Commentary no.

: 2

Title of Article : Federal budget will bring forward tax cuts as part of coronavirus
response

Source of Article: https://www.abc.net.au/news/2020-10-05/federal-budget-to-backdate-

tax-cuts-to-july/12732534

Date article published: 5 October 2020

Date commentary written: 6 February 2021

Section of syllabus: Unit 2 Macroeconomics

Word Count: 740 words

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Federal Budget will bring forward tax cuts as part of coronavirus response

By political editor Andrew Probyn and political reporter Stephanie Borys

Posted Mon 5 Oct 2020 at 1:21pm, updated Mon 5 Oct 2020 at 9:03pm

Treasurer Josh Frydenberg will unveil the changes in Tuesday night's Budget.(ABC
News: Matt Roberts)

Millions of Australians will have more money in their pockets within weeks, as the
Federal Government plans to bring forward and supercharge tax cuts in Tuesday's
Federal Budget.

Key points:

• The Budget will bring forward income tax cuts scheduled for 2022
• The plan will cut taxes for anyone earning more than $37,000
• The Government hopes the extra money will lead to spending and kickstart the
economy

The ABC understands Tuesday's Federal Budget will confirm tax cuts, scheduled to
start in July 2022, are being brought forward and backdated to July this year.

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The Government hopes the cuts will take effect by month's end, injecting up to $12
billion into take-home pay in 2020-21.

Under the plan, the upper limit of the 19 per cent personal income tax bracket will rise
from $37,000 to $45,000 and the 32.5 per cent marginal tax rate upper threshold will lift
from $90,000 to $120,000.

The tax plan means people who earn between $45,000 and $90,000 will take home an
additional $1,080 this financial year.

Workers who earn more than $90,000 will take home up to $2,565 extra, with people
earning more than $120,000 receiving the maximum benefit.

With Labor not expected to oppose the move, the Government believes the new tax
scales could be in place within as little as two weeks.

But by that stage, four months of the financial year will have passed — which means
four months of notionally lower taxation for millions of workers.

To address this, it is understood the tax cuts would be built into the last eight months of
wages.

For example, a worker on $85,000 would be entitled to $42 extra a fortnight over 12
months, but will instead get tax relief of about $63 each fortnight for the remainder of the
financial year, before it drops back to $42 in 2021-22.

A worker on $140,000 who would be entitled to $99 extra a fortnight would instead keep
about $148.

The low and middle-income tax offset, currently worth $255 for a worker on $37,000 and
$1,080 for those earning between $48,001 and $90,000, will also remain.

The Federal Government hopes Australians will spend the additional cash, to offset the
economic activity lost through international border closures, local COVID-19 shutdowns
and consumer caution.

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Treasurer Josh Frydenberg has previously outlined why the Government believed
bringing forward tax cuts would be a good idea.

"We are looking at that issue and the timing of those tax cuts because we do want to
boost aggregate demand, boost consumption, put more money in people's pockets, and
that's one way to do it," he said in July.

The changes will put more money in the pockets of millions of workers.(ABC News:
Brendan Esposito)

But recent data has shown households have saved more than usual due to uncertain
times.

In its pre-budget report, Deloitte Access Economics said tax cuts are fair and that
bringing them forward was wise, however it questioned whether people would spend the
money.

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The report also pointed towards other effective stimulus measures such as
infrastructure and generous unemployment benefits.

Labor backs the Government's stage two tax cuts but is yet to throw its support behind
stage three.

"For some months we have said that we have got an open mind to tax cuts for workers
on low and middle incomes," Shadow Treasurer Jim Chalmers said.

"We have raised concerns with stage three of the income tax cuts, stage three is the
least responsible, least affordable, least fair, and least likely to be effective because
higher income earners aren't as likely to spend in the economy as workers of more
modest means."

One of Australia's key welfare groups has outlined its opposition to the tax cuts and has
argued for other measures to be considered instead.

The Australian Council of Social Service's chief executive, Cassandra Goldie, said
further welfare support was needed, which would instead help the economy.

"To grow more jobs — a key part of that is demand, is consumer expenditure and every
economist is very clear that the dollars provided to people on the lowest incomes
through the social security payment system, Jobseeker, and other key social security
payments is the best expenditure the Government can do when it comes to putting
additional dollars into the hands of people who will spend it," she said.

The JobSeeker payment is in place until the end of December and the Government has
said that it will reassess the fortnightly payment later this year, well after the Budget is
handed down.

The final stage of the tax cuts plan is set to be introduced from July 2024. It would
abolish the 37 per cent marginal tax rate, creating a 30 per cent tax rate for all money
earned between $45,000 and $200,000.

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The ABC understands Tuesday's Budget will not change the timing of stage three, but
the Government may revisit the matter next May.

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Start of Commentary

The Australian government plans to bring forward tax cuts as part of COVID response
measures, benefitting those who earn above $37,000.The tax cuts are part of government
intervention to raise aggregate demand during low economic activity.

Fig.1: ADAS model depicting Australian economy

Keynesian AS
GPL

Pe

AD2

AD1

Yf
Ye1 Ye2 Real GDP

Due to COVID-19, consumer demand for goods and services in the economy decrease
as they spend less due to the uncertainty surrounding their job security and therefore are
more inclined to save for hard times due to less disposable income. There is less
expected returns on investment due to the decreased level of business confidence during
economic downturn and a decrease in willingness to invest across all rates. Net exports
see a decrease as international border closure due to COVID restrict movement of both
imports and exports across Australian borders. Due to a decrease in C,I, and X-M
components of AD, AD falls to the current AD1.

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Decreasing personal tax and marginal tax income rates are one way the Australian
government hopes to increase injections into the economy. Australian households will
have increased household disposable income and purchasing power, and Australians will
spend more on goods and services in the economy, increasing consumer expenditure.
Consumer expenditure forms a part of aggregate demand, which increases from AD1 to
AD2 with reference to Fig.1. Real GDP thus increases from Ye1 to Ye2, indicating actual
growth. Considering the presence of excess spare capacity due to COVID-19, when the
economy operates at the horizontal segment of the AS curve, there will not be any
increase in general price levels at Pe due to low competition and therefore no additional
cost for excess spare resources.

Fig. 2: Unemployment model depicting Australia’s labour market

Higher spending on goods and services in the economy creates additional demand for
goods which stimulates firms to increase output, so there is an increase in derived
demand for factors of production from ADL1 to ADL2. This causes a decrease in cyclical
unemployment from Q1Q2 initially to Q3Q4, as more labour is required for production of

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more goods. More people who are available for work and are actively looking for a job will
be employed to fulfil the rising consumer demand.

Other than bringing forward tax cuts, the Australian government also stimulates AD by
increasing capital expenditure such as on infrastructure, which forms a part of
government expenditure. There is a greater level of certainty that aggregate demand will
increase and may increase by a larger extent as both tax cuts and offsets as well as
government expenditure in infrastructure are direct instruments of demand management.
The Australian government can be reasonably certain that Australians will spend more to
boost the current low aggregate demand in order to pull the economy out of a recession.

However, these measures take a longer period to implement as government spending is

pre-planned and to change may encounter much bureaucratic red tape, thus may not be
the most effective solution when a more immediate method to alleviate economic
recession is required. By providing additional support for social security services and
unemployment benefits, Australians will feel financially secure to spend the additional
disposable income and are more likely to do so. This cushions the decrease in consumer
expenditure and as the government redistributes income to vulnerable groups, who will
spend on rent and household items which are goods and services produced in the
economy. This also improves equity as low or no-income group will have a minimum level
of income to support their basic needs.

Another concern for the effectiveness of this policy is if Australians choose to save
disposable income to prepare for uncertain times where there are still possibilities of job
layoffs and unemployment. This increases withdrawals from the economy which are not
spent as consumer expenditure, and therefore the extent of increase in aggregate
demand may be less than expected, so the relative sizes of consumer expenditure and
savings, and thus effectiveness of raising AD, are uncertain.

Overall, the Australian government could assess the trade-offs which occur during the
implementation of the tax cuts and maintenance of tax layoffs. The effectiveness of tax
cuts are likely to increase in the long run as consumer confidence picks up with
vaccination for COVID-19 taking place. The best solution could involve a multi-pronged

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approach of boosting consumer expenditure and government expenditure. Possible
trade-offs include administrative costs, long implementation periods, or inaccuracies in
estimation of services for the unemployed and for social security. The government would
have to decide which priority takes precedence and incur the cost of subsequent tradeoffs.

(740 words)

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