5.4 Encouragement of skilled immigration as an aggregate supply policy

• Apprenticeship and traineeships: Federal funding worth $2.7 billion was provided in the 2021–22 budget for creating around 170 000 additional apprenticeships and traineeships. • Support for women: The 2021–22 budget offered support for women in education through STEM scholarships in partnership with businesses, along with funding for 50 000 places for training in non-traditional trades. • Scholarships and other: The Rural and Regional Enterprise Scholarships program is designed to increase educational opportunities for young people in regional and remote communities, to complete their tertiary training. Additionally, in 2020 during the COVID-19 pandemic, the Australian government decided to invest around $300 million to provide 12 000 supported tertiary education places designed to help guide departing Year 12 students into areas of skill shortage in the labour market. This is on top of creating an additional 17 000 places in 2021. • The JobTrainer Fund: The COVID-19 lockdowns in 2020 caused over 1 million Australians to be unemployed. In response, the Australian government initially allocated $1 billion to set up the JobTrainer Fund to create over 340 000 additional free or low-cost training and job retraining places to ensure the unemployed and school leavers have the wanted skills needed to get a job. The 2021–22 budget increased financial support for the JobTrainer Fund, creating an additional 163 000 free or low fee training places for school leavers and the unemployed to up-skill in areas like health, education, IT, agriculture and science. How government budget outlays on education and training affect living standards Government budget outlays on education and training can help to make aggregate supply conditions more favourable, strengthening many aspects of material and non-material living standards, by improving domestic macroeconomic conditions leading to better living standards. This improvement can again be illustrated by referring to the AD-AS diagram shown in figure 5.6 (P xxx) with the outward shift in the AS line (the rise from AS1 to AS2) because education outlays cause a rise in productive capacity. Budget outlays on education and training can increase the non-inflationary rate of economic growth There are several ways that budget outlays on training and education helps to boost productive capacity and aggregate supply, and accelerate the sustainable, non-inflationary rate of economic growth: • In the long term, it improves the quality of our human capital resources, making workers more productive, adaptive and innovative, and lifting Australia’s dynamic and technical efficiency. • Improved training can ease Australia’s skills shortages or bottlenecks that would otherwise limit national production and restrict the growth in Australia’s productive capacity, AS and potential rate of growth in GDP. • By increasing efficiency and easing labour shortages, it slows the growth in wage costs, strengthens business profitability and international competitiveness, and makes aggregate supply conditions more favourable, encouraging business expansion rather than closure. Budget outlays on education can slow cost inflation and improve international competitiveness Outlays on education and training can slow production costs for businesses. In the long term, this promotes aggregate supply and eases cost inflation pressures in two main ways: • As mentioned, improving our human capital helps to make labour more efficient (it increases GDP per hour worked), slowing business costs and allowing firms to sell their goods profitably at lower prices, and strengthening international competitiveness. • It helps to ease the skills bottlenecks that would normally be reflected in higher wage costs and prices. Budget outlays on education and training can lower structural unemployment In the long term, budget outlays on education and training help to reduce structural unemployment: UNCORRECTED PAGE PROOFS • Having the right skills can help to make our labour force more employable and job ready, reducing structural unemployment that is often caused by the mismatch of skills and job requirements. • By easing skills shortages, budget outlays on education and training can slow the growth in wage costs that otherwise would occur. This encourages business expansion, fewer closures and improved competitiveness, leading to less structural unemployment.

Budget outlays on education and training can improve living standards Budget outlays on education and training makes aggregate supply conditions more favourable, strengthening the domestic macroeconomic environment and improving many aspects of living standards: • Through accelerating the non-inflationary rate of GDP growth, slowing cost inflationary pressures, improving our international competitiveness, and, in the long term, expanding employment opportunities.

This policy initiative can therefore help to grow average real incomes and purchasing power. This creates conditions that over time, strengthen material living standards. • Budget outlays on education and training can help to reduce market failure and the underproduction of socially-beneficial services due to the existence of positive externalities, otherwise ignored by profitseeking private owners of resources. In so doing, it can improve allocative efficiency and more fully maximise the extent to which society’s material wants are satisfied. • Budget outlays on education and training can also make workers more employable. They are less likely to be unemployed and on inadequate welfare, because they have wanted skills that can be used to grow the economy’s productive capacity. By helping to reduce structural unemployment, this policy measure improves non-material living standards by reducing stress, improving mental and physical health outcomes. Weaknesses of budget outlays on training and education as an aggregate supply policy So far, we have investigated how government outlays on training and education have helped to grow Australia’s efficiency, productive capacity and aggregate supply, improving domestic macroeconomic outcomes, international competitiveness and living standards. However, in practice, this aggregate supply-side budgetary policy measure involves some weaknesses, limiting their effectiveness: • Financial constraints: Even though education and training are key drivers of productivity, economic growth and living standards, and despite a rise in government budget outlays on education, funding as a proportion of GDP is still below other comparable countries (Australia was ranked 13th in 2020), One reason for inadequate spending in this area in recent years, is concern over large budget deficits and the burden on future generations of rising levels of government debt. • Money is sometimes misdirected: Despite the spending of billions of dollars on education and training each year, some of this has been directed towards the purchase of dubious resources (e.g. school canteens and gyms), often based on political considerations rather than social or economic outcomes. • Poor educational outcomes: Misdirected and inadequate funding of education, are factors contributing to poor learning outcomes and a general decline in standards against those in some other countries. For example. • Around 30 per cent of 15-year olds do not reach national literacy standards. • In Mathematics, Australian student performance has declined by the equivalent of about half a year. • Funding promotes inequity of opportunity: Some critics argue that the use of recent education funding models mean that too many resources are directed towards non-government or private schools, unfairly widening the gulf in facilities and opportunities offered to students. 5.3.3 Budget subsidies can grow aggregate supply Subsidies are an aggregate supply budgetary measure designed to improve resource allocation and grow productive capacity. They generally involve either cash payments (making up 45 per cent of the total value) or tax concessions (making up 55 per cent of the total) provided by the government to businesses, industries or individuals. Most typically, subsidies can: • help lower the production costs for particular industries and increase their profits, leading to business expansion and more jobs, rather than closure UNCORRECTED PAGE PROOFS • enable firms to profitably sell their goods and services at lower prices, increasing their affordability and strengthening international competitiveness • help change the behaviour of individuals, to improve their general wellbeing. • reduce market failure associated with positive externalities where some socially-beneficial goods or services are under-produced because decision makers focus on private gains, rather than considering the broader social benefits affecting society’s general wellbeing

Whatever form it might take, a government subsidy is normally only justified when there is a net gain in society’s wellbeing as a result of improved wellbeing and efficiency in resource allocation, or government intervention in the market is needed to promote greater equity in the distribution of incomes, goods and services.

Key features of the government’s recent policy on subsidies

Figure 5.11, part 1 shows that in the year to mid-2020, the Australian government spent over $11 billion on subsidies and industry assistance in the form of cash payments and tax deductions (excluding temporary COVID-19 assistance measures). Overall, this value represents a decrease since the high levels of the 1970s. However, although not shown in figure 5.11 part 1, between June 2020 and March 2021, the Australian government again dramatically increased its budget outlays on subsidies, as part of its COVID-19 emergency support packages that included und $90 billion for the JobKeeper wage subsidy and additional support for specific industries including the airlines, arts, tourism, higher education, aged care and building sectors. Figure 5.11, part 2, summarise a few of the areas that have received Australian government subsidies through recent budgets, while part 3 provides some recent examples of subsidies. In each case, remember that they seek to create positive incentives to change behaviour and make aggregate supply conditions more favourable, thereby encouraging the growth of productive capacity, AS and our potential level of national output.

FIGURE 5.11 Snapshot of the Australian government’s budget outlays on subsidies and other assistance 9.6 9.5 10.2 2015–16 2016–17 2017–18 2018–19 2019–20 2020–21 2021–22 2022–23 *Note: During June 2020 through to March 2021, the treasurer announced wide-ranging, temporary emergency measures that are not included in the above data. These include the JobKeeper wage subsidy costing over $90 billion, training subsidies, and a range of other industry subsidies whose total value dwarfed the outlays shown above. 10.92 9.9 10.2

Part 1-Estmated annual value of gross subsidies and other industry assistance* ($ billions, excluding temporary assistance provided during Covid) 11.4 11.8 Value of trade-related budget subsidies ($ billions) 11.9 Year

14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 Part 2-Percentage of gross budget outlays on subsidies and other assistance by Australian industry (excluding temporary assistance measures during Covid) Mining subsidies as a percentage of total = 4% Primary industry subsidies as a percentage of total = 20%

Manufacturing subsidies as a percentage of total = 29%

Services subsidies as aUNCORRECTED PAGE PROOFS percentage of total = 47%

Part 3 Some recent examples of Australian government budget outlays on subsidies to grow productive capacity and promote aggregate supply

Name of subsidy Details

Export Market Development Grants (EMDG) Managed through Austrade, these grants (e.g., $60 million in the 2019–20 budget) seek to help firms cover up to 50 per cent of the costs involved in the promotion of their goods and services in foreign markets. Tax Incentive Scheme There is a Tax Incentive Scheme for investment in R&D by smaller companies involved in innovation and the commercialisation of ideas for manufacturing and rural industry. It is designed to lift productivity and sales, and accounts for around a third of all budget assistance. Help for farmers suffering hardship Financial assistance payments up to $75 000 are available to eligible farmers who have experienced severe financial hardship due to drought, fires and floods. This reduces farm closures and maintains jobs and productive capacity. Export market development grants For some years now, the annual budget has made finance available to firms to help them cover some of the costs associated with growing their export market, enabling the expansion of our productive capacity. Tasmanian Freight Equalisation Scheme This scheme aims to reduce the transport cost disadvantage for businesses operating in that state, keep prices competitive, encourage expansion and develop new employment opportunities. Wage subsidies including temporary JobKeeper payments The 2018–19–20–21 budgets provided various types of ongoing wage subsidies to encourage employers to take on older, Aboriginal and Torres Strait Islander, rural and other disadvantaged groups and employ new apprentices. However, the temporary JobKeeper wage subsidy set a new record and cost over $90 billion between June 2020 and May 2021. Initially, it involved payments to eligible firms of $1500 per employee per fortnight so that eligible businesses suffering at least a 30 per cent fall in turnover, could continue to employ and pay their valued staff and start up quickly on the other side of the pandemic. Childcare subsidies Having access to affordable childcare, through funding in the 2019–20–21–22 budgets, allows lower income parents to increase their participation in work, which grows the size of Australia’s labour force and increases productive capacity. Subsidies for education and training including the JobTrainer scheme Subsidies are available through both the 2020–21 and 2021–22 budgets to encourage individuals to update and up-skill their education and training. For instance, the JobTrainer scheme introduced in 2020, made some training courses available either free, or at a very low cost. The aim is to help make our labour force more productive, employable and job ready, thereby improving Australia’s human capital, lifting efficiency in our use of resources and growing productive capacity. Subsidies to the coal mining industry Cash subsidies of around $5 per tonne are paid to coal mining companies to encourage production, consumption and employment. In addition, there are generous subsidies in the form of exemptions from fuel excise. Here, subsidies help to strengthen competitiveness, and expand sales, jobs and our mining capacity (although there is a trade-off involving negative externalities associated with accelerated climate change. Subsidies to encourage higher levels of investment spending

Subsidies in the form of accelerated depreciation allowances and instant tax writeoffs for businesses purchasing capital items, can reduce the cost of business investment spending that helps to grow jobs and productive capacity. The 2019–20–21–22 budgets, for example, increased subsidies to small and medium-sized firms as instant tax write-offs for the purchase of capital items to help reduce production costs and expand capacity. In 2020–21–22, the scheme was modified to allow eligible firms to deduct from tax, the full cost of depreciable capital assets.UNCORRECTED PAGE PROOFS

*Note for Part 1: During June 2020 through to March 2021, the treasurer announced wide-ranging, temporary emergency measures that are not included in the above data. These include the JobKeeper wage subsidy costing over $90 billion, training subsidies, and a range of other industry subsidies whose total value dwarfed these previous outlays. Sources: Data for parts 1 and 2 derived from Productivity Commission, Annual Report Series, 2019-20, Trade and Assistance Review, 2019-20, P6, see https://www.pc.gov.au/research/ongoing/trade-assistance/2019-20/trade-assistance-review-201920.pdf and other.

How budget subsidies affect the achievement of domestic macroeconomic goals, international competitiveness, and living standards

Subsidies can be used make aggregate supply conditions more favourable for individuals and firms so that collectively, they are more willing and able to produce goods and services. In turn, referring to the AD-AS diagram used in figure 5.6 (P xxx), you can see that subsidies can help increase productive capacity and shift the AS line out and to the right (an increase from AS1 to AS2), so that equilibrium occurs at the higher level of GDP (the rise from GDP1 to GDP2) yet at a lower level of prices (the fall from P1 to P2). Generally, this would tend to improve domestic macroeconomic conditions, international competitiveness, and living standards. Budget subsidies can increase the non-inflationary rate of economic growth There are several ways whereby targeted budget outlays on subsidies (eg, those for the mining industry, instant tax write offs for businesses purchasing new equipment, or the Tasmanian Freight Equalisation Scheme and the temporary industry assistance provided to various industries like aviation and tourism) can help to boost productive capacity and aggregate supply, and accelerate Australia’s long-term sustainable rate of economic growth: • Subsidies can be used by businesses to upgrade their equipment and technology, and restructure their operations, leading to better technical efficiency. In this way, they can grow Australia’s productive capacity and the size of our production possibility frontier. • Government subsidies can help to cover some of the production costs of local businesses, making them more profitable. This makes firms more willing and able to expand their capacity and output. • Subsidies can allow local businesses to sell at a lower price, making them more internationally competitive. This can also help local firms grow their market size and sales volumes, enabling them to gain more economies of large-scale production. Budget subsidies can slow cost inflation and improve international competitiveness Government outlays on subsidies (eg, instant tax write-off for firms purchasing new equipment, childcare, training, Export Market Development Grants) can reduce production costs for businesses and individuals, thereby making aggregate supply conditions more favourable, easing inflationary pressures and increasing our international competitiveness in two main ways: • As mentioned, by meeting some of the production costs of local firms, businesses can profitably sell their goods and services at lower prices, slowing cost inflation and increasing international competitiveness. • When subsidies are used to encourage businesses and industries to restructure their operations more efficiently, they again help reduce cost pressures and inflation, and strengthen the international competitiveness of local firms. Budget subsidies can reduce structural unemployment When subsidies are used to encourage local businesses to buy new equipment or to help cover wage costs, they can help to reduce structural unemployment: • Subsidies can be used to make firms more profitable by covering some of their costs. encouraging expansion and reducing the number of business closures (eg, during Covid lockdowns in 2020 and early 2021, the JobKeeper wage subsidy payments lowered the unemployment rate for June from 11.5 to 7.5 per cent). • Subsidies can also be used to reduce the cost of retraining and up-skilling individuals who might otherwise be unemployed because they have the wrong training or experience for the jobs on offer (eg, the JobTrainer scheme). Over time, this can help reduce structural unemployment. Budget subsidies can improve living standards Wel-targeted budget subsidies can help strengthen many aspects of living standards: UNCORRECTED PAGE PROOFS • By helping to accelerate the sustainable rate of GDP growth, slowing inflationary pressures and assisting employment in the long term, subsidies can help to grow average real incomes and the purchasing power of individuals, creating optimal conditions for better material living standards.

• Subsidies paid to consumers of goods and services (like solar panels and rainwater tanks) can help ease environmental problems (such as carbon emissions and climate change), reduce negative externalities (such as those associated with power production and consumption) and improve non-material living standards. • Subsidies can reduce market failure associated with positive externalities (eg, the Australian government subsidising the development of a Covid vaccine, and providing vaccination and testing free of charge). In the absence of government funding in these circumstances, it is likely there would be underproduction of some socially-beneficial goods or services because owners of resources make decisions based on private rather than wider social returns that benefit the general community and raise society’s wellbeing. Weaknesses of budget subsidies as an aggregate supply policy So far we have seen that budget outlays on subsidies can be considered an aggregate supply policy because they can make conditions more favourable for Australian businesses and grow our potential GDP, leading to better living standards. However, the payment of subsidies can have weaknesses: • Subsidies involve financial constraints: Recently, there has been concern expressed in some quarters, about large budget deficits and rising levels of government debt that may become a burden on future generations (because of the pressure to reduce outlays on government services and/or the need for higher taxes). Given these financial constraints, funds available for subsidies have been limited so that many potentially good projects have missed out. • Subsidies involve trade-offs: In a way, the payment of subsidies to one group or industry represents a higher tax levied on other individuals or businesses. There is also an opportunity cost or trade-off in terms of other budget outlays (such as education, infrastructure, health and welfare) that cannot go ahead, or have to be cut. The government needs to carefully weigh up what is forgone, and think of which outlays promote the greatest public benefit. • Subsidies can reduce efficiency: Subsidies can sometimes reduce efficiency in the allocation of resources by diverting them into areas of cost disadvantage (see topic 3). Additionally, some subsidies can allow local firms to remain inefficient and avoid restructuring their production more competitively or perhaps undertaking R&D. As a consequence, subsidies can reduce our productive capacity and living standards. • Subsidies can cause government failure: Subsidies can lead to government failure and unintended consequences (e.g. subsidies to the coal industry). They can reduce society’s welfare by being less efficient than the free operation of the price system. They can also involve opportunity costs where resources are redirected away from other uses where they may have added even more to our general living standards. • Subsidies may not create jobs: Subsidising inefficient industries or firms rarely creates jobs in the long term. • Political constraints: Subsidies are often politically popular when given, but are difficult to take away, when no longer needed. • Transparency: Subsidies are not always transparent and may be subject to political abuse designed to buy popularity with particular groups of voters or geographic regions. 5.3.4 Budget support for research and development can grow aggregate supply Government support of R&D through budget outlays and tax concessions, is another aggregate supply policy that can help make conditions more favourable for firms supplying goods and services so that collectively, they are keener to expand Australia’s productive capacity and increase aggregate supply. This support for R&D may involve either cash payments or more commonly, generous tax incentives or write-offs up to 150 per cent of the cost of R&D expenditure. They are provided to institutions, universities, firms and individuals to help grow the UNCORRECTED PAGE PROOFS quality of Australia’s human capital by encouraging technical and dynamic efficiency. Over time, these outlays can create strong positive financial incentives for businesses that expand the economy’s productive capacity, potential output and competitiveness.

A recent Australian Innovation System Report by the Department of Industry, Innovation and Science highlighted the importance of innovation encouraged by R&D, perhaps through government budget grants. For example, the Organisation for Economic Cooperation and Development (OECD) estimates that perhaps up to 50 per cent of a nation’s long-term rate of economic growth can be attributed to the level of innovation. Experts estimate that every $1 spent on Australian R&D by the public and private sectors produces an average benefit or return of $2 worth of increased business sales. This is because innovation greatly contributes to better efficiency in the use of resources, improved competitiveness, stronger business sales and profits, more jobs, higher incomes and better living standards. Budget measures to support R&D need to consider the following: • It is hard for the government to pick projects with real potential and predict winners. • Returns on R&D can sometimes be low and uncertain often discouraging the private sector from investing in this area. In addition, any returns often take time to produce results. • Grants help to reduce the private costs of research and, with strong laws on intellectual property rights; they increase private benefits and incentives for researchers. In addition, encouraging research may even reduce market failure (positive externalities) associated with the underproduction of potentially beneficial goods and services that may bring wider social benefits for the community, increasing efficiency in resource allocation and living standards. Key features of the government’s recent policy on R&D As shown in figure 5.12, the federal government plays an important role in encouraging various types of R&D through its refundable tax concessions, incentives or offsets, and direct financial support for businesses undertaking appropriate research. Figure 5.12 provides a snapshot of the policy: • Part 1 shows a slight overall rise in Australian government investment funding of R&D and other assistance, especially over recent years. • Part 2 illustrates changes in the type of assistance provided and the recent change towards using tax concessions. • Part 3 shows the general estimated breakdown in government outlays on R&D and other assistance across the various sectors, where the higher educational institutions and the private business sector (mostly through tax concessions) together took over 55 per cent of all grants. This was followed by the government sector (including research agency the Commonwealth Scientific and Industrial Research Organisation, or CSIRO) and multi-sectors (rural, health and medical, energy and environmental research). • Finally, part 4 reveals the number of funded R&D projects by industry sector. Not surprisingly, health UNCORRECTED PAGE PROOFS (including vaccine development, diabetes and traumatic injuries, heart disease), soil and water, food, environment, energy, advanced manufacturing, resources, transport and cybersecurity had the greatest number of funded projects.

More specifically, highlights of R&D funding from recent budgets to 2021–22 include the following: • Research & development tax offsets: For 2021–22, Australian companies conducting eligible R&D activities costing up to $150 million, can again apply for grants. The size of the offset provided depends on the company’s annual turnover. These grants totalling $2 billion, are designed to increase R&D investment and its application in the economy. • CSIRO funding: The Commonwealth Scientific and Industrial Research Organisation is a government statutory authority. The 2020–21 budget provided $459 million in funding over four years to 2025, to conduct research into areas like agriculture, livestock, food, oceans, bio-security and disease, artificial intelligence, space, oceans, the Antarctic, and climate. • Medical research: During 2020–21, the Medical Research Future Fund (MRFF) distributed about $380 million for specific medical R&D projects to organisations. In addition, and in response to the COVID-19 pandemic in 2020 and 2021, the budget allocated $42 million for vaccine development, not just to ease the health emergency, but also to reduce business closures and grow productive capacity. • The Patent Box tax incentive: The Patent Box tax incentive scheme will start in July 2022. Australian owned firms inventing and conducting R&D locally, and successfully gaining a medical and biotech patent, will have to pay just 17 per cent tax on their business profits.

FIGURE 5.12 Snapshot of the Australian government’s budget R&D and other assistance 9.9 10.2 2018–19 2019–20 2020–21 2021–22 2022–23 2023–24

Part 1-Trends in Australian government budget outlays on R&D and other assistance ($ billions - prior to the temporary Covid support measures*) 11.9 10.92 Value of budget outlays on R&D ($ billions)

14.0 12.0 8.0 6.0 4.0 2.0 0.0 10.0 Part 2-Changes in the share of Australian government budget outlays on R&D and other assistance, by type Per cent of budgetary assistance 80 60 40 20 100 UNCORRECTED PAGE PROOFS 0

2014–15 2015–16 2016–17 2017–18 2018–19 2019–20

Tax concessions Budgetary outlays

Part 3-The distribution of Australian government budget outlays on R&D by research sector, 2021–22

Government research, $2.32 million (21.2%)

Research by higher educational institutions, $4, 703 million (28.1%)

Private business enterprises for research including non-profit sector, $2.93 million (26.9%) Multisector research & other, $2.6 million (23.8%) Part 4-Number of government-funded R&D projects by focus area, 2021–22 20 40 60 Soil and Water FoodHealth Environmental change Energy Resources Advanced manufacturing Transport Cybersecurity *Note for part 1: During June 2020 through to March 2021, the treasurer announced wide-ranging, temporary emergency measures that are not included in the above data. These include the JobKeeper wage subsidy costing over $90 billion, training subsidies, and a range of other industry subsidies whose total value dwarfed the outlays shown above Sources: Data from various sources. Parts 1, 3 and 4 are from Australian government, Science, Research & Innovation (SRI Budget tables, 2021-22 and other- see https://www.industry.gov.au/data-and-publications/science-research-andinnovation-sri-budget-tables and Microsoft Power BI); Part 2 from Australian government, Productivity Commission, Annual Report, Trade and Assistance Review, 2019-20, Figure 1.12, P18, see Trade and Assistance Review 2019-20 (pc.gov.au) How budget support for R&D affects the achievement of domestic macroeconomic goals, international competitiveness and living standards? Government budget outlays and tax concessions to incentivise R&D are mostly designed to improve Australia’s technical and dynamic efficiency, and by doing so, grow the productive capacity of the Australian economy. Potentially, this policy can help to create more favourable conditions for the achievement of our key domestic macroeconomic goals, and therefore advance general living standards. Again, when looking at the macroeconomic effects of budget outlays on R&D, it is useful to refer to the AD-As diagram shown in figure 5.6 (P xxx). Here greater efficiency and the growth of productive capacity helps to increase AS (the rise from AS1 to AS2), and cause national equilibrium to occur at a faster non-inflationary rate of economic and employment growth (the rise from GDP1 to GDP2), with a slower rate of inflation (the fall from P1 to P2). Let us now look at the specific ways in which R&D grants might help to improve economic conditions. Budget support for R&D can increase the non-inflationary rate of economic growth Budget support for R&D help increase Australia’s sustainable, non-inflationary rate of economic growth and potential GDP: • By encouraging innovation, expanding information, understanding and new ideas, government financial 0 UNCORRECTED PAGE PROOFS support of R&D can promote dynamic and technical efficiency. This grows our access to resources (human capital) needed to develop our production possibility frontier or capacity. One recent example of R&D assistance in action was the funding of important health research into the development and manufacture of an effective Covid vaccination. The hope now is that our high vaccination rates will reduce

lockdowns, keep businesses and supply chains open, maintain productive capacity and hence increase the non-inflationary rate of economic growth. • Budget support for R&D can help to create more favourable aggregate supply conditions. They help to lower the production costs and raise the profitability of firms wanting to develop new products. This can make them more internationally competitive and ultimately lead to greater economies of large-scale production, strengthening economic growth.

Budget support for R&D can slow cost inflation and enhance our international competitiveness The use of budget outlays and tax concessions to encourage R&D can eventually help to improve the efficiency of resources, so more output is gained from fewer inputs. As mentioned, this can translate into lower production costs for producers and help to ease inflationary pressures and hence at the same time, improve our international competitiveness. Potentially, the encouragement of new ideas, processes and products that are not yet available to consumers overseas, may also improve our international competitiveness.

Budget support of R&D can reduce structural unemployment The impact of budget outlays on R&D on Australia’s unemployment rate depends mostly on the time period considered: • Depending on it’s nature, in the short- to medium-terms, it is possible that the encouragement of R&D may increase structural unemployment as firms innovate, restructure operations and develop new products and manufacturing processes. • However, in the long term, failure to innovate will cause industries to go into decline and die, adding to structural unemployment. So, although there should be many new jobs created by innovative businesses, these may be in different industries or areas, and involve the employment of staff with different skills, requiring effective education and training policies.

Budget support of R&D can improve living standards Financial support of R&D by budget outlays or tax concessions can help to improve our living standards: • Material living standards may be strengthened by using budget outlays and tax concessions to encourage

R&D. These can make aggregate supply conditions more favourable for firms, by cutting their costs.

In turn, they encourage the expansion of productive capacity and GDP, grow average real incomes and purchasing power, and lead to higher consumption per head. Support of R&D also makes local firms more internationally competitive and thereby create more employment opportunities. In addition, through greater efficiency, R&D grants can slow cost inflation and improve the purchasing power of incomes. • Non-material living standards may benefit from budget support of R&D for projects like medical research, renewable energy and the reduction of emissions that accelerate climate change and severe weather events that would otherwise reduce the quality of life. In addition, by creating new jobs in the long term, unemployment could be lowered, improving outcomes for health, happiness, family and community.

Weaknesses of budget support for R&D as an aggregate supply policy As an aggregate supply policy, providing budget support for R&D has certain limitations: • Financial or budget constraints: Given the government’s weakened budget position and rising debt levels following the GFC and the recent pandemic, there have been financial constraints limiting the use of this policy. This helps to explain the recent decline in government outlays on R&D grants as a percentage of GDP. In addition, by international standards, government support of R&D expressed as a percentage of GDP, lags well behind many nations. We are currently ranked twentieth and are well below the OECD average. • Long time lags for impact: There are often quite long impact time lags between providing the grants and seeing their effects on innovation and efficiency. They are not a short-term solution. UNCORRECTED PAGE PROOFS • Outcomes are uncertain: R&D grants come with no guarantee of success. Results are uncertain. Indeed, the money might produce no benefit, increasing the opportunity cost of the government’s decision and lowering society’s wellbeing.

Tax reform often involves changing the ways budget revenue is collected. It can be used to help make conditions more favourable for individuals and firms supplying goods and services so they are more willing and able to produce and expand the economy’s capacity. As an aggregate supply policy, tax reform usually focuses on: • reducing the tax burden through lower tax rates paid by individuals and companies as a proportion of their income, possibly also involving the provision of tax concessions and tax rebates • reviewing the tax base, coverage or inclusiveness of what particular types of things are to be taxed or not taxed (which goods or services, which income, what assets) • improving the tax mix or combination of different types of tax used to raise revenue (direct tax versus indirect, consumption taxes versus income taxes) • reducing tax avoidance and improving the integrity and effectiveness of the tax system. In addition, tax reform should be guided by at least three key principles: 1. Equity. Taxes should be equitable keeping in mind that those on higher incomes have a greater capacity to carry more of the tax burden, reducing the gap between high- and low-income earners. 2. Simplicity. The tax system needs to be simple and easy for firms and individuals to follow. 3. Efficiency. The tax system needs to encourage or incentivise effort and the earning of incomes by individuals and businesses, and have a minimum of red tape in administration. Through these types of tax changes, governments seek to increase the incentives for businesses to invest and produce, encourage individuals to work harder by reducing penalties for effort, and strengthen Australia’s international competitiveness. Overall, tax reforms can help to grow the economy’s efficiency, productive capacity, potential GDP and the level of aggregate supply, and through these effects, advance Australia’s domestic macroeconomic goals and living standards. Yet again, it is handy to refer to the AD-AS diagram shown in figure 5.6 (P xxx). Here, for example, lower tax rates create stronger incentives to grow capacity and increase AS (the rise from AS1 to AS2). In turn, this increases the non-inflationary, sustainable rate of economic and employment growth (the rise from GDP1 to GDP2), while prices actually fall (the drop from P1 to P2) improving our international competitiveness. Over time, domestic macroeconomic conditions are strengthened, supporting better living standards. Key features of the federal government’s recent budget policy involving tax reform Various governments have recognised that the tax system periodically needs to be reformed or changed. Reforming Australia’s tax system is an ongoing process because of shifting domestic and international developments. Table 5.1 provides a snapshot of key tax reforms. Here you should focus especially UNCORRECTED PAGE PROOFS on the reductions in tax personal and company rates, and think about how these incentivise effort, participation in work, and business investment and expansion, growing Australia’s productive capacity.

Name of tax Outline of key tax reforms Top rate in 2021–22 Historical top rate

PAYG income tax

There have been many changes to Australia’s personal income tax system: • 2012–13 — from July 2012, the tax-free income threshold was increased from $6000 to $18 200. • 2013–14 — the Medicare levy was increased from 1.5 to 2.0 per cent of taxable income to pay for the National Disability Insurance Scheme (NDIS). • 2014–15 to 2016–17 — there was an additional 2 per centtemporary budget repair levy for those in the top marginal tax bracket. • 2017–18 — there was some tax relief for low- and middleincome earners by lifting the upper income cut-off for the 32.5 per cent tax bracket. • In July 2019, a progressive three-stage reform package for personal income tax was finally passed by the Parliament: • Stage 1 (2018–19/2021–22): the upper income cut-off for the 32.5 per cent tax bracket was increased from $87 000 to $90 000 starting from July 2018, along with a rise in the low-middle income tax offsets, providing relief for low- and middle-income earners. • Stage 2 (2022–23/2023–24): the upper income cutoffs for the 19 and 37 per cent tax brackets will be increased from $37 000 to $45 000 and from $90 000 to $120 000 respectively, starting July 2022, along with rises in the low-middle income tax offsets, thereby providing further relief for low- and middle-income earners. • Stage 3 (2024–25): the 32.5 and 37 per cent tax brackets will be abolished and replaced with a single 30 per cent tax bracket covering incomes from $45 001 to $200 000 starting July 2024, which, along with rises in the low-middle income tax offsets, will provide further incentive and relief for low-middle- and high-income earners. • 2020–21 — In the delayed 2020–21 budget, the treasurer announced that stage 2 of the legislated cuts in personal income tax would be brought forward and backdated to July 2020, not only to give a boost to AD, but also to incentivise effort and AS. In 2020–21, the top marginal rate is 47 per cent, made up of the 45 per cent standard top tax rate plus the 2 per cent Medicare levy.

75 per cent (< 1951–52) (continued)UNCORRECTED PAGE PROOFS

Name of tax Outline of key tax reforms Top rate in 2021–22 Historical top rate

The three-stage reform of Australia’s system of personal income tax (from July 2018–June 2024)

Stage 1: PAYG rates from July 2018 to June 2020 Stage 2: PAYG rates from July 2020 to June 2024 Stage 3: PAYG rates from July 2024

Taxable income thresholds ($) Marginal tax rates (%) Taxable income thresholds ($) Marginal tax rates (%) Taxable income thresholds ($)

Marginal tax rates (%)

$0 to $18 200 0 $0 to $18 200 0 $0 to $18 200 0 $18 201 to $37 000 19 $18 201 to $45 000 19 $18 201 to $45 000 19 $37 001 to $90 000 32.5 $45 001 to $120 000 32.5 $45 001 to $200 000 30 (replaces the 32.5 per cent bracket) $90 001 to $180 000 37 $120 001 to $180 000 37 NA NA (the 37 per cent tax bracket is abolished) $180 001 and over 45 $180 001 and over 45 $200 001 and over 45 Company tax Rates of company tax have been lowered as part of tax reform. These have included the following: • 2000–01 — the tax rate on company profits was lowered from 36 to 34 per cent. • 2002–03 — the company tax rate was further reduced to 30 per cent. • 2015–16 — the company tax rate for smaller businesses with a turnover less than $2 million was cut to 28.5 per cent. • 2016–17 — The company tax rate for small to mediumsized businesses with an annual turnover less than $10 million was cut to 27.5 per cent. • 2017–18 — the definition of small to medium-sized companies was broadened to turnover of up to $25 million so even more companies would benefit from the 27.5 per cent tax rate. • 2018–19 — the 27.5 per cent tax rate was extended to small and medium-sized firms with an annual turnover up to $50 million. • 2020–21 and 2021–22 — The business tax rate was reduced to 26 per cent in July 2020 for small and medium-sized business enterprises (SMEs), with a further reduction to 25 per cent from July 2021. • Instant tax write-offs for capital items – Recent budgets provided tax relief through instant tax write-offs for small to medium-sized businesses purchasing capital equipment. 30 per cent for large companies and 25 per cent from July 2021 for small to medium-sized companies with an annual turnover less than $50 million.

49 per cent (1986–88) UNCORRECTED PAGE PROOFS

Name of tax Outline of key tax reforms Top rate in 2021–22 Historical top rate

Australian company tax rates in selected years, 1985 –86 to 2021–22

28.5 Tax rate for small and / or medium-sized companies (percentage of profits)

Company tax rate (percentage of profits) 40 50 49 49 39 39 36 36 36 36 30 27.5 30 26 1985–67 1989–90 1999–2000 2009–10 2015–16 Year Tax rate for large companies (percentage of profits) 30 25

60 30

30 20 10 2017–18 2020–21 2021–22

Source: © Australian Taxation Office for the Commonwealth of Australia.

Capital gains tax (GGT)

Capital gain tax is levied on the proceeds or gains after the sale of an asset like property and shares. • 1986–87 — the tax rate on capital gains (except on the family home, which is exempt) was effectively halved — only 50 per cent (not 100 per cent as before) of the capital gain was to be taxed. • 2018–19–20 — there was debate about the fairness of this tax discount between the Coalition and Labor Party. The maximum rate of 23.5 per cent (including the Medicare levy applies) NA (before 1986)

Superannuation tax concessions

For many years, Australian governments have wanted to encourage superannuation by providing generous tax concessions for contributions and end benefits. Their hope is to reduce the number of people dependent on the old age pension that is assets and means tested. • 2012–13 — the treasurer reduced the maximum concessional contribution for tax from $50 000 to a limit of $25 000 — also the current limit. • 2019–20 — there was discussion about the equity and efficiency of generous concessions that are especially enjoyed by the rich and weaken the budget outcome. 15 per cent contributions tax up to the concessional limit (zero rate for end benefits withdrawn after age 60)

30 per cent (1983 on lump sum payments above a threshold) (continued) 0 UNCORRECTED PAGE PROOFS