Coffs Coast Business, Politics

‘Social housing, Newstart increases trump tax cuts when economy turns down’.

When growth is slowing and interest rates are falling, the evidence indicates that a timely investment in social housing and an increase in Newstart are more likely to boost growth in jobs and incomes and provide better value than tax cuts, especially those going to high income-earners.

Every dollar invested in social housing and Newstart not only improves lives, it also increases GDP by $1.20-1.30.

By Peter Davidson

With wages and consumer spending stalling and unemployment rising, even the Governor of the Reserve Bank, Philip Lowe (puictured below), has called for the government to back interest rate cuts with fiscal policies to restore economic growth (See: https://www.afr.com/news/economy/look-beyond-monetary-policy-for-a-stronger-australia-20190604-p51ugu).

With interest rates at historic lows, there’s not much more the RBA can do with monetary policy to kick-start economic activity.

Philip Lowe: The move to lower rates “will assist with faster progress on reducing unemployment and will help achieve more assured progress towards the inflation target”. Photo Peter Braig

The impact of different fiscal policies on GDP growth

There are a number of ways governments can boost growth in consumer demand, incomes and jobs:

  • By investing directly in public infrastructure;
  • By raising expenditures on government-funded services like the NDIS (on which GDP growth has leaned heavily over the past year);
  • By increasing payments to the States or local government for those purposes;
  • By increasing social security payments to people with low incomes;
  • By lowering personal income taxes;
  • By lowering company or other business taxes.

Public investment and consumption boosts growth directly (though big infrastructure projects can take years to implement), while payments to States, social security recipients, and tax cuts have an indirect impact. The strength of that impact depends on the degree to which the recipients spend the money themselves. At a time like the present when household debt is high, many people are likely to save a large part of any increase in their incomes. Similarly, companies can either pay off debt or invest the extra income, and this depends very much on whether there is sufficient demand for their products from households (or other countries). If consumers are curbing their spending, companies are less likely to invest.

The impact of these efforts to strengthen demand depends on many factors including: household saving patterns (generally, high income-earners are more likely than low income-earners to save any extra income); the state of the economy (if growth is slower, a fiscal boost is more effective because it’s less likely to ‘crowd out’ private sector activity); the impact on the currency exchange rate (an increase in economic growth or an inflow of foreign capital will, all things being equal, increase the value of the dollar, which may slow the economy since exports are less competitive); how interest rates respond (if the RBA keeps them low, the impact is greater than where fiscal and monetary policies are working against each other).

Importantly, when interest rates are already very low (as they are now), fiscal stimulus has a greater impact because there is less the central bank can do on its own.

There is often a trade-off between government action that can boost growth quickly and the quality of the services or projects that are funded. This applies especially to public infrastructure. This is important, since higher government expenditure will (all things being equal) increase public debt and the higher debt is more justifiable if the services or projects bring lasting economic and social benefits.

Some experts have called for efficiency-improving ‘microeconomic reforms’ to lift future productivity and growth. These usually have a longer term pay-off, though some of the best short-term growth-enhancing measures (especially well-crafted public infrastructure investment) also improve future productivity. However, microeconomic reforms are unlikely on their own to boost growth in the short term, and may slow it down where they increase risk and uncertainty for businesses and households. Examples include disruptive changes to workplace relations and the ongoing uncertainty over energy policy.

Fiscal multipliers

The graph below compares the impact of different government initiatives on growth in GDP in the short-term (the next few years), using ‘multipliers’: that is, the increase in a nation’s economic output generated by each dollar of additional public expenditure or tax reductions. If the multiplier is one, then all of the additional public spending flows into higher growth in GDP. If less than one, some of the extra spending is absorbed – for example into household or corporate savings or imports. If greater than one, the extra spending generates more growth through positive feedback effects, for example due to improved consumer confidence and higher employment. (See here for a more technical discussion of fiscal multipliers.)

These estimates for fiscal multipliers are from the stimulus package implemented in the United States in 2009. The impacts will be different in other countries and at other times. However, the ranking of different policies according to their impact on overall economic growth is similar in other studies.

Some fiscal policies provide more ‘bang for buck’ than others

Note: The ‘upper and low bounds’ take account of margins for error in the research.

There is a clear order of cost-effectiveness here (all things being equal):

  • Public goods and services (especially infrastructure if the timing is right) are the most cost effective;
  • Higher social security payments are more effective than personal tax cuts;
  • Personal tax cuts for low and middle income-earners are more effective than those for high income-earners;
  • Personal tax cuts are more effective than business investment incentives.

The impact of the government’s tax cuts

In Australia, income tax cuts are likely to be much less effective than increases in social security payments because the lowest 30% of households by income do not pay income tax. Low-income households have little choice but to spend every extra dollar they receive on essentials. Thus, social security payments targeted to these households are more likely to be spent. In contrast, at a time when middle and high income-earners are heavily indebted, they will be tempted to use a tax cut to pay down mortgages and credit cards. On average, the highest 20% of household by income save one-third of their income, while the lowest 20% ‘dis-save’ – draw down their savings or borrow money to cover basic expenses.

High-income households save more of their income

Source: ABS (2018), Household Expenditure Survey. Canberra

Most of the government’s tax cuts come too late, and go to high-earners, to boost growth when it’s needed.

The cuts come in three stages commencing in 2019, 2022 and 2024. Stage 1 delivers $8 billion in tax cuts of up to $1,080 a year to middle income-earners on $30-126,000 (recall that the lowest 30% don’t pay tax) during 2019-20. Stage 2 commences in 2022 and provides $16 billion, mainly to the top 20% of income earners on $100,000 or more. Stage 3 commences in 2024 providing another $18 billion in that year, which again mainly goes to high earners. An individual on $90,000 gains $1,125 a year, rising to $9,075 for someone on $200,000 or more.

The impact of a $75 per week increase in Newstart and related allowances

In stark contrast to the tax cuts, the $75 per week increase in Newstart and related allowance payments (including Youth Allowance) for single people and single parents proposed by ACOSS would go mainly to the lowest 20% of households ranked by income.

Since people relying on these payments have little choice but to spend every extra dollar on the essentials of life such as food and rent, most of any increase in those payments is likely to be quickly and regularly spent. Further, it is likely to be spent mainly in the poorest regions – those that would otherwise be worst affected by any economic downtown.

The graph below shows the projected impact of this increase in Newstart and related payments on economic growth (GDP), from modelling by Deloitte Access Economics. This peaks at an increase of 0.15% of GDP in the first year as the money is spent by households, and then tapers off over the next 8 years or so as the economy adjusts and income taxes gradually rise to pay for the Newstart increase. In the third year, the fiscal multiplier is 1.2, wages grow by 0.2% of GDP and the policy creates 12,000 additional jobs.

The estimated cost of the increase in allowance payments is $3.3 billion in the first year. However, this is partly offset by higher income tax collections and other fiscal impacts from higher demand for goods and services across the economy. When those benefits to the public budget are factored in, the ‘net’ cost is $2.8 billion.

The impact of $6 billion in extra public investment in social housing

A key part of the Rudd Government’s 2009 economic stimulus package was the Social Housing Initiative (SHI), which invested $6 billion over three years in 20,000 new public and community housing dwellings. Construction targets were exceeded, with three quarters of dwellings built in the first two years from announcement of the policy.

Social housing construction can meet economic and social goals simultaneously.

There is a national shortage of at just over 400,000 homes that are affordable for people who are homeless or living on the lowest incomes (the lowest 20% by household income).

Over one third of new tenants in social housing were previously homeless. In the absence of the affordable rents, security of tenure, and other supports that are only available to them through social housing, more people on the lowest incomes will become homeless.

The multiplier from the Social Housing Initiative was 1.3. This is well above any likely economic stimulus from tax cuts. Housing construction creates local jobs, mainly uses Australian materials, and has flow-on benefits through the purchase of furniture, electrical appliances and the like. Timely social housing investment could help plug emerging gaps in home building construction. Dwelling commencements have declined by 8-9% in each of the last two quarters to March 2019. There is a large pipeline of already-approved projects in Sydney and Melbourne but this is likely to dissipate in about six months.

Crucially, social housing construction can be implemented more quickly than major road or rail projects.

Conclusion

Tax cuts, increases in social security payments, and investment in social housing are likely to boost growth in jobs and incomes, especially at a time like the present when growth is slowing and interest rates are falling. For my money (and the public’s) a timely investment in social housing (with a multiplier around 1.3) and an increase in Newstart (with a multiplier of 1.2) are better value than tax cuts, especially those going to high income-earners (multiplier unknown but probably less than 1).

The social benefits of modest expenditures on social housing and Newstart are huge, and long overdue.

Dr Peter Davidson works as Principal Advisor at the Australian Council of Social Service and Need to Know Consulting (where he also blogs). A more detailed analysis of the role of tax cuts and increases in social security payments in boosting growth is available from ACOSS.


First published at Pearls and Irritations, Tuesday 30 July 2019. See: https://johnmenadue.com/peter-davidson-multiplications-the-name-of-the-game-infrastructure-and-newstart-trump-tax-cuts-as-an-economic-stimulus/#more-29981

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