Economics
What happened to the “cost of living crisis”?
We’re still paying the price for a squandered resources boom.
It’s almost a statement of journalistic and political faith to assert that there has been a “cost of living crisis” over the last three years. But maybe all that’s happened has been a fall back to the stagnant real incomes of the pre-pandemic period.
When we look at incomes in a longer-term perspective, we see a recent blip in some otherwise established trends. That blip resulted from over-stimulation of the economy during the pandemic. In the come-down from that stimulation our incomes have fallen back to where they were before the pandemic, or maybe they are a little higher than in the pre-pandemic period.
It would be unrealistic to expect anything much better, because if we disregard the pandemic we see that over the last 15 years our incomes have been stagnant. That’s in line with our dismally poor productivity growth over that same period.
The statistical series that most closely aligns with our experience is per-capita disposable income: that is, our income after income tax. It’s not often presented in the press, presumably because it requires a few straightforward but time-consuming calculations drawing on ABS time series on disposable income, prices, and population.
The graph below showing real per-capita disposable income over the last 45 years – as long as there are consistent ABS time series – tells a few stories when it is broken up into three periods.
The first period, up to about 1996, was one of slow income growth – about 0.5 percent a year. This is the sort of income growth that is sustainable in an economy with modest productivity growth.
The second period from 1996 to about 2010 saw an extraordinarily fast rise in disposable incomes – about 3.0 percent a year. That was well ahead of productivity. Presumably much of this growth can be attributed to a commodity boom and to income tax cuts. The graph suggests there was a setback at the turn of the century, but that is simply an artefact resulting from the effect of the newly-introduced GST on consumer prices.
But then income growth stopped, introducing a third period when real disposable incomes stayed flat for eight years until we were hit with a pandemic, prompting a response in terms of massive fiscal stimulus payments. The resulting outbreak of inflation was met with a sharp rise in interest rates and tightening monetary policy, which brought disposable incomes back to where they were before the pandemic.
The uptick at the end of the series relates to a real disposable income growth over 2024. This is possibly the effect of tax cuts, and some other transfer payments such as rebates for energy. But it is unlikely that there will be sustained income growth: the government realistically expects real incomes to be flat for the next three years. Were it not for the pandemic the story of disposable incomes in Australia would be one of stagnation from 2011 through to 2028, an outcome consistent with zero labour productivity growth.
What is not picked up in this graph is the effect of interest rates on highly-indebted households, particularly those carrying significant mortgages. Assuming that the Reserve Bank will cut interest rates – although not to the extraordinarily low levels of the pre-pandemic period – household disposable income should improve. Indebted households have also been helped a little by the inflation of the 2022-2024 period which would have reduced the real value of their mortgages.
As we reflect on these movements we can ask if we were served well by the 1996 to 2011 boom in our disposable incomes. It possibly conditioned us to expect that we would always be a bit better off next year, compensating for our tendency, confirmed by behavioural research, to become overcommitted in our lifestyles. (It’s called “lifestyle creep”.)
Had the governments of that period, particularly the Howard government, held back on tax cuts and put the proceeds of the mineral boom into investment in education and infrastructure, and in building the government’s capacity, we may not have suffered the productivity slump of the last 15 years and we may have been able to continue a trajectory of modest but sustainable income growth.
Trump's tariffs
Trump’s tariffs make no economic sense, but they align with MAGA in the fantasy world of mercantilism.
It is easier to find a medical practitioner who promotes cigarette smoking than it is to find an economist who justifies tariffs. Australia has been through the painful process of effectively eliminating tariffs (by some measures we still have an average tariff rate of around 1.0 percent). There are no voices in Australia seriously suggesting we should re-introduce tariff protection for our industries, but in the USA the politics around tariffs are different.
Peter Martin, in a discussion with the Lowy Institute’s Jenny Gordon and the ABC’s Michael Janda, has devoted a session of The economy stupid to an explanation of the economists’ case against tariffs and the false (but understandable) ideas behind Trump’s trade policy: What’s with Trump and tariffs?.
To understand Trump we have to understand that he sees trade as a zero-sum activity. He has no notion of comparative advantage – the idea that there are gains all around when countries trade with one another and when in their domestic economies they concentrate on activities they do best. He sees trade solely as an advantage for the exporting country, rather than an opportunity for US consumers to enjoy access to goods produced in other countries, as if there is no consumer surplus in imports.
Tariffs in Australia
Tariffs are a core part of our own history: the main economic debate around Federation was about free trade versus protectionism, and most historians would agree that tariffs played a major part in shaping Australia as a country with a well-paid working class.
But tariffs went on past their use-by date, and by the 1980s the Hawke-Keating government was able to convince the Australian people that we would be better off with a more open economy. In this they were helped by the community realizing that behind the tariff wall we were paying too much for basic consumer items – clothes, cars and appliances in particular – and that our local production was often of poor quality. Americans are yet to learn that lesson.
To economists, and to anthropologists, it’s a strange way of thinking. Long before the emergence of modern economies human groups have been trading with one another to their mutual benefit. But at times in modern economies there has prevailed the idea that building up a trade surplus with the rest of the world is a desirable end in itself – an idea known in the textbooks as mercantilism. A moment’s reflection exposes its absurdity – what if every country tries to run a surplus? And in any case what’s the point in building a big fortune if you don’t intend to spend it on something? There have always been streams of mercantilist ideas among Australian policymakers, but they have faded into the background over the last 40 years.
Besides tapping into mercantilist ideas, which align with his MAGA vision, Trump is also able to call up in people’s minds the postwar image of well-paid manufacturing jobs in America. It’s a cruel trick, because even if industries such as vehicle manufacturing came back they would be so capital intensive they would employ little labour, and most of those workers, if they could be found, would necessarily be highly-skilled – probably not to be found among Trump’s supporters.
Martin and his colleagues go beyond the textbook arguments against tariffs. They acknowledge that even if the solutions Trump is trying to push through are foolish, the problems he is trying to address are real, and they have to do with the plight of those who have been left behind by globalization. They also have to do with the rise of China, which has become the world’s manufacturing powerhouse, able to churn out massive volumes of goods at low marginal cost.
Martin and his economist colleagues accept there are cases where it is wise for countries to support domestic production even if imports are cheaper, but they point out that tariffs aren’t the way to do it.
Even so, there can be a case for surcharges on certain imports. In this regard they could have mentioned carbon border adjustment mechanisms, which look like tariffs but which act to bring to account the full cost of production, including negative environmental externalities. These surcharges are similar to anti-dumping duties, which some economists defend on the basis that for efficient resource allocation prices should align with the cost of production.
Notably, however, none of the three economists suggest that Australia should apply retaliatory tariffs against the USA. That would simply suck us in to Trump’s lose-lose system.
Four propositions that fail the pub test
Yes, the GST is a regressive tax, but the services it funds are progressive parts of the social wage.
Under the heading Tweaking the tax system, Crispin Hull has four propositions, three of which relate to the GST.
- Increase the rate of the GST.
- Apply the GST to fresh food.
- Apply the GST to education.
- Delete tax deductibility for donations to charity.
He acknowledges that the ideas all fail the pub test, but he illustrates how they all make good economic sense, counterintuitively making our tax system fairer.
Why, for example, should crayfish and fillet steak be free of GST? Why should private school fees for manicured gardens and indoor equestrian centres be GST free? Why does the government need to maintain a 116-page schedule of what goods are in and which foods are out of the GST net?
How is it that the Nordic countries, whose governments sustain policies well to the left of our Labor government, maintain VAT rates of 25 percent, while we see a 10 percent GST as an absolute ceiling?
It is true, as most opponents of increasing the GST point out, that the GST is regressive with respect to income. The lower our income the higher proportion of that income we spend.
To assess the equity of our public finances, however, we need to look not only at how taxes are collected, but also how revenue from those taxes is spent. For example in a paper presented in 2013 – Taxes, our payment for civilization – I demonstrated, using Gini coefficients (a standard way of assessing equity) that the GST is indeed a regressive tax. But because the GST passes through to the states, and about half of state expenditure is on school education and health care, the progressivity of those services more than compensates for the regressivity of the GST’s collection.
And as Crispin Hull points out, the GST is one tax the 91 Australians with incomes above $1 million who paid no income tax cannot avoid.
Hull puts the case for a higher and wider GST as a means of collecting more public revenue. That’s an entirely reasonable proposition in view of our situation as a country collecting too little tax to sustain our public services. It is to be distinguished from the view put by those calling for increases in the GST to fund cuts in company and income taxes. That would be regressive.
The Australia Institute makes some of the same arguments as Hull in relationship to the GST. They favour widening its base to include private school fees and private health insurance, but they do not argue for raising its rate. Their main point is that the states have lost out because of the narrow base of the GST. In the 25 years we have had a GST many of the items on which GST is applied have become relatively cheaper than other goods and services exempt from GST, which means the states’ revenue base has been eroding.
The slow demise of cash
Policy concerns about debit card surcharges overlook the role of cash in tax evasion.
In Australia there are almost $100 billion of banknotes in circulation. Our increasing use of cashless transactions has hardly made a dent in the growth of people’s cash holdings.
That $100 billion is around $2 700 per head, or $10 000 per household: imagine a stack of 200 $50 notes, or 100 $100 notes. Apart from bankers, and auto dealers who occasionally encounter a spiv paying cash for a Ferrari, few of us ever see such large amounts of folding cash. We rarely come across $100 notes, even though they comprise almost half the value of banknotes in circulation.
We just don’t use much cash anymore: between 2007 and 2022 the proportion of consumer transactions financed by cash fell from 69 percent to 13 percent, and no doubt it has been falling since then as debit cards become most people’s preferred mode of payment.
Some people miss these
Our use of cash has been of policy concern in two aspects.
One concern is to ensure that cash can still be used for essential purposes, to cater for individuals who for some reason cannot use cash, and to deal with situations of digital outage. As from next year businesses will be required to accept cash for fuel, groceries and other essentials if it is offered. (The case for a cash mandate was established in a 2024 Treasury consultation paper.)
The other concern, which has been newsworthy in recent weeks, is about businesses’ use of surcharges for transactions other than cash.
Such surcharges violate the principle that the price displayed should show the full cost of the transaction. Also, among those who apply the surcharge it is usually at a standard rate, even though the fees charged for use of debit cards, for example, are much lower than the fees charged for credit cards.
This month the Reserve Bank has issued a pair of papers – a consultation paper and an issues paper – canvassing ideas for regulation of payments. They would probably prohibit surcharging, and would require banks to deal more fairly with businesses using their payments systems.
The more basic question, not really addressed in the Reserve Bank’s papers, is why businesses might want to encourage the use of cash, when there is the convenience and safety of electronic payment. The use of cash requires investment and effort in security, a heightened risk of break-ins, and the need to reconcile cash registers.
Then there is the need to deal with the day’s cash receipts. For small businesses this requires staff to visit a bank or ATM to deposit cash – a high-risk activity. Larger companies use Armaguard, the only company still providing that service, but as Peter Martin and his quests point out on The economy stupid – The end of cash? – as the need for such a service dwindles it is no longer profitable. Armaguard’s operations have been supported by a $75 million subsidy, financed mainly by the banks. If we believe it is important for cash to have an ongoing role, it may be necessary to have the cost identified as a community service operation, in the same way as Australia Post is subsidised for unprofitable mail delivery in rural areas. That subsidy could be from the government or from a levy on the banks.
How does it keep prices lower?
A 2008 staff paper by the Reserve Bank found that cash was the lowest-cost payment method for small businesses, but that was when cash was still the dominant form of payment. It therefore considered only the marginal cost of using cash, rather than the total cost of using cash. Those fixed costs of security and so on can be entirely eliminated when a business goes cashless.
Rationally therefore one might expect businesses to set a surcharge for cash, or to reasonably refuse to accept cash.
Yet following the suggestion that the RBA might prohibit surcharges, there have been protests from many small businesses, particularly those in the food service industries. The Council of Small Business Organisations, while welcoming the idea of lower bank fees, is less than enthusiastic about removing surcharges.
Maybe some businesses apply surcharges because they have never considered the costs of their processes.
Or maybe others are less than candid about their preference for cash, because cash allows for tax evasion in ways that electronic payments don’t.
Sometimes that evasion results from unprofessional business practices. Those who have consulted for or who have helped small businesses have often been appalled by their sloppiness, such as the way proprietors withdraw cash from the till to provide themselves with a wage, without any record. It is unsurprising that underpayment of superannuation, and failure to make PAYG tax payments, is relatively common in food service industries.
Undoubtedly there is also more deliberate calculated tax evasion in some businesses whose transactions are mainly in cash. It’s easy for cash-based firms to understate their income, provided they don’t take it to an extreme that would alert the ATO.
The most pathetic argument put up by cash advocates is that older people cannot handle cashless technology, as if anyone who isn't in Gen X, Y, or Z is a feeble-minded imbecile. It portrays the image that older people are carrying wads of banknotes, making them easy prey for thieves. A generation that has dealt with a change in the currency, the introduction of credit cards, and metric conversion, surely welcomes an opportunity to make their lives safer.
That brings us back to the $100 billion sloshing around. Some of it is in the small business cash economy, where the temptation for tax evasion is very high, particularly in those competitive businesses, such as cafes, where honest traders have to compete with less scrupulous competitors.
Perhaps the best outcome of the Reserve Bank’s review would be a ban on cash transactions – with some limited carve-outs. A ban on surcharges would be a second-best outcome in the public interest, and would be easier politically. People may have to pay a little more for their smashed avocado and lattes, but that’s a fair transaction if it helps honest businesses, and protects staff from the risks of having to handle cash.
A serious economist on the environment
One more time – there is no trade-off between a healthy natural environment and a strong economy.
If Ken Henry needs an illustration of the way our economic performance depends on the health of the natural environment, it has been provided in the form of an algal bloom wreaking havoc on South Australia’s ocean waters. On Radio National the state’s deputy premier, Susan Close, describes the bloom, moving seamlessly back and forth between the biological causes of the bloom – all related to climate change – and the bloom’s effect on those whose livelihood depends on the ocean. She doesn’t break her explanation between “the environment” and “the economy”, because such a distinction would be is false: there is just one complex interrelated system on which human wellbeing depends.
Fishing on South Australia's Golfe Josephine in better times
Minister Close's explanation is a 10-minute illustration of the main point Ken Henry made in his Press Club address last week: Our last best chance to restore nature and to power the net zero economy. It’s a rigorously-presented case for the Commonwealth to reform our “broken” environmental laws, namely the 1999 Environmental Protection and Conservation Act, which have failed to arrest a decline in the state of our ecosystems.
Henry makes repeated reference to the 2021 review of the Act, headed by Graeme Samuel, which successive governments have either opposed, or have left in the pile of matters that are too hard to handle. Samuel summarises his recommendations in a Financial Review article: Why Ken Henry’s plan could finally fix our broken environmental system.
Samuel makes it clear that he sees the Albanese government, with a clear majority in the House of Representatives and a Senate supportive of environmental values, as being in a strong position to legislate for reform. Not that this should be politically costly for the government, because smoother and clearer regulation, allowing for faster project assessment by an environmental protection authority at arm’s length from government, should surely be welcomed by investors.
The most significant aspects of Henry’s address, building on Samuel’s work, are his suggestions that our environmental laws should include a climate trigger to ensure that consideration of major projects takes into account their contribution to global warming, and that certain regions of high biodiversity be proclaimed as of high conservation value, with relatively stricter environmental standards than in other regions. He singles out land clearing for mention for its contribution to degradation of our natural resources.