RPT-MNI: Tax Cuts, Fiscal Policy Seen Complicating RBA's Job

(Story first published Jan 25)

The Australian government’s fiscal stance will add upward pressure to inflation, reducing the likelihood of a Reserve Bank of Australia cash-rate cut until late 2024 at the earliest and potentially adding to further rate rises, prominent economists and former staffers told MNI.

Brendan Coates, economic policy program director at the Grattan Institute, said the stage three tax cuts – while likely already baked into RBA and Treasury forecasts – will keep inflation elevated.

Economic commentators have argued the tax cuts set to start July 1 equate to a 50-75bp rate cut. The reductions, designed to address bracket creep, will see the top tax threshold moved to AUD200,000. However, the government revealed plans Wednesday to alter the cuts, offering greater relief to lower tax brackets and halving the benefit to higher earners.

Coates believes the 50-75bp cut estimation plausible, noting the reform will cost about AUD20 billion. “That's a non-trivial amount of money, of which at least some will be spent," he said.

DELAYING RATE CUT

The cuts will make further tax reform harder and weaken the flexibility of the federal government’s budget, Coates added. "The federal government is riding a short-term commodities boom. We don't know how long that's going to last, but we know the long-term pressures are there." Coates believes the tax reform alongside other inflationary pressures will make a rate cut unlikely until late 2024.

Mariano Kulish, University of Sydney professor and a former RBA senior manager, said any tax cut would drive inflation and make the RBA's task harder. He noted the Reserve had taken a more gradual approach to lowering price rises and any surprise could affect its trajectory and delay the return of inflation to target. He said the RBA should likely hike the cash rate further.

The RBA expects to reach the top of its 2-3% target band by the end of 2025. Its updated agreement with the treasurer, however, means it must target the middle of the band. (See MNI: Updated RBA Goals To Push Hawkish Stance - Ex Officials) The International Monetary Fund last week called on the government to do more to lower inflation.

While the RBA would have accounted for the tax cuts within its forecasts, it has not explicitly pointed to them within communications and it could not have foreseen the government’s latest proposed alterations to its plans, Kulish added.

Sean Langcake, head of macroeconomic forecasting at BIS Oxford Economics and a former RBA economist, said that while the original tax reform may have had a negligible effect on inflation, as it impacted higher earners with less need to increase consumption, the updated plan represented a redistribution of tax savings to a larger proportion of people who will spend the money faster.

"For an equal size change in budget position, the multiplier effect may be larger if they're redistributing wealth towards the lower end of the distribution," he argued. "[The government] says it will be neutral on inflation, but I struggle to see that." The Reserve could choose to hike at the February meeting depending on Q4 CPI due Jan 31, and it may need to update its forecasts due to the changed cuts, Langcake argued.

BUDGET AHEAD

MNI reported late last year fiscal policy remained largely contractionary as the government had greatly increased its tax take over 2023-24. (See MNI INTERVIEW: Fiscal Stance More Restrictive Than Rates-ExRBA) The government posted a AUD19 billion surplus last fiscal year, driven by elevated commodities prices.

Coates noted the upcoming federal government budget due May will likely continue to remain inflation neutral. However, increased cost-of-living payments, such as rent assistance, may add to price rises as a second-round effect, following an initial disinflationary impact, he said.

The Australian Bureau of Statistics calculates CPI net of rental assistance, and any government increase to the programme will reduce the input, a significant driver of inflation over the past 12 months. The government increased rent assistance 15% at a cost of AUD2.7 billion over five years in the 2023-24 budget.

Coates noted a similar increase this year could reduce the rental component of CPI about 2%, however, the economy may not feel any second-round inflationary impacts until CPI had already reduced to about 2.5-3%.