Treasury has estimated the redesigned stage three tax cuts would add just 0.1 percentage point or less to annual price increases – too small to affect the trajectory of inflation.
Treasury analysed how the government’s proposed changes to the distribution of the tax cuts – with those on higher incomes getting less, and lower incomes more – would affect consumption, along with other areas, such women’s participation in the workforce. It deemed the changes to inflation to be small.
Tax receipts would grow by $1.3bn in 2024-25, and increase by about $28bn over the decade to 2034-35, compared with the original version, Treasury modelling showed.
Guardian Australia understands that it was on the basis the demand effects were assessed to be minimal that Treasury did not plug the full suite of numbers into its main macro models. The Reserve Bank, too, is not expected to adjust its forecasts for inflation when it updates its predictions on 6 February.
Treasurer Jim Chalmers told ABC’s RN Breakfast on Thursday that the government had consulted the RBA governor, Michelle Bullock, as had the Treasury secretary, Steven Kennedy.
“[Bullock] has indicated to us that she does not expect what we’re proposing today to alter the Reserve Bank’s forecasts or expectations for inflation,” Chalmers said.
“I’m going to release in full the Treasury advice that we were provided in coming to this decision,” he said. “I’ve got it in front of me and it says very clearly the redesign of the stage-three tax cuts will not add to inflationary pressures.”
As reported on Wednesday, economists don’t expect the revisions to be large enough prompt the RBA to alter its interest rate plans in 2024 or beyond.
Guardian Australia understands both Treasury and the RBA determined the changes were not going to stoke pressure on prices because the total cost to the budget of the cuts was unchanged. The expected $20.7bn tax cut had been factored into models used by both organisation since it was legislated in 2019.
However, the redistribution of that cut so that those earning less than about $146,000 a year would receive a larger tax cut while those earning more would get less. Since those earning less typically spend more of any tax relief, there will be some extra demand in the economy.
It is understood Treasury was first asked by the government to start considering changes to Stage 3 around Christmas. Prime Minister Anthony Albanese gave his first media conference on 3 January, where he called on treasury and the finance department to provide ideas for easing cost of living pressures.
Among the work done was the first modelling of how stage 3 would affect participation in the labour market, filling a gap from the previous government.
Treasury determined that the difference between the tendency of middle income earners to consume and that of high income earners was too small to have an inflationary impact.
Jonathan Kearns, who was the RBA’s head of domestic markets until joining Challenger as chief economist a year ago, said it would probably “take an analyst half a day to make a back-of-the-envelope” estimate about the cuts’ inflationary effect.
In Treasury’s case, the modifications could be factored into a fiscal model and also one for the wider economy, Kearns said.
“It’s obviously a political decision” for Treasury not to run the model even if the aggregate effect on prices is likely to be “pretty small”, he said.
Warren Hogan, chief economist for Judo Bank, said it would be “surprising” Treasury hadn’t done specific modelling for inflation.
“[It] suggests this has all happened in the past few weeks,” Hogan said. “As an experienced economists, one can do the simple arithmetic on the impacts on consumption and domestic demand pretty easily and quickly using a few plausible assumptions about propensity to consume and save at different income levels.”
The RBA declined to comment.
In the advice released on Thursday, Treasury said the redesign “will not impact the inflation outlook”.
Inflation was projected to decline to 2.75% by June 2025, the advice shows, which would be well within the RBA’s 2% to 3% target range. The RBA will release its updated forecasts on 6 February, and may amend its prediction inflation will only slow to below 3% towards the end of 2025.
According to its fiscal modelling, the tax cut rejig will boost tax receipts in the 2024-25 year by $1.3bn. This addition, though, would be reversed to produce a $1.3bn reduction in receipts in the forward estimates to 2027-28. By 2034-35, the budget would be “around $28bn” better off over the decade than if the original policy remained.
There will also be a “small improvement” in bracket creep for the first seven income deciles over the next 10 years. “Under the recommended redesign, average tax rates for higher-income earners are still significantly reduced compared to a no change in taxes scenario but by less than under Stage 3 [as legislated],” the advice said.
More women and those with lower formal education would also be encouraged into the workforce, the advice states.
“Women have lower labour force participation rates and, when employed, are more likely to work part-time,” the advice notes. “When faced with the same percentage change to after-tax wages, women – particularly women with children – are more responsive in the amount they work compared to men.”
“The redesign is expected to produce a larger increase in labour supply, driven by increases in hours worked and participation of women with taxable income between $20,000 and $75,000,” the advice states. “Overall, the recommended redesign sees an increase in labour supply of about 930,000 hours per week (0.25%), more than double Stage 3. Female labour supply is expected to increase by 0.37%.”
Judo’s Warren said that it was important that the package was “broadly revenue neutral”.
“It has positive implications for labour supply, for example, which people often don’t factor into their thinking about this question,” he said.
Kearns said it was clear that online interest in the tax cuts began picking up over January, with almost 10 times as many searches in the past week as in December.
Investors, though, don’t expect the tax changes to be significant when it comes to what the RBA decides to do with interest rates. “If the stage-three tax cuts were expected to have a significant inflationary impetus then we’d expect to see expectations for the cash rate increase relative to those for the [US] Fed Funds rate, and there isn’t evidence of that.”
Brendan Rynne, KPMG’s chief economist said the assessment the policy changes would be “cost-neutral” was “optimistic”. His initial analysis suggested there was “a risk it could cost more than the government is assuming”.
“The changes are likely to be marginally more inflationary than the original stage 3 proposals, due to income shifting from higher income taxpayers (who are net savers) to lower income cohorts (net spenders),” Rynne said. “Inflation is already coming down fairly quickly – business surveys are showing this ahead of official data – so the danger is that by stoking aggregate demand, cost of living pressures will continue longer.”
KPMG estimates the total cost of the package – including the amendments – to be between 0.5%-0.7% of GDP, and so it would be stimulatory for the economy.
Luci Ellis, Westpac’s chief economist and formerly the RBA’s head economist, said “while the changes this week alter the distribution of the benefits, the macroeconomic impact of this – relative to the package as originally announced – is marginal”.
“We do not expect that this will affect the RBA’s view of the inflation outlook or the future path of the cash rate,” Ellis said.
-with Paul Karp
