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Economics Legislation Committee

ANTHONY, Dr Stephen, Chief Economist, Industry Super Australia


Evidence was taken via teleconference—

CHAIR: I now welcome Mr Stephen Anthony from Industry Super Australia, who is appearing today via teleconference. Thank you very much for appearing before the committee today. I invite you to make a brief opening statement, should you wish to do so.

Dr Anthony : My opening statement will be very brief. It would be that I have examined the budget outlook over the next decade, and my view is that we will be hard-pressed to afford tax cuts at the same time as growing the economy at the rate that is anticipated in this budget. There is no room for any sort of economic slowdown or interruption in the budget as presented last May. I think that would be my opening remark.

CHAIR: Thank you, Dr Anthony. That's not exactly comprehensive, but that will do us. The role of the superannuation industry, obviously, is to maximise superannuation returns for members, is it not?

Dr Anthony : That's right.

CHAIR: So how is using your time at today's hearing assisting with your core business of focusing on generating superannuation returns to members and keeping fees low?

Dr Anthony : I'll leave that to the executive of ISA and others, like our board, to decide. My role at ISA is to function, for example, like a bank economist—to be analytical and to be objective. That's what I endeavour to be.

CHAIR: Right. I don't really have any questions for the witness. I'm not entirely sure why they're appearing. I will turn over to the deputy chair.

Senator KETTER: Because they have an interest in public policy.

CHAIR: Superannuation policy.

Dr Anthony : There'll be implications for investment in all sorts of asset classes on the back of this too, Chair.

Senator KETTER: Mr Anthony, going through a number of comments you've made in the public domain in relation to the 2018-19 budget forecasts—you've sort of touched on this—what about your view about the assumption of 1.6 per cent productivity growth in the budget?

Dr Anthony : If you look at the budget outlook and the medium-term projection, the coathanger of that projection is the assumption of productivity growth of 1.6 per cent. That is double the current rate or the average of the period since the GFC. There has been a global slowdown in productivity, and that's certainly been experienced in this country. At the same time there has been a bit of a malaise in terms of microeconomic reform and policy development. So there aren't, in the pipeline, the sorts of impacts that are likely to drive productivity higher, at least in the short to medium term. For this reason, basing the centrepiece of the budget, and the medium-term projections, on such a high number seems to me to be imprudent.

Senator KETTER: Okay. And what about the migration figures that are used in the budget? Are they realistic?

Dr Anthony : One way of looking at the budget is the three Ps—population, productivity and participation. To derive the economic growth rate and, perhaps, the average rate through time, you can add these three things together. Basically, the budget, as we've just discussed, is assuming a medium-term rate of productivity growth, at least in the next decade, of around 1.6 per cent. Participation is assumed to be around zero, which leaves the population growth rate to be 1.5 or 1.6 per cent, depending on the year we're talking about.

The issue with that growth rate is that it's all well and good, but if we build our population at that rate through time without having the sort of strategic plan in place to make the most of that population growth and to develop human capital, then we are no doubt going to generate unbalanced growth in some regions of the country. Presumably, that's what we're seeing in Sydney and Melbourne right now. That sort of degree of imbalance is likely then to have deleterious impacts in terms of productivity as well.

In many ways, the strategic plan of the Australian nation is centred around that medium-term projection of the budget and what is contained within the IGR, which is where it comes from—the Intergenerational report, I should say. It seems to me that there isn't the supportive plan, or at least policy approach, that puts in place the appropriate infrastructure and which has labour moving to the relevant regions where it's most needed and, therefore, generates balanced growth across the country.

Senator KETTER: What about the implications in the budget as to how easily migrants will be able to pick up employment?

Dr Anthony : As far as I'm aware, at least in terms of the headline budget documents, that is not something that is particularly gone into. To a large extent, that sort of detail is just not captured in a budget projection.

Senator KETTER: And on the issue of wages growth: how credible do you think the underlying assumptions are that are in the budget?

Dr Anthony : The idea that we're going to move back to the sort of 30-year average of wage costs—wage prices—within 18 months seems extremely optimistic, I would have thought. It suggests a level of capacity utilisation in this economy and a return to the 'normal' of the pre-GFC period that we're just not observing. And it's not being observed here or in most of the world right now. So I would've thought that a budget strategy that's predicated on high wages growth is extremely—well, at least, not cautious; let's put it that way.

Senator KETTER: I think in fact you've used the phrase 'enormously risky' in the past; do you stand by that?

Dr Anthony : Yes.

Senator KETTER: On terms of trade, what's built into the forward estimates in the medium term?

Dr Anthony : What's built in is a small reduction in the terms of trade. Over the period of the outlook, it takes the terms of trade down to around 40 per cent above the level of 2003. Now, 2003 is important because that's when the mining boom began. So there is a small reduction in the terms of trade over the outlook and into the medium term, but it still leaves the terms of trade extremely high in historical terms. That may be correct but, once again, in a global environment that could experience significant shocks, those terms of trade could get dented very quickly, and obviously that would have significant impacts on the budget bottom line.

Senator KETTER: What do you say would be a more credible estimate in terms of the terms of trade?

Dr Anthony : What I would like to see is a judgement about what the long-term level is, and then some transition to that level within a reasonable number of years, and to have that as a working assumption. For example, if we said now that the new norm is, say, 10 per cent or 20 per cent above the level of 2003, and then we transition our terms of trade over a five- to seven-year period to that level, that would seem quite reasonable to me.

Senator KETTER: Just turning to your views about the economic and geopolitical risks in the international environment and their implications for Australia, can you tell us what sorts of risks exist out there, and, in particular, the risks in relation to China's monetary policy?

Dr Anthony : If you could just bear with me, I'm just going to open up a slide show that I've been developing for the Melbourne Economic Forum tomorrow. The key risks to the budget in my mind are as to that terms-of-trade assumption that we were just talking about. It's the assumption that we will have smooth and consistent growth of around 3.1 per cent into the medium term and strong terms of trade, and that there will be no busts in asset prices, either through Wall Street, or in China, or here in Australia, in Sydney and Melbourne, in terms of house prices. Then of course there are risks around foreign policy—for example, North Korea and, perhaps to a lesser extent, what's happening in the Middle East around Iran.

Senator KETTER: Just coming back to more domestic issues, you mentioned house prices, and there are other things that cause concern, such as household debt and potentially rising interest rates, not to mention the slow wages growth. What concerns do you have about those factors?

Dr Anthony : Going back to the work that we did at ISA last year on housing affordability and affordable housing, the greatest concern is the record indebtedness of the Australian household—the fact that a small amount of that debt is carried by households that are probably in over their heads and the fact that those loans were intermediated by financial institutions that had not done their due diligence on the loan, such that the people in those loans are very over-extended and now susceptible to higher global interest rates through the wholesale cost of borrowing and just general tightening in economic conditions here in Australia.

It does seem now that the markets have turned. Certainly Brisbane has turned, Sydney is turning and it seems that Melbourne is following suit as well. As I look around outside, there are cranes literally everywhere. So you really have the preconditions for a significant bust in the housing market. What you need now is a more general slowing of the economy on top of that to really cause a dent in economic activity. We hope that we can avoid that through good economic policy which particularly focuses on re-arranging spending towards infrastructure to help support that population increase that we were talking about earlier, and other high productivity growth policies.

Senator KETTER: Given all of the comments you've just made, how sustainable is this proposal for personal income tax cuts?

Dr Anthony : My view is that, by the middle of the next decade, the combination of the individual tax cuts and the company tax cuts would, even on the government's budget parameters, essentially remove all of the possible surplus that the economy could have generated if the economy softens or grows at an even slightly slower rate than that forecast in the budget. For example I modelled a half a percentage point of GDP lower each year from 2018-19. If that slowing occurs, the budget will be in deficit by around one per cent of GDP by the middle of the next decade. So I don't think the combination of these tax cuts can be affordable.

Senator KETTER: Are there any other interactions between the company tax cuts and the income tax cuts that you think we should be aware of?

Dr Anthony : The statement that I've made that they may not be affordable is neither here nor there if they represent tax reform. The question is: does this tax cut package represent tax reform? In my mind, it doesn't. I don't think what the government is proposing to do is really targeting the areas of the tax code, or Commonwealth-state relations in relation to tax, that would generate the biggest return to the Australian economy and then back to the budget. From that perspective, I don't think this is the right approach. In particular, Whilst the company tax cuts may be popular with business consultants and global multinational firms, I don't think they're the sorts of things that would help Australian businesses, especially given our dividend imputation regime.

CHAIR: Sorry, are we still talking about personal income tax cuts?

Senator KETTER: Yes, we are—and we're talking about tax reform. Dr Anthony, you talk about a preference for a more holistic approach to tax reform. What are the benefits of that type of approach?

Dr Anthony : For example, if we started with a document like the Henry tax review and its main findings—the key measures that you might put in place would be to broaden tax bases around a limited number of major taxes. Some of those are located with the federal government and some with the state government. You would simplify the structure of taxation overall and you would broaden the bases of various taxes that are chosen. You would, where possible, try to shift taxation to expenditure, not income, and fix factors of production—for example, towards land. For example, at the state level, you would favour a land tax and maybe some sort of betterment tax. You would remove stamp duties.

Senator KETTER: In terms of workforce participation, we've heard arguments about the fact that very marginal tax rates can impact on participation rates and hours worked. Can you tell me where the issues around workforce participation are most acute, and are these the areas this package is focused on?

Dr Anthony : The least advantaged in the workforce—say, low-income female workers—are the people who will be most sensitive to changes in tax rates and thresholds. Now, there really isn't much in this package for these individuals that is likely to engender greater effort on their part. Once again, getting back to this theme of tax reform, what you would want to do is focus on the interaction between the transfer payment system and the tax system to engender greater labour supply from these workers.

CHAIR: I just want to clarify something. Dr Anthony, you suggested that broader tax reform would be a better approach than simply lowering personal income taxes—broader tax reform similar to that seen in the Henry tax review. Is that correct?

Dr Anthony : Yes. I guess the point I'm trying to make is that if you're going to spend all this money over a decade and commit the national budget to these measures then you want to get a significant reform dividend from that effort. It seems to me that you could get more from this package than what is stated in the budget.

CHAIR: The Henry tax review recommended cutting company tax rates to 25 per cent, and it also suggested that the definition of small business should be increased from $2 million to $5 million. Are you suggesting that the ISA would support those measures?

Dr Anthony : What I'm suggesting is that I don't think you can take the Henry tax review one piece at a time. It was a complete package. The question is: is the company tax reform element of this the most critical part of the reform? I don't think that's where I would start.

Senator STORER: Dr Anthony, could you return to the discussion of the terms of trade and just run through—I think you noted that there was a projection of a small reduction in the terms of trade in the budget.

Dr Anthony : Yes. I'll grab my budget documents and just clarify what it is I'm saying there. Right now, the terms of trade are about 47 per cent above the level that they were at in 2003, when the China boom began, and the budget forecasts the terms of trade to reduce modestly—I'll just try to find the right numbers—by about five per cent in the budget year, and, from that point onwards, by about 2¼ per cent per year. In the context of a slowing Chinese economy, given that the monetary authorities in China have been tightening policy in the early part of this year, you would expect that their economy would respond to that tightening of monetary policy, perhaps in the second half of the year, and you would then expect Australia's terms of trade to react, to fall in the face of that tightening. The point that I would make is that usually, as the Chinese economy moderates, our terms of trade fall reasonably sharply, and that fall hasn't been reflected in the budget outlook at all. Certainly, in no way is there an attempt to trend the terms of trade back to some sort of longer-term level.

Senator STORER: If you expect our terms of trade to fall then effectively you're casting doubt on potential revenues?

Dr Anthony : Absolutely. As we've seen with today's national accounts, whenever we have a good quarter in terms of the terms of trade, it really floats all boats—it raises company profits and it raises compensation for employees or at least provides the propensity for that to happen. It's almost manna from heaven. But in the same way, when you take that manna away, life gets a lot more difficult and a lot more complicated, for business and for workers, and for governments for that matter.

Senator STORER: Is this why Mr Fraser and the secretary of the Treasury would've noted, 'Australia's nominal GDP is heavily influenced by commodity prices, which are highly volatile'?

Dr Anthony : That's right.

Senator STORER: Do you have an opinion about the different commencement dates of each part of the personal income tax plan, for example the changes that are due to occur on 1 July 2018?

Dr Anthony : My main comment about the construction of the tax package, mainly from the perspective of the individual tax cuts but also in terms of the impact of the company tax cuts, is that they're heavily back-ended. Most of the budget impact occurs in the last three or four years of the projection period—I'm talking into the middle of the next decade. Therefore, most of the hit to the budget bottom line occurs quite late. So, in a structural sense, the impact over the budget outlook is still relatively mild.

Senator STORER: Given the announcement today of growth rates and the pathway and the desire to provide relief for sections of the community in terms of cost-of-live pressures and wage stagnation, would it not be prudent to go ahead with the first elements of the personal income tax plan, those that are due to start on 1 July 2018?

Dr Anthony : Senator, I will leave that for you and others to decide. I would think there are a number of ways governments can help households cope with cost-of-living pressures and other issues. It seems to me that fundamental reform is possibly the best idea in that respect. To me, the low-hanging fruit there is things like industry and innovation policy, skills, technical training, tax reform that's fundamental, getting us back to being a low-cost energy nation and targeted infrastructure priorities. I think all of these things have greater merit than what I would describe as a more piecemeal approach to tax cuts.

Senator STORER: Could I just go back to some of your analysis before. You were talking about three elements—population, productivity and participation—combining to generate, as you see it, the growth rate over time. Did you not indicate that you saw in the budget that the population is due to grow at 1.5 per cent and productivity at 1.5 per cent—and did you say participation at zero?

Dr Anthony : What I'm talking about there is a budget statement at the end of Budget Paper No. 1. It's statement 8, page 8-23. Basically it outlines the path of real GDP growth in the Australian economy that underpins the budget projections beyond the forward estimates. It explains that labour productivity growth is assumed to be 1.6 or 1.5 per cent and population growth will make up the difference—so 1.5 or 1.6 per cent over the outlook and the projection period.

Senator STORER: And participation is therefore zero, you're saying?

Dr Anthony : These things aren't outlined in the budget documentation. I had to assume that there's a bit of a 'no change' assumption when it comes to participation. It could be a small negative.

Senator STORER: You said that, based on a 30-year average of wages, the wage growth assumptions in the budget would be highly optimistic—to meet within 18 months of now.

Dr Anthony : Yes, based on the experience of the last four or five years and certainly based on international experience, although what is happening in the US at the moment around wages is quite interesting, and it does seem that there is some pressure for higher wage increases, above 2½ per cent. That's suggesting that perhaps some change is in the wind there.

CHAIR: Thank you very much, Dr Anthony, for joining the committee today.

Proceedings suspended from 15:30 to 15:52