Respect the dismal science: public policy needs some economics

It has become increasingly obvious that public policy debate, though ostensibly about economic issues, has drifted further and further from time-tested economic principles.

These days, it seems economic growth and raising overall living standards through economic reform and improved productivity counts for nought and everything has to be “fair”.

Yet the risk with gearing policy towards equity at the expense of efficiency is that only fair economic performance will result.

Not excellent. Not good. Just fair. There are many examples of countries from Argentina to Zimbabwe where the demise of economics as a foundation for policy became a first step to economic demise.

During the recent election campaign increased taxes on individuals and business were proposed as fair, without regard to their macro-economic costs through lost work effort, investment and production.

Company tax cuts were criticised as an unfair giveaway to the top end of town when they were intended to improve Australia’s international competitiveness and improve long-term growth.

Mind you, the company tax cuts yet to pass through parliament would be much better sold if accompanied by equivalent cuts to the billions of dollars of industry assistance doled out annually by the federal government.

The GST cannot be raised to alleviate Australia’s serious fiscal problem because it would be unfair on low-income households, many of which pay no net income tax and are young.

Yet, because they are young, they are also likely to be richer than their forebears on average in the future because of continuous economic growth.

How much richer depends, of course, on how much productivity improves into the future because of greater efficiency.

Meanwhile, it is fair that the mostly older, top 20 per cent of taxpayers pay 60 per cent of the tax.

Pervasive economic illiteracy and an anti-business sentiment in the electorate is part of the present problem, and ultimately results from deficiencies in the education system.

The school social science curriculum grossly underemphasises basic economic facts and principles. Economics is not considered a core subject at primary school, for instance, and is only an elective at high schools, many of which do not even offer it. Generations therefore leave school not appreciating basic economic truths.

For instance, it is poorly appreciated that a vibrant business sector is necessary to grow the economy since business provides employment and hence income for most households in the economy.

Without business there would be fewer jobs created and no tax revenue to fund public sector jobs and activity in areas such as education, law and order, health, roads, defence and social welfare, including old age pensions.

It also is not recognised that government services are never free and that increasing government expenditure comes at the expense of increased taxes necessary to pay for it, or higher debt as a future tax. And those higher taxes impose additional costs on the economy.

Students also are unaware of the importance of international trade and investment to Australia’s prosperity and that its trade is mostly with countries in Asia-Pacific which are not full welfare states and are hungrier for success.

Populist protectionism also is likelier to thrive when kids leave school without appreciating why free trade and investment benefits the economy and their future living standards.

If fairness is to be a major guiding principle of public policy, what is needed to better inform debate and decision-making is an objective evaluation of just how unequal income distribution is in Australia, relative to the past and to other advanced economies using measures such as the Gini coefficient. At the moment the debate is flying blind.

Such a study also should carefully distinguish between inequality of income and inequality of wealth. At a guess, wealth in Australia is likely to be more unequally distributed than income, but by how much we simply do not know.

Most of the debate about fairness is about equalising income via higher taxes with far less attention to equalising wealth through other means such as higher inheritance and property taxes.

As the preoccupation with fairness is an economic issue impeding growth enhancing reform, the Productivity Commission is well placed to conduct such a study and present the salient facts. It also should canvass thoroughly the disincentive effects that high marginal income taxes and company taxes have on economic activity and future prosperity.

In light of these facts, instead of the notion of fairness creeping at a petty pace from policy to policy, the onus would then be on advocates of greater income redistribution to specify how much more redistribution would be enough, which generations should benefit most, and by when this should be achieved.

In the meantime, it’s time to give productivity-enhancing reform a fair go.