Government

Earlier than Expected Recovery

Following the turbulence of the past two years and the pronounced slowdown in the pace of growth, the Australian economy has commenced a sound, yet in some respects uneven, recovery. Australia’s proximity to Asia and our capacity to supply bulk quantities of those resources required for their expanding economies have shortened the downturn and now underpin our recovery. That said, in the early days of economic recovery not all sectors have seen immediate improvements in overall demand conditions, including many retail areas, tourism and hospitality, non-residential construction and multi-level residential building. These latter areas in particular have been constrained by difficulties in accessing finance for expansion and new projects.

The Henry Tax Review offers a once in a generation roadmap for tax reform

It is clear that prompt fiscal and monetary policy responses and a resilient financial system allowed Australia to escape the worst impact of the global recession. As the economy recovers, the focus for policy now needs to shift to restoring the budget position and implementing a program of tax and microeconomic reform that will enhance long-run productivity growth in the economy.

ACCI supported the use of timely, targeted and temporary fiscal stimulus to support the economy and protect Australian jobs. The fiscal policy response of the government was both timely and substantial, and has proven effective.

The Next Priority – Returning to Balanced Budgets

As we move through the next stage of the economic cycle, fiscal discipline has to be a core priority for future budgets. In this regard the business community welcomes the earlier return to a balanced budget in 2012-13. We endorse the immediate concern of government to consolidate our fiscal position and to pursue a credible deficit exit strategy. The government’s fiscal strategy contains laudable objectives for fiscal policy including restraining real growth in spending to 2% a year until the budget returns to surplus and keeping taxation as a share of GDP below the 2007-08 level of 23.6%.

Business will be now focused on seeing how the broad outline of the deficit reduction plan will be put into play. The real challenge will be delivering on those objectives in practice and not allowing spending pressures to claw back efforts toward fiscal consolidation and a return to surplus.

There are a range of reasons for confronting the budget repair task that lies ahead. Rebuilding the capacity to respond to any future economic downturn with discretionary fiscal policy is a key factor, as recent history has demonstrated. But also important is the impact that IMF research shows larger deficits and higher debt levels have in terms of increasing interest rates and, in turn, crowding out private sector investment. Further, it is also imperative that the budget is in a strong starting position to deal with the long run fiscal pressures associated with demographic and other structural changes.

A temporary budget deficit during the downturn was an acceptable price to avoid much greater economic pain, but the resulting deficits must not become entrenched. In a recovering economy a credible fiscal strategy will avoid additional pressure on government borrowing costs and avoid concerns about a potential increase in the overall tax burden. This would clearly militate against the willingness of business to invest and employ. The IMF has also stressed the importance of governments adopting credible deficit exit strategies.

Time for a Full Review of Government Expenditure - not Just Taxation

Considerable fiscal discipline will be needed to restore the budget position. Recent trends in real government spending suggest that the 2 per cent real cap will be a challenging target. The scale of the budget repair task confronting the nation may require more than just a proposed limit on real growth in spending. ACCI believes the government should consider conducting a “root and branch” review of all current budget outlays with a view to identifying areas of waste and inefficiency for either reform or rationalisation. Rationalising existing government expenditure and moving to smaller government will also expand the scope for meaningful tax reform and reduce the tax burden.

Taxation Reform and Providing Incentive

The Henry Tax Review promises to offer a once in a generation roadmap for tax reform. Business recognises the need for ongoing re-evaluation of the tax system and is supportive of reform that will deliver better economic outcomes. Elements of Australia’s taxation system are without doubt in need of reform but it is imperative that incentives to work, save and invest remain essential components of the tax architecture. Changes to the tax system have the potential to improve long-run economic growth prospects and productivity performance but only if they enhance these core fundamentals.

Successful tax reform will be measured by how it provides incentive to invest, encourages workforce participation and rewards risk taking and entrepreneurship. In the short term, reform also needs to support a return of private investment in the period of global economic recovery. Business will ultimately rate the reform process by measures which include, reducing income tax rates, maintaining capital gains tax relief measures for small business and the extent of progress toward abolishing inefficient state-based transaction taxes.

We have seen the first round of response to the Henry Tax Review by Government and welcomed the commitments to reducing company tax and providing depreciation benefits to small business. ACCI is opposed however to the Resource Super Profits Tax, which in its current form will have a detrimental impact on investment in the sector with flow-on consequences or ‘second-round’ effects in other parts of the economy.  It is vital that the industry and government are now able to negotiate a suitable taxation arrangement which will foster continued expansion and profitability in the resources sector while delivering benefits for economy as a whole.

Looking ahead there is much un-finished business in tax reform and a key priority of the wider agenda should include the alleviation of the payroll tax burden on Australian business. This objective assumes extra importance in seeking to alleviate the expense associated with increasing the Superannuation Guarantee Levy from 9% to 12%. Payroll tax is a direct tax on employment and one that is levied without any regard to a firm’s capacity to pay. Survey evidence reveals that the detrimental employment impact of payroll tax is significant. If the priority of the government is ensuring sufficient job creation to achieve full employment, adopting the Henry Tax Review recommendation to abolish payroll tax funded by a more broad based tax needs serious consideration. Apart from considering sizeable reductions in spending if we are to see the abolition of less efficient taxes, including payroll tax and other state based transaction taxes, these will most probably need to be funded through the mechanism of our existing broad based consumption tax.

Improving Our Productivity Performance

The Prime Minister in public speeches at the beginning of 2010 nominated improving the country’s productivity growth as essential to addressing the challenges ahead, including the fiscal pressures from an ageing population. ACCI agrees with the government’s prioritisation of the issue but acknowledges that the 2 per cent productivity growth target will be challenging and require a genuine commitment from all levels of government to engage in difficult and sometimes unpopular microeconomic reform. In short, policies to underpin productivity growth are now needed in order to translate this objective into an economic reality.

The focus of the next twelve months and beyond needs to shift from dealing with the aftermath of the global economic downturn to the task of reasserting a strong commitment to productivity enhancing reform. All levels of government need to embark on an ongoing program of microeconomic reform if we are to get close to achieving the ambitious 2% target.  ACCI has a range of priorities in this area, including the desire for better and less intrusive regulation, competition and free trade, quality infrastructure provision, investment in skills and retaining flexibility in labour markets.

Infrastructure Should Proceed Only After Cost Benefit Appraisal

Meeting Australia’s infrastructure needs will also be critical to maximising the long-run growth potential of the economy. It is essential that proposed projects pass transparent, robust and objective cost benefit analysis. The methodology used in those assessments should be publicly disclosed. Moreover, the private sector has an important role to play in delivering those projects and the government needs to consider options to maximise the scope for business to contract for the provision of new infrastructure investment and make public-private-partnerships attractive to private investors. Further funding commitments in the May 2010 Budget are welcomed and we now need to ensure value for money is maximised as projects are assessed and commenced.

Access To Finance For Small Business

Since the onset of global financial crisis in June 2007, Australian banks have become more risk averse, further tightening their lending criteria and increasing risk margins, especially for business borrowers. Moreover, Australian banks have also experienced significant increases in their own cost of borrowing, with negative flow-on effects for their lending rates for Australian borrowers, in particular small businesses.

As such, small businesses continue to face difficulties accessing finance from Australian banks even when a solid lending proposal exists. Unlike larger businesses, small businesses do not have the capacity to raise external finance through equity or corporate bond issuance and therefore rely heavily on intermediated finance from financial institutions for their working capital and new capital expenditure, including spending on machinery, plant and equipment and on opportunities for overall expansion.

Declining profits since the downturn, as evident from ACCI surveys, have continued to put downward pressure on small business retained earnings and further limited the sources of available finance. It is very clear that small businesses also face higher interest rate charges for loans relative to other borrowers. Data from the Reserve Bank of Australia (RBA) indicates that after the three successive interest rate hikes over the December quarter of 2009, small businesses were paying on average a margin of 3.97 percentage points above the cash rate for bank finance, compared to a margin of 2.29 percentage points for large businesses and 2.32 percentage points for mortgage customers - despite most of these business loans being residentially secured.

As the economy recovers and an increasing number of small businesses wish to expand and invest, a real risk is that the re-pricing of risk and the more limited access to credit at this end of the market will have a negative impact on growth and employment opportunities. As small businesses employ around 50% of Australia’s private sector labour force and produce nearly 40% of private sector industry value-added, they remain a vital engine of private sector growth.

ACCI, in a recent submission to the Senate Economic Committee, put forward a range of recommendations to deal with this issue, including making sure we promote further competition in the retail banking system and urging a Productivity Commission inquiry into the factors affecting the cost and availability of finance. However, as credit conditions have tightened for many smaller enterprises, business owners have identified other strategies to get on with business without necessarily relying on their traditional banking credit arrangements. We believe we will see further innovation in this area, including the use of asset financing provided by other market players and the improvement of business cash flow via the forging of new arrangements with customers. The danger, of course, is that such innovations may not be sufficient to overcome the current limitations of traditional bank-based modes of financing, and that as a result, business will restrict further borrowings until greater competition returns to credit markets, impacting negatively on employment and economic activity.