The economic challenges

In reality, of course, much of this enormous sum has already been dedicated to personal income tax cuts and to spending decisions which have had the effect of boosting domestic demand, at a time when it was already being boosted by the commodities boom, the lagged effects of earlier easy monetary policy, and rising asset prices.

And much as I wish it were otherwise, I accept that it would be politically impossible to walk away from the pledge for $31bn of tax cuts promised by Labor during the election campaign. But since there is now almost certain to be another round of upward revisions to forward estimates of revenue in the forthcoming Budget cycle, I hope the new Government will learn from the experience of its predecessor rather than repeat it.

There is another important respect in which fiscal policy decisions have added to the burdens shouldered by monetary policy.

There’s no doubt in my mind that some specific decisions of the previous Government induced people to take on more debt than they might otherwise have done. I’m referring, in particular, to the 1999 decision to halve the rate of capital gains tax, and to last year’s decision to remove income from superannuation funds by people aged 60 and over from the tax system altogether.

I can’t think of any sound principle of economics or public finance which says that income from speculating should be taxed at a lower rate than income from working - especially when increasing the proportion of the population who are working is supposed to be a policy objective. Yet that is the result of the decision made by the Howard government, with the support of the then Opposition, in 1999. And, in conjunction with the continued availability of “negative gearing”, this contributed significantly to the ensuing property boom, bringing aspiring landlords into competition with would-be homebuyers for a limited stock of housing.

I think it is little short of astonishing that, having spent five years telling the Australian people (correctly) that the ageing of the population constituted the biggest medium-term fiscal challenge facing the nation, the Howard government would make that challenge significantly worse by in effect making it optional for anyone over the age of 60 to pay tax, making it easier for quite affluent people in that age bracket to claim taxpayer-funded concessions and benefits, and as a result of one particular aspect of that decision (allowing people to contribute up to $1 million to superannuation before June 30 last year), encouraging another round of borrowing to acquire assets.

These two decisions were part of a more general pattern under the Howard Government of using the income tax system to favour particular categories of income, particular types of expenditure, particular groups of taxpayers, and particular forms of economic organisation, over others.

I would urge the new Labor Government to look seriously anew at reform of the personal income tax system with a view to reversing this trend.

Another significant challenge facing the new Labor Government stems from the unravelling of the global credit market bubble which developed in the aftermath of the collapse of the 1990s equity market bubble, in an environment of unusually low interest rates; a flood of money from developing to advanced economies, the obverse of the usual flow of capital from rich countries to poor ones; and a wave of “financial engineering” which foisted complex investment products with poorly understood risk characteristics on a wide range of unsuspecting borrowers and investors.

It is already apparent that the deflating of this bubble is causing significant stresses in the global financial system, and may well push the United States and perhaps others into recession.

Australia is far from immune to the stresses in the global financial system, and although our business cycle is now more closely aligned with that of the developing world, there are downside risks for our economy associated with the possibility of a sharp downturn in the US.

These developments add an additional significant complication to the task of containing and reversing rising domestic inflationary pressures. The challenge then facing the Government could become one of containing and reversing a sharper downturn in domestic demand than the one which the Reserve Bank is now saying, in effect, that we “have to have”.