The government is rumoured to be bringing forward tax cuts. Is that a good idea? Will people spend them? Do tax cuts count as Keynesian stimulus? Or is spending the only good kind of stimulus?
The government’s tax cuts are well understood, the only question is when they are going to make them. A major part of the plan is to get rid of two whole tax brackets, like so:
The 32% tax rate that applies to income earned between $37,000 and $90,000 and the 37% rate that applies to income between $90,000 and $180,000 would go. They would be replaced with a 30% tax rate.
At the same time, the top threshold of the 19% tax rate would shift up from $37,000 to $45,000. The 30% tax rate would then apply to the whole range $45,000 to $200,000.
Most of the benefit of this change accrues to high-income earners. Is that fair? We will come back to that later. For now let’s ask a separate question: is it going to actually stimulate the economy? Because Australia’s economy needs effective stimulus. We should try to get the most bang for our buck.
In theory, tax cuts can work as well as government payments in boosting spending. They both represent money coming out of the government’s bank accounts and into ours.
The difference is in what economists call the marginal propensity to consume. What amount of the money is spent, compared to saved? If people sit on the money, that’s ineffective. We would have blown up the budget deficit without generating much spending in Coles and Woolworths, JB Hi-Fi and Harvey Norman, Caltex and Qantas. Which is the point after all: to get the economy going and creating jobs.
Reserve Banks (RBA) economists have found that Australians on average have a marginal propensity to consume from tax cuts of around 80% to 100%. That’s pretty high, and it rebuts the more extreme claims that tax cuts are only ever saved. But the specifics matter.
At the margin, it depends who the tax cuts go to. They find higher-income people spend less of a tax cut, or lump sum payment.
“Lower-income households tend to consume a greater share of extra income, consistent with the idea that these households are more likely to be liquidity constrained,” they say. Income is not the only factor. Fear of the future also drives saving.
“[Households] that perceive that they are at greater risk of losing their jobs tend to consume less out of lump-sum transfers and income tax cuts.”
The focus of that research was in comparing tax cuts to once-off lump payments. People have a much higher marginal propensity to consume from tax cuts. We see tax cuts as a permanent change to our income, whereas a lump-sum payment (e.g. a $750 payment or a “baby bonus”) we know is a once-off so we don’t spend it all at once.
Incidentally, the tendency of the wealthy to save is why wealth is much more unequally distributed than income. The higher up the income ladder you go, the more saving you can do. The lower down you are the more urgent bills you have to pay.
In the US, research found the bottom 20% of households by income spend 97.4% of their income, while the top 20% of households by income spend 47.5% of their income.
So two things matter for a maximally effective stimulus: make sure it is permanent (not a once-off), and make sure it is aimed at poorer people. The government’s tax plan succeeds at the first count, but fails on this second count.
Of course there are ways to save a tax cut that might not be so bad. If richer households use the tax cut to pay down their housing debt, that might reduce risks in the system. But if you think that’s important, bear in mind the RBA has argued those risks are limited precisely because it is wealthy people who hold the housing debt.
There is also a good question about how much tax wealthy people should pay. We have a progressive tax system — meaning people who can afford to contribute more are asked to contribute more. We should be proud of that.
Here’s how our progressive tax system looks in practice. The top 10% of income tax earners earned around 30% of all income in 2014-15. They paid around 45% of all income tax. That’s a share that had been pretty stable since 2005-06. Meanwhile, the bottom 50% of income tax earners make 25% of all income and pay around 12% of all income tax.
The tax cuts the government is bringing in will make this less system less progressive. Whether you think that is fair or unfair is a judgment call.
That it will stimulate the economy somewhat is a fact. A good share of the extra income will flow out into the economy. But it is also true that the government’s planned tax cuts will do less to stimulate spending than a tax cut aimed at the bottom 50% of income earners.
It is difficult to see that those who already have disposable income will spend any more when they get a little bit more disposable income.
They do though! Rich people spend money on expensive things. More money = more expensive things. Boats, jetty repairs, household staff, art, etc,.
As an added bonus, the tax cuts will (in all likelihood) be the beginning of the austerity conversation, where public services will be cut, and the poor are painted as unworthy of the generosity of the hard-working taxpayers struggling under the weight of reckless government spending.
“The tax cuts the government is bringing in will make this system less progressive. Whether you think that is fair or unfair is a judgment call.”
No. The point economists are making is that if your objective is to stimulate the economy, tax cuts for the rich is an ineffective strategy, because the rich will mostly simply trouser them (or use them to bid up asset prices) instead of spending them back into the economy. If you want your stimulus money to actually be spent back into the economy, increasing JobSeeker or investing in social housing (or, heaven forbid, renewable energy infrastructure) would be a much more effective strategy, because 100% of that money will be circulated back into the economy pronto.
We knew this kind of thing during the GFC. Why is it suddenly the 80s again?
The Coalition government is simply taking advantage of the crisis to do what they always want to do – funnel resources from the poor to the rich.
You’re bang-on Marcus.
If stimulus is the objective, then look at Marginal Propensity to Consume and average Household Income.
Then it becomes obvious that the bottom 50% of households provide the most economic stimulus.
The poorest 10% of households are scraping by on about $32k/year, so an extra $1k there will go roaring through the local IGA, maybe service the Camry, perhaps even a holiday in a caravan park.
The wealthiest 10% of households average around $230k/year, where an extra $1k might end up in super, paying down debt etc but certainly there will be no urgent car/house repairs or other compelling and immediate expenditures that feed straight back into the economy.
And we are more likely to collect GST on expenditures by the poorer households.
Meanwhile, there is no end to the Corporate Welfare that we might pull back on if we were genuinely serious about budget repair; example $30 mio for the land out at Badgerys Creek (worth 3?), $500mio for the GBR Trust team, who incidentally have no marine science credentials at all, subsidies to the gas industry coming soon…and so on.
The hard working and frugal citizens of Trickledown applaud this policy decision. We have legitimate expenses and coffers to fill inside our snowcone. Others less deserving will eventually get the benefit of this largesse – the path is understandably a little circuitous. Possibly via Panama. Still as the Good Book says ( apparently ) ..good things come to those who wait quietly. Or something like that. Anything else is moral hazard. Except if you are too big to fail.
Good things come to those who steal, thieve, break and enter, double cross, bilk, commit larceny, forge, fraud, filch.., attractive to political, corporate, advertising, financial operators.
Sorry, but this misses out on the government taxing the same, then spending it directly on projects that create work. Hopefully of benefit, like social housing for the usual example.
It doesn’t have to pass through taxpayer’s hands as such.
And this discussion is coming as they reduce payments to low income earners in favour of the tax cuts. Higher welfare payments should be on the cards.
And that research was a decade ago. Is it the same now? Personal debt levels now vs then say ie how much people want to pay off debt.
There is always a problem putting up a permanent measure to a temporary crisis (or conversely boom as Howard/Costello did). The ‘cure’ may apply long after the problem.
What happens when the economy improves somewhat and they want to bring the budget back? They will cut spending because it is constrained by the tax cuts, concentrated on high income. Not on the military obviously, but anything social.