Chapter 3 - Issues raised

Views of economists

3.1 The committee heard evidence from a number of economists who suggested that there were several options available to the federal government for funding the rebuilding process.[1] Whilst the right of the government of the day to determine the fiscal measures necessary to fund its obligations was acknowledged,[2] the economists offered two alternatives to the flood levy:

(a) to reduce federal government expenditure, and

(b) to borrow the funds and thereby temporarily increase the budget deficit.

Reduce expenditure

3.2 The government has sourced funds for a part of the rebuilding package by deferring some infrastructure projects and making some budget cuts to deliver two-thirds of the $5.6 billion needed to rebuild flood affected regions.[3]

3.3 As part of the package, the government will delay infrastructure projects equating to $1 billion in order to free up funds and skilled workers at a time of skilled labour shortages across Australia.[4]

The need to get Queensland back on its feet is an immediate pressure for both the infrastructure budget and labour force capacity. It is also an important part of the Australian economy. However the Government’s commitment to the projects that are re-prioritised is clear: we will deliver all projects. Their construction has been deferred and once the reconstruction work is undertaken, those projects that have been rephased will recommence immediately.[5]

3.4 In addition to the delay of infrastructure projects, the government will make $2.8 billion in spending cuts including:

Not proceeding with the Cleaner Car Rebate Scheme
Abolishing the Green Car Innovation Fund
Reducing and deferring spending on the Carbon Capture and Storage Flagships and the Global Carbon Capture and Storage Institute
Abolishing the Capital Development Pool from 1 January 2012
Discontinuing funding for the Australian Learning and Teaching Council
Redirecting funds from the Priority Regional Infrastructure Program and Building Better Regional Cities Program
Capping annual claims under the Liquefied Petroleum Gas (LPG) Vehicle Scheme
Capping funding for the Renewable Energy Bonus Scheme – Solar Hot Water Rebate
Not proceeding with Round 2 of the Green Start Program
Capping funding for the Solar Homes and Communities Plan
Withdraw funding to the O-Bahn City Access project.[6]

3.5 Professor Anthony Makin, of the Griffith Business School asserted that additional areas of public expenditure cuts could easily be identified in the 2011-12 federal budget which has projected outlays of $364.6 billion in 2011-12.[7] Professor Makin suggested that, in his opinion, this would be the optimal approach:

Cutting public expenditure, particularly on industry assistance, is in turn preferable to allowing the budget to slip further into deficit.[8]

In a broader context, the whole economy should be taken into account with due regard to certain principles of macropolicy making. I would argue that one of those principles is to identify unproductive areas of spending across the economy and to make decisions to weed them out for the benefit of the economy in the longer term. There will be short-term costs, but to the extent that public consumption is cut it will add to saving in the economy and Australia is still relatively short on saving... Really, when looking at cutting spending across the board, there needs to be a whole-of-government review to identify those programs that are not delivering.[9]

3.6 Mr Saul Eslake of the Grattan Institute agreed that further reductions could have been identified:

In my view, there certainly would have been scope for further reductions in government spending. Most of the reductions in government spending which the government announced fell into one of two categories. The first category was reductions which they had to make because there would not have been sufficient skilled labour to undertake both the rebuilding and reconstruction of infrastructure effort that is likely to be required and other infrastructure projects according to their original timetables in Queensland and in other parts of the country.[10]

3.7 The committee however did explore the risks associated with extensive cuts in public expenditure, some economists suggesting that such a response would reduce economic activity, which after a natural disaster inherently places added strain on the economy.[11] Professor Warwick McKibbin, who appeared before the House Economics Committee, outlined the affects of various responses to reduced economic activity following a natural disaster or a temporary economic shock:

A natural disaster reduces economic activity when it occurs. Financing reconstruction requires immediate delivery of reconstruction effort and therefore an immediate funding response. There are at least three main ways to finance rebuilding. The first is to raise taxes, which further reduces private demand and therefore reduces economic activity even further. The second is to cut government spending, which also reduces economic activity even further.

The third is to increase the fiscal deficit temporarily—and I stress ‘temporarily’—to borrow to refinance the rebuilding... Both cutting spending and raising taxes worsens the decline in economic activity in the short term.[12]

3.8 The Australian Council of Trade Unions (ACTU) supports the levy, and sees it as a 'far better alternative to deep and far-reaching spending cuts.'[13]

We believe it would be detrimental to Australia’s long-term prosperity for the extra costs of the floods to result in a substantial re-prioritising of important Government spending initiatives including investment in infrastructure, or cutbacks to recurrent expenditures on health, education and other services.[14]

Greater deficit

3.9 Professor McKibbin outlined that one of the goals of economic policy is to smooth national consumption over time. He suggested the most effective means to do this is through an immediate funding response for the reconstruction effort through borrowing, and a temporary increase in the fiscal deficit:

The advantage of borrowing is that this does not directly reduce economic activity today, but spreads the cost of rebuilding over many decades into the future. The macroeconomic goal should be to reduce the negative effects of the disaster soon after it occurs. Only borrowing achieves this objective.[15]

3.10 Dr Richard Denniss of the Australia Institute agreed with Professor McKibbin's assertions:

What you want to do after a shock like that is to inject some money into the economy sooner rather than later and if you have a short-term interest in maintaining your budget position, you are going to make some strange decisions.

A household analogy would be to imagine if it were your own house that had just been flooded and you were trying to get yourself back on your feet in the month after the flood. Would you be spending money on new carpet and buying some new appliances and improving your amenity as quickly as you could and would you perhaps be borrowing to do that? Or would you be cancelling your kids’ swimming lessons and basically reducing the services that you are providing to your family, saying ‘We’ve got to balance the budget in the next month’? Or would you take those costs and spread them out over a longer period of time? I think borrowing makes enormous sense.[16]

3.11 Mr Eslake further detailed the minimal impact that borrowing would have on the current economy:

...by allowing the deficit for the financial years between now and 2011-12 inclusive to be higher, the surplus for 2012-13 to be lower than presently forecast or indeed the year in which the budget returns to surplus to be pushed out a bit further. I say that because the numbers entailed here, the $5.6 billion, represent a very small proportion of GDP, about 0.4 per cent of one year’s GDP. Bear in mind that we are talking about a sum being spent not in one fiscal year but rather spread over two or three fiscal years. As a proportion of any one year’s GDP, the additional borrowing that might be entailed if the government chose to fund all of it through borrowing would be about 0.2 per cent of GDP as a maximum

...

As it happens, the pattern of expenditure and hence borrowing that might have been required had the government chosen to go down the path of funding it all by borrowings would not have had any material impact either on the profile of the budget or on the way in which the financial markets or the Reserve Bank would have responded to it.[17]

3.12 While the ACTU notes that a greater fiscal deficit was certainly an option for the government, it acknowledges the government's commitment to obtain a budget surplus in 2012-13:

Australians understand that a modest deficit is an entirely reasonable way of funding nation-building infrastructure. However, the ACTU also accepts that the government has made a commitment to a fiscal strategy that will see the Federal Budget record a surplus in 2012-13.[18]

Why a levy?

3.13 Australia will be undertaking an unprecedented rebuilding programme after a summer of natural disasters. Rebuilding flood‐affected regions across Australia is going to be an immense national challenge with the Commonwealth’s costs expected to be in the vicinity of $5.6 billion. The levy is estimated to raise $1.8 billion towards these costs.[19]

Mr Hoffman—...With that comes an enormous cost to the public purse and also to individuals and companies. The challenge that we all face is that there needs to be a rebuilding...

CHAIR—Thank you, Mr Hoffman. Yes, indeed, it seems like a very big challenge at the moment. We have been saying this morning that, clearly, it is in not only the personal interests of Queenslanders but the overall economic interests of getting Queensland going again that it is appropriate for all Australians to contribute, because of the economic importance of Queensland in the scheme of things.

Mr Hoffman—That is so true. Given the scale of it, the impacts on the agricultural sector are immense. With the loss of economic production that is directly caused as a result of the floods and cyclones and the resultant damage to assets, investment in the assets to enable materials and suppliers to go into those affected areas to effect the repairs and then to enable them to get back on their feet and operating is paramount. The situation is confronted in the mining sector, where large areas of mines in Central Queensland and, to a lesser extent, in the Surat Basin are still not fully operational and will not be for some time whilst it continues to rain and they are unable to clear the water and restart production. So investment by the private sector as well as the public sector to ensure that we are back on track economically as well as socially and environmentally is fundamental to the state and the nation’s wellbeing.[20]

The Government's response

3.14 On 27 January 2011, in an address to the National Press Club, Prime Minister Gillard announced a suite of measures that would be implemented to help Australia rebuild after the summer of natural disasters.

3.15 In that address, the Prime Minister detailed that the package announced was developed in the context of the country's current economic outlook as well as the Government's long-term reform agenda and commitment to bring the budget back to surplus in 2012-13:[21]

Simply spending to rebuild without addressing the balance between supply and demand in the economy as a whole is not an option. That would only drive up the cost of skilled labour and the cost of building materials and other economic inputs, reduce value for money...rob our mining industry and other economic sectors of the skills and material they need, and ultimately spill over into higher inflation and interest rates.[22]

3.16 As a result of the current economic environment, the rebuilding process will place added demand on the economy. The Prime Minister's rebuilding package is designed to reduce the demand on the economy during the rebuilding phase.[23] It does this through the introduction of a one-off flood levy, the deferral of some infrastructure projects and by cutting some spending programs. In total these measures amount to the required $5.6 billion required for rebuilding.[24]

3.17 As identified by the Prime Minister, given Australia's current financial and economic context; an economy with close to full employment and skills shortages; there is a need to offset the additional demand that will be put into the economy through the required rebuilding program with the demand that already exists. A levy seeks to achieve this balance.

3.18 Although alternative approaches such as funding the reconstruction effort by solely borrowing or cutting public expenditure were explored, the government decided a levy would most effectively achieve the balance required.

3.19 Mr Eslake acknowledges the government's right to make this decision, and concurs that the choice made will not be detrimental to the economy:

I do not start from a position that temporary or permanent levies on income tax are, prima facie, wrong. They are a legitimate policy instrument. I mentioned there and I do again that I have some sympathy with proposals that have been made elsewhere for a Medicare style levy to fund a national disability insurance scheme, for example. In the context of the matter that you have before you here today I said, and I still believe, that the income tax levy proposed by the government was one of three options that could have been considered, with neither of the other two being in any way economically irresponsible, either more so or less so, than the particular proposal which the government has put before you for consideration today.[25]

3.20 Moreover, whilst Dr Dennis did not believe there was a macroeconomic imperative to respond to the funding for reconstruction with a flood levy he stated:

...if the government does want to raise additional revenue then I think the flood levy is an efficient and an equitable way to do it.[26]

Committee view

3.21 The committee considers that the introduction of a one-off levy is an equitable and reasonable response for the Government to have taken to fund the reconstruction effort that will be required as a result of the summer of natural disasters.

3.22 The committee takes this view in the light of evidence it has received that suggests that the amount of levy any one taxpayer will pay is slight and in the average case will have the equivalent weekly cost of a cup of coffee from a cafe.

3.23 The committee also considers that the Government has taken all reasonable steps available to it to ensure that the levy does not have a negative effect on those more vulnerable taxpayers by:

limiting it to those taxpayers with taxable income greater than $50,000 who were not affected by the recent natural disasters; and
making it progressive, ensuring that those taxpayers who are better off will pay a little more.

Recommendation 1

3.24 The Committee recommends that the Senate pass the bills.

Committee comment – Economic response for future natural disasters

3.25 In light of the many natural disasters that have occurred in a relatively short space of time in both Australia and the Asia-Pacific region the committee believes it would be prudent to examine the adequacy of its preparedness for future reconstruction efforts following a natural disaster, and its impact on the economy.

3.26 The committee acknowledges the many valid points presented by the economists to both the House and Senate inquiries, and can see merit in further examination of a more consistent national approach to natural disasters. The Senate Economics References Committee is currently examining these matters and also issues relating to State Government insurance. The committee looks forward to its report.

Senator Annette Hurley
Chair

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