What to do about recession

Yesterday I had an article in the Canberra Times, saying that we are already in a per-capita recession (last quarter had real growth of 0.1% and population growth of 0.4%), but that the government should stop trying to “save” us.

In short, my argument is that there are real problems in the economy and this recession is the price we have to pay. Politicians can force us to wear helmets, pay tax and go to school… but they can’t pass a law that forces the laws of economics to change.

By trying to “save” us, the government will only make the situation worse. Continued bail-outs will prevent the market from adjusting and build more moral hazard. Activist fiscal policy will waste money and distort the economy for no real benefit.

What we need now is exactly what we needed before the recession and what we will need after the recession — tax cuts and a more flexible labour market.

23 thoughts on “What to do about recession

  1. the problerm is that govts of all stripes feel they have to ‘save us’.

    it would be more instructive to propose the least damaging policies to ‘save us’ whilst appearing to be hyper-active on our behalves.

  2. Another way to beat recession is to ban the use of the word, and jail anyone who says bad things about the economy! It’s what they’re doing in Korea! A Blogger, using the name Minerva, correctly predicted the fall of the Korean Won, and the government is prosecuting him for saying bad things about the economy, thus causing his prediction to come true!
    If we all think happy thoughts, nothing bad can happen! Can you say Newspeak?

  3. IMHO Tax cuts wont work and never have. Tax cuts for businesses only sees the CEO take a bigger bonus or profit (or other person in management). Individual Tax cuts rarely amount to anymore than a “sandwich and milkshake” and don’t fill the fuel tank.

    If you want a more flexible labour market, establish improved Australia-wide public transport. That wont happen because its all about the roads instead of fixing the train lines or having improved bus networks etc. So it wont happen as we sold out the railways back in the 80s. We need an Australian Warren Buffet to buy them all back.

  4. Vee

    No offense and please don’t take personally. However that is about the stupidest comment I’ve seen in a long time. It’s so stupid there’s no point in even addressing it directly.

    In fact it’s so stupid I’m embarrassed reading it.

  5. If by “work” you mean stop the recession, then you are right. The recession is a fact.

    But if by “work” you mean improve the efficiency of the economy, promote growth and allow people to retain the fruits of their labour — then it certainly will work.

    The idea that company tax is felt primarily by CEOs is simply wrong. The pain of company tax is felt by owners of capital (investors), labour (workers) and consumers.

  6. Vee

    I am a small business owner. The largest line item by far on my ‘Expenses’ statement is ‘staff costs’, though ‘Insurance’ is fast catching it. The easier it is to fire my staff, the more i would hire. This might sound counter-intuitive but is a fact. Also, the cheaper staff are to hire, the more of them i would hire.

    Hence the govt could promote employment in my business by reducing my payroll taxes or reducing my corporate tax bill. Or, even better, it could encourage flexible job contracts so that i would be able to reduce expenses in the event of a downturn.

    If you are concerned that any reduction in business tax would feed direct to my own bottom line (something i am trying to maximise because i am motivated to take risk by the pursuit of higher personal profit), then the govt could simply pay me to hire workers or to train youngsters. I would like that very much.

  7. Investing in public transport (eg urban rail) would be less bad than handouts to banks or car manufacturers.

  8. Vee,

    Do you believe that taxing a commodity reduces it’s demand? If so, do you not think taxing labour (as with income and payroll tax) would have a similar effect on employment levels?

    If you want a more flexible labour market, establish improved Australia-wide public transport.

    lol… I don’t know where to begin here.

  9. Nice article, John, I’m going to pass it on to a few people. A pity the last third couldn’t be longer/more fleshed out. I guess the word limit was too tight? Or did some dastardly subbie chop some out?

    [JOHN: Word limit forced me to chop several other points]

  10. Investing in public transport (eg urban rail) would be less bad than handouts to banks or car manufacturers.

    Except Vee wasn’t saying that.

  11. I think the general order of things for a recession is to tax and regulate industry to a standstill and then claim that the problem is “free markets gone mad” and then repeat until there is nothing left to tax or regulate.

    Am I right?

  12. You should write more John.

    Vee raises some issues but comes up with the wrong answers. If you want to look at labour mobility, look at the taxes on transferring real property. That IMO is a major contributor to labour market inflexibility.

  13. John. Good article. I’ve sent it off to several business contacts. Any chance we can have access to the “original” before it was edited down to meet the word count? maybe it can be stuck up on the ldp blog?

  14. are payroll and income taxes really much different? wouldn’t reducing income tax have a similar effect on employment as reducing payroll tax.

    this seems especially obvious in the PAYE world. my employer spends spends an amount of money to employ me. this is made up of a transfer to the government in the form of payroll tax and a transfer to the government in the form of my PAYE tax obligations. i don’t see a major difference between income tax and payroll tax just because the employee nominally gets given the income tax component before they give it the government.

    i guess there are small differences because i can take deductions out of my income tax but not the payroll tax and the minimum wage is calculated without the payroll tax component but with the income tax component. but i don’t see why this would make a big difference…

  15. Payroll tax is like income tax but it specifically targets income from labour and excludes income from interest, dividends and other such things. As such its impact is focused on labour. This encourages people to employee extra capital instead of extra labour. The easiest labour to replace using capital is unskilled labour (which is why it is generally cheap).

    In short payroll taxes create unemployment at the harsh end of the labour market and are worse than income tax.

  16. I actually managed to explain payroll taxes’ negative effect to my girlfriend. Even a leftie, economic illiterate like her can see it was a stupid idea in the first place if you want more jobs πŸ™‚ Too bad Rudd is too much of an idiot to see the elephant in the room

  17. Since there are comparisons of cutting Payroll Tax and Income Tax here and new readers like drscroogemcduck have turned up, it’s probably worth telling them and reminding others about the work of Professor Kim Swales and his colleagues (see also my own independent work on the topic). That is basically a Negative Payroll Tax, analogous to the better known Negative Income Tax but attached to a suitably broad based carrying tax with impact on employers; technically, it’s a Pigovian virtual wages subsidy that raises both employment and GDP. The proposed carrying tax is usually a GST/VAT, but there are better candidate taxes from the point of view of lower deadweight burden on the overall economy (ones which aren’t in place in Australia at the moment), and you could adapt Payroll Tax itself to do it on its own, which would be worse.

    As others have mentioned, the crucial difference between cutting Payroll Tax and cutting Income Tax (and also going negative on either) is the “impact” or “legal incidence”, which is where the tax first hits, as compared with the “incidence”, which is where the tax ends up after being passed on. A lot of economists think only the incidence matters as they believe only the aggregates and ultimate effects matter. They are subtly wrong. In the long run, cutting or going negative with either tax would work out the same. However, there are two related problems with working through Income Tax:-

    – Payroll Tax cuts would start working straight away, in the first instance by reducing retrenchments, then quite quickly by encouraging apprenticeships and entry level work (including reskilling opportunities that would help people move out of old areas, i.e. part of labour market flexibility), and then by simply making more employment openings overall, mopping up much of the rest of non-frictional unemployment – all, with a Negative Payroll Tax matched to unemployment benefits. My informed guess is that this would work its way through in two years or less, well within politicians’ election-bounded time horizons. Working through Income Tax cuts would take far longer, as it would need real wages to fall enough that people could price themselves into work in each of the categories involved; even with inflation eroding real wages, we are talking ten years or more.

    – Since other things are at work in the economy, some of them much faster than the time scale of Income Tax cuts, it’s entirely possible for the leaks to gain on the pump, so to speak, i.e. for other things promoting unemployment to gain on the improvements delivered by Income Tax changes and make them ineffective. We might well never reach the long run those changes need.

    Over and above that, a Negative Income Tax would make huge budget and funding problems for the government until it eventually delivered more revenue from overall employment improving. On the other hand, Negative Payroll Tax is structured so that there are no budget and funding problems at all, even if something slowed down the improvements. It’s not quite as good as that when you are simply cutting Payroll Tax, as some other tax would have to be raised or government outgoings reduced to compensate (or some combination). Personally, I would prefer that the whole thing be merely a transitional stage towards something with no government involvement at all, but that’s another story and it’s not where we’re starting from.

  18. Perhaps I missed it, but I don’t think anyone has noted that payroll tax is collected by the States. So I’m not sure there is much the Feds can do about it.

  19. PML – at the moment there is a payroll threshold for each firm below which no payroll tax applies. An easy step towards your prefered system (which by the way I quite like) would be to modify the tax free threshold so that it relates to full time equivalent employees rather than payroll dollars. In other words the tax free threshold for payroll may be say $400,000 for the first employee and $10,000 extra for each additional worker. So if you employ 21 people payroll can be up to $600,000 before payroll tax would apply. Whilst if you employ 11 the threshold is only $500,000.

    As ED points out payroll tax is a state tax and unemployment benefits are paid by the federal government so expecting some integration of the two might be more than we can expect from our political system.

  20. E.D. and TerjeP, the straightforward way for the Commonwealth to address state level Payroll Tax is to cut states’ grants in proportion to their Payroll Tax take – ideally, a little over 100%, doing it indirectly by increasing the GST offset that much for the states in question (since they get the GST take, that would cut that to match their Payroll Tax take).

    TerjeP, what you are describing is the variant I mentioned, a Negative Payroll Tax carried by Payroll Tax itself. It would work, but the downside is that the percentage taken after the offsets would have to be very high to be revenue neutral (which politicians and bureaucrats would insist on – e.g., see the framework for the submissions in the other comments thread). That makes it harder for businesses to expand their capacity, an analogue of the problem of Income Tax taper rates in getting rid of poverty traps. With a GST as the carrying tax the burden falls on actual use and hurts new investment less, and it’s possible to design an even better carrying tax based on commercial plant and premises. Properly structured, that wouldn’t materially affect any individual firm’s new investment, as that would serve to raise the rate on a pool of firms. That is, it wouldn’t fall on actual capacity but on potential capacity as indicated by aggregate installed capacity, so even firms that didn’t install more would be charged on the potential while those that did would have an advantage from not paying the part that fell on other firms. I think a good proxy to use is the number of people resident or working in an area to get the total take for that area, which should be apportioned according to floor space, street frontage and type of use of premises (determined by the type but not amount or value of equipment there).

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