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BUDGET REPLY ADDRESS TO CEDA
19-May-2010
The Government has just handed down its third Budget. Since coming to power and under cover of the Global Financial crisis it has taken us from $22 billion in surplus to a deficit this year 2009/2010 of $57.1 billion. In the process it has spent 60% of the capital in three savings funds created by the previous government for national investment; the Building Fund, the Health Fund and the Education Fund.
Next year the deficit is tipped to be $40.8 billion and the budget is expected to return to surplus in 2012/13. We do not believe that it will.
Our response to the Budget finds two over-arching problems:
The two arms of policy – fiscal and monetary – are moving in opposite directions. Lazy and unrestrained fiscal policy means that monetary policy alone is controlling the economy. This Budget reveals that stimulus spending will continue until 2014, 4 years after the end of the GFC. Meanwhile there have been 5 interest rate rises in a row.
The other problem is the Resources Profits Supertax which we find so abhorrent that we have centred our Budget response around our determination to do all we can to make sure this tax does not see the light of day.
The Government has described Australia as simultaneously:
- suffering from the fallout of the global financial crisis (why else would we be continuing to spend the stimulus dollars, 40% of which remained unspent only three months ago); and
- in the midst of a resources boom, courtesy of our most globally competitive industry – mining - that is so problematic, it requires a super profits tax to bring it back to earth.
The Government’s response to this apparent inconsistency is our two speed economy, due to the demand from China for mineral resources from WA, QLD and off shore.
I have never accepted this two speed economy argument. I was pleased to see a paper by Deloittes, released this week, titled “Clouds in the silver lining? The two speed economy and Dutch disease” which provides the analysis to debunk this argument. It states;
“Australia does not have a two speed economy; it has thousands of industries operating at different speeds, with price and resource adjustments taking place constantly”.
If states like NSW where the drivers of economic growth are the commercial property market and SA where the drivers of growth are public infrastructure projects and defence shipbuilding, are falling behind, why is this the fault of states like WA and QLD where industries are booming?
The government is running some crazy lines. They go like this;
Resources are more of a curse than a blessing; manufacturing and the services industry are falling behind; it’s not the fault of debt laden state governments who have failed to re-invest in infrastructure; it’s the fault of the mining industry for pulling too far ahead!
Mr Swan was in Adelaide yesterday talking about Mining Boom Mark 2 and remarked that
“the revenues from the RSPT will be invested in growing the economy – ensuring Australians benefit from the exploitation of non renewable resources long into the future”
As an aside It appears we are being re-educated to replace the term “mining” with “exploitation of non renewable resources”. The real problem I have with this statement is that it is the private sector, not governments who should be making decisions about investment.
Wayne Swan also said that “a high degree of flexibility within the workforce here in SA has helped avoid mass lay offs and skills destruction”. There is one year to go before Julia Gillards new workplace laws come fully into operation. I wonder if that same flexibility will exist then?
In the context of the resources boom, the Treasurer and other Government Ministers like to mention Dutch disease and raise the spectre of us falling victim. The Dutch disease theory is this: an increase in revenues from natural resources will de-industrialise a nation’s economy by raising the exchange rate which makes the manufacturing sector less competitive. It gets its name from the decline in the manufacturing sector in the Netherlands after the discovery of a large natural gas field. In fact it is difficult to prove the relationship between an increase in natural resource revenues, the real-exchange rate, and a decline in the lagging sector. There are a number of different things that could be causing an appreciation of the exchange rate. There are so many factors at play and every economy is different.
In the Netherlands, economists have argued that the decline in the Dutch manufacturing industry was actually caused by unsustainable spending on social services. Nigeria is also often quoted as a victim of Dutch disease. In fact the abundance of natural resources in that country gave rise to governments that are less accountable to the people, have little incentive for institution-building, and fail to implement growth enhancing reforms. Higher corruption, more rent-seeking activity and greater civil conflict result.
As economists have studied Dutch disease they have found that to the extent it really exists at all, the manufacturing sectors with the highest capital intensity are less affected by windfall shocks and a diverse manufacturing sector is the key to being cushioned from resource shocks.
The present government used to lecture us about house prices going up and how that showed we were mismanaging the economy. I used to think it’s not a bad problem to have if you own the house. It’s a lot better than the house price going down.
The mining boom is a good problem to have. Every boom is followed by a bust – our previous 150 years of history tell us exactly this. I cannot believe our Prime Minister really thinks China will sustain a never ending commodity boom and has, in fact, pocketed the proceeds already.
You cannot escape the fact that to levy a tax at 40% and then make miners pay 28% is a double tax whammy that singles this industry out for punishment like no other. The effective tax rate post supertax is 58%. Our tax system contains many complicated mechanisms to avoid the same income being taxed twice; dividend imputation, credits for withholding tax, separation of superannuation balances and so on. It is the double taxation aspect of the RSPT that should offend us most.
The Government claims that the tax will result in a 4.5% increase in investment, a 7% increase in employment and a 5.5% increase in output from the sector in the long term. They will not show us the modelling but we know it was based on the assumption that resources are location specific and therefore investment will continue to flow. This is illogical as we all know that capital transfers freely throughout the globe. And there is no shortage of resources around the world. If I used PowerPoint, I would now show you a table that you will, instead, have to imagine.
It shows the top 15 countries ranked by the volumes of their reserves. Australia is one of 15. Russia has more reserves of iron ore than we do, Guinea has more bauxite, Chile has more copper, China has more zinc, South Africa has more gold and Canada has more potash. We have the most nickel.
The next slide would show the top twenty ‘riches’ nations ranked by the value of their resources. South Africa and Russia are first and second respectively, Australia is third. Then there is Canada, Brazil, China, Chile, USA Ukraine and Peru followed by ten more.
Most metals have a good geographic spread. If capital is taxed too heavily in Australia, it will move elsewhere.
I was insulted by the Government’s dismissal of mining companies as repatriating profits overseas; an easy target because they are not really Australian. It is true that the investment in Australian mining has more than doubled in the past decade. Approx 150bn of offshore funds have been invested to help extract Australian natural resources, much more than our own government has invested over this period. We have a simple choice. Either we use the savings of Australians or the savings of foreigners.
The PM should not be suggesting that our mining industry is tainted by its overseas ownership; that is outrageous. At the very moment that he was doing this, my opposite number, Assistant Treasurer Nick Sherry was in the Middle East, selling Australia as a global financial hub for Islamic finance products!
It is generally estimated that over 75% of all cash generated by mining companies is invested back “in country”. Shareholders have received 25% pf the company’s cash through dividends. THAT is what we should be regarding as a fair share.
According to Philip Lowe Assistant Governor of the Reserve Bank, in Australia, the main task is to expand the supply side of the economy so that demand can grow solidly without causing inflation to rise.
The key to improving the supply side of the economy are investment and productivity growth. We have become a high investment country in recent times because of the resources sector which has quickened the increase in capital stock.
Investment in Australia is high because of high returns on capital, particularly in the resources sector.
This is not going to continue if Mr Rudds super tax gets up.
Mr Rudd believes that revenue from the resources boom is needed to invest in the nation’s long term human capital. With respect this is a meaningless statement.
As economists know, capital is the material means of production and labour is labour. What raises living standards is sustained economic growth, a rise in the ratio of capital to labour. When that ratio improves, the value of labour’s marginal product and therefore wage rates increase. That creates the prosperity that the Government says it wants to secure and that we say is under threat from the RSPT.
Remember a dollar of tax is a dollar not invested.
The real problem that we should all have with the proposed RSPT is the way that the issue has been handled. The mining companies put their submissions into the Henry Review process and were not consulted further. The Government allowed some strategic leaks so that everyone sort of knew it was coming. The announcement on May 3 followed. But not the detail. There were calls between the federal and WA treasuries two nights before the Henry announcement asking questions about how the royalty system in WA actually worked in practice. A consultation panel has been formed so that affected mining companies can tell the Government and Treasury officials how to make their tax actually work. I imagine the opening line of the consultation process goes like this;
“We want to tax you to the tune of $9billion. We want the rate to be 40% and everything above a 6% cost of capital is a super profit. Tell us how to do it?”
I was in the Henry review lock up with a dozen Krispy Kreme donuts, no air-conditioning and a thermos of instant coffee so maybe I wasn’t at my sharpest BUT I can say that Henry’s outline of a rent tax, was quite different to the one the Government announced.
Henry had the company tax take lowered to 25% not 28%
In Henry’s plan royalties are not rebated they are removed. There is a difference. It is not clear to what extent States can raise royalties within announced timelines. Mining companies must still make the necessary royalties calculations and must deal with State Treasuries, before transferring the result to a RSPT calculation which in itself requires another whole set of books. It is not clear where the taxing point will be; just out of the ground or further down the processing chain. It is not clear what the final deduction for depreciation will be.
Meanwhile a multi billion dollar industry is supposed to enter a holding pattern and wait and see? From Opposition there is one certainty we can offer the resources sector, we will vote against the tax in Opposition and we will rescind it in Government.
I do not accept that the Government believes its lines on the resource tax. It is imposing the tax because it needs the cash. In the Budget announcement, Wayne Swan referred to the lowering of the personal income tax rates on 1st July. These were the tax reductions they voted against while in Opposition and finally, through gritted teeth agreed to prior to the 2007 election. The Treasurer is now spruiking these tax cuts as contributing to 85 000 more jobs. I don’t disagree. But remember the Treasurer’s statement that the Resources Tax will contribute to a 7% increase in employment?
The question is, if a tax cut is good for the economy why is a tax increase (the resources tax) also good for the economy?
As policy makers, what we should be doing is reducing the infrastructure bottlenecks to encourage more investment in our mining sector.
The Government responded to this in a typical Labor manner by using the funds collected from the RSPT to set up a new infrastructure fund paying an initial $700 million to the states in two years time. And the rules under which such a fund will operate?
“Funding will be distributed in a manner which recognises that resource rich states face large associated infrastructure demands” says the Government fact sheet.
This is not a savings fund, this is a slush fund.
The government inherited three infrastructure funds from the Coalition. It has spent 60% of the capital in those funds. It runs an infrastructure program called Infrastructure Australia which is essentially a black box. Projects (not very many) emerge from the black box according to a priority list that we never see. The biggest infrastructure allocation the Government has made was to the National Broadband Network and they did that without any consultation.
Other measures in the Budget:
- Business tax measures dealt more with administrivia than real reform.
- CGT relief for restructure
- Improved operation of the rules relating to taxation of consolidated groups
- Reductions in GST compliance costs
The government made much of its jump start in the company tax rate cut for small business; businesses with a turnover of less than $2million will reduce to 28% from the 2013 income year. This does not help small businesses who operate through partnerships or trusts and it is disappointing that the government has not indexed this small business threshold – it has been $2m for well over three years.
The small business write off is increased from $1 000 to $5 000 from 1 July 2012, enabling businesses to immediately write off some of their assets. Remember this is just a timing measure and only accelerates the timing of the deduction. It is questionable how many businesses will benefit. The Budget also introduced one depreciation pool, instead of two to write off all other assets at 30%, a measure which may make it simpler for some to manage their tax affairs.
The small savers benefit gives individuals a 50% discount on the first $1 000 of interest earned. This will save someone earning $1 000 $150 a year. This is far less than the Henry measure which was for a 40% tax rebate on all interest, in an attempt to bring the tax rate on this type of savings into line with the lower taxed alternative investments in capital or superannuation.
The standard deduction for work related expenses has almost taken centre stage, which is rather pathetic. From the 2013 income year taxpayers will have the option to claim $500 standard deduction to replace all other deductions. The standard deduction will increase to $1 000 the following year.
A far more efficient measure would be to allow salary and wage taxpayers to elect not to lodge a return.
The Super Guarantee is increased to 12% by 2020. There is also a $500 contributions tax rebate for low income earners.
From 1 July 2012 taxpayers over 50 who have Super under $500 000 will be able to make extra contributions to catch up. This reverses a previous budget measure which saw this cap come down to $25 000
Some commentators are suggesting that the debt and deficit attack of the Opposition has lost its sting and Australia has in fact survived the GFC and the Government is managing the economy well because we are back in surplus in three years.
Let us look at the situation more closely:
There will be a Budget cash deficit of $37 billion in 2010-11. Government net debt is expected to rise to over $91 billion by 2013-14. The Government will not run a Budget surplus until at least 2014-15 and if it cannot stop spending it will never run a budget surplus.
But the elephant in the room is State debt for which the Commonwealth is ultimately responsible.
Macroeconomics.com estimates that the combined budget deficit of all Australian governments will be $50 billion in 2010-11 with general government net debt rising to $156 million over the outlook. This excludes local government debt and around $129 billion in public sector corporate borrowings expected to accumulate by 2013-14 along with $117billion in unfunded state superannuation liabilities.
Big public debt means big future taxation.
It has not tackled the structural budget deficit of $26 billion. Since coming to office and June 30 this year the Government has generated new net discretionary spending of $108 billion (this includes the stimulus of $70 billion)
Poorly designed fiscal stimulus measures such as the cash splash, the roof insulation debacle, school building etc will cost up to $70 billion and will fail to purchase ANY micro-economic reform. You have to try really hard to waste so much money in such a short time! And they have
The point is this. The Government has forecast a return to surplus but this is not by cutting spending, it is by waiting for the economy to recover and taxation receipts to pick up AND by assuming a rapid and sustained improvement in our terms of trade.
In conclusion Shadow Treasurer Joe Hockey is addressing the Press Club in Canberra right now, detailing the difficult task we face as an alternative government, cutting $16 billion from existing and future government programs.
We know this may not be popular with the electorate but I believe it to be an honest response, in fact the right response to the Mr Rudd’s incompetent management of this economy.
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