Two Budgets, Two Elections and a Rate Cut: A Drama in 3 Acts. / by Adam Howard

Welcome back, trendsetters...

Big few weeks in finance and economics; HUGE!!.  Rate cut, Federal Budget released, a Federal Election called and State Budget released.

Now, I am no expert on these matters, but I've had a few requests for my thoughts about these momentous events and what they mean for the masses.

Well, here it is in a nutshell: 

- rate cut = ridiculously cheap debt;

- Federal Budget = fiddling around the edges, a further hollowing out of the middle class and a step further down the path of income and wealth inequality;

- a Federal Election = OMG.  2 months of this shit???? and

- a State Budget = what happened to all that money we were meant to be making from the mining industry?  And why won't the Feds give us more of the GST pie?

Sorry.  Really.  I'm sorry.  I shouldn't be so cynical. 

I am genuinely interested to see who wins out of Malcolm Turnbull and Bill Shorten as they both try to sell the Australian public the SAME rather ordinary, second-hand Holden Commodore which we all drive around in for the next 3 years.

First, the rate cut.

Monetary policy is the domain of the Reserve Bank of Australia (RBA), where the RBA uses the cash rate to influence other interest rates in the market which, in turn, impacts the behaviour of borrowers and lenders.  The goal is to control inflation within target band of 2-3% (price stability), ensure full employment and maintain confidence in the Australian currency.

Inflation and economic growth are both now below 2%, and unemployment is rising, hence the rate cut.  The Aussie dollar is also still quite high, at around 75 cents US, making our exports a little more expensive than they could be, adding further weight to the reason for the cut.

But the most obvious impact for the 24 million of us out there is that around 20th of May our home loans will get cheaper as the banks pass on all, most or some of that 0.25% cut.

Now, that might not seem like much...0.25%, but when you add it all up, well, it actually produces a big number.

With a debt market of $2.6 Trillion, that means a reduction in interest payments of $6.5 Billion per annum.

The argument is we will all then spend that money; a fuel injection for the engine of the Australian economy.

Nice analogy, huh?

Now, my concerns.

In a $1.6 Trillion economy, $6.5 Billion just does not buy you what it used to.  A rate cut of that size isn't going to solve any of the problems we currently have.  Once again, it just kicks the can down the road, by facilitating the creation of more debt...something we don't really need any more of.

We are also running out of monetary room.  At 1.75%, the cash rate is dangerously close to zero.  Here's some relativity for you.  The cash rate was cut 1.50% during the early days of the GFC.

If the same were to occur now, the cash rate would be at 0.25%.

That might sound great when you think about your home loan repayments, but there are some other factors to consider.

Lower interest rates also generally mean a lower growth rate, which means rising unemployment and flat wages growth.

So, yep, your home loan just got cheaper, but the risk of you losing your job or being asked to take a pay cut also just increased.

What about the Budget?

Well, the two things which I thought were most obvious were the planned reduction in the corporate tax rate from 30% to 25% over the next 10 years, and the changes to superannuation contributions, asset caps and taxes.

The theory is that a cut in the corporate tax rate will actually mean more money spent on stuff by company owners, as they have more disposable income.

It is thought this cut will also fuel more investment for the same reason: more disposable income for company owners.

And finally, paying less tax will leave more money available for owners to pay higher wages, meaning there might be a halt to the "hollowing out" of the Australian middle class.

To counter the argument that this cut will actually just fuel higher corporate profits, the cuts are being introduced over a long period, and are being offered to smaller companies first, with larger companies (measured by turnover and employee numbers) only getting the benefit of the cuts some time down the track.

Concerns?

How does a tax cut pay for itself in an environment of flat growth and an existing deficit?

Once again, the argument is the money that "trickles down" will actually broaden the income base for the government, as that extra after tax profit will multiply as it moves down into the economy, via wage earners, suppliers and others.

This means GST receipts go up, and other income tax receipts go up, cancelling out the initial tax cut.

Will it work?

Well, I have my doubts....and not just because it's easier to be a doubter than it is to be a supporter.

You see, this approach has been tried before in the UK under the Thatcher govenment, and in the USA under the Reagan administration.

Tax cuts at the top end which are meant to trickle down to the larger population.  Unfortunately, it didn't work in either case, with wealth and income inequality growing in both nations.

But, it's cool, right?  I mean, we have been watching Australia slowly get Americanized for a few decades now, and we are usually 10 to 20 years behind them in adopting cultural norms, social policies and economic policies.  So this shouldn't come as any surprise.

What IS surprising is, we have so-called smart people in charge, who see failed policies overseas, but adapt them anyway.

There will be arguments that this is not the same.  You know, the "this time it's different" argument.  But, like I said above, it's just fiddling around the edges and continuing down the path we are already on.

Now, the changes to superannuation.

Super is a little confusing...isn't it?  I mean, I get the idea.  It's savings for retirement, right?? 

And it's meant to supplement, or even replace entirely the Federal Government funded aged pension.

And the whole notion of a super fund vs a self managed super fund is basically a question of whether you want someone to manage your retirement savings for you, or whether you want to do it yourself.

But the details and complexity...oh my god!  It does my head in. 

So, here are the big details.

- Total Super assets in Australia are currently worth about $2 Trillion.

- If we use the long term return on capital of 5% as a default rate, this means those Super assets currently generate about $100 Billion in earnings.

- Super is taxed at 3 stages:  when it goes into the fund, on earnings generated by the fund and when it comes out of the fund.

-  The changes to Super now mean taxes on when you put money into the fund are increasing.

So, a quick summary of what those changes mean:

- the maximum tax free lump sum you can put into your Super account has been capped at $1.6 Million, otherwise you are taxed 15%.  Previously there was no cap.

- there is now a lifetime cap of $500,000 you can deposit into your Super fund from after tax income.   Anything above that is taxed at 15%. 

- the cap on annual concessional contributions has been reduced to $25,000.

I don't know what everyone else thinks, but if you are in a position to do any of the above:  dump $1.6m into a super fund at one time; put $500k extra in discretionary contributions into your super, or put an extra $25k per annum into your super, then you are fairly well off.

The upper end of town is definitely copping some higher taxes there.

So, I regard the above as good changes.

Compulsory super is a great scheme, introduced by the greatest Federal Treasurer of all time, Paul Keating.

BUT, now that super assets and super income have grown so large, it's probably time to change the tax rates for money coming OUT of a super account, rather than at the point the funds go in.

With approx $100 Billion on revenues, an increase in the tax rate from 15% to 20% might also be a good idea.

Anyway, just my idea.  Don't want to upset anyone.

Finally, the State Budget.

At first glance, it's not pretty.  Record deficit of about $4 Billion.  High debt.  Low GST distributions.

But the story isn't all bleak.

Over the course of the last 8 years Western Australia has received a large boost in public assets: Elizabeth Quay, Fiona Stanley Hospital, the Airport Link, Yagan Square and the Northbridge Link, Perth Arena, the under construction Perth Stadium, just to name a few.

So, certainly a lot of the increased receipts from mining royalties have had to be spent on providing this infrastructure.

This is good news, with public assets now worth just under $200 Billion.

In addition, the Perth metro area has also had to cope with an increase in population of between 400,000 and 500,000, and that means much more infrastructure has been needed.  Schools, roads, sewage, power....

More good news.  More people means more spending, which means a wider tax base.

So, if you were to look at the Perth skyline, an aerial view of Perth or view a fly around of some of our new suburbs you would agree, this is good news, and probably money well spent.

Finally, the Budget included an announcement that the freeze on hiring new public servants is over.

Even more good news.  So, all those public servants on expiring contracts should be able to get rid of some anxiety.

To summarise, record debt, record deficit, but all things considered, not bad, right?

Well, I dunno...

I have some issues with timing and appropriateness.

First, appropriateness.

If we go back to the list of public assets that have been built, we need to ask the burning question "Did we really need some of them?"

A new hospital?  Yep.

Better service for our overloaded airport?  Yep.

But a nice harbour?  A cutting edge sports stadium?  I can confidently put them in the "nice to have" basket, rather than the "essential infrastructure" basket.

How about, instead of some of those nice assets, we built a new public high school for the western suburbs?  Or a highway extension from Kalgoorlie to Port Hedland.  Or train lines to the outer suburbs?

And what about timing?

At the very least, large spending on assets like those should come AFTER spending on all other essential assets has been allocated, AND you have money in the bank.

And on timing, let's return to an argument I have discussed before.  Our ol' mate, the witty and urbane economist John Keynes argued for government spending to be counter-cyclical.  So, when the private sector stops spending, the public sector starts spending.

That would mean, in WA's case, that the public sector should be spending big now, but it's not.  It's winding back spending.

The State Government blew the budget too soon and now we are left with a doubly big vacuum.

Troubling....

Finally, let's look at this spending and investment program from the perspective of a household that experiences a sustained period of higher than expected income.

Some households paid off the credit card, made a nice dent in the home loan and put some money in the bank.  Reduced debt, on the basis that they believed this income level was crazy high and might not be around forever.

Other households bought a new car, a beach house and a jet ski, took some cool holidays to Bali and generally had an awesome time.

So, what's true for WA's households is true for our government.

Some households retired debt.  Some households took on more debt.

And when income levels drop, the biggest killer is debt.  If you have too much it becomes increasingly difficult to service that debt.

And THAT'S where the WA State Government now finds itself.

Or Goods and Services Tax (GST) receipts are low.  The lowest in the country.  What this means is that of all the GST collected in WA and sent off the Federal Government, only a proportion is given back to the WA State Government as distributions.  About 30%.

The rationale from the Feds is "Aren't you guys killing it with mining royalties?"

Our response?  "Well, we were, but we blew that dough, and then we had to take a pay cut, which we didn't see coming and, well, we need some more money."

The Feds response?  "Yeah, cool guys.  Soon, but just not right now."

So, now the State Government is actually having to use borrowed funds to meet basic operating costs, while GST receipts fund other states.  Once again, troubling...

Quickly back to my household budget analogy. 

There is a phenomenon called "pluralistic ignorance" where an individuals reject an idea, a suspicion, a concern, but are convinced that everyone else accepts it.

Most households struggle with their finances and family budget.  Most, but not all.

They don't talk about it too much, especially not with other households, because that stuff is private, and you don't want to appear a fool for not being able to take care of your affairs.

But everyone experiences the same concerns.

Well, so do our elected officials.  Just because they are elected officials, with wise minds at their disposal, doesn't automatically make them better at managing the household finances than everyone else.

The Global Financial Crisis and the struggle to recover since should have made that crystal clear.

Food for thought....