In a previous article (posted yesterday) I compared the Coalition and Labor fiscal plans. The credibility of these plans, as well as their value, depends significantly on whether the underlying economic parameters upon which the plans are based are sound, and equally how those plans will impact on economic activity and growth.
By Michael Keating
These issues are discussed further below in the second part of this series comparing the two Parties fiscal plans.
Both major Parties fiscal plans are based on the economic forecasts prepared by the Treasury and published in the Pre-election Economic and Fiscal Outlook (PEFO) which was released at the beginning of this election campaign. Two questions therefore need to be addressed. The first is how reliable are these Treasury forecasts? The second, is how will the two Parties’ respective fiscal plans impact on the economy? Do their Plans improve the economic outlook, or increase the risks?
The Economic Outlook
Unfortunately, in recent years the authorities – the Treasury and the Reserve Bank – have established a track record of being two optimistic in their projections of economic growth and the increase in household incomes in particular. These forecasting errors of course then raise questions about the reliability of the Coalition and Labor fiscal plans, with the revenue forecasts being especially vulnerable if income growth is less than predicted.
On Friday, just after the release of Labor’s Budget Plan, the Reserve Bank bowed to reality and revised its forecast for the rate of economic growth for next year (2019-20) downwards to 2½ per cent compared to 2¾ in the PEFO. If we assume the same ratio of revenue to GDP as in the PEFO, then this revision to GDP knocks $2.2 billion off the Government’s projected budget surplus of $7.1 billion; emphasising the vulnerability of these projected surpluses to variations in the growth of the economy.
The Economic Impact of the Coalition and Labor’s Economic Plans Compared
The Coalition’s Economic Plan
What is most striking about the Coalition’s economic strategy is the fact that it doesn’t really have a plan.
The Coalition gives every indication that it has endorsed the Treasury growth model where the medium-term growth of the economy is determined by the growth in the three PPPs (productivity, (employment) participation, and population. At the very least, therefore, one would have expected that a Coalition Government would have programs and policies designed to improve some or all these three PPPs. But in fact, there is nothing of this kind in the Coalition’s so-called “Economic Plan”. In the few instances where the Coalition does see a need for government action – such as energy – its policies are a contradiction of traditional Liberal policies that aim to improve markets and incentives for private enterprises and individuals; instead this Coalition Government relies entirely on direct intervention, such as paying polluters not to pollute, price controls and even threatening nationalisation.
The Coalition would probably also argue that it is increasing investment in infrastructure and that will increase economic capacity over time. However, the largest part of this planned increase is some years away, so as not to imperil the Coalition’s other objective of a return to a cash surplus on the budget. Most importantly, very little of this planned investment has been submitted to cost-benefit analysis, and there are good reasons for believing that most of this proposed increased investment in infrastructure is a waste of public money.
This means that the Coalition is essentially relying on tax cuts that heavily favour the highest income households to act as a stimulus to enterprise. The hope is that the benefits of increased incentives for the top income earners will over time trickle-down and stimulate increased jobs and wages growth for the rest of the population.
Frankly such hopes defy experience. There is no evidence that reducing the present marginal tax rates for the rich would make any difference to their work effort or their investment behaviour. These people have little discretion about how hard they work, and don’t need extra incentives. Indeed, we know that nothing changed in this respect when the top marginal tax rate was dropped from 60 per cent to 45 per cent. Equally other countries with higher tax rates than Australia manage to increase their per capita incomes just as rapidly as we have. Instead the priority if we want to increase incentives would be to address the disincentives faced by low-income women who would like to return to the workforce or work more hours per week.
In sum, we have a situation where productivity and wage growth are flat-lining, but it is hard to see how Australia’s economic performance will improve under the Coalition so long as it continues to offer more of the same inaction and lack of policy reform. Instead, the Coalition continues to hope, despite all the economy’s past under-performance, that somehow the situation will turn around.
Labor’s Economic Plan
In contrast the thrust of Labor’s policies to support economic growth is aimed at investment in human capital and increasing demand by increasing the income available to middle income households.
Labor has promised significant increases in expenditure on early childhood education, schools, and tertiary education. Over time this should help improve the ability of Australia’s future workforce to adopt and adapt to technological change which is the main determinant of future productivity growth. In addition, technological change has been the key reason for increasing inequality in all the advanced economies. It is technological change that has hollowed out the jobs in the middle of the distribution and increased the premium for skills. Accordingly, investing in people so that they can respond better to technological change is the best way to achieve a more equal society over time. This more equal distribution of incomes will then lead to higher consumption and thus help sustain aggregate demand which is the main reason for the economic stagnation that we have been experiencing.
But while the benefits of increased education and training only accumulate over time, Labor is also offering more immediate support for families which should reduce their cost of living pressures. For example, under Labor, a couple with two children under the age of 5, where the mother has an annual income of $35,000 and the father earns $70,000 would get a combined tax cut of $1430 a year, an additional $2400 in child care subsidies in two years, and the planned freeze of private health care premiums at two per cent will see them $344 better off. In sum, under Labor’s policies this family will be better off by $11,843 over the next three years – a gain in their total disposable income over the three years of 3¾ per cent.
In addition, Labor is promising to take action to lift the minimum wage over time and restore penalty rates. This should increase the wages of the most low-paid workers, and also help to lift their consumption and thus aggregate demand.
In sum, Labor should be congratulated for rejecting the conventional wisdom and not adopting the small target strategy that has become the norm for all Opposition parties since John Hewson led the Liberal Party in the 1993 election. Instead, Labor has produced a comprehensive reform package that is directed to dealing with the underlying causes of the recent economic stagnation that Australia has been experiencing.
On the other hand, future economic growth is much less certain under the Coalition. They are essentially promising more of the same, and their policies do not really address the low wages and increased inequality which are the reasons for that economic stagnation.
Michael Keating is a former Head of the Departments of Prime Minister & Cabinet, Finance, and Employment & Industrial Relations. He is presently a Visiting Fellow at the Australian National University.
First published at Pearls and Irritations – Wednesday 15 May 2019.