OPINION

Don't believe the doubters: tax cuts are still the best long-term option to stimulate the economy

Particularly when considered on a net tax basis, the top two quintiles are basically carrying the load for everyone else. Picture: Shutterstock
Particularly when considered on a net tax basis, the top two quintiles are basically carrying the load for everyone else. Picture: Shutterstock

In a year where so many things have been uncertain, it's reassuring that at least some remain the same. The government has started the traditional, pre-budget leaking of policy initiatives.

Both the Prime Minister and the Treasurer have flagged tax cuts to stimulate an economy smashed by the COVID-19 recession.

The conventional argument for stimulus is that temporary government action is needed to make up a short-term shortfall in demand. This temporary boost can then be unwound when the economy is moving again.

There are a lot of reasons to be sceptical of fiscal stimulus in general, including long lead times, uncertain benefits, the suspension of cost-benefit analysis and standard budgetary rules and the difficulty of cutting spending afterwards, locking in long-term costs.

In reality, stimulus is often as much about the politics of being seen to be doing something as any economic impact.

However, if there is to be a fiscal stimulus, by far the best option is to bring forward the tax cuts currently legislated to take effect in 2022 and 2024.

There are several advantages to this proposal. The first is that the size and scope of the cuts have already been debated and decided by Parliament. The government won't need to relitigate a resolved issue.

Another big advantage of tax cuts over spending increases is that tax cuts let households decide where the extra spending will go. Households will purchase goods and services they actually want, not the sectors favoured by government for political reasons.

This makes the economy more efficient, unlike increased government spending - which often shifts resources to inefficient sectors.

Government stimulus spending typically involves projects and programs that would otherwise fail to pass through the budget process in normal times, because their costs exceed their benefits.

Reductions in marginal tax rates will encourage work and risk-taking. In the longer term, this builds a more sustainable recovery by promoting private sector activity. A strong private sector is necessary to have a robust public sector. It simply doesn't work the other way around.

It's also worth noting, given that the budget deficit is expected to be enormous over the forward estimates, that previous CIS research found when behavioural impacts are incorporated into the modelling, the overall cost of the tax cuts is far less than anticipated - almost $90 billion less than previously anticipated over a 10-year period.

And, even more advantageously, these costs have already been factored into the longer-term budget position. Any new initiatives would create additional costs on top of the cost of tax cuts.

Nor do arguments against tax cuts survive scrutiny.

Some economists dislike cuts because of a misperception that they will tend to be saved rather than spent, and therefore would be less effective stimulus than government spending.

That is only true in the very short term. Over a horizon of several quarters or years, it is clear that changes in taxes flow through into higher consumption and investment, and recent research suggests the multiplier effect of tax cuts is broadly comparable to that of spending.

Moreover, given the enormous debt load of the private sector in Australia, it's hard to see how offsetting this with additional saving would be a bad thing overall.

Others have concerns about the distributional impacts of tax cuts, arguing they favour the rich.

It is hardly a surprise that the benefits of tax cuts accrue to those who actually pay tax. Despite claims to the contrary, the truth is the proportion of income tax paid by those in higher brackets has been increasing, not decreasing, over time.

Particularly when considered on a net tax basis, the top two quintiles are basically carrying the load for everyone else.

Second, distributional impacts of government policy should not be assessed on an individual basis. The increasingly touted view that every government action should increase progressivity cannot be supported. What matters is the overall stance of government policy, and that remains very heavily focused on redistribution.

During the recession, the government has already spent an enormous amount of money on programs that favour lower-income families - including JobSeeker and JobKeeper.

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But it is not only those on unemployment benefits who are doing it tough right now. Government should lighten the load on everyone.

In contrast, boosting welfare spending in the name of stimulus creates additional burdens down the track. As the government is already finding, even temporary increases in welfare payments are hard to unwind. Supplements and increases introduced during a crisis tend to become permanent.

Even if you accept that governments could borrow at low rates to invest in infrastructure projects, there are drawbacks.

First, most infrastructure projects are complicated and require years of planning, making them less useful as stimulus. The rail and road projects of Paul Keating's "One Nation" stimulus were announced in 1992 but did not get going until 1994 or 1995.

Second, government stimulus spending typically involves projects and programs that would otherwise fail to pass through the budget process in normal times, because their costs exceed their benefits.

As Marion Terrill of the Grattan Institute has documented, government spending plans that are assembled hastily typically fail to deliver the promised benefits. No one wants a repeat of the pink batts program.

Advocates for bigger government have long been arguing more government is the answer to economic malaise - and everything else besides. The evidence does not support that claim and we should be doubly sceptical of the argument when the plans are put together in haste without the usual scrutiny.

By contrast, tax cuts are a good long-term policy option. At least we can be thankful government is finally making a good decision for the wrong reasons - rather than the other way around.

  • Simon Cowan is Research Director, and Peter Tulip is Chief Economist, at the Centre for Independent Studies.
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