At budget time each year, governments get a chance to spell out their priorities and map out a preferred pathway to a better future. A good process sees the evidence gathered, policies framed, competing arguments thrashed out and decisions ultimately taken and announced.
The external environment also matters, at times generating unhelpful headwinds or, on occasion, welcome tailwinds. Governments are forced to play the hand they are dealt, and like much in life, success depends on a combination of skill and luck. There will always be surprises no matter how careful the planning.
But sometimes a ‘hiding hand’ is encountered - which throws up new, unforeseen challenges when the original plan doesn’t turn out the way it was intended. These hiding hands can be a blessing in disguise because they force fresh creativity and innovation in solving for the unexpected.
Greater incentive to invest
The main game for Australia right now is to consolidate the recovery in economic growth and ensure that the benefits are widely shared. The budget will be central to this.
Sustaining economic growth is going to depend on investment in one form or another – in physical assets, in knowledge-based human capital and in technological innovation.
As companies look to leverage digital technologies and pursue new avenues of value creation they’ll likely need complementary investments to ensure the full benefits of those technologies are harnessed.
Corporate tax cuts boost confidence
The Government’s Enterprise Tax Plan to lower the company tax rate for all businesses should be supported. Over time, it will provide a boost to the economy from higher investment and, more immediately, because of the positive impacts it will have on business confidence.
The Budget provides an opportunity to support investment in other ways including through better R&D tax incentives and, on the expenditure side, further funding for the economic infrastructure necessary to preserve the liveability of our cities and sustainability of our regions.
Personal tax cuts to support Australian households
The Budget is also expected to detail personal income tax cuts, which would be timely.
Many households have been dealing with rising energy prices and other cost of living pressures, and over the past twelve months there has been no growth in household disposable incomes on a real per capita basis.
This has shown up in cautious consumer spending, which has been one factor holding down Australia’s overall economic growth.
Return to above-trend growth uncertain
Personal tax cuts come at a significant cost to the budget, and some will argue they can’t be afforded – or should be deferred - until the budget has been balanced.
There are good reasons to worry about persistent budget deficits and the national finances do need to be fixed. But we shouldn’t lose sight of the role that stronger economic growth can play in the budget repair task. Basic arithmetic tells us that if the economy grows faster than the rise in debt each year, then the debt-to-GDP ratio must fall.
Personal income tax cuts should provide a near-term boost to consumer confidence and could help jump-start household spending. Prospects for the economy are good, but a return to above-trend growth is by no means assured. Tax relief that feeds the animal spirits could well set in train a virtuous cycle that sees more investment and jobs, with flow-on effects to higher revenues.
The budget will understandably be viewed in the context of the coming federal election. But policy also needs to be set with an eye to the medium-term and beyond.
Tax system needs to adapt to digitisation
The digitisation of society that is unfolding is rich in opportunity but also a key driver of social and economic change. It will be important that we anticipate the challenges that come with this and start to think about the adjustments that will be required. This includes ensuring that the tax system is able to adapt in parallel.
Tax relief offered in the budget will serve a purpose in strengthening activity in the near-term, but over time comprehensive reform of the tax system is needed. To be effective, tax reform also needs to be accompanied by sensible and sustainable spending reform. There will be different views on how best to progress all of this, but a ‘principles-driven’ approach with a clear pathway for reform would be a useful start.
Tax reform requires community buy-in
Major changes to the tax framework require broad community support and buy-in, and this means a system that is unambiguously progressive. The tax system must be capable of raising enough revenue to fund the efficient operation of government, but it needs to do this in a way that is as supportive of economic growth as possible. The mobility of talented people will mean that future wealth creators will be attracted to countries that offer the best conditions and competitive tax rates.
A comprehensive approach to reform that is coherent and consistent is essential because the reality is that tax reform is unlikely to succeed if it is done in small doses.
This year’s budget is being delivered at time when substantial changes are occurring around us – and these changes are unsettling for many people. We can’t predict the future but we do have a sense of the forces that will shape it. And as a nation we hold some very good cards in our hand. We need to play them well.
Chief Economist, EY
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The views expressed in this article are the views of the author, not Ernst & Young. This article provides general information, does not constitute advice and should not be relied on as such. Professional advice should be sought prior to any action being taken in reliance on any of the information. Liability limited by a scheme approved under Professional Standards Legislation.