The Blog of Fleeced

The Australian federal budget is due to be released tomorrow night, and there is an expectation of some form of tax cuts.  The reason expectations are so high include the facts that the budget has a huge surplus, it’s an election year, and inflation is running pretty low.

Of course, the government doesn’t want inflation to get out of hand, because this will put upward pressure on interest rates – a big vote loser in the “mortgage belt” – and everone knows that tax cuts increase inflation… don’t they?  This certainly seems to be the consensus:

• Low inflation prompt tax cuts speculation (ABC)
• Low inflation gives Costello green light for tax cuts (The Australian)

Being one who loves to question conventional wisdom, I’m naturally sceptical.  After all, doesn’t tax increase the price of goods?  Do we really believe that removing the GST, for instance, would result in higher prices?  Why do we believe that reducing income taxes would be any different?  After all, income tax reduces supply of labour (through decreased incentives to work) as well increasing the cost to the employer.  Part (though not all) of this increased cost of production is naturally passed onto the consumer (who also has less take-home pay!)

So… tax causes inflation, but removal of those taxes also causes inflation?  I don’t buy it (and I’m not the only one)

It seems obvious, that if cost of production goes down, then some (though again, not all) of these savings will also be passed on to the consumer – unless the business has no competition (but even in this case, the lower costs and higher potential for profits will encourage new competitors).

It seems that taxes are a multiple-negative: they reduce productivity, reduce savings and increase prices!  Reducing them at every opportunity seems to be a no-brainer.

The treasurer himself seems to (at least partially) recognise this:

“Well the one thing I will say for tax cuts as opposed to expenditures is that by and large tax cuts are generally pro-growth. If you have a choice between spending some more money or cutting taxes by the same amount by and large, cutting tax is pro-growth. They are good things for the economy. They generally give more incentive for work. They generally increase economic growth. Now, some spending can do that but we also know some spending can be wasted. That is clear. Governments don’t always get it right.”

I guess we’ll just have to wait until tomorrow night to see if he puts our money where his mouth his.