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John Quiggin

Commitment cuts too deep

John Quiggin Australian Financial Review

25 October 2007

Disruptive marketing is one of those buzzphrases that float around the air of business schools, and, if they take hold, end up on the covers of the kind of book you buy at airports. The idea is that, faced with a strong incumbent firm, an entrant to a market needs to throw out the rulebook and try to make people think differently about the good or service in question.

It’s a bit of a surprise to see an incumbent using disruptive marketing tactics, but having entered the election campaign far behind in the polls, John Howard had little choice. Rather than saving his biggest single election promise for the traditional policy speech, Howard launched his $34 billion tax cut proposal after announcing the election but before the Parliament had even been dissolved, thereby avoiding the restrictions of caretaker mode, and allowing him to bring forward the release of the Mid-Year Economic and Fiscal Outlook, on which the tax cut policy was based.

Howard similarly changed the rules with respect to the debate, making a unilateral declaration of the terms under which it would be conducted, and saying he would go ahead with and without Rudd. The decision to ban the infamous ‘worm’ measuring audience attitudes came back to bite him, but it was certainly a bold stroke.

The standard response of market leaders to disruptive marketing efforts is to ignore them, and this might well have been the correct approach for Rudd, but Howard’s combination of incumbency and disruption made it a high-risk choice. Rudd agreed to the debate, and, consequently, had little choice but to match Howard’s tax cuts, with the variation that the money allocated in the Howard plan to those on incomes over $180 000 a year would instead be used to provide an education rebate.

Tax cuts on this scale raise a number of concerns. The most prominent has been that tax cuts will increase the risk of inflation, and the likelihood that the Reserve Bank will feel it necessary to increase interest rates. With the bad inflation news announced yesterday, an increase in interest rates before the election is virtually inevitable, but prospective tax cuts can scarcely be blamed for that. The real concern is that a preannounced commitment to three years of tax cuts, with ‘aspirations’ for further cuts will generated a permanent bias towards tighter monetary policy.

The government’s defence is that, given the improved position projected in the mid-year outlook, the tax cuts can be delivered while holding to a stable fiscal policy with a surplus of around 1 per cent of GDP. Having used the government’s estimates, Labor can offer the same defence, with the additional twist that its $3 billion education rebate will promote the development of skills and thereby reduce inflationary pressure. This is a nice debating point, its relevance to the medium term economic outlook is limited. Most of the beneficiaries will still be in school for some years to come.

Looking at the mid-year outlook, the improved parameters that are expected to deliver additional revenue to the government depend to a large extent on the minerals boom. Whereas the budget estimates were based on a projection that commodity prices would return to normal levels over the course of 2008-09 and 2009-10, the mid-year outlook incorporates more optimistic forecasts, in which prices continue to rise through 2008-09 and do not return to normal levels until 2010-11.

Given the longevity of the boom, which has defied repeated predictions of a return to more normal conditions, this seems like a plausible estimate. But a commitment, three years in advance, to large-scale tax cuts ought to be based on more than a plausible estimate.

Even more important is the forecast that government expenditure will decline, relative to GDP. The estimates anticipate a decline in welfare expenditure, relative to the Budget projections, due to continued strength in the labour market, a decline in net capital expenditure, and little or no real increase in public expenditure on goods and services.

After taking out the tax cuts, the projections allow little room to meet the unexpected requirements for additional expenditure that arise in the course of any three-year period, let alone to address the backlog of unmet needs in health, education and expenditure that has built up under the current government. Labor’s decision to match the cuts may have been tactically necessary, but it will create big problems in office, particularly if the optimistic projections of mining boom revenue fall short.

John Quiggin is an Australian Research Council Federation Fellow in Economics and Political Science at the University of Queensland.

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