Long Term Growth Before Short Term Tax Cuts

Recently published projections suggest that the Federal government will enjoy a steadily growing stream of budget surpluses in the future. Such projected surpluses have not always been realised in the past, and a recession could easily wipe out the surpluses anticipated today. Nevertheless, the achievement of a surplus is a rare enough event that it is important to consider how best to take advantage of it.

The first necessity is to use better measures of our financial position. Although Australian governments are supposedly moving to accrual accounting, Commonwealth fiscal policy continues to focus on obsolete and misleading cash flow measures of income and expenditure, and on irrelevant measures of the financial position such as net financial debt.

The Commonwealth should follow the lead of Queensland (and the private sector), and present income and expenditure statements in which current and capital expenditure are separated. It should also follow the Queensland lead and focus on net worth rather than net debt.

Although the effects of accrual accounting are mixed, it is likely that they would show an even more favourable position than the cash flow accounts used at present. It follows that the government has the option of reducing taxes or increasing expenditure while maintaining stable net worth over the course of the business cycle.

The current government has clearly signalled a preferences for tax cuts. The opposition has taken a more equivocal position, opposing some of the tax cuts proposed by the government, but signalling that it would not seek to reverse them, or impose any new taxes, if elected. In effect, therefore, there is a bipartisan consensus that reductions in tax rates have a higher priority than increases in expenditure.

This consensus is not the outcome of open political debate. The expenditure cuts of 1996, which violated unequivocal commitments, were justified at the time as emergency measures needed because of an allegedly critical budget position. But when the budget position improved, the proceeds of the earlier expenditure cuts were used to finance tax cuts.

The damage done by the 1996 cuts in areas such as higher education is still being felt, and will have adverse consequences for many years to come.

The push to cut taxes is not based on an economic analysis of costs and benefits or on any clear evidence that electors prefer tax reductions to improvements in services such as health and education.

Survey evidence collected by the Economic Planning Advisory Commission in the early 1990s, before the most recent round of cuts showed that the majority of electors would prefer improvements in services to tax cuts. Moreover, there is ample economic investment to suggest that investment in human capital, through education and other human services is a greater contributor to economic growth than investment in physical infrastructure, let alone the increase in luxury consumption expenditure that is likely to be the main result of the current tax cuts.

The present government has been blessed with good luck in the current economic cycle. It seems likely however, that the opportunities presented by relatively favourable macroeconomic outcomes will be squandered. An increase in private consumption, generated by tax cuts, may temporarily prolong the current expansion, but it will not contribute to future economic growth.