Clouds in the Economic Sunshine

Vol. 7, No. 6

SUMMARY

The perception of only "five minutes of economic sunshine" since the 1990-91 recession has considerable validity:

• The recovery is one of the slowest and nowhere near the longest.  Growth per capita has been only slightly faster than in countries which bottomed around the same time.  Moreover, while the unemployment rate came down faster than in most other countries, it started higher and now seems "stuck" at around 8.5 per cent.  Further, the "blow-out" in the current account deficit until recently, and the recent upward movement in wage and price inflation, suggest limits to growth.
• During the recovery, real interest rates increased to a peak (8.7 per cent) which, on past experience, is likely to inhibit growth for the immediate future.  Indeed, rates are likely to remain at levels that add to the discouragement to investment coming from profitability that is now declining before having even recovered to pre-recession rates.  Business investment has recently recovered strongly, but from an all-time low base and to only about its historical average level.  Remarkably, there has been no net domestic saving during the recovery and, while labour productivity has grown strongly, it is unclear that any structural improvement has occurred.
• The quite marked slow-down, starting in mid-1994, suggests growth well below the rate needed to reduce unemployment to 5 per cent by 2000.  Growth in 1995-96 may turn out to be 3 per cent or even less, compared with the Budget forecast of 3.75 per cent, and the need for 4-4.5 per cent.
• An important cause of the slow-down is the perception that the Government would repeat the policy mistakes of the 1980s.  This and the experience of the 1980s have created an increased aversion to risk-taking.

To reduce the clouds, budgetary and monetary policies need to be set in a medium-term framework that provides much more confidence that such policies will improve savings and inflation and, hence, economic growth.

Above all, Governments (and others) need to foster a culture that encourages entrepreneurship and profit rather than focusing on income distribution.  The failure to deal adequately with union opposition to economic reform is a major concern.

Five big clouds -- outmoded industrial relations, high real interest rates, low savings, inadequate profitability, and taxation that is excessive and misdirected -- need to be lifted.  Claims that reforms would have adverse social or other consequences, are misleading or inaccurate -- or both.

INTRODUCTION

There has been much discussion of Opposition Leader John Howard's thesis that, since the recession of the early 1990s, Australians have experienced only "five minutes of economic sunshine" before the economy has again started to slow.  The Government has strongly rejected the thesis that clouds have appeared, arguing that the slowing is in line with policy intentions and is needed to ensure that economic activity is kept at "sustainable" levels. ⁽¹⁾  Indeed, following the release of the June quarter national accounts figures, Prime Minister Paul Keating suggested that "we have got the economy where we want it", and Reserve Bank Governor Bernie Fraser told a Parliamentary Committee on 19 October that "I think we're in better shape than we've ever been".  The Government has also rejected suggestions that recent trends indicate that the 1995-96 growth in gross domestic product (GDP(A)) is likely to be significantly below the Budget forecast of 3.75 per cent, or that unemployment in the June quarter of 1996 will be above the Budget forecast of 8 per cent. ⁽²⁾

Notwithstanding the Government's rejection of the "five minutes of economic sunshine" thesis, however, it is widely perceived as having considerable validity.  Many have difficulty in understanding how the economy could be portrayed as being in such good shape when it has slowed to significantly lower rates of growth than the Government itself acknowledges are necessary to keep reducing unemployment from existing high rates to its 5 per cent target by 2000.  The slow-down in economic growth which has undeniably occurred since mid-1994, the "blow-out" in the current account deficit to levels reached in the late 1980s, the continued high rate of unemployment, and the tightening of monetary and (to a very minor extent) budgetary policies have all added to a level of uncertainty and insecurity already heightened by the experience of the 1980s, the recession of the early 1990s, and the more competitive environment in which both businesses and their employees now operate.  This uncertainty has been further increased in recent times by the Prime Minister's decision to conduct a "phoney" election campaign, which means that the adverse economic effects normally produced by election campaigns will occur over an extended period.

The purpose of this paper is to assess the perception that clouds are indeed blocking the sunshine, by reviewing the economic recovery since the recession troughed in mid-1991, and by examining the factors which have contributed to the slow-down since mid-1994.  It also includes an assessment of the economic outlook on the basis of the Government's existing economic policies, together with suggestions as to how the clouds could be lifted. ⁽³⁾

THE RECOVERY

The Government's claim that the sixteen consecutive quarters of economic growth to the June quarter of 1995 is Australia's "best result in 24 years" is highly misleading.  In particular:

• the recovery has not been the longest period of consecutive growth.  Using trend estimates of growth in GDP (the appropriate measure), the longest period is 33 quarters in the late 1960s and early 1970s;
• the recovery has, since the bottom in the June quarter of 1991, been the slowest of any -- except for the two weak recoveries following the enormous Government-induced real wages increase in mid-1974 (and, in terms of growth between growth-cycle peaks identified by the ABS, ⁽⁴⁾ has been the slowest, averaging only 2.5 per cent per annum between 1988-89 and 1994-95);

  Table 1:  The Sunny Periods

  Trough	Peak	No. of quarters	Average growth per quarter (%)
  Jun 1961	Sep 1965	17	1.45
  Dec 1965	Mar 1974	33	1.28
  Jun 1974	Mar 1977	11	0.73
  Sep 1977	Mar 1982	18	0.84
  Mar 1983	Dec 1985	11	1.41
  Mar 1986	Mar 1990	16	0.97
  Jun 1991	Jun 1995	16 so far	0.86

  Source:  ABS, National Accounts (various).

• while Australia has been experiencing one of the fastest growth rates, if not the fastest, amongst OECD countries, growth rates in per capita terms (which provide a more accurate indication of what is happening to relative living standards), heavily qualify this picture.  In particular, the gap between Australia's per capita growth rate since the economy bottomed in mid-1991 and that of other Anglo-Saxon countries (where activity troughed at about the same time) is much narrower than the gap between overall growth rates.  And while our per capita growth rate since mid-1991 has been significantly higher than the average for OECD countries, that is mainly due to the later troughs in activity in other non-Anglo-Saxon OECD countries and to the extended recession in Japan.  In recent quarters, our per capita growth rate has moved back towards the OECD average.  Over the longer haul, the average rate of growth in Australia's per capita GDP has been about the same or only fractionally above that for the average of OECD countries and for the US;
• while Australia's faster growth in population also means that we have had a faster growth in employment than the OECD average and than the great majority of OECD countries, a more effective test of labour market performance is whether the faster growth in the working-age population is being absorbed into the workforce.  Although Australia's unemployment rate since its peak in the December quarter of 1992 has dropped more quickly than the OECD average, Australia started from a position of having the second-highest rate in the OECD, and its unemployment rate is still well above the OECD average. Recent indications suggest that unemployment may have "bottomed" around the relatively high rate of 8.5 per cent.  Moreover, OECD analysis suggests that Australia's NAIRU ⁽⁵⁾ has increased over recent years -- a damning indictment of the operation of the labour market;

  Table 2:  Unemployment Rate (Seasonally adj) ⁽¹⁾

  	Aust	US	UK	NZ	OECD Major 7	Total OECD
  4th Q 1992	11.2	7.2	10.4	10.2	6.9	7.3
  Aug 1995	8.3	5.6	8.7	6.3 (2)	6.6	7.4
  per cent change	-25.9	-22.3	-16.3	-38.2	-4.3	+1.4 (3)

  ⁽¹⁾ OECD standardised unemployment rates.

  ⁽²⁾ June 1995 figure.

  ⁽³⁾ Note that the OECD average rate peaked in the March quarter of 1994 at 8.0 per cent and has since declined to 7.4 per cent.

  Source:  OECD, Main Economic Indicators.

• the recovery resulted in a "blow-out" in the current account deficit up to the middle of 1995 which suggested that Australia remains far too susceptible to the risk of external debt "crises" and is still only able to avoid such "crises" by slowing growth to below rates at which unemployment will be reduced;
• it also led to the recent upward movement in "underlying" inflation to over 3 per cent per annum from recession-induced lows, and an intimation by Reserve Bank Governor Fraser that it may go a "lot higher".  This gives rise to similar concerns about speed limits to growth in a context where real interest rates rose, by December 1994, to levels (8.7 per cent) likely on past experience to produce a quite marked slow-down about a year later;

  Table 3:  The Clouded Periods

  Trough	Peak	No. of quarters	Average growth per quarter (%)
  Dec 1960	Jun 1961	2	-0.82
  Sep 1965	Dec 1965	1	-0.13
  Mar 1974	Jun 1974	1	-0.32
  Mar 1977	Sep 1977	2	-0.06
  Mar 1982	Mar 1983	4	-0.88 *
  Dec 1985	Mar 1986	1	-0.06
  Mar 1990	Jun 1991	5	-0.33

  Note:  * Deepest recession

  Source:  ABS, National Accounts (various).

• the recovery follows the longest period of recession experienced by Australia in the post-World War II period and the second "deepest";
• corporate profitability did improve (measured by net rates of return on capital) but not back to even pre-recession, let alone pre-1974-75, rates;
• the recovery eventually produced a strong increase in business investment starting about two years ago, but from an all-time low base which has left it still only around its past average of about 11 per cent of GDP in a context where business investment plans now appear to be being scaled back;
• it involved no domestic saving over the whole recovery period once allowance is made for depreciation and inflation;
• it also produced a strong growth in labour productivity, but has left it unclear if that reflects any structural improvement, particularly as productivity growth now appears to be slowing sharply.

Indeed, there is now clear evidence of a quite marked slow-down in the recovery, starting in mid-1994.  Even if there were to be the mild rebound predicted by some analysts, ⁽⁶⁾ GDP growth seems likely to fall short of the Budget forecast of 3.75 per cent.  It would not be surprising if it turned out to be 3 per cent or even lower, and if unemployment in the June quarter of 1996 were significantly above the 8 per cent Government forecast.

Such an outcome would warrant a "B minus" mark, especially when measured against the growth rate of 4-4.5 per cent acknowledged by the Government itself as necessary to achieve 5 per cent unemployment by 2000.  Taken together with the points made in the preceding paragraphs, such a poor growth performance would substantially validate the perception of only five minutes of economic sunshine.

Table 4:  Trends In Key Economic Drivers

	Private Consumption (Trend)	Dwelling Expenditure (Trend)	Business Investment (Trend)	Domestic Final Demand (Trend)	Exports (Trend)	GDP(A) (Trend)
						Total	Non-Farm
percent change on previous quarter (annualised)
June 1994	5.3	15.2	31.5	8.1	6.0	6.5	7.5
Sept 1994	5.1	9.6	29.6	6.2	2.0	4.7	6.1
Dec 1994	4.9	-4.2	11.4	4.4	0.6	3.0	4.4
Mar 1995	4.1	-13.6	-0.2	3.5	0.9	2.6	3.1
June 1995	3.0	-17.4	-3.9	2.1	0.2	2.1	1.7
Forecast (four quarters to June Q 1996} (1)	3.75	-11	14	2.75	11	3.75	3.5

⁽¹⁾ Note that these Budget forecasts are for the increase over the June quarter in 1995, not the increase over the previous quarter as the other figures show.

Sources:  ABS, National Accounts, June Quarter 1995;  Budget Paper No. 1, 1995-1996.

THE CLOUDS OF UNCERTAINTY

An important cause of the recent slowdown -- which commenced about the same time as the tightening in monetary and (to a lesser extent) budgetary policy (whose effects are generally assumed to be lagged by up to a year or more) -- was an ongoing and widespread perception that the Government could repeat the policy mistakes of the 1980s.  The experience of the 1980s, and the recession at the end of them, created a greater aversion to risk-taking on the part of both businesses and (to a lesser extent) consumers.  This produced what economists might describe as a "rational expectations" reaction, with many businesses and consumers taking precautionary action to ensure that they did not become over-committed.  If the Government had taken early action to acknowledge that much of the problem of the 1980s had reflected inept economic policies, and if it had set out a much more coherent medium-term policy framework designed to reduce the risk of repeating that experience, expectations may have been different.  In fact, the blow-out in the current account deficit up to mid-1995, and the sharp increase in real interest rates during 1994, reinforced the perception of a risky economic climate.

The belated and very minor tightening in fiscal policy in the 1995-96 Budget, and the "pre-emptive" tightening of monetary policy in the last half of 1994, may have alleviated this perception to some extent.  However, both budgetary and monetary policies are still seriously inadequate.  They also need to be set much more convincingly into a medium-term framework that itself provides much more confidence that they will improve Australia's performance in regard to both savings and inflation and, hence, economic growth.

While the microeconomic reforms of the 1980s should have resulted in a structural improvement in productivity, the statistical evidence to date is not encouraging.  It should not be overlooked that, even if improved growth potential has been created, that may not bear fruit if the Government's approach to macroeconomic policy, and to providing an economic "climate" conducive to investment and profit-making, continues to make businesses and consumers unduly averse to risk-taking.  The most important need, little recognised in most discussions about the economy, is to create a culture that encourages genuine entrepreneurship and profit in the mutual interests of labour and capital.

Australia is a long way from having such a culture, with opposition to such reforms by various interest groups being a major inhibiting factor which neither major political party appears able to handle particularly well.  This is particularly true of groups which focus more on the possible effect of reforms on the inequality of income than on the likely increases in total income and employment.  The biggest obstacle to economic reform, however, is the trade union movement, which seeks to protect existing workers from competition from their unemployed fellows.  The present Government, while claiming mostly spurious benefits from an Accord which excludes those who are the main source of capital and employment, appears to be particularly inept at handling its close relationship with unions -- and the Opposition seems unduly scared of tackling the problem, notwithstanding the dwindling number of trade union members and what appears to be the widespread community support for action to reduce union power.

THE INDUSTRIAL RELATIONS CLOUD

There is little or no basis to most of the claimed benefits from the Accords.  There is considerable evidence to suggest that they have had significant adverse effects in encouraging the inappropriate macroeconomic policies that ultimately created Australia's external debt problem, and in inhibiting productivity growth.  During the main period of the Accord in the 1980s, Australian businesses faced higher increases in labour costs than in the major seven OECD countries.  That is, other major OECD countries, which also have strong trade union movements, kept inflation and labour costs down to much lower rates without an Accord.  In fact, it was only the recession and high unemployment of the early 1990s that brought the growth in Australian labour costs down to rates that were internationally competitive.  Under the 1980s Accords, international competitiveness continued to be maintained -- but only through a depreciating exchange rate, which reflects a decline in relative living standards.

In the current economic environment, and with appropriate monetary policy objectives that make it clearer than the present monetary policy that there is an unequivocal commitment to maintaining low inflation, there is no reason to maintain an Accord -- and good reason to be rid of it.  No other country has judged such an arrangement to be required or likely to be beneficial.

While growth in productivity has occurred during the Accords, except for the period since the economy bottomed in mid-1991, Australia's labour productivity growth has been slower than the OECD average and generally slower than in periods prior to the Accord. ⁽⁷⁾  Moreover, this relatively poor growth performance has occurred despite the fact that there is widespread acceptance that productivity levels are considerably below international best practice, implying that there is considerable scope to lift productivity, possibly by as much as 25 per cent.

The higher growth in labour productivity since the economy bottomed in mid-1991 does raise the possibility that there has been a structural improvement in productivity.  At least part of that higher growth, however, may be merely cyclical.  The most recent trends in labour productivity suggest that the rate of growth may already be declining.

The Government's latest changes to the industrial relations system purported to encourage the negotiation of employer-employee agreements at the enterprise level.  But union opposition to this approach "forced" the Government to impose a complex system of requirements on such negotiations, including compliance with an ongoing system of awards by arbitral authorities, and to "tighten" the regulation of employment conditions generally.  The new arrangements, in fact, significantly inhibit the negotiation of such agreements and the efficient operation of the labour market.  The OECD's 1995 Survey noted that "the new legislation still remains very complex and highly prescriptive" and raised "the question as to whether awards are best suited to perform a safety-net function".  It might be added that the so-called "community standards" which the Government purports to be protecting are far from universally agreed, let alone universally applied.

There is, in fact, little basis to the claims that further deregulation of the labour market would undermine "community standards" and have undesirable social consequences.  On the contrary, to the extent that the present award system results in the payment of higher wages than is justified by productivity performance, it will maintain higher unemployment than is necessary.  Further, if an increase in inequality of incomes were to occur as a result of labour market deregulation, and if that were judged to be inappropriate, ⁽⁸⁾ it could be off-set through the social security system, just as the present Government has been offsetting (albeit inefficiently) the increased inequality that has occurred during the period of the Accords.

Comparisons with developments in income inequality in the US are misleading and, in some regards, inaccurate.  They take no account of likely differences in the quality of US labour at low income levels and discount too readily the benefits of lower unemployment levels.

THE INTEREST RATE CLOUD

Based on the measure used by the ABS as one of the indicators in its Composite Leading Indicator, real interest rates (that is, nominal rates less inflation) have doubled from a low of just under 3 per cent in the September quarter of 1993 to an estimated 6 per cent in the September quarter of 1995.  While the 6 per cent figure is below the peak of 8.7 per cent reached in the December quarter of 1994, such a high level of real interest rates discourages capital expenditure by businesses as well as some expenditures, especially on housing and consumer durables, by individuals.  Following each of the two previous occasions on which real interest rates exceeded 8 per cent during the 1980s, there was a marked slowdown in economic activity about a year after.

It remains to be seen whether the increase in real interest rates to 8.7 per cent in the December quarter of 1994 actually results in a fall in quarterly GDP(A).  Given that there is a time lag before it takes effect, however, there seems little doubt that that increase is now reinforcing the slowing which has been in evidence since the middle of 1994.

Australia's high level of real interest rates reflects a number of factors:  the past record of successive governments in running a higher rate of inflation than the OECD average;  the blow-out in Australia's foreign debt during the 1980s;  the perceived inadequacy of the present inflation objectives of monetary policy;  and the perceived potential for political interference/influence in determining changes in monetary policy settings.  To the extent that the past is influencing the present, there is an even greater need to establish a much more credible approach by setting the maintenance of low inflation as the sole objective of monetary policy.  This can be done by prescribing the limits of inflation objectives much more tightly than at present and by clearly giving the Reserve Bank the sole responsibility for the operation of monetary policy to achieve the inflation objective set by Government.  As the 1995 OECD Survey of Australia points out, "progress to date in building monetary policy credibility could be eroded if underlying inflation were to exceed the authorities' objective for more than a brief period".  In this context, the recent increase in "underlying" inflation to over 3 per cent per annum, together with Reserve Bank Governor Fraser's statement that it could go a "lot higher", is a cause for serious concern and is likely to keep real interest rates too high.

THE SAVINGS CLOUD

While the current account deficit "bottomed" in the March quarter of 1992 at 2.9 per cent of GDP, the recovery in demand quickly brought it back above 3 per cent of GDP -- the level which Reserve Bank Governor Fraser has described as "sustainable". ⁽⁹⁾  By the June quarter of 1994 it had reached 4 per cent of GDP.  This was undoubtedly one of the factors in the decision to implement the first, "pre-emptive", tightening of monetary policy in August 1994, when official cash rates were increased from 4.75 per cent to 5.5 per cent.  The further increase in the current account deficit (reaching an average of 5.6 per cent of GDP in each of the last two quarters of 1994) also almost certainly influenced the two subsequent 1 per cent increases in official rates to the current level of 7.5 per cent.

It now appears that the current account deficit has, at least for the moment, peaked in the June quarter of 1995.  It did so, however, at no less than 6.6 per cent of GDP -- that is, above the peak of 6.0 per cent of GDP reached in the June quarter of 1989 which preceded the monetary policy "crunch" in late 1989.  Moreover, the foreshadowed revision to the $27 billion (6 per cent of GDP) forecast for the deficit for 1995-96 would still leave it at around $22 billion or 4.5 per cent of GDP.

While the immediate risk of another external debt crisis has passed, that appears mainly to be a result of the marked slowing in the economy.  The question remains as to what happens when activity picks up again.  In short, the experience of the recovery since mid-1991 suggests that Australia remains far too susceptible to the risk of an external crisis.

The increase in the current account deficit to unsustainable levels during the recovery reflects an increase in the draw on foreign savings to finance investment in Australia.  The main concern in regard to this increased draw on foreign savings is that it has been accompanied by (and essentially derives from) a reduction in the rate of domestic saving.  The accompanying graph, which uses the ANZ measure of domestic saving, ⁽¹⁰⁾ shows not only a downward trend in such saving (interrupted briefly in the late 1980s), but also the virtual collapse in net national saving since the early 1990s.  In fact in the June quarter of 1995, Australia dissaved for the first time outside of a sharp recession.

Chart 1:  Australian Domestic Savings *

Source:  ANZ Savings Report (Access Economics).

Note:  For explanation of method of calculation, see footnote 9.

The virtual collapse in net national savings since the early 1990s is a serious cause for concern, since there is a need to lift domestic investment to achieve sustainable higher growth rates and to reduce the current account deficit to levels which would reduce Australia's exposure to the risk of a foreign debt "crisis".  This concern was highlighted in the recent article in The Economist which identified Australia as a possible "next Mexico" and concluded that "the causes of its current account deficit are bad".  The Government, with apparent reluctance, very slightly tightened budgetary policy in the 1995-96 Budget, to allow the Commonwealth to make a positive contribution to national saving.  The projected contribution is too small, however, and is in any event based on estimates whose credibility is subject to a serious -- and growing -- question mark.  The Government needs to give a much firmer and more convincing commitment to making a substantial positive contribution to saving through the Budget.

The Government's scheme to lift net private sector saving through additional compulsory superannuation contributions also implies a smaller estimated net addition to national saving than appears to be required, even if the Government's estimates are accepted.  But, given that the tax and social security systems provide a significant disincentive to saving, these estimates also have a strong element of doubt.  There is the further important issue as to the appropriateness of the Government compelling people to save in order to offset the disincentive effects on saving which flow from its own tax and social security policies.  At the very least, the latter should be addressed first.

THE PROFITS CLOUD

Australia's stock of capital (net) is estimated to have increased by less than 2 per cent per annum over recent years.  Given that, then unless business investment (in particular) is increased to considerably higher levels, there are serious doubts as to whether the overall rate of economic growth can be lifted on a sustainable basis.  The strong increase in 1994-95 and the forecast strong increase for the current year (which now seems likely to be lower than the Budget time forecast of a 13 per cent increase), would still leave such investment at only about its historical average.

This is hardly surprising:  the acknowledged strong increases in corporate profits over the past three years still appear to leave corporate profitability (measured by the net rate of return on capital) below levels reached in the late 1980s and well below pre-1974-75 levels.  The recent downturn in (nominal) corporate profits suggests that profitability is now falling.  Yet against the background of the relatively depressed levels experienced in a good deal of the period since 1974-75, there is an evident need for an extended period of higher profitability.

ABS data on company profits do show strong real increases in each of the three most recent years.  However, the real increase of 20.9 per cent between 1988-89 -- the peak before the recession -- and 1994-95 (the apparent peak in this cycle), averages only a very modest 3.1 per cent per annum.  Moreover, there will be little, if any, growth in profits in 1995-96.  In fact, the quarterly trend figures for (nominal) company profits before income tax have been falling since September 1994.

Large falls in 1989-91, and the falling trend over the past year, highlight the high risk which businesses (and investors) face -- primarily as a result of the failure of macroeconomic management to keep the economy on a more stable growth path.  Nobody expects Governments to smooth away the business cycle entirely.  But the sort of mismanagement that occurred during the 1980s clearly exaggerated the cycle and has added a risk premium to business investment in Australia.

Chart 2:  Business Investment *

Source:  ABS, National Accounts.

Note:  Investment in non-dwelling construction and plant and equipment by the private sector.  Includes purchases of assets from the public sector.

There is also a need for other measures to encourage entrepreneurship and profits by extending and speeding up microeconomic reforms which would reduce business costs, increase productivity, and help close the gap between Australian and international best practice.  The reforms undertaken to date are clearly a mixed bag, as indicated by the Bureau of Industry Economics' International Benchmarking Report for 1995.  That report confirms that, while the performance gap between Australia and overseas countries has been narrowed in some industries and on some measures, it generally remains large and has widened in other industries and on other measures.

Chart 3:  Private Corporate Trading Enterprises
Net Rate of Return (Annual)

Source:  Capital stock figures are from ABS,
Australian National Accounts:  Capital Stock (Cat. No. 5221.0).

* Estimate

Note:  The net rate of return is

(corporate gross operating surplus - corporate depreciation) x 100.
           (corporate business investment capital stock)

THE TAX CLOUDS

The Government argues that there is no case for reducing the level of taxation in Australia, given that Australia already has one of the smallest government sectors in the OECD and the second-lowest tax burden amongst OECD countries.  That burden is still significantly inhibiting economic activity in Australia, however, through the disincentive effects of additional taxation, or the so-called "deadweight losses", which tend to increase proportionately with increases in rates of taxation.

Apart from high deadweight losses from existing levels of taxation, there are also high tax-compliance costs.  Estimates by Dr Jeff Pope of the Curtin Business School suggest that the cost of complying with taxation requirements amounted to $8 billion in 1990-91, just over 12 per cent of all taxes collected.  The highest compliance cost was estimated to be for company tax (23 per cent of tax collected).

The high costs of existing taxation levels are inadequately recognised, partly because of the perception that Australia is a low-taxed country.  But a country only qualifies as being low-tax if it can be shown that government expenditure should not, and could not, be reduced.  That is clearly not the case with Commonwealth own-purpose expenditures, particularly in regard to social security and associated forms of assistance, which have increased by nearly 2 per cent of GDP since Labor assumed office in 1982-83.

Table 5:  Commonwealth Own-Purpose Outlays
increase from 1982-83 to 1994-95

	percentage points of GDP
Social Security/ Welfare	1.17
Health	0.84
Education	0.40
Labour/Employment	0.38
Other	-0.89
Total	1.90

Source:  Department of Finance.

Had these increases in outlays not occurred, Commonwealth taxation could have been about $9 billion less in 1994-95 -- a real cut.  But not only has the Commonwealth not cut its own taxation:  it adopted a policy of solving its budgetary problems by cutting assistance to the States, resulting in an increase of 1.3 per cent of GDP in the burden of the mostly inefficient taxes which the States levy.

The projections in the 1995-96 Budget for a current account surplus of about 0.5 per cent of GDP in 1998-99, rely primarily on reducing outlays relative to GDP and assume no tax cuts of any size over the whole period to 1998-99, notwithstanding the "bracket creep" that will occur over the period ⁽¹¹⁾ and the fact that the last income tax cuts were in 1993-94.  Indeed, tax as a proportion of GDP is actually projected to increase from 24.2 per cent of GDP in 1995-96 to 24.5 per cent of GDP in 1998-99, at which level it would be 0.5 per cent higher than when Labor gained office in 1982-83.  Moreover, the Commonwealth Government does not have a good record of sticking to its forward expenditure estimates.  Indeed, within 5 months of delivering the Budget, Treasurer Willis had already conceded a $917 million net addition to the expenditure estimates for 1995-96.

Personal income tax is projected to bear the brunt of the projected increase between now and 1998-99.  While "cuts" have been made in personal income tax since the Government came into office in 1982-83, the burden of that tax is in fact projected to be the same in 1998-99 as in 1982-83.  That is, the "cuts" will have done no more than eliminate the effects of bracket creep over the whole period since 1982-83 and will not have been real cuts.  Moreover, while the Superannuation Guarantee Charge is technically not a tax, the (compulsory) increase which will occur in that levy has effects similar to a tax increase.

The existing system, by which taxation is levied primarily on income rather than expenditure, is also having longer-term adverse effects on growth.  A review of the tax system should give serious attention to proposals for a flat-rate tax which now appears to have considerable bipartisan support in the United States.  Making such a tax the main source of government revenue could not only significantly increase the incentive to earn additional income, thereby adding to employment and living standards generally, but would also result in a major reduction in the large compliance costs which the existing system imposes.

CLEARING THE CLOUDS

The reality is that "the fundamentals" still fall a long way short of the levels needed to sustain economic growth at a pace that reduces unemployment and stabilises foreign debt.  Until there is greater recognition of the need for a cultural change, the general economic climate will remain clouded.  Moreover, the prospects of achieving growth rates sufficient to improve Australia's relative international performance on a sustained basis, and reduce unemployment even to the Government's 5 per cent target by 2000, will remain dim.  Yet the potential is enormous.  As a resource-rich country with a relatively highly-skilled work force and political stability, the opportunities for investment and economic growth are almost unlimited -- if the economic environment is right. ⁽¹²⁾  But major improvements are needed in the macroeconomic policy framework, and the clouds that prevent the sunshine getting through in a number of particular areas must also be lifted.

ENDNOTES

1.  "Sustainable" in this context evidently refers to the widely agreed need to maintain inflation at a low rate and to keep the current account deficit to levels that significantly reduce the risk of an external "crisis".

2.  See the interview with Treasurer Willis on Channel 7's "Face to Face", 19 November 1995.

3.  This paper summarises the assessment.  Supporting analysis is provided in a separate, more detailed, paper which is available on request.

4.  In its analysis of growth in productivity (ABS Cat. No. 5234.0)

5.  The rate of unemployment before inflation starts to accelerate.

6.  The effect of ABS methodology in calculating the contribution of the farm sector to GDP is likely to add about 0.2 percentage points to the GDP(A) trend growth estimate for the September quarter even though the main contribution occurs later.

7.  Some argue that the wage "restraint" that occurred during the Accord period led to some substitution of labour for capital, thus reducing labour productivity growth.  However, this does not sit easily with the fact that wages growth was faster in Australia than in our major trading partners.

8.  There is, in fact, no agreement on what constitutes a socially appropriate distribution of income.  Also, the inadequate measurement of changes in income distribution simply assumes that people are in the same income group that they were in, say, 15 years ago, which is obviously not the case in many instances.

9.  The implication that a 3 per cent average is sustainable implies, of course, that the deficit needs to operate below 3 per cent of GDP for a time.

10.  The ANZ measure estimates saving on a net rather than a gross basis, that is, it allows for depreciation of the existing capital stock.  It also adjusts for the effects of inflation on saving.

11.  The Treasury has supplied estimates to the Senate Economics Legislation Committee showing that by 1998-99 tax revenue will be at least $5 billion higher as a result of bracket creep over the four years to 1998-99.  (As the estimates are for each individual year only, they understate the total revenue effect).

12.  Access Economics Investment Monitor, for example, currently lists $135 billion of investment projects which, if committed, would involve a major surge in business investment, currently running at around $50 billion per annum.