Australian Business Economists Dinner

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Foreign Investment Policy Changes
September 3, 1999
East Timor, Economy, Tax reform, Republic
September 10, 1999
Foreign Investment Policy Changes
September 3, 1999
East Timor, Economy, Tax reform, Republic
September 10, 1999

Australian Business Economists Dinner





The Economic Outlook

I am delighted to have the opportunity to speak tonight.

I last addressed the Australian Business Economists dinner three years ago. I wonder what sort of reaction I would have got then if I had predicted that the following years would see the growth economies in Asia experience the worst economic and financial crisis for over 30 years, Japan would go into recession, but the Australian economy would experience an unparalleled period of economic growth and would be one of the strongest growing economies in the world.

You would have booed me off the stage. Even if you had believed the first prediction, you would likely have questioned how the Australian economy could continue to grow in such an eventuality.

My intention this evening is not to dwell on the past, or the accuracy of forecasters, but to look to the future and, more specifically, say a few words about the current account deficit and the impact of tax reform on the short-term outlook for the economy, particularly inflation.

But before doing that, it is worthwhile to briefly re-cap on where we have come from and where we are today.

Australia has successfully weathered the Asian financial crisis. Indeed, Australia has grown by over 4 per cent in each of the past two years – growth rates that have been the envy of the world.

What we have seen is an Australian economy that has not only been stress-tested by the international financial crisis, but has come through with flying colours.

Australia has moved into a new era of strong growth and low inflation that has not been experienced since the so called “golden age” of the 1950s and 60s. But remember, the 1950s and 60s were decades when Australia faced a very supportive international economy and not a severe regional crisis.

The Australian economy today is one in which the private sector is better able to make soundly based investment decisions, which result in resources going to productive uses. In short, we have lifted the productive potential of the Australian economy. We can produce more for any given level of inputs.

This has resulted in incomes and living standards of Australian families rising strongly, and almost half a million jobs created in the past three years. While unemployment is still too high, it has fallen to around 7 per cent, its lowest level in almost ten years.

Why has Australia weathered the Asian storm so successfully? Because of a coherent, targeted and integrated policy framework. In particular, the prudent management of monetary and fiscal policy, a soundly based regulatory arrangement for our financial sector, and the success of microeconomic reforms, including the Government’s labour market reforms.

One judgement of which I am absolutely sure, is that we would not have been able to weather the Asian storm if we had still been running Budget deficits. If the Government had not moved so decisively to put the Budget back into surplus before the onset of the Asian crisis, the outcome would have been awful to contemplate.

But of course, the challenge of good economic management is never completed. We must maintain policy discipline if we are to continue to foster the low interest rate environment which has been so supportive of domestic demand, and allowed the exchange rate to adjust fully in support of our export and import competing sectors.

So, after a number of years of growth of 4 per cent plus, what do recent indicators say about the economy? The June quarter National Accounts clearly indicate that there has been some moderation in growth. We all know about the volatility in the quarterly estimates and the 0.2 per cent growth in the June quarter probably overstates the extent of the moderation. But average quarterly growth of around 0.8 per cent in the first two quarters of 1999 is probably getting closer to the mark.

Significantly, the moderation in growth is very much in line with the forecasts presented in the 1999-2000 Budget. At Budget time we forecast that economic growth would moderate over the course of 1999, reflecting the impact of continued below trend growth in the world economy, particularly on business investment. In fact, the Budget forecast was for growth in business investment to be flat in 1999-2000. But remember, this comes after six years of strong growth that brought business investment as a share of GDP to around historical highs. So the moderation in business investment evident in the recent June quarter accounts comes as no surprise.

Looking further out into 2000 and beyond, we expect the domestic economy to pick up as the international economy improves and we see the benefits of the Government’s tax package. Since the Budget we have seen improvements in world economic activity and we expect that this will continue into 2000-2001. The global economy in 1999 is being led by continued strength in the US, a modest turnaround in Japan and recoveries in Asia. While the US can be expected to ease back in 2000, world growth is likely to be supported by a pick-up in Europe and a further improvement in Asia. In fact, the world economic environment is perhaps looking a little stronger than we had expected at the time of the Budget.

I will elaborate a little further on the impact of tax reform on the short-term outlook, but before doing so, let me say a few words on the issue of the current account deficit.

The inevitable consequence of Australia growing considerably faster than many of our export markets is a rise in the current account deficit. In line with Budget forecasts, Australia’s current account deficit widened over the past year to be 5 per cent of GDP in 1998-99, peaking for the June quarter at 6.2 per cent of GDP.

The rise in the current account deficit comes as no surprise. It reflects the combined effect of weak export prices, weak world demand, and a strong domestic economy. In the past year, Australia’s terms of trade fell by 5.1 per cent, as export prices fell. Combined with low commodity prices, exporters have had to accept large falls in contract prices for bulk commodities, as a consequence of the Asian downturn and recession in Japan. Elaborately transformed manufactures have been particularly affected by the Asia crisis and export volumes fell by 2 per cent in 1998-99, as they are more sensitive to changes in income in the countries of destination. Given this situation, it is impressive that export volumes in total increased in 1998-99, if only by 1.7 per cent.

While export prices fell, domestic demand was strong – a combination of low interest rates, strong employment growth and in more recent times, strengthening confidence. The alternative to a rise in the current account deficit in 1998-99 would have been for domestic demand to plunge and a sharp fall in economic activity and rising unemployment. It is worth remembering that the crisis economies in Asia recorded current account surpluses during the depths of their troubles, not as a result of an improving export performance, but because of plunging economic activity and in turn a sharp fall in imports.

The moderation in domestic demand growth forecast for 1999-2000 will flow through to a moderation in import growth, while stronger world growth should allow exports to pick up.

But of course the size of the current account deficit alone is not the key issue, it is whether it is sustainable. When judging the sustainability of the current account deficit, it is the general policy environment that is the distinguishing criteria.

As far as the current account is concerned, there is no room for complacency. It is critical that a sound policy framework be sustained and enhanced if investor confidence in Australia is to be maintained. It is therefore important to proceed with reform, including tax reform, to enhance the climate for investment in Australia. If our economic climate is conducive to long-term productive investment and if our tax and regulatory regimes are not distorting choices, then private investment with sound returns should add to sustainable growth and stability, not detract from it.

We have not, at any stage, been complacent. Our reform agenda has been massive and continues unabated. Let’s take a bit of a stocktake of the past three years. The Government has had clear aims of:

  • putting the Budget into surplus;
  • pursuing a medium-term objective for fiscal policy;
  • locking in accountability and transparency in fiscal policy through the Charter of Budget Honesty;
  • re-enforcing the independence of the Reserve Bank;
  • increasing competitive disciplines through on-going Competition policy reforms and privatisation;
  • accelerating the move to enterprise bargaining and improving labour market programmes;
  • introducing a major package of reforms to the financial sector which have ensured sound corporate governance and prudential supervision; and
  • introducing landmark reform of the taxation system.

This is co-ordinated and comprehensive policy.

I would like to turn now to the issue of the impact of tax reform on the economic outlook.

The introduction of The New Tax System is a landmark achievement designed to improve resource allocation, reduce compliance costs and avoidance and increase incentives to work, save and invest. As such, it will contribute to an improvement in the economy. But I will direct my comments this evening not to the long-term benefits that tax reform will bring to Australia, but its impact on the short-term economic outlook.

The New Tax System will provide a fiscal stimulus to the economy but, as I have already outlined, this is coming against the background of some moderation in economic growth and a low inflation environment. It is the impact of the fiscal stimulus and an improving international environment which leads me to predict that we will see some strengthening in growth in 2000 and beyond.

More immediately, there will be some change in the composition of growth as some expenditure is brought forward and some deferred. On balance, the overall effect of the tax reform package on economic activity during the transition phase to the introduction of the GST on 1 July 2000 is likely to be slightly positive for growth in 1999-2000 in through-the-year terms.

Turning to the impact on inflation – in advance of the introduction of the GST, there are two aspects of tax reform that will have a bearing on the CPI, and indeed, have already started to have an impact.

The reduction in Wholesale Sales Tax rates from 32 per cent to 22 per cent on 29 July reduced the price of a range of consumer items, such as stereos, TVs, watches, etc. This will put downward pressure on the CPI. In the December quarter there will be offsets to this downward pressure from higher tobacco taxes.

The introduction of the 10 per cent GST will result in a one-off change in the price level and the major impact on the CPI will be felt in the September quarter 2000.

The precise size of this impact in the September quarter will depend in part on a range of timing issues. For example, for items which are expected to fall in price, there may be some price discounting by wholesalers and retailers in the June quarter, ahead of the GST tax changes.

The extent to which lower production costs resulting from the new tax arrangements will flow through to retail prices in the September quarter will also need to be taken into account.

In contrast, in the quarters following the September quarter 2000, there are likely to be some very low CPI outcomes as some of the indirect effects of the tax changes flow through. These include reductions in business tax costs, as wholesale sales tax costs currently embedded in the production chain are eliminated, and as new arrangements for reduced diesel and State tax imposts begin to feed through the system.

So, taking all the offsetting effects into account, the first year effect of The New Tax System will be below the effect flowing through in the first quarter of 2000-2001.

The Government will be making estimates of the likely size and timing of these various direct and indirect effects on the CPI, and preliminary forecasts for 2000-2001 will be released with the Mid Year Economic and Fiscal Outlook, likely to be published in November.

In looking at the longer term effect of the GST package on prices, there are a number of influences that need to be recognised.

First, as already noted, the direct effect of the GST will be partly offset by other elements of the package such as the removal of and reduction in the wholesale sales tax, diesel excise and State taxes. And while most of the GST effects will be up-front, some of these offsetting effects will take time to flow through fully.

The benefits of reduced costs to business from the removal of wholesale sales tax embedded in production costs will not be immediate, but will take several quarters to flow through into retail prices. Some effects, such as the introduction of input tax credits for business purchases of motor vehicles and the abolition of the Financial Institutions Duty will also take time to flow through.

Thus, the longer-run effects of the GST on prices will be much lower than the initial effects.

Second, the implementation of the GST package will result in “first round” increases in the level of prices, but there are likely to be few if any “second round” effects that would result in the package feeding into ongoing inflation.

The extent of any second round effects will, of course, depend on the degree of competition in the market place as well as the extent to which there are any wage claims that seek to compensate for the price increases.

The Government believes the strong competition that now characterises the Australian economy will ensure that there is no profiteering in this implementation phase and that the offsetting savings in the package are passed on to consumers. The Australian Competition and Consumer Commission has been charged with ensuring that the price rises faced by consumers are appropriate and it has already taken steps to ensure that consumers will be treated fairly.

Wage developments will be an important consideration during this period, and the Government has designed the package to include tax cuts and other measures such as increased pensions that will more than compensate consumers for the overall increase in prices. Thus, there is clearly no basis for any increased wage claims to compensate for price increases.

Taxpayers will receive around $12 billion a year in personal income tax cuts from 1 July 2000. The tax cuts arise from a combination of lower marginal tax rates and higher tax thresholds.

All taxpayers will receive a tax cut and almost 90 per cent of taxpayers will face lower marginal rates. Importantly, over 80 per cent of taxpayers will face a marginal tax rate of 30 per cent or less. All in all, the tax cuts constitute the largest personal income tax cuts in Australia’s history.

By way of example, from 1 July 2000 a person on male total average weekly earnings will take home around $1325 per annum or nearly $25.50 per week more than under the current tax system. This is equivalent to a wage rise of over 5 per cent under the existing tax system.

Families also benefit significantly from the new tax system through large increases in assistance, greater choice, simplification and a significantly improved interaction between the tax and social security systems. The families package builds on the Family Tax Initiative introduced by the Government in 1997 which provided increases in the tax free threshold for families.

Under The New Tax System, these tax free thresholds for families will be effectively increased further by the increases in payments. The families package will benefit more than two million families at a cost of around $2.4 billion a year.

A single income couple earning $29,000 with one child aged under 5 years will have a total increase in take-home pay of over $3,000 a year – around $800 a year in tax cuts and around $2,200 a year in increased family assistance – or more than $58 a week.

We should also not forget the generous compensation arrangements for pensioners and allowees. The Government will increase all pensions and allowances by 4 per cent from 1 July 2000. The 4 per cent increase is made up of a guaranteed 2 per cent real increase, as well as a 2 per cent component that represents an advance on future CPI increases.

For pensioners, the 4 per cent increase will be paid as a pension supplement on top of the base pension. Furthermore, these arrangements are in addition to the Government’s legislated commitment that the base pension will continue to be at least 25 per cent of Male Total Average Weekly Earnings.

As I have said, we are in the process of landmark reform of our tax system – one which will produce many benefits to the Australian economy – and its implementation is well under way.

The Government has made available $500 million to assist small business, charities and education bodies prepare for the GST. This assistance is being provided through:

  • An education program on business skills for The New Tax System ($40m);
  • Assisting key industry and professional organisations such as farming groups to deliver information and assistance to their members ($130m);
  • An ‘adviser education’ program to increase the number of people able to train others to provide advice on business skills and the GST ($7m); and
  • Direct assistance to individual enterprises to prepare for the GST ($320m).

In addition, I recently announced that the Government would legislate to provide an immediate tax write-off for businesses with a turnover of less than $10 million for GST-related plant or new software purchased before 1 July 2000. The estimated cost to revenue of this measure alone is $175 million in 2000-2001.

But as I have already said, the challenge of economic reform never ceases. We are pushing on with reform to ensure we have a business tax system that provides Australia with the competitive framework necessary to promote growth and investment. And this is the focus of the Ralph Review. The Ralph Report has been taking a considerable amount of my time lately, and that of the Cabinet, and you will shortly be hearing a great deal about it when the Government announces its decisions and releases the Report.

I believe we have a once in a lifetime opportunity to fundamentally reform and improve our business taxation system.

Australia is already recognised as the stand-out economy of the recent economic and financial crisis.

It is important that we maintain the impetus in relation to economic policy. At a time when we have pressure on the current account, it is important that the Government runs a fiscal surplus position, it is important that the Government carries forward its structural reform in relation to tax and it is important that the Government makes sure we have a non-distortionary economic investment climate.

We must take full advantage of this opportunity to build on our strengths and further enhance our economic performance. As I said in the Budget speech earlier this year, “The next decade could be a special one for Australia.”

Thank you.