Treasurer Josh Frydenberg doesn’t want anyone saying the budget he unveiled this week involves applying some “fiscal stimulus” to get the economy moving faster. He’d prefer to say his budget is “pro-growth”.
But what is fiscal stimulus? And does that label apply to this year’s budget? Only if you’re prepared to be called a “Keynesian” economist. Which Frydenberg isn’t.
Why not? Because in the hard right circles in which many Liberals move, the name of John Maynard Keynes (rhymes with Brains) has become a swearword. (That’s because their penchant for dividing people into political friends and foes exceeds their understanding of economics.)
The K-word isn’t one used a lot by the Reserve Bank. My guess is it would be quite pleased with what Frydenberg has done in coming up with his own version of what, when Kevin Rudd did it after the global financial crisis in 2008, was dubbed a “cash splash”.
But the Reserve would limit itself to saying Frydenberg has made the budget “less contractionary” than it would have been.
The “fiscal” in fiscal stimulus is just a flash word for anything to do with the budget. The managers of the macro economy often do things intended to stimulate it to grow faster, create more jobs and make us more prosperous.
In last year’s budget, Scott Morrison introduced a new “low and middle income tax offset” (known to aficionados as the lamington) worth $530 a year, to be received by workers earning between $48,000 and $90,000 a year, with those on lower or higher incomes getting lesser amounts, starting from last July.
The offset was equivalent to about $10 a week but, because it’s a “tax offset”, they don’t get it until they’ve submitted their annual tax return at the end of the financial year and received their tax refund cheque. That cheque (these days actually a transfer to their bank account) will include the offset.
So workers should receive their first offset payment as a lump sum sometime in the September quarter of this year.
But this week the government decided to increase the amount of the offset by $550 and to backdate it to last July. So about 4.5 million taxpayers will be given a cash grant of $1080 in a few months’ time. When they spend that money, it should give the economy a kick along.
First point to understand, however, is that though the motive for the policy changes politicians announce in budgets is usually political – they just want to buy our votes, for instance - that doesn’t stop those measures having an effect on the economy.
Economists ignore the political motivations and focus on the likely economic effects.
Second point, while it’s easy to see that something as sexy as a tax cut could, when it’s spent, add to economic activity, that’s just as true of the government's spending to build new infrastructure, or add new medicines to the pharmaceutical benefits scheme, or spend more on education.
So what will stimulate the economy is all the new programs the government decides to spend on, less any cuts in government spending or new tax increases it makes.
The budget papers show that, since the midyear budget update in December, the government’s decisions to change tax and spending programs total $5.7 billion, spread over the present financial year and the coming year.
That total stimulus is equivalent to about 0.3 per cent of gross domestic product – meaning that, despite all the excitement, it’s not exactly huge.
Third point, while most people see immediately that the things governments do with their budgets affect the economy, it takes them longer to realise that, particularly because the economy (GDP) is about four times bigger than the budget, the things the economy does also affect the budget.
That is, there’s a two-way relationship between the budget and the economy.
As the economy grows during the upswing of the business cycle, this should improve the budget balance, as the progressivity of the income tax scale (aka bracket creep) causes income tax collections to grow faster than income itself, and government spending on dole payments falls as more people find jobs.
Alternatively, as the economy slows during the downswing of the business cycle, tax collections also slow down and dole payments grow as people lose their jobs.
Keynesian economists refer to this source of improvement or deterioration in the budget balance as the “cyclical” component.
In contrast, they refer to the improvement or deterioration in the budget balance caused by the explicit decisions of the government to change taxes and government spending as the “structural” component.
Keynesians judge the “stance of policy” adopted in the budget by the change in this structural component. And, as we’ve seen, they’d judge the stance this year to be mildly stimulatory.
The Reserve – which needs to know what effect changes in the budget are having on the strength of demand in the economy so it can decide what it needs to do about interest rates – makes no distinction between the cyclical and structural components of the budget balance.
It simply looks at the direction and size of the expected change in the overall budget balance, which it calls the “fiscal impact”.
As well as seeing that the balance was expected to swing from deficit to surplus, it would note from the budget papers that, since the midyear budget update in December, tax collections and spending underruns were expected to improve the budget balance by $9.7 billion over the present and coming financial years.
In other words, the budget was now expected to take a further $9.7 billion more out of the economy than it put back in. Such a fiscal impact would be contractionary, not stimulatory.
But Frydenberg’s new spending and tax cut, costing $5.7 billion, will make the budget a bit less contractionary than it could have been. Good.
