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Australian economy: Senator Nick Minchin screws up on tax cuts

Gerard Jackson

Monday 30 January 2006

Anyone who thinks Government ministers actually know anything about economics need look no further than Finance Minister Nick Minchin, who, according to Alan Wood (The Australian, Super idea but it’s just the start, 25 January 2006), gave the Young Liberals an economics lecture on Sunday 22 January. That the Young Libs need lectures in economics goes without saying. Unfortunately the same applies to Mr Minchin.

The lecture, which Wood approvingly referred to, stated that calls for reductions in government revenue, either through tax cuts or spending, risks overheating the economy, aggravating inflation and pushing up interest rate. (Access Economics recently made the same absurd statement about inflation and tax cuts). This is the kind of dangerous economic rubbish I have come to expect from politicians and economic commentators.

Let me make this as simple as I can.

What Minchin and Wood are saying is that tax cuts would increase aggregate spending. But how? If a government is not running a surplus when it cuts spending then aggregate spending can only increase if the government expands the money supply to underwrite the tax cuts. If the government underwrites the tax cuts by an equal cut in its own spending then aggregate spending remains unchanged. What does change, however, is the composition of spending, with individuals spending more of their own money and the state spending less.

The situation is somewhat different where the government is running a surplus. Now if the surplus has been used to buy assets then, once again, aggregate spending remains unchanged, even if the surplus is used to fund tax cuts. This is because in order to fund the cuts the government would have to sell assets.

However, if the government has maintained the surplus in the form of idle balances at the RBA or commercial banks then using it to fund tax cuts will raise aggregate spending — just as a monetary injection would. Yet the same people who argue against tax cuts because they are inflationary are the same people who totally ignore the money supply! Obviously the likes of Minchin are oblivious to the fact that their objection to income tax cuts is a half-baked monetary one.

Furthermore, their objections are just a variation of the excess-purchasing-power argument that would have it that inflation is caused by too much spending. But where did the spending come from? Let me provide a clue: it’s called money supply. From March 1996, when Howard won power, to November 2005 currency expanded by 84 per cent and M1 by 118 per cent. All that a government has to do to accumulate a surplus under these circumstances is to make sure that its own spending does not exceed the increase in tax receipts that its criminally loose monetary policy has created.

One can only wonder at the intellectual powers of men like Wood and Minchin who fear the so-called inflationary consequences of tax cuts while blithely ignoring the Government’s massive monetary expansion. That Minchin and Wood have no understanding of how changes in the money supply affect the economy was sadly emphasized by Minchin’s argument, approvingly summarised by Wood, that

If the Government pushes too hard on the fiscal accelerator through tax cuts or spending increases, the Reserve Bank has to hit the monetary brakes. In short, lay off the pressure for big income tax cuts.

This is pure Keynesian bunk. The only time “the monetary brakes” have to be applied is when there has been a loose monetary policy the consequences of which the Reserve Bank now has to deal with. Piling absurdity upon absurdity, Minchin went on to say that

There is, however, a very obvious way to reduce taxation without unduly stimulating the economy and putting upward pressure on interest rates, and that is to look at how we tax savings as opposed to taxing spending or income. When I spoke to you last year I advocated removal of the superannuation surcharge, and I was pleased that we were able to do so in the subsequent budget. This year I want to say to you that there is a very good case for abolishing the current 15 per cent tax on superannuation contributions.

In an exchange with Malthus — a proto-Keynesian — who argued that depressions are caused by too much saving, Ricardo replied with the devastating observation that to save is to spend. John Stuart Mill felt impelled to underline the same point by stating that

The person who saves his income is no less a consumer than he who spends it. (On the Influence of Consumption on Production, 1829).

By arguing that lifting the super tax will not affect aggregate demand, Minchin is in fact committing the Malthusian (underconsumptionist) fallacy of confusing savings with cash balances*. This egregious fallacy is the perceived wisdom in our bureaucracy, universities and economic forecasters.

Wood tells us that Greg Smith, former head of Treasury’s tax division, pointed out that the Government’s budget surpluses are built on superannuation taxes and that “This was essentially a transfer from private to public savings, substantially neutralising the national economic benefits of running a budget surplus”. But budget surpluses are not savings. To save is a process of transferring spending from present goods to the production of future goods. Moreover, surpluses have no essential benefits.

One should at least be grateful that Mr Smith apparently understands that taxing savings, which is what governments have been doing to superannuation, is to tax future living standards and so keep them lower than they would otherwise be. It’s a pity that the Treasurer Peter Costello is blind to this fact. Or maybe he reckons that his own tax-payer funded indexed pension will protect him against the folly of taxing the future.

Note: Minch’s nonsense about the inflationary consequences of tax cuts has the full support of Tim Colebatch, economics editor of The Age who fatuously asserted that eliminating the super tax

...would reduce taxes without increasing inflationary pressures; it would not run the risk that the Reserve Bank would have to lift interest rates to take the money back off us. (At last, a decent tax plan 24 January 2006)

*Eliminating the super tax affects real aggregate demand through increased investment.

Gerard Jackson is Brookes’ economics editor

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