Covid-19 – is forcing governments around the world to recognize that we are all in this together. Unfortunately, Simon Birmingham’s recent declaration that the Government will return to its agenda of reducing the progressivity of Australia’s taxation scales as soon as the virus is defeated (ABC News Breakfast, 1 April 2020) suggests the government doesn’t yet understand what this means:
“We want to make these measures temporary so that we can get spending back under control and continue with our plans for lower taxes in the future because lower taxes are going to be a crucial part of continuing the economic recovery for Australians and Australian business.”[1]
Perhaps these comments were made partly in response to pressure from economists representing commercial interests, but unfortunately it indicates that our government will likely fail to learn the most important lesson from the current crisis – the value of society.
In 1987 Margaret Thatcher famously declared that there is “no such thing as society” – a statement that became synonymous with conservatives’ aspiration of reenvisaging, transforming, and arguably dismantling significant aspects of the State in the service of the view that all that exists is individual endeavour and their willingness to cooperate with each other.
Boris Johnson, in a deliberate repositioning of conservative policy position, recently opined from his Covid-19 enforced self-isolation that ‘there really is such a thing as society’. However, it remains to be seen whether this new position will be more honoured in the breach than in the observance. Is it Johnson’s intention that the previously derided ‘society’ should exist behind a ‘break glass in case of emergency’ – to be employed only when a financial crisis or pandemic demands that the tools of democratic socialism are called upon to rescue the economy from critical failures of late-stage capitalism and austerity‑depleted institutions?
In responding to the current pandemic, one may be tempted to focus narrowly on the role of Chinese ‘wet markets’ as the cause of Covid-19, and to recommend pressuring China to outlaw these risk vectors. This view fails to recognise that outlawing wet markets (and their ‘on the spot butchering’) presupposes the widespread availability of home refrigeration. Adopting practices more familiar to westerners would require that China replicate the practice of butchering meat in centralised abattoirs and therefore demands meat products with a longer shelf-life, which also demands greater reliance on antibiotic use in farm animals. While this might reduce the risk of animals as vectors for viruses, it would exacerbate the risk of breeding ‘superbug’ bacteria. Further, treatment of viral infection often goes hand-in-hand with treatment of secondary bacterial infections, so abandoning wet markets might reduce the number of novel viral infections, while also indirectly reducing the effectiveness of available treatments.
One immediate lesson of this brief analysis is that public policy is difficult and not necessarily obvious. Optimum human behaviours do not fall as if from heaven as the automatic result of free‑market incentivisation. Farmers in China or Australia are not automatically ‘incentivised’ to adopt policies to prevent viral outbreaks or stop superbugs unless governments design and implement policies specifically to drive those behaviours. Optimum risk reduction and mitigation of viral pandemics requires action of the State at every level – public funding for monitoring of viral outbreaks, basic scientific research, vaccine development, stockpiling of medical equipment, permanent employment of expert advisors and appropriate rules and regulations to incentivise optimal behaviour within whatever private markets exist – whether they be ‘wet markets’ or competing factory farms, abattoirs and supermarkets.
Another lesson is that sound public policy that shapes behaviour of individuals through creating institutions and tweaking incentives is the process through which human societies can improve livelihoods beyond what individuals can achieve on their own. Game theory tells us that individuals, acting through personal incentivisation, cooperation and altruism will reliably fail to achieve even mutually agreed optimal outcomes. This is what Thatcher failed to grasp – there is such thing as society, and it is formed from the institutions that must be carefully designed, informed by public policy, with the goal of optimising the structures of incentives that shape behaviour of individuals, families and enterprises. That stuff is not automatic, nor intrinsic to willing cooperation.
Stepping back from the immediate problem presented by Covid-19, we must avoid falling for the availability heuristic – the tendency focus on emotionally salient recent events, and thereby over‑emphasise only risks and issues that are front-of-mind.
We are experiencing a global viral pandemic today, but institutions that have been shaped by austerity budgets and philosophical commitment to free‑market solutions have also resulted in under‑investment in mitigation and risk reduction of other existential risks. Climate change, increasing bushfire risk, collapse of the Murray-Darling river system, as well as global risks such as solar storms, asteroid impact, and potential negative impacts of artificial intelligence or nanotechnology all pose threats for which humanity is poorly prepared. The global impact of Covid-19 reinforces the wisdom of the old adage – an ounce of prevention is worth a pound of cure. And preventing or mitigating each existential threat demands a well-funded proactive State.
We may be tempted to respond with the observation that in order to pay for such programs we need a healthy economy, and that requires incentivisation of investment through lower taxation. Hence Simon Birmingham’s call for a return as soon as possible to reducing taxation, and in particular, reducing tax progressivity. But this is a knee-jerk response that deserves to be unpicked.
The Neoclassical economic model that unpins the politics of austerity and the belief that the economy will grow faster and be more productive with ‘low taxation’ is founded on another instance of the availability heuristic that is now looking very dated.
In the 1980’s when Thatcher claimed there was “no such thing as society” developed economies suffered from a capital shortfall – a residential mortgage in Australia attracted an annual interest rate of 16% as borrowers competed for what was then a dwindling stockpile of investment capital. The need to grow the stock of capital to fund investment was the front-of-mind issue that guided the formation and adoption of the Neoclassical growth model. Neoclassical economics begins with the observation that growth can derive from capital investment, so (according to this model) having more capital available to fund investment is an unmitigated benefit to a healthy, growing economy. The Neoclassical economic revolution of ‘Thatcherism’ and ‘Reaganism’ prompted reduction of tax progressivity, which incentivised accumulation of capital, which was necessary to invest in growth.
It is perhaps a baffling omission, but nonetheless true that this economic orthodoxy (which still guides conservative economic policy today) fails to account for the fact that incentivisation of investment depends not only on the availability of capital, but also on an investor having confidence that their capital will generate a positive return. When progressivity of taxation is reduced (which goes hand-in-hand with reduced government spending too), this has the effect of increasing the rate of capital accumulation at the expense of the share of the economy that flows back to previous investors as consumption and income.
Will the economy grow more or less with such policy settings? It depends on whether the economy is constrained by lack of access to capital (as it certainly was in the 60’s and 70’s), or by businesses competing over a dwindling flow of domestic aggregate demand (as it is today).
The over-simplified prescription that always recommends ‘lower taxation’ is a relic of an economic theory devised to solve the front-of-mind economic problem from 40 years ago – too little available capital.
Today a residential mortgage costs around 3%, and official interest rates are zero or even negative in many countries. Clearly something fundamental has changed since Thatcher’s time. We are no longer short of capital and reducing tax progressivity will not help grow the economy.
Businesses now squabble to secure a share of a barely growing pool of domestic aggregate demand (in Australia it is flat or shrinking on a per capita basis). Policies that reduce the progressivity of taxation will redirect taxes that fund government consumption to instead fund additional savings. This will increase the rate of growth of the capital stockpile when it is already a glut, while reducing total domestic demand when it is already declining in real per capita terms. As a result, competition between businesses for the available aggregate income will become tighter, and the rate of return on investment will reduce further. This will reinforce the trend of declining rates of return on capital that has been obvious since the time of Thatcher’s promotion of rugged individual self-reliance.
In the context of the current capital glut, lower taxes will not promote growth. Reduced tax progressivity and a smaller State will reduce aggregate income, and disincentivise investment and growth.
Perhaps counterintuitively, if we want to incentivise business investment today, we need to tip the balance back in favour of increasing aggregate income, not growing the capital glut. That means increasing real wages so that consumers have more money to spend. It means government increasing the progressivity of taxation to fund programs that mitigate risk (to prevent or reduce the severity of the next catastrophe) and address other social priorities; and redistributing income to the poorest in society (who spend everything they receive, thereby increasing aggregate demand and creating investment opportunities for businesses and entrepreneurs).
Returning to a healthy, growing economy requires that the State plays a role of deliberately optimising the balance between capital stock and income flow – despite economists assumptions to the contrary (and they are only assumptions), that is not something that free markets optimise on their own. Government policy must not, therefore, be limited to short‑term interventions only in the event of an emergency. In terms of the fundamental drivers of the productivity of the economy, we really are all in this together – investors and consumers, rich and poor. Sound public policy is needed to strike the right balance between incentive to save and incentive to spend.
When capital stocks are adequate (as they were in the 1950 and early 60’s, and are again now) more progressive taxation optimises long term economic growth, and reduces financial volatility. This was seen throughout the Golden Age of Capitalism – from late 40’s to early 70’s.
– “U.S. Federal Individual Income Tax Rates History, 1913–2011”. Tax Foundation. 9 September 2011. Archived from the original on 16 January 2013.
Wikipedia says that “Globally, the golden age was a time of unusual financial stability, with crises far less frequent and intense than before or after.” [2]
“OECD members enjoyed real GDP growth averaging over 4% per year in the 1950s, and nearly 5% per year in the 1960s, compared with 3% in the 1970s and 2% in the 1980s [declining to 1.5% in the 2000’s and 1% in the 2010’s].”
– https://www.stlouisfed.org/on-the-economy/2017/february/why-economic-growth-slowing-down
It really is no coincidence that the only time in human history when any society imposed top marginal tax rates ranging from 70% to 90% for a sustained period also coincided with the longest sustained period of high economic growth. The Golden Age of Capitalism coincided with the ‘Golden Age of Highly Progressive Taxation’.
This is the most important sense in which the current crisis must promote a policy reset – we are all this economy together, and the government must not shirk its responsibility to actively manage the balance between growth of capital stock and growth of aggregate income through a deliberate policy response. And, unlike Neoclassical economics, the policy analysis must consider that a healthy, growing economy needs a balance of both capital and income.
It should be obvious that this call for increased progressivity of taxation and increasing real wages has absolutely nothing to do with ‘class warfare’ – the strawman argument of diehard defenders of trickledown economics. It is simply what responsible economic management demands.
The current pandemic and financial meltdown reinforces the urgent need for Australia to abandon the planned and legislated Stage 3 tax cuts, and instead pursue policies that increase real wages and increase the progressivity of the taxation system. Without this, we will continue to lurch from one catastrophe to another.
[1] https://www.trademinister.gov.au/minister/simon-birmingham/transcript/interview-abc-news-news-breakfast-michael-rowland-0
[2] https://en.wikipedia.org/wiki/Post%E2%80%93World_War_II_economic_expansion