If Labor Wins, the Budget Surplus Could be Short-Lived

From an economics perspective, the Federal election is shaping up as one to forget. Australia’s economic growth is currently running at less than our population growth, with this situation commonly being labelled as a “per capita recession”. Neither major party is putting forward anything material on tax reform or productivity reform, the two things that if implemented correctly are guaranteed to push growth and wages in a positive direction. Bold economic reforms like these were last seen from the Hawke/Keating and Howard/Costello governments. Since then, Australia has been coasting on its previous reform efforts, population growth and China’s boom. 

For this election it’s more of a battle of which major party is making the bigger errors in its economic policies. On this count, both parties are banking on high migration and no recession in the medium term to be able to fund their preferred policies. High levels of migration are becoming increasingly unpopular and the probability of a global recession that washes through Australia is building.

In judging the tax changes put forward, it is helpful to remember the maxim that “whenever you tax something you get less of it.” The reverse is also true, in that consumers and businesses will do or buy more of something when taxes are lowered. The tax reductions proposed by both major parties for low and middle income earners are a positive development. Moving people off welfare and into a job is great for their mental and financial health as well as the budget bottom line. 

The Coalition’s plans to flatten and decrease income taxes further up the spectrum are also good policy, but these proposals are a mere shadow of what should have been. The tax white paper process, which was buried by Malcolm Turnbull, was heading in the direction of substantial change to the tax mix. This would have allowed for much greater income tax rate cuts funded by land taxes and a broader GST. This is what meaningful tax reform would look like. Some points must be given to the Coalition though for getting the budget back to a surplus position. It has been slow progress after Labor killed off Joe Hockey’s attempt to make rapid improvements in the deficit position they left behind.

Labor’s proposed tax changes have ignored the tax maxim and common sense. The independents and minor parties are generally saying they won’t support franking credit and negative gearing changes so it seems unlikely Labor will get their proposals implemented. That might be a blessing in disguise for Labor, as if they were implemented they would raise nothing like the $5 billion per year each that Labor is banking will be available for it to spend. 

The negative gearing changes would see investors switch to mostly buying new properties. Secondary properties would be primarily bought by either owner occupiers or developers, with developers demolishing existing houses and replacing them with apartments or townhouses that investors will favour. This simple change of investment strategy will see almost no increase in the tax collected and little change in the amount of new housing stock added.

The franking credit changes are also relatively easy for investors to get around. A simple internet search brings up a host of articles that detail the tricks financial planners have up their sleeves to help retirees maintain their income. Some of these strategies include;

• Replace high yielding franked shares with high yielding debt securities or debt funds

• Replace high yielding franked shares with growth shares, then sell a portion of the growth shares each year to mimic an income stream

• Switch from a SMSF to an industry fund, particularly one that allows for purchasing individual stocks and/or transferring in your existing holdings

• Add younger members to a SMSF

The holes are so big in these policies that even Treasury has flagged the huge uncertainty in their costing review of the proposed franking credit changes. Treasury admits it has had to guesstimate what the “behavioural response” will be and it doesn’t want to be held accountable if it turns out that taxpayers are craftier than the bureaucrats have estimated.

Putting a cynical political observer’s hat on, Labor is promising to spend more and based on their recent history they will do that. However, their claims that they will cover the increased spending through tax increases won’t survive contact with the real world. If the polls showing Labor in front prove out, Australia is likely to have only a brief period of surplus. That will leave Australia with little capacity for a fiscal response when a real recession eventually arrives.