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Wednesday 19 June 2024 by Philip Brown

The Coming Tax Cuts and The Outlook For Retail Spending

The much-discussed Stage 3 tax cuts begin on 1 July. There’s no doubt that the cost of living is a major issue for households at present. While the tax cuts aren’t going to be a solution by themselves, they will go a reasonable way to helping those struggling with mortgages or rent, with flow-on effects into broader retail spending.

The new financial year beginning July 1 brings a new set of tax brackets and material tax cuts for every taxpayer in Australia. At the same time, there’s also a lot of discussion about whether the RBA will or won’t do one more rate rise – or might they do one rate cut by the end of the year.

These two prospects are not normally directly linked, but when you think about the household sector’s propensity to spend, it’s worth comparing them side-by-side. Our first Figure is the Stage 3 tax cuts, expressed fortnightly, along side the impact of a 25bp rate cut on different sizes of 30-year mortgages.

As you can see, the Stage 3 tax cuts offer a cut of around $55 per fortnight to someone on AUD70K per annum (which is close to the median adult wage). That would be about the same impact as the reduction on an AUD700k mortgage from a single 25bp rate cut. The difference, of course, is that only mortgage holders see the change from the rate cut, while every taxpayer will see a change from the tax cuts. Oftentimes, there’s more than one person working for each mortgage, too, of course.

This comparison drives home a few points. One, it shows just how massive the impact on the economy of repeated RBA moves can be. These tax cuts are the largest seen in many years, but the RBA could easily deliver 25bp of rate cuts per month or more, for months on end, if the cycle turns abruptly. They delivered rate hikes repeatedly on the way up to the current cash rate.

Second, this comparison shows that if economists tell you the tax cuts don’t matter to the economy, but that another rate move is the key, they might have lost track of the fundamental dollar values.

Overall, the comparison shows quite clearly that while the tax cuts are not going to reverse the entire RBA cycle, they are probably of more importance than a single rate move, at least to the household sector.

So what might such a shot in the arm do for households? The recent data on retail sales has been notably weak. Retail sales is measured in nominal dollars, which means that it should be rising in line with population and inflation. That makes the current growth rate of just 1.28% per year indicative of noticeable belt-tightening by many. As the chart shows, there’s been materially weaker growth than usual for a long time now.

The breakdown of where the growth has been weakest confirms a few suspicions. In a high cost of living environment, you would expect the more discretionary items would fall first. That’s partially true, but it’s not quite so clear-cut. There’s been a material fall in clothing, department stores, and household goods. These are predominantly items where new purchases can at least be delayed, if not entirely avoided. An old suit or an old couch can be used a little longer if money is tight.

One item that cuts against the grain is Cafes/Restaurants – particularly as it’s growing more quickly than the broader “food” category. The Food category represents food prepared at home, for the most part. The comparison of Food against Cafes/Restaurants suggests that spending on eating out is growing more quickly than food overall – that’s a little unexpected in a belt-tightening environment. We’re getting into speculative territory here a little, but the drivers could be one the following:

Inflation: People are eating out less often but paying more for the privilege when they do it. As such, the total spend is rising but there is still some measure of belt-tightening.

Uneven social impact of rate rises: While higher rates and higher rents are difficult for renters and recent homebuyers, they are a boon for others. Those who already own property and are living on the proceeds of investment (mostly, but not always, older people) would have found the last few years very beneficial overall and might be inclined to spend more on luxuries, like eating out.

Uneven spread within a category. It is entirely possible that rather than budgeting for a set meal at a set restaurant, households instead budget a dollar value for “eating out” and then vary the quality of the restaurant to keep within that budget. If so, there could be a small increase in total spending driven by population or inflation, even as belt-tightening occurs via a reduction in the quality of the restaurant frequented.

The impact of the July 1 tax cuts on spending will be a temporary boost to spending in many of the industries suffering most. The extra cash will be spent and will then recirculate around the economy further. We’re expecting to see an increase in retail sales and other similar consumption-orientated series in July and August.

Overall, we don’t think the tax cuts will be enough to change the trajectory for the RBA. This is mostly because the RBA is explicitly modelling the anticipated effects of the tax cuts and incorporating them into the forecasts already. So even if there is an increase in retail sales or some price measures, it will need to exceed the RBA’s expected outcome before it influences RBA behaviour. The most likely outcome is that the RBA remains on hold for a material period. The current FIIG forecast is for a rate cut in November, but there is also risk that the rate cut comes later than that.