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Statement 3: Maintaining Low Inflation and Strong Growth

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Part V: The Timing of the Price Changes

As noted previously, the highly competitive nature of the Australian economy, combined with the generous compensation arrangements integral to the tax reform package, lead to the conclusion that price changes due to indirect tax reform should be one-off in nature, and hence not feed into ongoing inflation. It is this conclusion that underlies the assumptions and expectations of the timing effects of the price changes discussed below.3

Short Run Price Estimates

As noted in Statement 2, `ongoing' inflation (that is, leaving aside the one-off impact of indirect tax reform on prices) is expected to be within the 2-3 per cent target band in 2000-01. In other words, the indirect tax changes are being implemented at a time when the outlook for ongoing inflation remains favourable.

The price changes associated with The New Tax System will not all occur on 1 July 2000, when the GST is introduced and the WST is abolished. For example, some parts of the overall package have already been implemented. The government's 30 per cent rebate on private health insurance was introduced on 1 January 1999, the rate of WST on a range of goods was cut from 32 per cent to 22 per cent from 29 July 1999 and the new cigarette excise arrangements took effect from 1 November 1999. Other elements of The New Tax System will not come into effect until 2001, 2002 and 2005.

Nor will changes in retail prices necessarily occur at the time that the relevant indirect tax rates change. For example, there is some evidence that motor vehicle prices have already been affected, ahead of the introduction of the new tax arrangements. There has also been very strong activity in the housing sector ahead of the changes to the indirect tax arrangements that has seen prices of new project homes increase.

Taking these factors into account, the changes to indirect tax arrangements are estimated to increase the CPI by around 2¾ per cent during the year to the June quarter 2001. The impact on the CPI will become smaller over subsequent years as later elements of the package take effect.

The impact of the revised indirect tax arrangements on prices will not be felt evenly through 2000-01. The main impact will occur in the September quarter 2000 (see Chart 3), because the immediate impact of the GST on retail prices will only be partially offset by the removal of WST on final consumption items. While estimating quarterly outcomes is inherently difficult, the overall increase in the CPI in the September quarter could be of the order of 4½ per cent, of which a little over 3¾ per cent would be the result of one-off price changes associated with indirect tax reform.

In the following couple of quarters, CPI increases will be smaller than would otherwise have been the case, as the removal of embedded WST and lower business costs (including from lower transport costs) restrain price increases at the retail level. While the exact timing effects may be complicated since competitive forces may result in businesses anticipating cost savings in their underlying cost structures, it is likely that CPI increases will be very low in the December quarter 2000 and the March quarter 2001.

Chart 3: Forecasts and Projections of the Impact
of The New Tax System

Chart 3:  Forecasts and Projections of the Impact of The New Tax System

(a) Excludes the impact of The New Tax System on prices.
Source: ABS Cat. No. 6401.0 and Treasury.

This pattern of price increases underlies the forecast that the CPI will rise by 5¾ per cent in year-average terms in 2000-01 and by 5¼ per cent through the year to the June quarter 2001. This through-the-year increase comprises ongoing inflation of around 2½ per cent and a one-off increase, due to the first year impact of the changed indirect tax arrangements, of around 2¾ per cent.

By the September quarter 2001, the through-the-year increase in the CPI is expected to fall to around 1½ per cent, somewhat below the `ongoing' inflation rate.

Long Run Price Estimates

The longer-term impact of The New Tax System on the CPI will be less than the impact in 2000-01. This is because other parts of The New Tax System package that will reduce the overall CPI impact (such as the phased introduction of input tax credits for motor vehicles and the abolition of various State taxes), will be introduced in 2001, 2002 and 2005. In the longer term, the overall effect of The New Tax System measures on the CPI is likely to be around 2¼ per cent, or around 1¾ per cent if tobacco is excluded.

In the original announcement of A New Tax System, the impact on the CPI given prominence was an increase of 1.9 per cent. Since that figure was first published, there have been changes to both the package itself and how the CPI is measured.

The original 1.9 per cent rise referred to the cumulative impact of the package on the CPI through the first two years to 2001-02 and excluded the impact of the reforms on tobacco. Tobacco was excluded since the increase in tobacco excises reflects public health considerations, rather than indirect tax reform per se.

Over time, the impact of A New Tax System on the CPI was expected to fall below 1.9 per cent as businesses gained access to full input credits on their motor vehicle purchases, reducing business costs and hence ultimately consumer prices. As a result, the original long-run estimate of the CPI impact from A New Tax System was 1¾ per cent.

Since the original announcement, the package has been amended to make basic food GST-free, thus reducing the CPI impact. However, this change will be partly offset by increased business compliance costs associated with changes to the package and the changes to diesel fuel credit arrangements. The basic food exemption and other changes together are expected to subtract about ½ percentage point from the cumulative CPI impact of the package. This would imply a cumulative CPI impact of around 1¼ per cent over the long run.

Another, more technical, factor that has affected the original estimate of the impact of indirect tax reform on the CPI is a change in how the Australian Bureau of Statistics measures the CPI. The change in the treatment of the First Home Owners Scheme, together with other changes made in calculating the CPI for the 13th series (as compared to the 12th series), will add around ½ percentage point to the measured impact of The New Tax System.

Consequently, the long-run impact of tax reform on the CPI (excluding tobacco) remains around 1¾ per cent.

3 These estimates are based on detailed modelling involving assumptions regarding margins, flow through, etc. As such, the estimates cannot be improved after the event and hence will not be changed.

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