Policy Approach

Budgetary Policy

You have already learned about budgetary policy and the strong impact that it can have on aggregate demand. The government is also able to use the budget to have a direct impact on aggregate supply. There are two broad means by which this is possible.

Taxation

The government can manipulate the way in which resources are allocated by changing the way in which things are taxed. This is an indirect approach to try and change supply side conditions – the government is trying to create incentives that will affect the decisions of individuals and businesses. For example, imagine that there were two products that were very similar in all respects, but one attracted a much higher tax than the other. In the long term we would find that more consumers would purchase the item that incurred the lower tax, and as a result more resources would be allocated to the production of that item. On the other hand, fewer resources would be consumed in the manufacture of the item that was being taxed. The government uses taxes to affect our behaviour in exactly this way.

For example, certain products result in negative externalities, and so the government is keen to ensure that the consumption of these items is minimised. Products such as cigarettes, alcohol and petrol all incur an excise that is designed to minimise consumption, and compensate the community for the damage that is done. This system is successful; the percentage of people in Australia who smoke cigarettes has fallen from around 75% at the end of World War Two to 28% today. On the other hand, people in developing countries (where cigarettes do not attract a tax) are far more likely to smoke.

Taxation policy can also be used to affect aggregate supply (as opposed to the supply of just one product). The government will try to encourage investment in capital items, as these will add to the productive capacity of the economy. For example, after the Henry Review of Australia’s taxation system was released in mid-2010, the federal government responded by changing the allowable deduction rules for equipment costing less than $5,000. This is a complicated change, but in simple terms the change means:

1. In the past, purchasing a capital item for a small business (like a computer or a camera) could be deducted over several years. This is known as “depreciation”.

2. Today, any item costing less than $5,000 can be deducted in the year that it was purchased.

3. This will act to reduce the tax bill of small businesses in the short term. As a result, this creates an incentive for small businesses to buy these items.

4. As more businesses purchase these items, they will become more efficient. The final impact should be an increase in aggregate supply in the Australian economy.

In the 2010/11 budget, the government also announced that the company tax rate would fall from 30% to 28% by 2014/15. This was designed to encourage participation from the private sector in the belief that this would result in more efficient outcomes.

Infrastructure

Through the budget the federal government can also have a direct impact on aggregate supply. This is because the government will use the budget to create public infrastructure that can be used by all businesses. When businesses are able to move products efficiently throughout Australia, they will save time and money. This means that they will be able to pass on lower costs to consumers, and they will be encouraged to create even greater levels of output. These are exactly the characteristics that we would hope to see when there has been an increase in aggregate supply.

For example, the government takes responsibility for each of the following infrastructure items:

1. Most roads – Although we have some private roads (eg CityLink in Melbourne), the majority are funded by the government. The federal government will fund those roads that are deemed to be of “national significance”, such as freeways that run between states.

2. Rail networks – Although our rail networks are generally operated by private companies, the rails are on public land. When the need to extend the rail network is identified, it is the government that will fund this growth.

3. Ports – The Australian government has spent a great deal of money trying to make Australia’s ports more efficient. This is crucial for ensuring that imports and exports can move quickly in and out of our economy.

4. National Broadband Network – Since 2009 the federal government has committed money for the creation of a National Broadband Network. This will make the internet faster, and more readily available.

Examples of each of these can be found in recent budgets. In the 2010/11 budget the government allocated $1 billion to renew rail networks, and $5.6 billion for a new infrastructure fund. They have also allocated over $4 billion each year for the National Broadband Network.

Current Page: Budgetary Policy