“c05AggregateSupplyPolicies_PrintPDF” — 2022/6/14 — 4:32 — page 421 — #37
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the quantity and quality of our human capital, lowered efficiency and eroded Australia’s productive capacity and living standards. • They help to reduce the disincentives of bracket creep (also called fiscal drag) as individuals move into higher tax brackets when their incomes rise, that otherwise would cause the average tax burden to increase over time and act as a supply-side disincentive. • Cutting company tax rates. There have been significant reductions in tax rates for small and medium-sized companies over recent years, taking the rate from 30 to 27.5 per cent for 2019–20. A further reduction to 26 per cent occurred in 2020–21, decreasing to 25 percent in 2021–22. Furthermore, recent budgets to 2021–22 also provided tax relief through instant tax write-offs for small to medium-sized businesses purchasing capital equipment. The 2020–21 budget allowed businesses with an annual turnover of up to $5 billion to be able to deduct the full cost of improvements in eligible depreciable assets, and this was extended in the 2021–22 budget to June 2023. Company tax reforms like these have been used to grow Australia’s productive capacity and promote aggregate supply: • Lower corporate rates create powerful incentives for businesses to expand through investment in new plant, equipment and technology. This boosts technical efficiency and capacity. In turn, higher efficiency helps keep production costs down and causes after-tax profits to be stronger. As a result of better returns, profit-hungry firms and individuals supposedly become more willing and able to expand production and capacity, increasing aggregate supply. • Lower company tax rates in Australia relative to those overseas have helped to make local export and import-replacing firms even more internationally competitive. This has led to business expansion and the growth of aggregate supply. (Even so, Australia’s company tax rates are still much higher than those in many countries in our region.) • In addition, relatively lower company tax rates here should help to attract foreign investment that would help to grow efficiency, productive capacity, employment, incomes and living standards.
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How tax reform as part of the budget can affect, domestic macroeconomic goals, international competitiveness and living standards
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Many economists argue that the government’s tax reforms, mostly involving reductions in various tax rates, have ramped up the positive incentives to encourage higher levels of business investment, reward greater effort, increase participation in the work force and hard work by individuals, all of which can help improve efficiency in our use of resources. Through greater incentivisation, reforms have made Australia’s aggregate supply conditions for businesses and individuals more favourable, thereby growing our productive capacity. Yet again, it is handy to refer to the AD–AS diagram shown in figure 5.6 (Pxxx). Here, for example, lower personal and company tax rates create stronger incentives to grow capacity and increase AS (the rise from AS1 to AS2 ). In turn, this increases the non-inflationary, potential rate of economic and employment growth (the rise from GDP1 to GDP2 ), while prices actually fall (the drop from P1 to P2 ), thereby also improving our international competitiveness. Over time, domestic macroeconomic conditions can be strengthened, supporting better living standards. With this in mind, let us now take a closer look at the likely impact of tax reform on Australia’s domestic macroeconomic goals, international competitiveness and living standards.
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Tax reforms in the budget can increase the non-inflationary rate of economic growth
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The government seeks to have the highest sustainable rate of economic growth that does not add to inflation (namely, when chain volume GDP rises by an average of around 3 per cent a year). Budgetary tax reforms can work to expand productive capacity, and increase aggregate supply and the potential rate of economic growth, in several ways: • Lower personal income tax rates (e.g. 2018–24) can create greater rewards or incentives, and motivate individuals to work harder, work longer hours and gain promotion. They can also encourage higher rates of participation in the labour force (helping individuals avoid the welfare trap). Together, these outcomes may help to increase access to labour resources and grow productive capacity, elevating Australia’s potential GDP.
TOPIC 5 Aggregate Supply Policies
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