Do markets now expect the stage 3 tax cuts to be inflationary?
The Treasurer has been reported as saying the RBA Governor said the changes to the stage 3 tax cuts won’t 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.
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Jonathan Kearns is Chief Economist and Head of Regulatory Affairs at Challenger, where he also sits on the investment committee. He worked for 28 years at the Reserve Bank of Australia, occupying a wide range of senior roles, including Department Head for Domestic Markets Department, Financial Stability Department, Economic Analysis Department and Economic Research Department. He also led the Bank’s work on climate change across four departments. Jonathan also worked at the Bank of International Settlements in Basel. He has published research in the fields of international finance and macroeconomics. He has a Ph.D. from Massachusetts Institute of Technology and Bachelor of Economics (Honours) from the Australian National University.
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Jonathan Kearns is Chief Economist and Head of Regulatory Affairs at Challenger, where he also sits on the investment committee. He worked for 28 years at the Reserve Bank of Australia, occupying a wide range of senior roles, including Department...
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Jonathan Kearns is Chief Economist and Head of Regulatory Affairs at Challenger, where he also sits on the investment committee. He worked for 28 years at the Reserve Bank of Australia, occupying a wide range of senior roles, including Department...
Expertise
No areas of expertise
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