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[HSC] Economist: 3rd October

A summary of this fortnight's Economics news: rising inflation & interest rates!

Zack Bolland
99.80 ATAR, Dux, 8th in NSW for Econ
HSC Economist

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[HSC] Economist: 3rd October

Finally, inflation is beginning to slow down. Australia has seen its annual inflation rate fall after reaching a high of 7% in July, with the US and UK also seeing decreases in their annual inflation rates. Yet, it is hard to say whether this will affect the decisions of central banks around the world, as advanced economies globally continue to hike interest rates at a rate never seen before. Shifting away from central banks and the RBA, the Australian Government has been critiqued in recent weeks over its decision to go ahead with the controversial Stage 3 tax cuts due to concerns about income inequality and rampant inflation. Thus, this fortnight’s article will analyse the changing nature of monetary policy and interest rate hikes, as well as determining whether the Stage 3 tax cuts are still necessary in the current Australian economic climate.

The legislated Stage 3 tax cuts are sparking debate amongst Australians

Back in 2018, the Australian Government proposed a range of tax cuts as part of their ‘Personal Income Tax Plan’, continuing their proposal in 2019 as part of their “Lower Taxes for Hard-Working Australians” Budget measure. Following the announcement of these tax cuts, concerns were raised about Stage 3 of the proposal, which proposed the following changes:

  • Removing the $120,000 to $180,000 tax bracket
  • Increasing the tax bracket threshold from $180,000 to $200,000
  • Reducing the marginal tax rate faced by the $45,000 to $200,000 tax bracket from 32.5 per cent to 30 per cent

Concerns were first raised by Adam Bandt, a MP from the Australian Greens, leading to a budget analysis conducted by the Parliamentary Budget Office in 2021. However, only two weeks ago, the Parliamentary Budget Office released costings on the tax cuts. As per this release, the PBO estimate that the tax cuts will cost $243.5bn cumulatively out to 2033. 

Whilst this is a significant financial burden for the Australian Government, in theory, this should improve income inequality by reducing the amount of tax payable for income earners within the $45,000 to $200,000 tax bracket. By reducing the amount of tax payable, this increases the level of disposable income for low-to-middle income earners and thus should, in theory, reduce the Gini coefficient to improve income inequality.

However, as per the PBO’s recent costings, their estimates suggest that of the $243.5bn cumulative amount, 6% will go to the richest 1% of income earners and 77% will go to the richest 25%. Furthermore, these costings suggest that those earning above $180,000 will retain 48% of the total benefits of the Stage 3 tax cuts, despite only making up 3.7% of income earners in Australia. Contrary to fundamental economic theory, this will increase the level of income inequality and hence, increase the Gini coefficient for Australia. 

Not only have the tax cuts been critiqued from an economic perspective, but they have proven to be unpopular amongst the general population amidst rising inflation and rising interest rates. As per a survey conducted by the Australian Institute, 41% of people supported repealing the Stage 3 tax cuts, while only 22% wanted them kept. Undeniably, economic conditions have changed dramatically since 2018, where inflation was low, growth was mediocre and the cash rate was sitting at 1.5%. As a result, Australian citizens are campaigning for the government to respond to these changing conditions rather than keeping an outdated election process.

The Stage 3 tax cuts are due to come into effect in July 2024 and were originally proposed by the Morrison government, with support from the Labor government as well. Whilst Jim Chalmers, federal treasurer, has argued that the government is focusing on short-to medium-term economic conditions at the moment, it is hard to say whether they will fulfil their promise from 2018.

Is this going to be the last 0.5% cash rate hike?

Last month, the Reserve Bank of Australia made the decision to hike the cash rate to 2.35%. As per the ASX, there is a 79% chance that the RBA will make the decision to increase to 2.85%, a 0.50 per cent hike, at the monthly meeting on the 4th of October. If this is the case, Roy Morgan estimates that one in four mortgage holders would be at risk of mortgage stress. This is the equivalent of 1.1 million people, around 4% of the entire Australian population.

Since the first interest rate hike earlier in 2022, the interest rate has been hiked in consecutive months at a rate of 0.5% each time. It is highly likely that Phillip Lowe will continue to hike rates by 0.5% in October, as well as November, according to Roy Morgan. However, after November’s interest rate hike, it is hard to say whether the RBA will continue hiking interest rates at such a rate, as the number of mortgage holders considered at risk increase. 

Philip Lowe has noted on several occasions that he intends to continue hiking interest rates, similar to the US and the UK. As of today, the US Federal Reserve interest rate is 3.25%, with the UK interest rate sitting at 2.25%, close to Australia’s current rate of 2.35%. Yet, the US recorded an annual inflation rate of 8.3% in August, with the UK recording an inflation rate of 9.9%. Whereas, Australia’s annual inflation rate hit 6.8% in August. Whilst annual inflation rates have finally begun to decrease, inflation rates across all 3 economies remain far above the common target of 2% headline inflation. 

Thus, it is hard to determine whether Phillip Lowe will continue hiking rates by 0.5% every month beyond November of 2022. However, given that inflation is falling, it is likely that he will decrease the size of interest rate hikes moving into 2023.