What might Tuesday's Federal Budget contain?
by Phillip McGann, 03/05/2007

A lot has been speculated recently about the upcoming Federal Budget and what little extras will be included to encourage voters to focus on how good things are with the current government in control. Yes, it is an election year and obviously the government will be enticed by the prospect of spending some of the huge Surplus on giveaways prior to the election later in the year

The problem is that if these giveaways include tax cuts, then there is a fear this will lead to interest rate rises later in the year as well – not a good result for an incumbent government still reeling from three rises last year.

So why would tax cuts lead to rate rises? Well the theory is that the higher the tax cuts the more money people have to spend and this leads to an acceleration of activity in an already buoyant economy. This would potentially lead to an inflation outbreak and the Reserve Bank would likely pounce on this as justification for a rates rise.

So what is the government to do? 

Well it could target tax cuts to lower income earners who have not benefited as much in recent budgets, thereby maximising the electoral benefits whilst dulling the economic impact. However, this will be hard to do due to the nature of the tax scale and the fact that if you tinker with them at the lower end, then every taxpayer benefits further up, not just the lower income earners. One way to overcome this may well be to increase the Low Income Tax Offset that gives lower earners a tax benefit at year end, whilst not flowing up the tax scales as happens when the tax scales are raised.

It could delay the tax cuts till next year thus staying the RBA’s hand whilst promoting its voter friendly credentials. However, this will delay the hard cash benefits people would rather see straightaway.

A third possibility may well be to alter the tax treatment of superannuation (as it did last year for those cashing in super) and reduce the contribution tax rate or the earning tax rate. This would not be inflationary at all as the funds are curtailed in Super and not available to be spent. These are good ideas but probably not as voter friendly as the others.

Or, the government could come up with something totally unexpected and from “left field” as it did with Super last year – no one saw that coming and was very well received by pre retirees and those over 60.  Time (in this case Tuesday week) will tell!