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Chapter 1 The flood levy Bills
The natural disasters
The Queensland floods
The dimensions of the Queensland flood disaster have been staggering. Between
30 November 2010 and 24 January 2011, thirty-five people have died as a result
of flood-related incidents. This is the foremost tragedy
of these events and the Committee extends its deepest sympathies and
condolences to the family and friends of the victims.
From the end of November 2010 through to mid January 2011, flooding has
occurred over large areas of south-east and central Queensland with areas such
as Condamine and Chinchilla being flooded several times. In addition, flooding
of the Herbert River has occurred in North Queensland with the town of Ingham
being isolated. Almost every river in Queensland south of the Tropic of
Capricorn and east of Charleville and Longreach, except for the southeast
coastal fringe south of Maryborough, reached major flood level at some stage
from 26 November 2010 to 7 January 2011.
The 10-12 January 2011 floods affected south-east Queensland causing
major flooding of the Lockyer, Bremer and Brisbane Rivers. These were the most
destructive floods of November–January period. The Bremer River level at
Ipswich peaked at 19.5 metres at approximately 4 pm, which was slightly below
the 1974 flood levels. The Brisbane River level
at Brisbane peaked at 4.46 metres between 3 and 4 am, which is below the 1974
peak of 5.45 metres.
Loss of property has been devastating. As of 21 January 2011, the
estimate of the total number of houses across Queensland that saw flooding over
their floorboards was 5,400 homes. The number of affected houses is 21,000,
while a further 15,000 had flooding into their yards. 3,600 homes were also
evacuated and 5,900 people evacuated. In response, governments established over
70 evacuation centres.
The property damage has had a terrible effect on individuals and families.
The Australian Council of Social Service stated in evidence:
Some of this will have an effect on people that lasts many
years. Even though the flood itself was relatively short in duration, if your
house and all your household possessions were destroyed—family records were
often completely lost—that may have all sorts of impacts, material, emotional
and psychological. In many cases it will take many years for people to rebuild
their lives to the point they were at before the flooding.
...What we really need to see now is a long-term commitment
to help those people affected to rebuild their lives, because we are not
exactly sure how the impacts will manifest over time. They will affect
different people and households in very different ways. Some people will get
over them very quickly; others will take a long time.
Of Queensland’s 73 local government areas, 51 have had a disaster declaration
since these events started and 14 of those local government areas have been
severely impacted with very serious flooding. The damage to roads is yet to be
assessed in detail, but local governments estimate that some 90,000 km of local
government roads have seen some form of damage. This figure does not include
federal highways, state roads or railways.
The implications of this damage and disruption for the national economy
are also profound. Initial estimates put the damage at $10 billion, but AMP chief
economist Shane Oliver suggested a figure of $30 billion with an estimated $13
billion dollar cut to the March quarter GDP. The Queensland Treasury
estimates that economic growth in that state in 2010-11 will drop from an
initial figure of 3.75 per cent to 1.25 per cent.
The Commonwealth Treasury stated that it will take a number of years to calculate
a precise cost of the floods. However, it is clear
that an enormous human, social and economic cost has been visited upon
Severe Tropical Cyclone Yasi crossed the Queensland coastline near
Innisfail and Cardwell on the morning of 3 February 2011. Rated
Category 5, the cyclone featured extreme conditions such as wind gusts of
up to 285 kilometres per hour, a lowest air pressure of
929 millibars, recorded at Tully, and a 5 metre storm surge at Cardwell, just
south of Mission Beach. As a tribute to the preparations made by the authorities,
no-one died as a direct result of the Cyclone. However, the Committee
very much regrets the death of a 23-year old man near Ingham, who asphyxiated
while using a generator in a closed room during the event.
The region has large plantations of bananas
and sugar cane and these have been extensively damaged. Early estimates were
that 75 per cent of the banana crop, valued at $350 million, was wiped out. 100
per cent of the sugar cane crop in the region, with a value of $500 million, is
estimated to be destroyed. The CEO of peak body Canegrowers stated:
We've had reports from sugarcane farmers in Tully and
surrounds of sugarcane crops which have snapped in half and whole farms that
have been completely flattened. Trees are uprooted, roofs are missing and power
poles are now lying as flat as the sugarcane.
The built environment has also suffered. Preliminary figures show that
Cyclone Yasi destroyed 150 homes and left a further 650 uninhabitable. Further,
2,275 homes were moderately damaged. Tens of thousands of homes were without
The Victorian floods
The La Nina event that helped cause the Queensland disasters also led to
extensive flooding in Victoria in mid-January. The Bureau of Meteorology
reported that rainfall records were broken in parts of the state, where up to a
summer’s rainfall fell in five days. Some locations received over 200 mm
of rain in a single day. Press reports indicate
that two people died as a result of these floods,
and the Committee extends its sympathies and condolences to the family and
friends of the deceased.
At the end of January, the Victorian Department of Primary Industries
calculated that the damage to agriculture could be as much as $2 billion. This
included over 41,000 hectares of field crops, over 51,000 hectares of pasture,
83,000 tonnes of hay and silage, and almost 2,000 kilometres of fencing.
In the second reading speech for the Bills, the Prime Minister stated
that the Commonwealth would assist in funding repairs for the Calder and Sturt
highways. As at the time of this
report, the Victorian Government’s flood traffic alert listed well over a
hundred road closures caused by the floods.
Recovery and reconstruction to date
The Queensland Treasury outlined in evidence progress so far in that
Yesterday, in the Queensland Parliament, the Premier tabled
the Queensland Reconstruction Authority Bill. The new, independent authority
will manage and coordinate the government’s program of infrastructure
reconstruction and recovery within disaster affected communities. It will be
overseen by a Queensland Reconstruction Board, which will be chaired by Major
General Mick Slater and will include two members nominated by the Australian
The Commonwealth-state Natural Disaster Relief and Recovery
Arrangements, NDRRA, is the primary mechanism for responding in the federation
to natural disaster events. The Australian and Queensland governments are
developing a national partnership agreement, which is intended to further
strengthen the governance and accountability provisions of the NDRRA. This will
include detailed performance monitoring and reporting arrangements and new
governance arrangements, including the establishment of the Australian
Government Reconstruction Inspectorate.
Finally, the Queensland government has established the
commission of inquiry into the Queensland floods with wide-ranging terms of
reference, including flood preparation and planning, the performance of private
insurers, the flood response efforts, land use planning, early warning systems
and infrastructure operation. Again, it has a major task, but it is intended
that it report by January 2012. I should also say that the recovery effort is
already well underway, with priority restoration of essential water, energy and
transport services and disaster recovery assistance for affected people in the
community. The big task ahead of course is restoration of our community assets
and personal homes, and that is a very big challenge for the authority and for
the Queensland community more broadly.
The Committee acknowledges that many Queenslanders have made significant
contributions in the response to the natural disasters in that State. Many
people acted heroically to save the lives of others and many people have since
acted selflessly in assisting with cleanup and reconstruction.
One issue the committee explored in evidence was the extent to which the
current reconstruction would prepare Queensland for future floods. The
Queensland Treasury stated:
... the [Queensland Reconstruction Authority] has a very
extensive role to play. It will have a capability to look at that issue and it
will have the ability to work with local government around the planning of how
restoration should occur in severely impacted flood-prone areas. It does have
provision to, for example, declare reconstruction areas and to designate areas
as acquisition land. When land is declared as acquisition land, owners will be
prevented from disposing of the land, other than to the authority or another
nominated entity, such as local government. But that will occur only in circumstances
where the local government has sought the assistance of the authority in
considering the appropriate land planning issues for that area...
In some areas there may be other solutions—for example,
raising the levels of houses, which is one option being canvassed; or shifting
settlements in some areas to slightly higher areas. There may be a range of
local circumstances where they consider appropriate arrangements. Flood
mitigation might also be an appropriate strategy in some areas.
The Committee was also interested in whether it would be possible to use
improved construction techniques so that roads would not need to be rebuilt
The [Natural Disaster Relief and Recovery Arrangements] do
allow for what is termed ‘betterment’. Where there is an opportunity identified
for improving an asset’s resilience against future events, that is considered
by the various funding parties as to whether that would an appropriate
investment and then it may be eligible for funding. It is considered on a
case-by-case basis for betterment events. Obviously in the scale of
infrastructure we are talking about here, the identification of where those
opportunities might lie is something that is yet to occur. Certainly we have
not allowed in our estimates for substantial betterment. For example,
flood-proofing the national highways would be a massive investment which we
have not factored into these numbers.
The Committee appreciates that preparing the affected areas for the next
adverse weather event is a technical and costly exercise. But, regardless of
whether these Bills are passed, one of the most important outcomes of the
reconstruction will be the ability of reconstructed areas to withstand future
events, either through better design or better location.
National disaster relief and recovery arrangements
The Queensland Treasury advised that there have been long standing
agreements between the Commonwealth and the States that govern responsibility
for funding infrastructure recovery and that their operation depends on certain
thresholds being met. In this case, the agreements require the Commonwealth to
pay three quarters of infrastructure costs.
The Commonwealth’s responsibilities in rebuilding state infrastructure
directly affected by a natural disaster are outlined in a ministerial
determination from 2007, titled Natural Disaster Relief and Recovery
Arrangements. Broadly, the Commonwealth has agreed to fund 75 per cent of
rebuilding essential state infrastructure for all damage in a financial year
assessed above the higher of two thresholds, and 50 per cent of rebuilding for
all damage assessed between two thresholds. The thresholds are calculated as a
proportion of state revenue. In the case of Queensland for 2010-11, the two
thresholds are $83 million and $146 million.
Therefore, given the extreme scale of the Brisbane floods, the
Commonwealth will be funding 75 per cent of almost all of the damage to
essential infrastructure. This spending is not discretionary. In effect, the
Commonwealth has become the insurer for State governments for extreme natural
The Insurance Council of Australia advised the Committee that private
insurers have allocated reserves of $2 billion to meet costs arising from the
Queensland floods, which comprises 43,000 claims. For Cyclone Yasi,
$0.5 billion has been allocated, comprising 30,000 claims.
The Council advised that, if they followed historical patterns, these figures
would continue to increase and reach close to their final amounts in three
months. These claims relate to
homes and businesses.
The Committee explored the issue of whether there were any barriers to individuals
privately insuring their properties and contents against flood. The Council
stated that the market for flood insurance was now well developed:
There is no market failure in flood insurance for riverine
flood ... it is available in the market and it has been for some years now, and
has been heavily advertised. Our experience in flood zones is that consumers
who are aware that they are in a flood zone generally do seek out flood cover
and take out the cover. It is a little too early to tell how far that has gone
for this particular event, but we expect that towards the end of the month we
will have some data around that point. There is a small element of people now
who for whatever reason—potentially that they did not understand that they live
in a flood zone, that they did not understand the product or that they have not
researched it appropriately—have chosen a product that on its face does not
cover the flood risk.
However, the Council identified two outstanding issues. The first is
developing a standard definition for flood, which the industry first attempted
in 2007. However, the industry’s initial proposal was rejected by the Australian
Consumer and Competition Commission and insurers are using their own
definitions where they underwrite the risk. The industry has recommenced discussions
with the Government on a standard definition.
The second issue is developing publicly available flood data that
insurance companies can use to accurately determine the flood risk for
individual properties and that individuals and businesses can use as well. The
Council stated that freely available, high quality information would improve
insurance products and that the Commonwealth could have a central, coordinating
There is a great deal of good government flood data available
at the moment but it is patchy, some of it is old and some of it is difficult
for us to obtain. As to your question about the level of government, at the
moment most states approach it by delegating it to local government. That
presents a difficulty for other users of the information at a national level
who then need to go and negotiate with individual local governments right
across the country. Our view is that this is national infrastructure and that
it should be done centrally and federally with the cooperation of the states so
that for the first time, much like they have done in the US, all Australians
can get access to high-quality flood mapping that properly informs them of
In relation to the State of Queensland, the Queensland Treasury stated in
evidence that they had investigated reinsuring their risks externally but
ultimately did not do so. After the hearing, the
Queensland Treasury provided further advice:
QGIF [Queensland Government Insurance Fund] is a self
insurance fund established by the State to manage property (excluding
infrastructure such as roads, railways etc), general liability and other risks.
It also excludes loss or damage due to natural disaster events for which
funding is available under NDRRA.
Re-insurance for QGIF was investigated in detail by
Queensland Treasury in 2004 in relation to property and general liability. This
did not cover State roads, railways or Local Government assets. Quotes were
obtained through QGIF’s insurance advisor.
...the quotes related to broad property exposures subject to
risk sharing parameters (e.g. limits per event and retention amounts) and therefore
did provide some limited property cover for such events.
In the circumstances, if re-insurance was secured and
subsequently retained, subject to any variation in terms over time, it could
have been called upon to a limited extent during current events, noting that
damage to State building assets is currently estimated at around $150 million
(some of which is not eligible for NDRAA funding and will be funded from other
insurance/State sources). The value for money of this cover would also depend
upon an assessment of other factors such as the cost of premiums and retention
amounts (i.e. risk retained by State) over time.
On the day of the hearing, the Queensland Treasurer stated in the
Queensland Parliament that it would be difficult to obtain reinsurance for
flood risks for state infrastructure assets and that other state governments do
not externally insure their roads:
I am still unaware of any government in Australia that has
natural disaster insurance which would have covered the losses from the event
in Queensland. Of those states which do pay a premium to a private insurance
company, it is the norm that, firstly, council owned infrastructure is not
insured and not included and, secondly, roads are excluded from the policy.
This is an important point. The damage bill from the floods had been estimated
at $5 billion, as I said. Of this, $2 billion was for local government
infrastructure and $2.5 billion was for the road network. That equates to $4.5
billion worth of costs that would not be covered under the insurance coverage
some other states hold...
I have noted with interest recent comments from unnamed
industry sources that natural disaster insurance for Queensland is readily
available. Previous market soundings have indicated that an insurance premium
would likely be in the hundreds of millions of dollars. It would also involve a
complex, lengthy and costly due diligence process. This is not just a matter of
ringing different companies to get a better quote on your home and contents
On the other hand, the Insurance Council of Australia argued that there
may be ways in which it may be possible to access the global insurance market
as a way of increasing the options for governments in Australia to manage their
risk and to make a link between managing the risk and financial responsibility
There is the instrument of the national disaster relief
guidelines that are available. They are essentially a COAG instrument. There is
the opportunity to use those arrangements to look at better ways of, if you
like, globalising the reinsurance risk. One such way could be to have an
independent agency, such as APRA, examine state government reinsurance
arrangements. APRA examine the private sector arrangements and there are guidelines
This is not unusual; the Obama Fiscal Commission actually
recommended the idea of local authorities—in their case, state governments as
well—examining reinsurance arrangements and offloading it that way for very
much the same reasons we experience here, that the federal agencies often have
to step in and assist state governments in the US, particularly those who are
in the disaster zones, such as with Katrina, Andrew and the like.
Another issue raised by the Council is that the tax review, Australia’s
Future Tax System, recommended that insurance taxes should be abolished.
The argument in the review report is that these taxes are inefficient and lead
to a welfare loss. Alternative taxes are available.
In the view of the Committee, these natural disasters are a reminder
that there is a range of significant policy issues in the insurance field that
would benefit from a Government-sponsored review. The Committee encourages the
Government to consider such a process to address the issues brought out by these
The Commonwealth’s policy response
On 27 January 2011, the Prime Minister announced a package to help
rebuild flood-affected areas. The Government estimated that its contribution to
reconstruction of essential infrastructure would be $5.6 billion.
The Committee received evidence that Commonwealth funds would not be paid for
private recovery efforts.
The Prime Minister’s announcement stated that, of the $5.6 billion, $1 billion
would be funded through delaying some infrastructure projects,
$1.8 billion through the one-off levy, and $2.8 billion in spending
cuts. The largest of these were:
- the Cleaner Car
Rebate Scheme, providing $429 million
- $350 million from
total of $800 million allocated to the Priority Regional Infrastructure Program
- the Capital
Development Pool, providing $299 million
- $264 million from the
National Rental Affordability Scheme, reducing the dwelling target from 50,000
Although the inquiry did not concentrate on these spending cuts, the
Committee received criticisms about the reduction in the rental scheme from
Saul Eslake and the Australian Council for Social Service.
To the Committee’s knowledge, the Commonwealth has not made an estimate
of its contribution to Cyclone Yasi. In evidence, Treasury stated that it
expected the total public sector cost would be similar to that for Cyclone
Larry in 2006, which was $0.5 billion. However, on the day of the hearing, the
Queensland Treasurer announced in the Queensland Parliament that his estimate
of the cost of Cyclone Yasi would be $800 million.
The Commonwealth Treasury expects that detailed estimates will be published in
the forthcoming Budget.
The response of the markets
The markets were sensitive to the effects that rebuilding may have on
inflation and interest rates, but responded in a positive way to the
announcement. For example, Citi stated that ‘The package helps to moderate some
pressures on inflation from the flood’ and, ‘At the margin the package assists
the RBA in managing the inflation impact from the rebuild’.
The Commonwealth Bank reported:
There are some attractive features to these proposals. Adding
an (essential) rebuilding overlay to an economy already at full employment
carries with it some inflation risks. Making room by lifting taxes and cutting
spending looks appropriate even though the fiscal backdrop remains very good.
Christopher Joye, the Managing Director of Rismark commented:
More specifically, the government is trying to reduce the
inflationary consequences of the floods for fear of the influence they will
have on monetary policy. This makes sense.
... if you want the real proof in the pudding of the
government's case, consider this – interest rate futures markets have rallied
hard today in response to the package, materially reducing the probability of
future rate hikes on the basis that the measures are anti-inflationary.
Craig James, CommSec’s Chief Economist reported as follows:
...this is the right levy for the times – modest in size,
temporary, progressive and applying to those on higher incomes...
The fact that the Government is cutting spending and applying
a new levy on Australian consumers may reduce the need or urgency for the
Reserve Bank to lift interest rates over the year.
Conduct of the inquiry
On Thursday, 10 February 2011, the Prime Minister introduced the Income
Tax Rates Amendment (Temporary Flood Reconstruction Levy) Bill 2011 (the Tax
Rates Bill) and the Tax Laws Amendment (Temporary Flood Reconstruction Levy)
Bill 2011 (the Tax Laws Bill) into the House of Representatives.
On the same day, the House Selection Committee referred the Bills to the House
of Representatives Standing Committee on Economics for consideration and
The Committee announced the inquiry and called for submissions on
Friday, 11 February. The Committee received eight submissions and these are
listed in Appendix A. The Committee held a public hearing on the Bills on
Wednesday, 16 February. The organisations and individuals who attended the
hearing are listed in Appendix B. The submissions and the transcript of the hearing
are available on the Committee’s website.
The proposed operation of the Bills
The Bills raise a one-off levy that applies to individuals’ taxable
income in 2011-12. It is projected to raise $1.56 billion in 2011-12 and $235
million in 2012-13. Funds raised will be paid into Consolidated Revenue. There
is no legal requirement in the Bills that they be used for reconstruction
activities, but the Commonwealth has given such a commitment under the National
Disaster Relief and Recovery Arrangements
The levy does not apply if a taxpayer earns less than $50,000 annually.
If the taxpayer earns between $50,000 and $100,000 in 2011-12, then the income
above $50,000 is taxed at a rate of 0.5 per cent. If the taxpayer earns more
than $100,000 annually, then they pay $250 (the tax on their income up to
$100,000) and then their income above $100,000 is taxed at 1 per cent. Table 1
shows the amount of tax that individuals pay at various levels of income.
Table 1 Levy amounts for various levels of taxable income
Annual taxable income ($)
Levy amount ($)
based on the Explanatory Memorandum for the Bills
The Prime Minister’s announcement gave $68,125 as the figure for average weekly
full time earnings.
With this structure, the levy is clearly progressive. In evidence, both
the Australian Council of Social Service and the Australian Council of Trade
Unions supported this feature.
Certain classes of taxpayers can be excluded from the levy. This
comprises those people who were affected by a natural disaster between 1 July
2010 and 30 June 2012. In order for the exemption to apply, the Treasurer must
make a legislative instrument to this effect. The Bills place no restriction on
how such a legislative instrument would operate, so it is subject to the full
operation of the Legislative Instruments Act 2003. In particular, the
instrument would be subject to disallowance and the Treasurer would be required
to consult before making the instrument. The Committee finds this exemption to
be inherently fair.
The Explanatory Memorandum provides the following advice on how the levy
will interact with other parts of the tax system:
- A trustee will be
liable for the levy where they have income that is taxed as if the income was
of an individual.
- The levy cannot be
reduced by non-refundable tax offsets.
- Credit entitlements
can be applied against the levy.
- The Tax Office will
issue new withholding schedules and will generally take the levy into account
in determining pay as you go instalment amounts.
The Tax Laws Bill specifically limits the levy to income from the
2011-12 year. The Income Tax Bill includes sunsetting provisions. Therefore,
further legislation would be required for the levy to be extended to other
financial years. The levy applies to only one income year.
The Committee does not have any concerns about the drafting of the
Bills. In this regard, the levy is a straightforward matter and no witnesses
raised issues about this.
Incidence of the levy
During the hearing, Treasury provided advice on the number of taxpayers
who will be paying the levy. The total number of taxpayers earning in excess of
$50,000 is 4.84 million. From this figure is subtracted 185,000, which is the
number of people who are expected to be declared exempt from the levy on the
basis of being in a natural disaster area. This leaves 4.66 million people who
are expected to pay the levy. This is out of a total number of taxpayers of 10
million, so just under half of taxpayers will be subject to it.
By way of comparison, the Committee asked Treasury what proportion of
taxpayers paid the one-off increase to the Medicare levy (from 1.5 per cent to
1.7 per cent) to help pay for the gun buyback scheme in 1996-97. Treasury
replied that 6.9 million individuals paid the Medicare levy in this year, out
of 8.6 million taxpayers, comprising 80 per cent of taxpayers.
The Police Federation of Australia raised the situation of someone who
takes a superannuation lump sum during 2011-12 and whether this would unfairly
increase their tax burden. Treasury responded that
some taxpayers would pay extra tax in these circumstances, but that they could
rearrange their affairs to mitigate this effect because it only applies for one
...the issue relates to people
who have reached preservation age for the purposes of superannuation,
which is 55, and who retire and draw down a lump sum payment in the period
ahead of the so-called tax-free super age of 60, so between 55 and 60 years of
age. There is a potential for such people to draw down a large lump sum payment
from a tax superannuation fund and, in that case, that large lump sum payment
would be taxable income. If they draw down such a large lump sum payment during
2011-12 ... that would form part of their taxable income and would then be
subject to the levy in the way that any other form of taxable income would be
subject to the levy...
... this all turns on a case where the individual decides to
take all of their superannuation as a lump sum payment in that particular year...
It would be possible, for the example, for them to take a smaller amount as a
payment for them to live on through the year and roll over the rest of their
superannuation, which would therefore mean that it would not be considered
taxable income through the year and would not attract the flood levy.
The situation is one where the relevant individual, given
their personal circumstances, really ought to seek some advice on their
Treasury also made the point that, if someone did incur a sizeable flood
levy through a superannuation payout, for example of $6,500, then this would
imply that they had a taxable income in the period of $725,000, which would
mean that they would pay income tax of approximately $85,000 and a Medicare
levy of approximately $11,000. Therefore, the flood levy would comprise only a
small component of their taxes for that year.
The views of economists
At the hearing, the Committee questioned two economists, Saul Eslake and
Professor Warwick McKibbin, about the economics of the proposed levy. The main
point raised by Mr Eslake was that the reconstruction costs are small when
compared with Commonwealth finances (e.g. annual spending is approximately $350
billion), which means that, in practical terms, the Government could raise the
funds in several ways:
...compared with what the government did decide, there were
at least two other alternatives that could have been pursued without damaging
consequences for the Australian economy. The first of those is that the
government could have elected to fund part or indeed all of the $5.6 billion
that it estimates will be its share of the reconstruction and rebuilding effort
through additional borrowings...I say that because the numbers entailed here,
the $5.6 billion, represent a very small proportion of GDP, about 0.4 per
cent of one year’s GDP...
Differences of that order of magnitude are not the stuff of
which increases in interest rates, for example, are made...
The second choice that they have could have made was to have
funded more than they have decided of the Commonwealth’s costs by further
reductions in expenditure as opposed to a levy. In my view, there certainly
would have been scope for further reductions in government spending...
What I am here to say is that it is of no significance to the
quality of economic management or to the outcomes for interest rates or other
aspects of Australia’s economic performance whether the government’s
reconstruction effort is funded entirely by borrowings, entirely by reductions
in government expenditure or by some combination of the three.
Mr Eslake summarised his opinion as follows:
When I say that had they decided to fund all of it by
borrowing... the basis for that judgement is that the additional borrowing
entailed in the government choosing to fund all of it by adding to the deficit
is so small relative to the economy that it would have had neither any impact
on the economy itself nor on the level of interest rates nor on the judgements
which financial markets and others would have made about the credibility of the
government’s fiscal policy. Had the cost been 10 times what has been estimated
on this specific occasion then I think their judgement might have been
different, but that is because of the size rather than because of the intrinsic
nature of the decision itself.
Professor McKibbin took a more theoretical approach. His argument was
that, in general, borrowing is a better way of meeting one-off reconstruction
costs than increasing taxes or cutting other spending because it maintains
demand when the economy has suffered a shock. The proviso is that a government
should initially be in a sound financial position. If a reconstructing government
has high levels of debt or there are other circumstances that cause lenders to
doubt that it will repay borrowings, then it may need to take other approaches:
There are at least three main ways to finance rebuilding. The
first is to raise taxes, which further reduces private demand and therefore
reduces economic activity even further. The second is to cut government
spending, which also reduces economic activity...
The third is to increase the fiscal deficit temporarily—and I
stress ‘temporarily’—to borrow to refinance the rebuilding. The advantage of
borrowing is that this does not directly reduce economic activity today, but
spreads the cost of rebuilding over many decades into the future. The macroeconomic
goal should be to reduce the negative effects of the disaster soon after it
occurs. Only borrowing achieves this objective. Both cutting spending and
raising taxes worsens the decline in economic activity in the short term.
The role of the government in income smoothing and risk
sharing for the national economy is a fundamental tenet of sensible public
finance policy. Of course, the general rule may not apply in all cases. If a
government has no economic credibility then the ability to borrow may not be an
option, and so pay as you go may be necessary. Also, if government debt to GDP
were very high, the additional borrowing may raise the risk premium on
government debt and therefore incur additional costs in excess of benefits for
As Professor McKibbin noted, the Commonwealth
Government is in a sound financial position, especially when compared with
other developed economies. Therefore, his analysis suggests that, as a matter
of economics, borrowing would be optimal.
Two other topics arose in the discussion of the economics of the Bills.
Firstly, the Committee asked Professor McKibbin what effect the Bills would
have on inflation. Although he did not have the opportunity to do any modelling
in response, Professor McKibbin responded that it would ‘probably have a downward impact on inflation’ by
reducing aggregate demand. Secondly, Mr Eslake noted that imposing the levy was not material to
the current projections as to when the Budget would return to surplus. In other
words, the Budget is still estimated to return to surplus in 2012-13:
Therefore, if the government decided not to collect a levy
but instead funded the amount that the levy is expected to raise by additional
borrowings there would still be a large budget deficit in 2011-12, but not by
so much bigger a margin as to have any impact on interest rates, financial
markets or the economy. And there would still be a budget surplus for 2012-13,
less than currently forecast but only by the amount of about $200 million that the
levy is expected to collect in that year plus perhaps an additional $100 million
of extra interest payments on the additional borrowings that the government
would have to undertake primarily in 2011-12. So the levy is not designed to
have any impact one way or the other on the government’s target for returning
the budget to surplus by 2012-13.
At a time of widespread tragedy and devastation, the broad spectrum of
Australian society has responded to the floods and other natural disasters in a
multitude of ways, such as through donations of money or goods, giving others
temporary accommodation, or cleanups. Governments are repairing and rebuilding
infrastructure. The question presented by the Bills is how governments might
pay for the rebuild.
The Committee is of the view that we can fund the recovery of essential
infrastructure so as to reflect our wider response to the disaster. In
evidence, the Australian Council of Trade Unions referred to our need to take
collective responsibility for each other:
... as a nation, we believe we need to take collective
responsibility for each other’s welfare, particularly in times of disaster, and
a progressive levy on wage and salary earners is consistent with this
The work of volunteers, emergency services, the Defence Forces and
others in the recovery has been entirely consistent with this idea of
collective responsibility, which is also the philosophy behind the levy.
Therefore, the Committee recommends as follows.
Craig Thomson MP
That the House of Representatives pass the Bills.
21 February 2011
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