Inflation alarm as tax cuts boost wallets

Stage 3 tax cuts will fatten the wallets of all Australians, but an economist is warning the new taxation landscape contains dangerous inflation risks that could pummel mortgage holders with higher interest rates.

It all hangs on how families decide to spend their uptick in wealth, Dr Nalini Prasad from the UNSW School of Economics said.

“Everyone likes getting more income,” she said.

“The increased average take-home pay is $42 per week.

“If individuals decide to spend most of the increase in their income from the tax cut, then this will be inflationary and put upward pressure on the cash rate.”

The cash rate, set by the Reserve Bank of Australia, serves as a benchmark for mortgage rates across the economy.

It now sits at 4.35 per cent following an aggressive rate tightening cycle from the RBA designed to tame growing inflation in the economy.

RBA Governor Michele Bullock has warned the Board will lift rates again if necessary to return inflation to a 2-3 per cent target range and June’s inflation report delivered troubling news for homeowners.

The consumer price index jumped to 4 per cent in the year to May, the Australian Bureau of Statistics, up from 3.6 per cent in April.

Economists had expected a more modest increase of 3.8 per cent.

Deutsche Group chief economist for Australia Phil O’Donaghoe said the shock increase would likely push the Reserve Bank of Australia to hike rates in August by 25 bps to 4.6 per cent.

“Underlying inflation is intolerably high in Australia,” he said.

Dr Prasad said the long-term success of the cuts would depend on a resolution to Australia’s current inflation woes.

“In the longer term, if the economy builds more productive capacity, then I’d expect more investment to occur from the tax cuts, but we need to resolve the inflationary problems in the short-term first,” she said.

“For the economy to benefit fully from these tax cuts, productive capacity needs to be increased.

“Otherwise, the immediate effect might be limited to higher inflation without significant gains in economic growth.”

There is some evidence, however, the cuts might not add to inflation pressures.

Banking behemoth NAB estimates more than a third, or 36 per cent, plan to save extra money rather than splurging on non-essentials.

A majority of Gen Z Australians, or 53 per cent, will save rather than spend and 49 per cent of those earning between $100,000 and $150,000 will likely choose frugality over extravagance, the bank’s data shows.

NAB personal banking executive Paul Riley said the plan to save rather than spend Stage 3 would help in the “fight against inflation”.

“Despite cost-of-living pressures, Australians have been prioritising their savings wherever possible over the last year or so,” he said.

“The money people expect to get back from stage 3 tax cuts will help supercharge their savings or rainy-day funds.”