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  • Don’t Pop Champagne Corks Over Longest Growth Streak

    In this guest commentary, Prof. Anis Chowdhury – a new Associate of the Centre for Future Work, and a distinguished global economist – provides some important perspective on this longest expansion in history.

    Little to Rejoice About in Australia’s Record-Long Expansion

    by Anis Chowdhury

    On April 1, Australia will overtake the Netherlands to lay claim to the title of the longest economic expansion on record, entering our 104th quarter of economic growth, as the nation narrowly avoided slipping into a technical recession.

    With the release of the GDP figure on 1 March, the government expressed a sigh of relief. It showed that Australia’s economy grew by 1.1 per cent in the last quarter, after slipping 0.5 per cent in the three months to December 1.

    Should we rejoice at this?

    It seems, Treasurer Scott Morrison thinks so. As the government is breathing easy, the Treasurer responded by saying “Our growth continues to be above the OECD average and confirms the successful change that is taking place in our economy as we move from the largest resources investment boom in our history to broader-based growth.”

    To be fair, the Treasurer was also cautious and acknowledged that nation’s economic growth “cannot be taken for granted and is not being experienced by all Australians in all parts of the country in the same way”.

    However, with this cautionary note the Treasurer has contradicted himself. If the nation’s growth cannot be guaranteed; if all Australians in all parts of the country are not sharing the benefit of this longest stint of growth, then it is simply not broad-based; nor is it inclusive.

    The nation’s growth still comes largely from mining, agriculture, forestry and fishing, as its manufacturing sector continues to shrink. The share of manufacturing in GDP now stands at around 6 per cent which is less than half what was four decades ago. Despite the longest growth stint, Australia still remains a primary-producing, two-speed economy.

    Australia’s terms of trade — the ratio of the nation’s export prices to its import prices — grew by 9.1 per cent, thanks to strong price rises in coal and iron ore, marking a 15.6 per cent improvement on the December 2015 quarter.

    Thus, Australia’s economic growth continues to be driven by commodity price booms, behind which is the economic expansion in emerging Asian economies, mainly China and India. If these economies sneeze, Australia will catch a cold. Hence, the Treasurer is correct, the “nation’s growth cannot be guaranteed”; it cannot be sustained.

    Even if it is sustained, it is not sustainable in the sense of ensuring social stability and protecting the environment. Australia’s current development trajectory is unlikely to achieve the Agenda 2030, the most ambitious and transformative goals for sustainable development adopted by the nations of the world in September 2015 at the United Nations.

    Let us reflect on some key indicators. First, Australia’s official unemployment rate edges up to 5.9 per cent in February, from 5.7 per cent in January, while underemployment skyrocketed to 1.1 million. The staggering underemployment is more a structural problem than a result of cyclical phenomena. The rise in unemployment and underemployment happened, even when we were told that labour market flexibility would boost employment – the main argument put forward in supporting recent cuts in penalty rates.

    Second, even without the penalty rate cuts, wages growth has been stagnant. The 1.1 per cent GDP growth that technically saved the economy from a recession, was accompanied by falling employee compensations by 0.5 per cent.

    Thus, the 0.9 per cent increase in household consumption, contributing 0.5 per cent to growth, which according to the Treasurer, was a key factor in bolstering the post-mining boom economy, seems to have been debt-driven. No wonder, Australia’s household debt at close to 125 per cent of GDP, is now the third highest in the world. At 187 per cent of household income, the RBA’s worries about household debts are not unfounded.

    Third, the divide between rich and poor is growing in Australia, according to a new national survey, which found more than a quarter of households have experienced a drop in income. At the same time, the socio-economic conditions of indigenous Australians remains shamefully at the Third World level. They don’t live as long as other Australians. Their children are more likely to die as infants. And their health, education and employment outcomes are worse than non-Indigenous people. Despite promising to close this gap on health, education and employment, the 2017 “Closing the Gap” report card finds that we are failing on six out of seven key measures. With less than year until the first wave of “Closing the Gap” deadlines, the road to reducing Indigenous disadvantage appears ever longer.

    Fourth, the latest Australia’s Environment Report 2016 reveals that Australia’s biodiversity is under increased threat and has, overall, continued to decline. It also reveals that pressures on the environment has increased from coalmining and the coal-seam gas industry, habitat fragmentation and degradation, invasive species, litter in our coastal and marine environments, and greater traffic volumes in our capital cities.

    While the quality of growth and overall socio-economic well-being continue to regress, what is the response from government? Regrettably, it is the same mantra: “repair the budget”; “cut welfare expenditure”; “cut wages and employment conditions”; “cut company tax”; “cut environmental regulation”, etc.

    Why these cuts? Because they will help keep our triple A credit rating! In the words of the Treasurer, “We must take the necessary steps to keep expenditure under control structurally, to boost investment, to maintain the AAA credit rating…”

    That is a huge leap of faith in the face of contrary findings world-wide, including Australia, that these sorts of measures do not boost investment; they do not fix the structural problems in the economy; they do not close the societal divide (between the rich and the poor, between indigenous peoples and the rest of Australia); and they do not protect our biodiversity or mitigate pressure on our environment.

    Public policies for structural transformation and environmentally sound, inclusive growth are for the brave hearts, not for the meek who remain hostage to the unaccountable credit rating agencies.

    The post Don’t Pop Champagne Corks Over Longest Growth Streak appeared first on The Australia Institute's Centre for Future Work.

  • Employers’ pyrrhic penalty rates win reflects self-defeating economics

    The equity implications of the commission’s decision are odious. Store clerks and baristas are already among the least-paid, least-secure members of Australia’s workforce. The retail and hospitality workforce is disproportionately female, young and immigrant. Most work part time, and casual and labour-hire positions are common. In short, the burden of this decision will be borne by those who can least afford it.

    Penalty rate cut: how did it happen?

    Workplace reporter Nick Toscano contextualises the Fair Work Commission’s announcement on Thursday that Sunday penalty rates paid in retail, fast food, hospitality and pharmacy industries will be reduced from the existing levels.

    Remember, too, that it’s in retail and hospitality that recent scandals regarding underpayment of wages and other violations of labour law have been rife. Weakening labour standards that are already poorly enforced thus constitutes a double jeopardy for service workers.

    It’s notable that the commission only targeted low-paid service workers with this review of penalty rates. There are many other people who need to work Sundays and holidays, including emergency personnel, essential service workers, healthcare workers and others. The commission stressed it wasn’t calling for those workers to lose their penalties, too (although employers everywhere are no doubt preparing to push to extend this precedent to other industries). If it’s all about changing “cultural norms” regarding weekend work, then why have these low-paid service jobs been singled out?

    All of this says much about the political and economic context for the Fair Work Commission’s deliberations. There was no emergency in Australia’s retail and hospitality sector; no crisis that needed immediate attention. It’s not that stores and restaurants couldn’t do business on Sundays under the existing rules; any casual observer can attest to the brisk trade that now takes place right through the weekend. It’s just that those businesses would be considerably more profitable if wages were lower.

    So penalty rates became the target of a sustained pressure campaign by business, backed by conservative political leaders. The commission heard those complaints and acceded to them. Whatever the precise wording of the commission’s legislative mandate, it was never envisioned as a mechanism for rolling back employment standards; it was supposed to protect them. This decision will therefore spark a political debate not only over the merits of this specific decision, but over the commission’s overall mandate and function.

    The politics of that debate will be complicated. Coalition leaders are hiding behind the commission’s supposed neutrality – although they are clearly pleased with the decision (and many explicitly lobbied for it). Labor’s response, meanwhile, is coloured by the fact that it created this commission; Bill Shorten now promises to adjust its mandate. None of this will stop the anger among working-class families who’ll lose income because of this decision. The threat to penalty rates was a potent doorstep issue for union campaigners across Australia before the last election, which the Coalition almost lost. It will be an even hotter button in the next one.

    The economics of the rollback are even more muddled than the politics. Retail lobbyists claim the decision will unleash a surge of new job creation, but those promises are hollow. After all, the market for retail and hospitality services depends primarily on the strength of domestic consumer spending power – more so than any other part of the economy. Australians have a certain amount of disposable income. Will they shop more, and eat out more, just because stores and restaurants stay open longer? Of course not.

    To the contrary, slashing retail and hospitality wages can only undermine demand for the very services that these businesses are selling. It’s incredibly ironic that, even as the commission’s Judge Iain Ross read his judgment on live television, the Australian Bureau of Statistics was releasing yet another dismal report on national wage trends. Average weekly earnings in the period to last November grew at an annualised rate of just 0.4 per cent: slower than any other point in the history of the data, and well behind the rate of inflation. This reflects both the stagnation of hourly wages, and the continuing shift to part-time and casual work (for which retail and hospitality employers are among the worst culprits).

    So this won’t increase the amount of money Australians have to spend in shops and restaurants. Instead, there will be an incremental decline. If stores actually do stay open longer hours, the same spending must now be spread across longer operating hours, driving down productivity. Retail lobbyists should be careful what they ask for.

    Meanwhile, employment in these industries will continue to reflect bigger, structural forces. For example, the whole Australian retail sector has created precisely zero net jobs over the last three years, largely because of the structural shift to big-box retailing (which employs fewer workers per unit of sales). That’s not going to change just because big-box stores can now pay their staff $10 an hour less.

    In short, Australia’s economy isn’t held back because wages are too high. It’s held back because wages are too low. And the stagnation of wages is no accident: it’s the cumulative result of years of deliberate efforts to weaken the power of wage-setting institutions (including unions, minimum wages and awards). The Fair Work Commission chopped away a little more of that edifice this week.

    The greatest irony is that it’s retail and hospitality businesses – which led the push to cut weekend wages – that confront the weakness of household spending power most directly. Each employer may individually celebrate the prospect of paying lower wages. Yet for their industry as a whole, this decision is collectively irrational and ultimately self-defeating.

    Jim Stanford is economist and director of the Centre for Future Work at The Australia Institute.

    The post Employers’ pyrrhic penalty rates win reflects self-defeating economics appeared first on The Australia Institute's Centre for Future Work.

  • Denying The Downside Of Globalization Won’t Stop Populism

    Treasurer Scott Morrison recently started pushing back, delivering a staunch defense of globalization to an audience in Sydney. Like other world leaders responding to the wave of populism, Mr. Morrison doubled down with strong claims about the universal, lasting benefits of free trade. Australians may be anxious about their economic future, he conceded. But don’t blame globalization.

    Globalization “increases our living standards and always has,” Mr. Morrison bluntly proclaimed. Free trade, immigration and inward foreign investment are “the very sources of … prosperity.” Resisting globalization, he suggested, is like thinking “we can pull the doona over our head and insulate ourselves.”

    Denying any potential downside to globalization, and deriding critics as hiding from reality, will not defuse the wave of anger that put four One Nation senators into Parliament. Contrary to Mr. Morrison’s claims, there is ample evidence that Australia’s trade performance has deteriorated badly in recent years, despite –- or perhaps because of -– the acceleration of free trade.

    Globalization, as currently practiced, is imposing real, lasting damage in many parts of Australia, and producing a fertile political environment for nationalism and xenophobia. The political and policy responses to that danger must go beyond denial.

    Mr. Morrison stressed the effectiveness of his government’s trade agenda, especially what he called new “export trade deals” with China, Korea, and Japan. (This curious terminology deliberately neglects that free trade agreements are also intended to facilitate imports!) “The results are there to see,” he said.

    Or are they? As a share of GDP, Australia’s exports have declined significantly since the turn of the century, even as government inked several free trade pacts. Services exports also contracted relative to GDP. And ironically, Australia did worse with its free trade partners, than with the world as a whole.

    For example, we now have one year of experience under free trade with Japan and Korea. Perversely, Australian exports to both countries declined in the first year: by 9 percent for Korea, and 16 percent to Japan. Yet Australia’s imports from Japan and Korea surged by 14 percent and 24 percent, respectively.

    Therefore, Australia enjoyed more exports, and a better trade balance, without free trade than with it. In the first months of free trade with China, Australia’s exports are also declining. Similarly, under Australia’s trade pacts with the U.S., Thailand, Singapore and Chile, imports grew much faster than exports — and in some cases exports didn’t grow at all.

    There’s little reason to believe that new deals being pursued by Canberra (with India, Indonesia and the Trans Pacific Partnership) would have any better results.

    The cumulation of many bilateral trade deficits is an overall global payments imbalance that is driving Australia deeply into international debt. Australia’s current account deficit reached $77.5 billion last year: the biggest ever (in nominal terms). Relative to GDP, that’s the second-largest of any OECD country — behind only the U.K. (another hotbed of populism). It’s even worse than precarious emerging economies (like Brazil, South Africa or Turkey).

    Mr. Morrison actually celebrated this large international deficit last week, suggesting it allows Australia to invest more and grow faster. But he has it perfectly backwards. Business investment is contracting rapidly in Australia, not growing. And with Australia buying so much more from the rest of the world than it sells, we end up with less production, fewer jobs and less income. The gap can be offset with growing international debt, but only for a while.

    This miserable trade performance is clearly contributing to Australia’s weak labour market: declining total hours of employment, disappearing full-time jobs and unprecedented wage stagnation. So disaffected Australians aren’t making it up when they conclude their prospects have diminished, and no amount of boosterism can change that reality.

    Moreover, they have sound reasons to blame globalization as one important factor (certainly not the only one) for their predicament.

    If Mr. Morrison and other free-traders want to truly counter the divisive and dangerous ideas of nationalism and xenophobia, they should start by acknowledging that globalization does indeed have a downside, not just an upside. Then they must move to implement policies -– like balanced trade, job creation, stronger income security, and better vocational education — to assist those Australians who have been harmed by it.

    The post Denying The Downside Of Globalization Won’t Stop Populism appeared first on The Australia Institute's Centre for Future Work.

  • The Flawed Economics of Cutting Penalty Rates

    It was a “sleeper” issue in the recent election, and led to the defeat of some high-profile Liberal candidates. But now the debate over penalty rates for work on weekends and public holidays shifts to the Fair Work Commission. The economic arguments in favour of cutting penalties (as advocated by lobbyists for the retail and hospitality sectors) are deeply flawed.

    Penalty rates for working on weekends were an important “sleeper” issue in the recent federal election. On the surface, both Labor and the Coalition agreed the future of penalty rates would be determined by the Fair Work Commission. But that superficial consensus couldn’t hide deep differences in what the respective parties were actually hoping for. Labor explicitly urged the FWC to maintain existing penalties: double-time on Sundays, and time-and-a-half for Saturdays. Many Coalition candidates, on the other hand, endorsed a reduction in penalties – consistent with the views of business lobbyists who want lower operating costs on weekends.

    At the grass-roots level, meanwhile, the issue resonated strongly with significant numbers of voters. Union activists launched an 18-month “Save Our Weekend” campaign, knocking on tens of thousands of doors in marginal seats before the election was even called. Opinion polls showed strong support for retaining (or even increasing) weekend penalty rates; respondents opposed cutting penalties by two-to-one margins, or more. The swing against the Coalition in ridings targeted by the penalty rates campaign was nearly twice as large (6 percentage points) as the national swing.

    Penalty rates will remain a charged issue in the political arena. But for now, the main attention shifts to the FWC, whose decision is expected in coming weeks. The Commission should reject the entreaties of retail and restaurant employers for lower penalties, because the economic case for cutting penalties looks shakier all the time.

    Employers in all sectors routinely claim that cutting wages will strengthen job-creation. But this purported trade-off between compensation and employment is refuted by macroeconomic evidence. Indeed, historical data suggest higher wages are more often associated with stronger employment outcomes, not weaker: in part because household consumption spending (which depends directly on wages) is crucial for overall spending power and hence economic vitality. The retail and hospitality industries have been the most aggressive advocates of weaker penalty rates. Yet ironically, it is in these sectors that the argument for wage-cutting is weakest of all.

    After all, employment in stores and restaurants depends directly on the level of consumer spending. And this demand constraint is more binding in domestic service sectors than any other part of the economy. In export-oriented industries, employers can at least pretend that lower labour costs will boost sales (by undercutting foreign competition and hence winning new business). Even here the argument is not convincing, since in practice global competitiveness depends more on productivity, quality, and innovation than on low wages. But in non-traded domestic sectors, where Australians produce services for other Australians, the logic falls apart completely.

    Remember, Australian consumers already spend far more than they earn. That’s why average consumer debt is growing rapidly: now equal to 125 percent of national GDP. How could making it less costly for shops and cafes to open on weekends, somehow unleash new reservoirs of spending power, and stimulate tens of thousands of new jobs? In macroeconomic terms it’s simply not possible.

    Keeping businesses open for longer hours on weekends, doesn’t mean consumers have more money in their wallets. Instead, the same amount of retail and hospitality spending must now be spread across longer opening hours. If anything, that hurts productivity and profitability, and will eventually lead to the closure of some retail and hospitality firms that were already operating on the financial edge.

    It’s the same reason why opening a new shopping mall cannot, on its own, increase total employment levels. Unless there are other factors driving an expansion in broader incomes and spending, opening one store must inevitably lead to a closure somewhere else.

    It’s especially laughable to hope that cheaper weekend labour could somehow attract new business to Australia’s stores and cafes. Are penalty rate opponents expecting a surge in tourists from China, perhaps – who were just waiting for cheaper Sunday shopping before booking their trips?

    In short, the very industries pushing hardest for reduced penalties – retail and hospitality – are the ones most dependent on the spending power of domestic consumers. Hence they would directly experience the most economic blowback from their own wage cuts.

    Indeed, there is abundant evidence that unprecedented stagnation in wages is already undermining growth and job creation. Nominal wages are inching along at their slowest pace in recorded history (barely 1 percent per year). Real wages, adjusted for inflation, have been falling since 2013. Economists of all persuasions have highlighted the resulting weakness in household incomes as a key factor behind sluggish growth, rising personal debt, and unemployment and underemployment.

    Ultimately, rolling back penalties would simply constitute a major effective wage cut for workers who are already among the worst-paid in society. It will exacerbate the broader wage stagnation that is holding back Australian growth. And it will whet the appetites of other employers for more wage suppression – now on grounds of “keeping up” with the advantages granted to retail and hospitality.

    Australia needs higher wages, not lower. Let’s hope the Fair Work Commission sees this big picture.

    The post The Flawed Economics of Cutting Penalty Rates appeared first on The Australia Institute's Centre for Future Work.

  • Bracket Creep Is A Phoney Menace

    Other thresholds don’t change. Taxpayers making over $80,000 will thus get a small saving ($6 per week at most). Those who make less, get nothing.

    It’s not the most expensive tax cut in the budget. It will cost an estimated $800 million in the first year – barely half the $1.5 billion lost annually by cancelling the deficit repair levy on incomes over $180,000, and far less than the ultimate cost of Morrison’s company tax cuts. But it is the most transparent and easy to understand of all the budget’s tax measures. And it will spark the most gossip around the water-cooler. Who makes over $80,000 per year, anyway? And who makes less? It’s hard to imagine a more “us versus them” tax policy.

    The Treasurer’s own rhetoric reinforces this schism: he says it will “reward hard working Australians,” encourage them to work overtime, take more shifts, and accept a promotion. The clear implication is that people making less than $80,000 are not interested in working more hours or taking promotions. Indeed, they aren’t even “hard working” in the Treasurer’s terms, and hence don’t merit protection from “creeping” taxes.

    The Treasurer tried, but failed, to define the measure as one that benefits “average” wage-earners. Mean annual earnings for a full-time worker employed year-round are indeed near $80,000. But this does not remotely describe the typical Australian. First off, the mathematical “average” is skewed upward by super-high incomes at the top of the income ladder; the median full-time wage (received by the full-time worker in the exact middle of the distribution) is $10,000 lower than the average, and well below the threshold. Likewise, women (even those employed full-time year-round) earn $10,000 less than the mathematical mean.

    Federal Treasurer Scott Morrison delivering his first budget, in 2016.
    Federal Treasurer Scott Morrison delivering his first budget, in 2016.

    But the bigger problem is that a shrinking share of Australians have full-time permanent jobs to start with. Part-time work now accounts for almost one in three jobs – the highest on record. And labour hire, temporary contract, and other forms of precarious work are increasingly the norm. Very few of those workers earn anywhere near $80,000. At most about one in four Australian workers (and perhaps 15 per cent of all tax-filers) will get the full $6 per week saving.

    The whole concept of “bracket creep” is itself as misleading as Morrison’s maths. He says taxpayers are “pushed” into higher tax brackets by rising incomes, constituting a punitive and underhanded tax grab. But this description merits some careful second thought.

    There are two different reasons why a worker’s income might rise. One is pure inflation, experienced across all wages and prices. In that case, nothing “real” changes, and a higher tax rate might seem unfair (although we should remember that the cost of many government programs also grows with inflation, and someone has to pay for that).

    Alternatively, it might be changes in a worker’s real income that qualify them for the next bracket. If they worked more hours or took a promotion (as the Treasurer urges), then their real income rises, and so does their tax. That’s not bracket creep, and there’s nothing “underhanded” about it. In fact, that is the whole point of a personal income tax system in which tax rates depend on income.

    Moral panic over bracket creep is all the more ironic given the unprecedented stagnation in Australian wages, reflecting sustained weakness in the job market. Average weekly earnings in the private sector are growing at their slowest pace in history: under 1 per cent per year (slower than inflation). The budget itself acknowledged this is badly hurting Commonwealth revenues. With wages going nowhere fast, this is hardly the time in history to make a mountain out of a bracket creep molehill.

    If the government truly wanted to prevent inflation from distorting taxes, it could simply index all parameters in the tax code to consumer prices (as other countries, like the U.S. and Canada, have done). Then all thresholds, not just the one cherry-picked by Morrison, would rise 1.3 per cent this year, the same as year-over-year inflation. But that would depoliticise the whole process, hardly acceptable in a year when every single clause of the budget is focused on getting the government re-elected. So Morrison picked one politically-potent threshold, lifted it seven times faster than inflation, and left everyone else to get “creeped.”

    Previous ad-hoc increases to thresholds have lifted them far faster than inflation. In fact, with this latest increase, the third tax threshold will have risen twice as much as inflation since 2003. Combined with rate reductions also targeted at top brackets during that time, government revenues have been undermined badly, and the upward redistribution of after-tax income has been exacerbated.

    In short, the politics of Morrison’s over/under game are hard to understand. He will deliver a tiny benefit to less than one in four employed workers, and barely one in seven tax-filers. Most Australians won’t get a cent. But the economics are even worse. His divisive and false anti-tax narrative undermines the long-run stability of the government’s revenue base, damages public services, and reinforces inequality.

    The post Bracket Creep Is A Phoney Menace appeared first on The Australia Institute's Centre for Future Work.

  • 6 Reasons to Be Skeptical of Debt-Phobia

    However, this well-worn line of rhetoric will fit uncomfortably for the Coalition government, given its indecisive and contradictory approach to fiscal policy while in office. The deficit has gotten bigger, not smaller, on their watch, despite the destructive and unnecessary cutbacks in public services imposed in their first budget. Their response to Australia’s fiscal and economic problems has consisted mostly of floating one half-formed trial balloon after another (from raising the GST to transferring income tax powers to the states to cutting corporate taxes), with no systematic analysis or framework. And their ideological desire to invoke a phony debt “crisis” as an excuse for ratcheting down spending will conflict with another, more immediate priority: throwing around new money (or at least announcements of new money), especially in marginal electorates, in hopes of buying their way back into office.

    In short, the politics of debt and deficits will be both intense and complicated in the coming weeks. To help inoculate Australians against this hysteria, here are six important facts about public debt, what it is – and what it isn’t.

    1. Australia’s public debt is relatively small

    Despite annual deficits incurred since the GFC, Australia’s accumulated government debt is still small by international standards. Debt can be measured on a gross or net basis; gross debt counts total outstanding borrowing, while net debt deducts the value of financial assets which the government also possesses. Gross debt for all levels of government equaled 44% of Australian GDP at the end of 2015 (according to the OECD). That was the 5th lowest indebtedness of any of the 34 OECD countries (see table below), equal to about one-third the average level experienced across the OECD. Moreover, despite recent deficits, the growth of debt in Australia was considerably slower than in most other OECD countries. Of course, having low debt in and of itself does not justify increasing it. But given the universal fiscal challenges that have faced industrial countries since the GFC, Australia’s debt challenge is both unsurprising and relatively mild.

    Australia’s Debt in International Context: General Government (all levels) Gross Financial Liabilities (%GDP)
    2015 10-yr. Change
    Australia 44.2% +22.4 pts
    U.S. 110.6% +43.7 pts
    Japan 229.2% +59.7 pts
    France 120.1% +38.3 pts
    Germany 78.5% +8.1 pts
    Italy 160.7% +41.8 pts
    U.K. 116.4% +60.3 pts
    Canada 94.8% +19.0 pts
    OECD Average 115.2% +36.3 pts
    Source: Author’s calculations from OECD Economic Outlook #98, Nov.2015.

    2. A government debt is matched by an asset

    Australians aren’t “poorer” because their government accumulates a debt. Any rise in government debt is mirrored by an increase in some offsetting asset. This is true in both accounting terms, and in real economic terms. For example, government typically issues a bond (or some other financial instrument) to finance a deficit. But that bond also constitutes an asset in the investment portfolio of whoever lent the government money. Most Australian government debt is owned by Australians. In fact, investors increasingly appreciate the opportunity to invest in government bonds, because they are safer than other assets at a time of financial uncertainty. (That investor interest is one reason interest rates on government debt are so low.) So government debt translates into someone else’s wealth – usually someone in Australia.

    This match between liabilities and assets is also visible in concrete economic terms – especially when new debt is issued to construct a real, long-lasting capital asset (like a road, a transit system, a school, or a hospital). In this case, the matching asset is owned by government itself, and so its own net worth won’t change much at all: it takes on a new debt, but also has a new asset. For budgetary purposes, the government must account for the gradual wear-and-tear of that asset (called depreciation), which appears as a cost item on the budget. But it hasn’t “lost” the money it raised through the new debt: it invested it, and that investment carries both financial and social value.

    3. Other sectors of society borrow much more than government

    Tired rhetoric about how governments need to act “more like households” is especially ironic, given that households are by far the most indebted sector in Australian society. Household net debts equal close to 125% of GDP – or around 4 times the net debt of government (all levels), according to data from the Bank for International Settlements. It is factually wrong to claim that “households balance their budgets,” and therefore governments must do the same. Households borrow regularly – and thanks to overinflated housing prices and stagnant wages, that borrowing is growing rapidly. The same is true of business: net debts of non-financial corporations are more than twice the net debt of government (see chart).

    In fact, it is quite rational for households and businesses to borrow, when needed to fund purchase of long-run productive assets (like a house or a car for consumers, or a factory or new technology for a business). Business leaders know that rational, prudent borrowing will enhance the profitability of a corporation. Indeed, any CEO who said paying off all company debt was the top priority of the firm would be chased from office by directors and shareholders (who would understand the pledge was irrational and superstitious). Following exactly the same logic, government debt can be rational and productive – especially (but not only) when it is associated with the acquisition of long-run productive assets (like infrastructure). Close to two-thirds of the Commonwealth government’s 2015/16 deficit (projected to be $36 billion) is associated with capital spending, including $11 billion in capital transfers to lower levels of government and $12 billion in net investment in Commonwealth non-financial assets. Contrary to the rhetoric, Australians do largely cover the cost of current public services with their current tax payments. Government borrowing is primarily required to fund capital spending.

    4. Interest rates are low, and falling

    The cost of public borrowing has fallen dramatically as a result of the decline in Australian and global interest rates since the GFC (see chart). Indeed, the two factors are connected: large government deficits resulted primarily from underlying economic weakness (this is true in Australia, like elsewhere in the industrialized world), which in turn bro8ught about low interest rates (via both central banks and private financial markets). These very low interest rates mean that the cost-benefit decision associated with any new government borrowing has been fundamentally altered, in favour of borrowing.

    Current interest rates are likely to stay low for many years to come, given the continuing failure of the global economy to regain consistent momentum, the slowdown in China, and other factors. (In fact, it is possible that the Reserve Bank of Australia may soon cut its interest rate further, below its current record-low 2% level, due to weak growth and signs of deflation here in Australia.) Ten-year Commonwealth bonds can presently be floated to private investors for little more than 2% interest (close to zero in real after-inflation terms). If government can borrow for what is effectively zero interest, and put that money to work in the real economy doing useful things (including both infrastructure and public services), then it is irrational to let old-fashioned balanced-budget mythology stand in the way.

    Even if current interest rates do not fall any further, the average effective interest rate paid on overall public debt will continue to fall for years to come. The current average effective rate paid on Commonwealth debt (about 3.5% last year) reflects the weighted average paid on all maturities of debt. As past debts come due, they are refinanced at now-much-lower interest rates (those prevailing on new issues of bonds). That will pull down the average weighted interest rate for several years into the future – even if the rate on new issues stabilizes or increases somewhat. Consider that new ten-year bonds can be issued for less than half the interest rate paid a decade ago. The refinancing of those bonds will generate enormous future interest savings for government (equivalent to home-owners who re-mortgage their homes to benefit from the decline in household lending rates).

    This is why the economic burden of public debt servicing is not growing, even though the debt is. Government budget projections forecast debt service remaining at between 0.9 and 1.0% of GDP for the next 5 years, with the effect of rising debt offset by falling interest rates. And those government projections likely overestimate true interest costs (partly for political reasons). For example, the December 2015 MYEFO update assumes a significant increase in interest rates in the coming year (its near-term interest rate assumption was 0.3 points higher than the assumption used in last year’s budget); ongoing global and domestic economic weakness makes that highly unlikely.

    5. The debt/GDP ratio is a more meaningful fiscal constraint than a balanced budget

    Fear-mongers think that by talking about public debt in “big numbers,” the fright value of their dire forecasts can be magnified accordingly. But all macroeconomic aggregates are measured in big numbers. And what’s more important than the absolute size of debt, is the government’s capacity to service that debt. That, in turn, depends on the flow of government revenues, which in turn is driven primarily by overall economic growth. That’s why economists prefer to evaluate public debt relative to GDP (called the “debt ratio”). Even this ratio can overstate the real burden of debt, in times (like now) when interest rates are low and falling.

    Avoiding a lasting, uncontrolled rise in the debt/GDP ratio is a more meaningful fiscal constraint on government, than trying to balance a budget in any particular year. Economists do not agree on a maximum “acceptable” limit for that ratio. But most agree it cannot rise forever. (Some economists argue that there is no limit on a government’s ability to issue sovereign debt denominated in its own currency, and the recent experience of countries like Japan – whose debt ratio is five times Australia’s – is consistent with that view.)

    At any rate, Australia is far away from any feasible “ceiling” on public debt relative to GDP. And remember, like any ratio, the debt/GDP ratio has both a numerator and denominator: growing the denominator is as effective as shrinking the numerator, if the goal is reducing the value of the combined ratio. In this regard, the stagnation in Australia’s nominal GDP in recent years has been more damaging to the trajectory of the debt ratio, as has the addition of debt through continued deficits. The government’s policy focus should be on expanding economic activity (and the jobs and incomes that go with it), rather than suppressing the deficit with austerity measures (which have the unintended consequence of undermining growth and hence the economy’s ability to service a given amount of debt).

    6. The government can incur moderate deficits every year, yet still stabilize its debt burden

    A related and under-appreciated countervailing argument is to note that government can run a medium-sized deficit on an ongoing basis, and yet experience no increase in the debt/GDP ratio at all – so long as the economy is progressing at a normal pace. A deficit adds to the numerator of the ratio, while economic growth expands the denominator. So long as both are expanding at roughly the same rate, the ratio will not be changed. (Our reference to economic expansion envisions more jobs and incomes across the economy, including in the public sector, and with due attention to the need for environmental sustainability.) This basic arithmetic provides government with an additional degree of maneuverability in financing essential services and investments, without unduly increasing the debt ratio.

    A simple numerical example helps to illustrate the point in Australia’s context. A healthy economy should be expanding by at least 5-6 percent per year in nominal terms: divided roughly equally between inflation (given the RBA’s 2-3 percent inflation target) and greater output of real goods and services (driven by both population and productivity). The Commonwealth’s current net debt ratio is slightly below 20 percent of GDP. With a healthy economic expansion, the government could incur an annual deficit of 1-1.25 percent of GDP (or close to $20 billion per year) but still stabilize the debt ratio below that 20 percent benchmark. And there is nothing magical about a 20% debt ratio; if Australians were willing to tolerate a larger steady-state debt ratio, then the size of this annual permissible deficit would be correspondingly higher. All this merely reinforces the need for government to focus on supporting job-creation and incomes, not balancing its budget – and confirms that ample fiscal space is indeed available for the Commonwealth to fund public services and infrastructure spending (with the fringe benefit of reinforcing strong job creation that should be their top priority).

    The post 6 Reasons to Be Skeptical of Debt-Phobia appeared first on The Australia Institute's Centre for Future Work.

  • State Income Taxes Would Promote Inequality and Debt

    The latest “big idea” on tax policy from the Coalition government is to grant independent income tax powers to the states. This would be accompanied by a devolution of funding responsibility for big-ticket services like health care, hospitals, and schools. Prime Minister Turnbull argues that forcing state governments to raise the money they spend will lead to more accountability and efficiency in public service delivery. And it’s a politically convenient response to the demands from states for more revenues: “If you need it so much, go out and raise it yourself.”

    While this trial balloon serves a short-run political function for a government struggling to define its agenda, it would be a terrible way to organize long-run fiscal affairs in a diverse, federal country. Canada’s experience with tax devolution is an appropriate cautionary tale. Like Australia, Canada is a federal country with a complex division of government responsibilities, a vast resource-dependent economy, and big economic and social gaps between regions.

    Canada’s ten provinces have the power to set their own personal income and company taxes. They also set province-specific GST rates. The result is enormous variation in tax rates (and rules). Top marginal provincial income tax rates range from 11.25 percent in Alberta, to over 25 percent in Quebec and New Brunswick. Provincial GST rates range from zero in Alberta, to almost 10 percent in Quebec. In each case, provincial taxes are in addition to those levied by the federal government (with its own GST of 5 percent, and a top marginal federal income tax of 33 percent). Each province also sets its own rules regarding coverage, eligible deductions, and tax brackets, complicating inter-provincial business.

    It’s not just that individuals must pay tax twice, to different levels of government. (In fact, at tax-filing time, taxpayers must fill out two forms to separately determine what they owe to the federal and provincial governments.) More damaging are the long-run fiscal and social mechanisms set in motion by interprovincial tax disharmony.

    Provinces enjoying stronger economic conditions can reduce their tax rates, yet still raise adequate revenue. This sparks a destructive race-to-the-bottom in tax rates that undermines government revenues in all provinces.

    The worst example of this occurred during the resource boom of the 2000s. Oil-rich Alberta adopted a low flat-tax applying to all taxpayers (no matter how wealthy). This helped the Conservative government there get reelected. But it exacerbated demands in other provinces (especially neighboring British Columbia and Saskatchewan) to reduce their own taxes in tandem. Well-off Canadians (especially those receiving business or investment income) can easily establish multiple “residences,” allowing them to pay tax in the lowest-rate province.

    Smaller, poorer provinces bear the brunt. Consider New Brunswick, in Canada’s poorer east, with a population of just 750,000. Its top marginal income tax rate is more than twice as high as Alberta’s (and New Brunswickers also pay an 8-point GST premium). This makes it all the harder to retain young talent, attract investment, and catch up to the rest of the country. Underfunding provincial schools won’t help economic recovery, either.

    By undermining fiscal capacity, tax competition has also contributed to the escalation of provincial debt. Some provinces (like New Brunswick) now owe over 40 percent of their GDP in provincial debt (on top of their share of federal debt, another 33 percent of GDP). Alberta and other higher-income provinces have virtually no debt. Yet indebted provinces pay higher interest rates than Ottawa, resulting in many billions of dollars of avoidable debt service charges. It would be much cheaper for both revenues and debts to be managed centrally, minimizing both tax competition and interest rates.

    The Coalition’s most unbelievable claim is that tax devolution will end fiscal squabbles between the governments. That was the theory in Canada in 1977, when the federal government transferred 13.5 percentage points of income tax powers to the provinces, to fund provincially-delivered health and education programs. Forty years later, however, the squabbling is louder than ever. The provinces cannot single-handedly fund public services from their own revenues (especially given the destructive effects of tax competition). So Ottawa still transfers $65 billion per year to the provinces (one-quarter of all federal spending). And debates over those transfers are as intense as ever. Right now, for example, the provinces are furious over a unilateral reduction in federal health transfers.

    Federalism is a messy business. And that’s probably how it should be: the whole idea is to ensure a healthy balance between national and regional interests. But the hope that a one-time tax transfer to lower governments can somehow fix all problems of funding and accountability is pure fantasy.

    The post State Income Taxes Would Promote Inequality and Debt appeared first on The Australia Institute's Centre for Future Work.

  • Company Tax Cuts: A Cautionary Tale from Canada

    Whatever the motive, the constituency most disappointed by this about-face is the corporate sector. Business leaders hoped to ride the coat-tails of a “tax shift” to achieve a significant reduction in company income taxes. And they continue to beat the drum for lower business taxes, financed if necessary from other fiscal savings. By sweetening after-tax returns, they argue, business capital spending will accelerate: driving GDP expansion, more jobs, and fiscal dividends for government. In short, everybody wins.

    But is their promise of a growth dividend realistic?

    Never mind economic models, which depend entirely on whatever assumptions are programmed in by the modelers. Instead, let’s consider some real-world experience to judge whether company tax cuts would indeed generate a significant growth dividend. Canada’s recent experience with deep corporate income tax cuts is especially relevant to Australia, given the structural similarities between the two economies: large geography, dependence on major resource projects, and large inflows of foreign capital.

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    The Canadian federal government implemented three successive federal corporate tax reductions over the last generation. (Provincial governments also levy their own corporate taxes, averaging around 10 per cent, added to federal levies.) The first stage occurred in the late 1980s: the statutory rate was reduced from 36 per cent to 28 per cent, but various loopholes and deductions were closed in the process. The second reform occurred early this century: the general rate fell to 21 per cent, and preferences for manufacturing and resources were eliminated. The latest cuts were implemented beginning in 2007 by former Conservative Prime Minister Stephen Harper (defeated in last year’s election): he cut the base rate to 15 per cent, and eliminated a 1.1 per cent CIT surtax. Those last reductions alone still cost the federal government over $15 billion (Canadian Dollars) in foregone revenue each year.

    Together, these successive cuts reduced combined Canadian corporate taxes (including provincial rates, which also fell in several provinces) from near 50 per cent of pre-tax income in the early 1980s, to 26 per cent today. In theory, the resulting boost to profits should have stimulated a strong response in business investment. Unfortunately, hopes for this “jobs and growth” dividend have been repeatedly dashed.

    Instead of growing, business spending on fixed capital (machinery, structures, etc.) declined under lower company taxes, by about one full point of GDP since the reforms began. Business innovation spending (one of Mr. Turnbull’s top priorities) fared even worse: business R&D outlays shrank by over one-third as a share of GDP, to a record low of just 0.8 per cent. In fact, over the last decade real business investment performed worse than during any other era in Canada’s postwar history. Several provincial governments have given up waiting for the promised investment boom, and are now increasing company tax rates to help address chronic deficits.

    It is instructive to compare Canada and Australia’s investment performance over this period. Both countries face the same booms and busts in global commodity prices. Yet in the last decade business spending on fixed assets grew more than twice as fast in Australia, according to OECD data: by 3.9 per cent per year in Australia (after inflation), despite higher company taxes, versus an anemic 1.7 percent in Canada. Canada’s GDP outgrew Australia’s in just two of those ten years, and last year the country slipped into outright recession.

    One especially painful side-effect of lower company taxes has been the sustained accumulation of liquid assets by Canada’s non-financial businesses. Corporate cash hoarding accelerated dramatically after the turn of the century. Non-financial firms now hold cash and other liquid assets equal to over 30 per cent of GDP. IMF researchers have shown that corporate cash holdings grew faster in Canada than any other G7 economy (and twice as fast as in Australia).

    With businesses investing less than they receive in after-tax cash flow, lower taxes only add to the stockpile of idle liquid assets, draining spending power from the economy. In this regard, lower corporate taxes may very well have weakened growth and job-creation, not strengthened it. In any event, Canada’s experience is a sobering reminder to Australian policy-makers: anyone expecting a tax shift to generate a big growth dividend is likely to face chronic disappointment.

    The post Company Tax Cuts: A Cautionary Tale from Canada appeared first on The Australia Institute's Centre for Future Work.