Is Australia ready for the income support cliff?

With the 6 October Federal Budget only days away, the Government faces a challenge of how do they balance the tapering of fiscal support while targeting to lift economic activity?

COVID-19 has caused such upheaval that policy makers have been left without a tried and tested strategy for how to boost aggregate demand and stop the economy derailing. 

What the Federal Government wants to do is create sustainable economic conditions so that businesses and households no longer need direct support. The reality is Australia is facing an economic cliff if the income support used to weather the initial crisis is withdrawn too quickly.

There’s no rule book for what to do, but past principles hold true: that the immediate response be, as Treasurer Josh Frydenberg says, “timely, targeted and proportionate”; and that as the initial shock passes, focus turns from support to recovery and reform.

It is no easy task – a balancing act where timing is critical and complicated by ongoing restrictions placed on economic activity. Withdrawal of the current crisis response stimulus means Australia faces an income support cliff, at a time when an insolvency cliff, productivity cliff and construction cliff also loom large. It means the Government needs to consider the creation of policies that enable support to be tapered, while lifting economic activity.

EY modelling suggests that a mix of policies, including personal income tax cuts, maintaining a higher JobSeeker payment rate and infrastructure spending, would be effective. Fiscal spending of about $60billion over the next two years could lower unemployment by about 1 per cent.

Key to recovery is supporting private consumption, which accounts for nearly 60 per cent of economic activity. The balance of household income and savings is delicate at a time like this. It is also complex. Households need to feel good about their future income prospects and job security to spend, and business needs to benefit from that spending to feel comfortable investing, growing and hiring.

The initial fiscal response did its job in cushioning household income – in fact, it did such a good job that despite higher unemployment, falling wages and Australia’s first recession in nearly three decades, household disposable income rose in the June quarter. Assistant Reserve Bank Governor, Guy Debelle described it as “quite a remarkable and highly unusual outcome”, noting normally recessions see incomes fall in line with declining output and job losses. Household disposable income rose 2.2 per cent last quarter and 8.2 per cent if we count early access to superannuation and rent and mortgage holidays as income.

Despite the income boost, household consumption fell by just over 12 per cent in the June quarter. Because of a mix of restricted movement in lockdown and a boost in precautionary savings, households saved $1 in every $4 of disposable income in the June quarter. What the Government needs to work out, is how to get households spending again. 

But confidence is fickle, and difficult to lift while the economy is under so much pressure. In the meantime, directly supporting household income is important, it feeds through to the economy and ultimately helps lift confidence. When confidence is weak, though, household income support is most effective when targeting low- and middle-income earners.

Direct support in the form of a $750 cash payment has been repeated in the September quarter, targeted at that demographic. Combined with the higher rate of JobSeeker, an additional $15 billion of superannuation being drawn down and some ongoing rent and loan deferrals have supported spending.

Data from the banks confirms spending for services and consumer goods is happening, with much of it being on food, furnishings and household equipment, which is no surprise given the periods of lockdown, with spending up between 1 and 5 per cent in mid-September compared to a year ago.  ABS retail trade data shows spending in July was 10.6 per cent higher than in February, prior to COVID-19.

Analysis by ANZ of their own card spending data in the report ANZ data: spend jumped for younger support recipients 8 September 2020 shows how effective well targeted income support is to boost spending. It found recipients of the second $750 payment increased their spending by 23 per cent in July compared to same period last year. While younger recipients, aged under 30, increased their spending by more than half year-on-year.  Non-recipients, in contrast, only saw a 2 per cent year-on-year increase.

What income cliff?

However, a steep income cliff is coming, possibly big enough to derail economic recovery. With no further $750 support payments scheduled, the COVID-19 supplement for JobSeeker reduced to $250 a fortnight, and fewer loans being deferred, there is a real possibility that households will topple over an income cliff.

Removal of direct stimulus means household incomes will be around $23 billion lower in the December quarter than in the September quarter, roughly equivalent to 9.5 per cent of household consumption.

Can we avoid toppling over the cliff?

Treasurer Josh Frydenberg will deliver the Government’s federal budget on 6 October. That needs to do four things for households:

1. Ease the income cliff to avoid an income recession;
2. Support aggregate demand to create jobs and lower spare capacity in the labour market;
3.  Support the most vulnerable;
4. Create an environment where consumer confidence can rebuild.

There are a variety of levers the Government can pull to do that. Both parties have agreed income tax for middle income earners should be reduced in the future, and these can easily be brought forward from the legislated 1 July 2022 start date. It would equate to a boost of about $6-7 billion in after tax income for FY21, which has the same effect as a wage rise, something we’re unlikely to see otherwise in the year ahead.

But, the data shows it is low income earners who inject more of any direct cash benefit they receive from the Government, and they won’t benefit from this policy change at all. In other words, it provides a boost to disposable income among those who have the ability to save, and in the current environment are likely looking to build financial buffers.

EY modelling suggests that compared to the pre-COVID-19 savings rate, the current level of savings in the economy makes those tax cuts about half as effective for stimulating additional household consumption. 

Having said that, there seems little downside in bringing forward tax cuts that are already legislated. Some of the income boost will be spent, there could be a confidence kicker, and those households that save will be improving their balance sheets which is a positive for future growth. In addition, those with higher disposable incomes are more likely to assist the rebound in sectors most adversely affected by lockdowns in the tourism and hospitality sectors.

Stimulating near and long-term spending

A key component of the recovery phase is the need to boost aggregate demand through direct Government spending in the economy – either recurrent spending, for example health services, or investment, such as infrastructure. Public policy can also be used to encourage private spending in the economy. Higher aggregate demand feeds through to jobs, which further supports household income. Easing the income cliff, however, requires immediate, and more targeted economic support

A key factor in the looming income cliff is that on current policy JobSeeker payments are scheduled to return to the pre-COVID-19 level of $40 a day at the end of December. One option to ease the income cliff would be to extend the COVID supplement, keeping JobSeeker at a higher rate than the old Newstart. The issue of what rate it should be set at permanently is not considered in this report and is a complex balance of support while maintaining an incentive to work, and is a structural impost of the fiscal accounts.

Extending the higher rate would be among the most effective options to help economic recovery because as ABS data shows, low income earners don’t tend to have the luxury of saving the support they receive. It is targeted, timely (and can be temporary). According to ABS’s 2015-16 Household Expenditure Survey the gross savings rate for the median household earning $84,000 annually (gross), was 15 per cent. In contrast, the gross savings rate for the median household earning $49,000 is just 8 per cent, and for those in the lowest income quartile, the savings rate is negative. That means, these households spend more than they earn – in 2015-16, the median household in the lowest income quintile consumed about $28 a week more than they earned, or $1,500 a year. 

Additional direct payments

Another $750 support payment would also be an effective option to help smooth the income cliff– it is temporary, timely and targeted at those most likely to spend. The evidence suggests it was successful in April and July. If we conservatively assume 90 per cent of such a payment is spent, a further $750 payment to the five million Australians who received the second round, could push $3.4 billion into the economy in a timely way.

Alternatively, a voucher scheme could work to boost spending in those industries that have been directly impacted by restrictions, like the UK’s ‘Eat Out to Help Out’, Singapore’s ‘SingapoRediscovered’ or even a national version of Tasmania’s ‘Make Yourself at Home’ scheme. Not only does a voucher translate into direct spending, unlike cash which can be saved, but it’s also likely to lead to an additional boost as people top up the value of their voucher.

Long term demand

Ultimately the Government needs to consider how to support aggregate demand in the economy, which is what will drive jobs and relieve the need for household income support measures, which are expensive.

There are a variety of ways policy can do this but public investment – notably infrastructure - is the Federal Government’s strongest recovery option; analysis by the IMF, OECD and Treasury all suggest direct investment has the largest economic multiplier – or the anticipated change in GDP per dollar spent - among the presented options. It’s clear there will be infrastructure measures in the budget, it’s a question of size and type. 

But, there is strong evidence that during an economic downturn, and with monetary policy reaching its effective-lower bounds, all forms of fiscal stimulus become more effective at stimulating aggregate demand. And we do expect a range of levers to be pulled in upcoming federal and state budgets.

Low interest rates open policy choices and we know that the economy will be weaker and unemployment higher without additional fiscal stimulus.

EY modelling looked at the impact on unemployment of bringing forward Stage 2 personal income tax cuts; extending the additional $250 JobSeeker payment; and an additional $40 billion of infrastructure spending as called for by Reserve Bank of Australia (RBA) Governor Lowe. Each policy drove the unemployment rate below the RBA’s base scenario, and taken together, the estimated $60 billion cost of these three measures over the next two years, could directly reduce the national unemployment rate by around 1 per cent by the end of 2022. Moreover, there could be a second-round boost to consumer and business confidence, which is what is required to get households and businesses to spend and invest, which leads to private sector led sustainable growth.

At current interest rates, the cost of an additional $60 billion (about 13 per cent of GDP) of policy spending would be equivalent to 0.1 per cent of GDP today. An equivalent loan (as a proportion of GDP) following previous recessions in 2009 and 1991 would have needed much higher servicing requirements of 0.5 per cent and 1.5 per cent of GDP respectively. Current RBA settings and commentary suggest that the short end of the yield curve it is expected to remain anchored at 0.25 per cent – or lower – for at least three years and the experience post the GFC is that it takes a long time to raise interest rates. So low interest rates will be a feature for years to come.

Cheap debt does not, however, remove the need to maintain a focus on projects that deliver an economic or social benefit, or in other words, improve productivity or fulfil a future need. Moreover, sustainable future economic growth requires more than just a shift from response to recovery, but also to reform. Productivity enhancing reforms raise the speed limit of the economy, meaning faster job creation and a more resilient economy for the future. 

The COVID-19 economic crisis, is unlike any other crisis Australia has faced in 100 years and will require a proportionate response. Fortunately record low interest rates make tackling the current economic challenge achievable. A mix of policies will be needed when the Federal Government unveils its October 6 Budget, which will reveal unprecedented spending, deficit and debt projections.