Do markets now expect the stage 3 tax cuts to be inflationary?

Relative to the legislated stage 3 tax cuts, the changes increase the income of low and middle income tax payers (and reduces the incomes of high income households) who have higher propensities to consume and so this change would be expected to increase consumption and inflation. The question is how significant this is?

Speculation about the stage 3 tax cuts grew over January (Google searches for “stage 3 tax cuts” soared, ie almost 10 times as many searches in the past week as in December) with the basic shape of the changes discussed in the media over the past week.

Overall, the market does not think the impact on inflation is significant. Over January (and even before) changes in the market’s expectation for the RBA cash rate in December 2024 have very closely followed changes in the expected US Fed Funds rate. If the stage 3 tax cuts were expected to have a significant inflationary impetus then we should have seen expectations for the cash rate increase relative to those for the Fed Funds rate, and there isn’t evidence of that.

Relative to the legislated Stage 3 Tax Cuts, the new tax rates benefit anyone earning less than $146k, some 12 million people, at the expense of those earning more than this, a bit over 2 million people. To be clear, those with an income higher than this still benefit relative to current tax rates, they just benefit by less than they would have under the Stage 3 Tax Cuts.

Relative to the Stage 3 Tax Cuts, the new rates shift around $7 billion of income from high-income earners to low and middle-income earners. That sounds like a lot, but this only amounts to some 0.5% of household disposable income of $1.5 trillion. When you multiply that by the difference in the marginal propensity to consume between high and low/middle-income earners you get small numbers relative to aggregate consumption. 

The net effect on consumption, GDP and inflation will surely wash out relative to the noise in economic data and our regular forecasting errors. So it’s not surprising to see markets discount the likely impact on the cash rate.

To stay up to date on the latest economic insights, subscribe to Macro Musing on LinkedIn and follow Jonathan at jk-econ.