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Rudd's tax cuts - inflationary or illusory?

By David Jeffery

Mark Davis has a nice piece in the Herald today questioning the angst expressed by so many people about Rudd's election promise to cut taxes in an inflationary environment.

Davis points out that these announced tax 'cuts' (and the Howard government's cuts of the past few years) are not necessarily cuts at all: the stated amount of the cut is the predicted reduction in the amount of tax collected because of the change to tax rates, compared to what would have been collected if the change hadn't been made (not compared to what was collected last year). The upshot? A government can collect more income tax than the year before and still call it a tax cut - and everyone seems to buy it.

So what about the proposition that the latest batch of tax cuts due this July and said to be "worth" $7.1 billion will fuel inflationary pressures?

Taking Treasury's most recent forecasts, and using some back-of-the-envelope figuring, suggests that Canberra could collect about $4 billion more in personal tax next financial year compared to this year.

And as a share of the economy that would see the tax take from individuals decline
by a little under 0.2 per cent of GDP.

So while the Government has been defending the tax cuts with convoluted arguments such as their effect on boosting labour supply and on dampening wage demands, the simpler reality is they will not fuel demand excessively because they are not nearly as generous as the politicians would have you believe.

Speaking of inflation and things macro, one thing that I don't think has received enough attention is the emissions trading scheme due to kick off in 2010. It will come too late to influence our current bout of inflation but, depending on its design, it could have significant macroeconomic consequences down the track.

Full post as published by Oikos on March 16, 2008 (boomark / email).