucket of petrol to put out a fire.

But John Howard and Peter Costello have defied conventional wisdom about the dangers of further inflaming the risk of an inflation-led interest rate rise by doing just that.

Yesterday they added a plan for $34 billion of tax cuts to the $14 billion that has already been spent since the May Budget, and all before the inevitable and as-yet unquantified election sweeteners go onto the economic bonfire...

The tax package plan unveiled by Mr Costello and the Prime Minister on its own is a good blueprint to offer incentive to those on the margins of the job market and reward hardworking Australians.

Indeed, the best component is the proposal to lift the low income tax offset (something the ALP has been considering), as this benefits most people in a position

And by setting out a timeline for the tax changes and setting a goal to have a top personal rate of just 40 per cent, the coalition can claim to be both forward-looking while also having an eye on international tax competition issues.

However, you can’t separate the tax policy from the mid-year economic and fiscal outlook that Mr Costello released with his big, bold package.

That’s where the problems lie. The projections in that document show the economy is moving into top gear on a straight road, while the terms of trade keep pumping premium grade fuel into the petrol tank.

CommSec chief economist Craig James said it was clear the economy was running at gangbusters, with forecasts now pointing to an acceleration in activity. He said Mr Howard and Mr Costello were flirting with an inflation spillover that would attract the attention of the Reserve Bank, which holds the interest rate brake.

“The Reserve Bank is, by its very nature, very conservative and it’s likely to err on the side of higher interest rates,” Mr James said.

Westpac global head of economics Bill Evans was left almost speechless by some of the upward revisions made to the Treasury’s economic forecasts.

The expected surplus for 2007-08 is 40 per cent higher than that predicted in May.

Mr Evans said the tax cuts may not warrant higher interest rates on their own but the overall strength of the economy — with inflation, household consumption, business investment and private final demand all picking up and unemployment falling — probably would.

“It’s not government policy, it’s just the strength of the economy, and the forecasts show that,” he said.

With firefighters like Mr Costello and Mr Howard, let’s hope we’ve all got some good insurance coverage.

Also worth reading on the 34 billion tax cut bonaza:

David Uren in the Australian

Tim Colebatch in the Age

Jessica Irvine in the Sydney Morning Herald