Tuesday, February 03, 2009

TUESDAY COLUMN: It's a Budget, not a package

It is not helpful to think of the statement Kevin Rudd is about to present as a "stimulus package". It is more helpful to think of it as "mini-budget".

Remember mini-budgets?

Whenever some totally unexpected development had rendered the budget forecasts and strategy meaningless, the whole thing was redone and presented afresh.

The Whitlam government had two of them in three years. They added to an aura of crisis. And there was indeed a crisis. Perhaps because of that the mini-budget fell out of favour in subsequent years, being replaced by the blander-sounding "economic statement".

Kevin Rudd's statement will be a mini-budget in all but name...

He revealed Monday that it will be presented to the parliament, it will include updated revenue and spending forecasts, it will include updated economic forecasts, and it will detail a range of spending and taxation measures across a number of fronts. Taken together these things define a budget. Delivered months before the budget is due, they define an emergency budget.

There's no doubt that we need one. The Opposition has been rightly calling for updated economic forecasts for months. The most recent official forecasts, delivered in November have been rendered laughable. They talk about $40 billion in lost tax revenue. This week's statement will tell us it's $115 billion. The November forecasts had economic growth slipping from 2.75 per cent to 2 per cent. The International Monetary Fund now has it sliding to minus 0.2 per cent.

Especially disturbing is the erosion in income tax revenue. Back in November, well into the global financial crisis, the government expected hardly any hit to income tax revenue. Almost all of the hit was to be taken by company and capital gains tax revenues.

This week's statement will predict a $13 billion collapse in income tax takings in coming years - something that can be reconciled with very big job losses. The November update had employment actually increasing in each of the future years. The Rudd mini-budget will have it sliding.

It is important that it is a proper mini-budget with proper forecasts because taking us into its confidence is about the most important thing the Prime Minister can do. As he makes a point of telling us, "we're in this together".

Many of the specific measures will be exactly what we need. The billions to be spent insulating homes will not only soak up some of the expected unemployment, they'll also set us up to live better when the recession, if not the heat, is over.

Anything the Prime Minister tries is unlikely to do much harm - at least right now, and nothing he tries will be enough.

Kevin Rudd says he hasn't given up on escaping a recession - he says he will "move heaven and earth" to avoid one. But heaven and earth won't be enough. The flood of the money that was coming into Australia is slowing to a trickle. Japan - still our biggest market despite the talk about China - cut its industrial production by 10 per cent in December. China's economic growth has halved. And those of us who have lost 30 per cent of our wealth or are worried about losing our jobs are unlikely to resume spending like we used to however much money he shovels our way.

Financial markets are expecting the Reserve Bank to cut interest rates by one complete percentage point today to their lowest level on record. They might be surprised - the Bank might cut by more. But that won't be enough either.

The most that we can hope for is to minimize the extent of the recession and the long-term harm it does to the people it throws out of work. And to apply band-aids where the financial system breaks down.

The $4 billion so-called RuddBank to assist property developers is no more or less than a necessary housekeeping measure to keep credit flowing. It is hard to see how it deserves political criticism.

Kevin Rudd yesterday described the Opposition's approach as "one rolling political frolic". It's easy to agree.

On Sunday its Treasury Spokesman Julie Bishop frolicked in fields where serious decisions need to be made by calling on the government to introduce "broad and sweeping tax cuts that will increase the tax base and increase tax revenues".

No-one I know of thinks that sweeping tax cuts that will increase tax revenues, certainly not in the present environment. But she issued a follow up statement saying there was Australian evidence for the proposition.

When I emailed her office asking what the evidence was they emailed back two studies, neither of which showed any such thing. When I asked for clarification her office put me onto the Opposition's external tax consultant Henry Ergas who was in Papua New Guinea.

It's an awful look for an alternative government at a time of crisis.

It isn't developing its own coherent plan (at least deeply enough to understand the research it is purporting to rely on) and it is carping at the government's attempts to do the right thing.

The Rudd mini-budget will be far from perfect, but it will help.

From Julie Bishop's office, Monday February 2:

As regards corporate income tax, the OECD (
Fundamental Reform of Corporate Income Tax, 2008) shows that while effective tax rates on corporate income in the OECD area declined from over 30% in the early 1980s to about 20% in 2004/5, corporate tax paid as a percentage of GDP for the OECD area increased from about 2.2% to about 3.5%.

Also Harvard Professor Martin Feldstein estimated (
Journal of Political Economy, 1995) that a 1% reduction in the marginal tax rates on personal income increased taxable income by between 1% and 3%. Since then many other studies have been undertaken, and while some find lower estimates, many others find estimates that are higher. At the same time, there is evidence that reductions in the highest marginal tax rates (which are typically found at the low and high end of the earned income distribution) give rise to the greatest positive response.

From me:

The reports you have sent me do not back up the Shadow Treasurer's statement.

What she said in her press release was:

"It has been the experience in Australia and other OECD countries that reducing tax rates and expanding the tax base increases tax revenues."

The OECD report examined corporate tax. It did not say that reducing corporate tax rates brought about increased corporate tax revenues. Indeed, it looked to other explanations for the growth in corporate tax revenue and was uncertain whether corporate tax collections would continue to keep pace with GDP if, as it expected, corporate tax rates continued to slide:

Here is its guess as to what is at play:

"This might partly have been caused by the broadening of corporate tax bases, for
instance through the provision of less generous tax depreciation allowances. Corporate tax
rates will probably continue to decrease in the near future. However, whether it will be
possible to further compensate these rate reductions by additional base broadening
measures remains to be seen."

Feldstein's JPE paper examined personal income tax. It made no finding that reducing tax rates increases tax revenues.

It summed up its finding this way:

"a change in income tax rates has substantially less impact on revenue than would be true if there were no behavioural response to marginal income tax rates."

It expects cutting income tax to cut tax revenue, but not by as much as would be the case without behavioural responses.

Do you have anything that backs up the claim made in the press release?