New Economist

What economics tells us about labour law

Harvard labour economist Richard Freeman recently visited Australia, and has written an article complaining about its labour law on VoxEU: From fair-go to rip-off: Australia’s new labour code. Freeman may well be right - but the current conservative government appears doomed at the forthcoming polls, so some roll-back is likely. What really caught my eye, though, was his comment about what economics tells us about labour law:

Whoever gets elected this fall should scrap Workchoices and take the opportunity to develop a truly modern labour code. Economics offers four principles for such a code.

First, the law should encourage efficient bargaining – that is, bargaining that “leaves no money on the table”. Per the Coase theorem, this means clear and simple regulations so that labour and management can bargain for maximum efficiency even as they fight over distribution. A few basic rules regarding the property rights to employment and workplace decisions in place of rules that are hundreds of pages of micro-managed dos and don’t dos.

Second, economics suggests keeping government officials out of the workplace bargaining. Hayek may have been a curmudgeonly conservative terrified by a now obsolete socialist threat, but he was right about lodging decisions with the people who have local information (subject to some concern about externalities). We want workers, unions, and management to have the scope to experiment with alternative contract provisions. We would encourage diversity on the notion that “one shoe does not fit all feet.” If your firm wants to include a clause in a contract that provides a remedy for harsh, unjust, or unreasonable dismissal of workers, you should have the right to do so.

Third, we would strive that the parties covered by the code agree on the rules rather than seek to impose them without major public support. If there is one lesson from human resource management, it is that workers participation in decisions -- their voice at workplaces -- is critical for a healthy and productive workplace. The Workchoices legislation is based on an outmoded control-and-command view of how workplaces operate. It is alien to the world in which firms operate on the basis of partnerships, group incentives, team production, profit-sharing, and employee-share ownership.

Fourth, economics suggests that any labour code build in some insurance for the protection of workers, even though such insurance may cost a bit of economic output. How much insurance to give workers is a matter of political debate and the weighing of alternative costs and benefits. The more leftwing view can be represented by the following statement: “Perhaps modest economic inefficiency is cost worth paying for if it prevents blatantly unfair behaviour by employers”. The rightwing view is: ”Perhaps some unfair behaviour by some employers is cost worth paying if it gets more jobs”. Different analysts can subscribe to either of these statements and remain true to the economics of weighing benefits and costs.

Three of his four points sound to me like a description of the British industrial relations system. We only fall down on the third - employee voice. Yet do economies like Germany, with Works Councils rampant, really have a better performing labour market?

How should immigrants be integrated into the labour market?

The OECD has published four new Social, Employment and Migration Working Papers which provide accounts of how Germany, Sweden, Australia and Denmark have have handled their post-war migrant intakes. Each have different histories and policy responses, and while none could be considered an unequivocal success, Australia seems to have done better than most. The Danish government has actively promoted integration but employers appear to treat even the children of OECD immigrants badly. Sweden is still stuck with the legacy of the scarring effect the 1980s economic crisis, while Germany faces high levels of inactivity amongst Turkish women and a 'second generation' problem. Here are long excerpts from the executive summaries:

No. 47. The Labour Market Integration of Immigrants in Germany (PDF) by Thomas Liebig

Germany is currently in the process of a major restructuring of its complex integration framework. Under the new Immigration Act which came into force on 1 January 2005, there is a uniform introduction programme for all permanent immigrants.

As in the past, integration services focus largely on language training. There is little evaluation with respect to the effectiveness of this kind of training and it is generally not linked to labour market needs. Indeed, the scarce empirical evidence suggests that language training in Germany may not be very effective as a means of labour market integration. In addition to the regular integration services, there is a multitude of innovative projects. However, these are often locally-based and time-limited, and seldom designed in a way that would enable proper evaluation.

With respect to employment and unemployment rates, and particularly given their low educational attainment and the current economic situation, the labour market integration of immigrant men is relatively favourable in international comparison. However, immigrant women, and particularly those of Turkish origin, have very low employment rates. This is partly an outcome of policies which limited the labour market access of spouses. Most of these legal obstacles have been removed under the new Immigration Act.

The situation of the so-called “second generation” is of concern, as they have very low educational outcomes. This hampers their access to vocational training, which appears to have an even stronger impact on their employment prospects than on those of natives. The low educational attainment of the second generation seems to be at least partly attributable to structural features in the German education system, such as the early streaming which puts migrants’ children in a lower track. Especially problematic is the relatively late starting age for kindergarten and the prevalence of half-day education in kindergarten and school, which limits exposure to the German language at a crucial age. Immigrants’ access to self-employment is hampered by legal obstacles and a lack of information and subsequent access to financial credits.

Despite positive experiences with temporary employment as a labour market integration tool for immigrants in other OECD countries, immigrants are not a focus group of the Federal temporary employment programme.

No. 48. The Integration of Immigrants into the Labour Market: the Case of Sweden (PDF) by Georges Lemaître

The past fifteen years have seen a higher share of humanitarian migration in Sweden than in the past. This is a form of migration for which labour market integration appears to be slower than for other forms of migration in all countries. At the same time there has been a growing diversification of migration away from “Western” countries to those with a greater cultural distance.

With 1985 came the introduction of social assistance for refugees for an eighteen-month introductory period, the transfer of responsibility for integration away from the Labour Market Board and the refugee dispersal policy in which refugees were assigned to municipalities throughout Sweden to relieve the pressure on the large agglomerations, with local economic conditions not always being taken into account. The dispersal policy had a negative effect on immigrant outcomes, particularly with respect to those arriving during the economic crisis, for whom the effects seem in many cases to be persistent.

With the severe economic crisis of the 1990s, asylum seeking in Sweden continued and those asylum seekers that were recognised and granted a residence permit were met with a labour market situation that was highly unfavourable and where considerable numbers of native-born Swedes with domestic formal qualifications and work experience were also looking for work. At the same time, the crisis struck immigrants already present and employed disproportionately. The re-integration of immigrants into the ranks of the employed was rendered all the more difficult by the fact that some two-thirds of jobs, in the Swedish labour market appear to be filled through informal methods.

The situation of immigrants has improved significantly since the trough of the economic downturn, especially for new arrivals. The relatively favourable impact on employment of a minimum amount of language training and of vocational training for this group and the relatively low take-up of these suggest that there is room for improvement with regard to labour market outcomes in the early years of residence, which can be expected to persist with continued residence.

The situation for immigrants having arrived since the mid-eighties and having suffered the brunt of the economic crisis of the nineties remains unfavourable. It is difficult to see how the continuing employment problems of this group can be turned around without a strong economic expansion, given the re-enforcing nature of further non-employment on both inactivity and employer perceptions. If targeted measures are politically infeasible, then general measures that provide especially favourable results for immigrants need to be encouraged and expanded.

...What employers recognise and reward seems to be Swedish work experience and successful integration tends to be associated with early contact with the labour market. Results seem to suggest that the benefits of early employment experience on later employment are much stronger than those of Swedish vocational education. Improving the efficiency of language instruction so as not to overly prolong labour market entry and ensuring that proficiency requirements reflect actual occupational needs are matters of some importance.

No. 49. The Labour Market Integration of Immigrants in Australia (PDF) by Thomas Liebig

Overall, the labour market integration of immigrant men in Australia can be considered to be relatively favourable in international comparison. This is partly attributable to selection policy and the prevalence of the English language in many parts of the world. Even with similar socio-demographic characteristics, skilled migrants tend to perform better than other migrant groups. In contrast to the positive outcomes for immigrant men, the labour force participation of immigrant women is not high in international comparison.

The Debate Over Inequality

by Mark Thoma

Well, me versus Samwick, Mankiw, and DeLong seems like a difficult match to win, but I am going to persist anyway. Stay the course so to speak (see also the Paul Krugman column that is at issue, an earlier post by Andrew Samwick, my response to Andrew, and a follow-up at Angry Bear). Each is objecting to Paul Krugman's claim that government policies can change income inequality and that changes in political ideology can explain, in part, variations in income inequality over time.

I hope to have more to say later, but for now let me offer a bit of evidence from Australia through Andrew Leigh, and add a bit more on the US as well. First, here's Andrew Leigh:

Top Floor, Going Up, by Andrew Leigh: An updated version of my research with Tony Atkinson on top incomes is written up by John Garnaut in the SMH today. There’s not much there to surprise regular readers of tbis blog. But since it’s not every day that I crack the front page of the SMH, I thought I’d indulge in some shameless self-promotion.

Here's the abstract from the article (PDF). It's also written up in the Sydney Morning Herald, as noted by Andrew:

ABSTRACT Using taxation statistics, we estimate the income share held by top income groups in Australia over the period 1921-2002. We find that the income share of the richest fell from the 1920s until the mid-1940s, rose briefly in the post-war decade, and then declined until the early-1980s. During the 1980s and 1990s, top income shares rose rapidly. At the start of the twenty-first century, the income share of the richest was higher than it had been at any point in the previous fifty years. Among top income groups, recent decades have also seen a rise in the share of top income accruing to the super-rich. Trends in top income shares are similar to those observed among other elite groups, such as judges, politicians, top bureaucrats and CEOs. We speculate that changes in top income shares may have been affected by top marginal tax rates, skill-biased technological change, social norms about inequality, and the internationalisation of the market for English-speaking CEOs.

Factors like top marginal income tax rates and social norms are connected to the political environment, but of course, this is in no way conclusive. A lot of the change is driven, according to their results, by the incomes of CEOs. But I think it's at least suggestive that the political environment drove some of the change.

For the US, as passed along to me in an email, factors such as the New Deal's very large tax increases on the wealthy, both directly on income and indirectly on corporate profits are an important factor connected to the political environment at the time. It's an open question how much of the change in inequality that might explain by itself.

Unions are also worth taking seriously with union membership nearly tripling to about a third of the workforce from the mid 1930s to the mid 1940s. This would affect all wages, not just those in sectors where unions are prevalent. The decline of unionization after the 70s is also a factor to consider, and there's a strong case to be made that this was made possible by a political environment that allowed union busting to occur. In any case, I don't think this is a settled question and I hope to follow up with more later. [dual posted]

Update: Please see Brad DeLong's excellent summary and follow-up on this debate.

Australia 1,2 3

Australia is like one of those nice, industrious, middle class kids at the back of the class. Pleasant enough, but apt to be overlooked. But this blog can no longer ignore events down under. It's been a busy few days:

1. OECD heaps praise on Australian economy. After 15 consecutive years of economic growth, another good 'report card' was never in doubt. The OECD expects the Australian economy to grow by 3% this year, rising to 3.5% in 2007. Its GDP per capita has now surpassed all G7 countries except the United States. So the challenge was to come up with something to criticise in Monday's OECD Economic Survey of Australia (summarised in the free Policy Brief, PDF).

The report picked on the complex system of federal-state funding and public service provision, the need for further reforms to infrastructure services, and measures to raise labour force participation. The OECD warned that Canberra had to guard against both inflationary pressures and the eventual downturn in commodity prices. It also said Australia's central bank "scores poorly" on transparency. The Reserve Bank of Australia does not publish explanations for 'no-policy-change' decisions, nor does the bank release the minutes of its board meetings. All important enough, to be sure, but hardly suggesting imminent crisis. Which is probably one reason why...

2. The Australian Prime Minister is to contest a fifth term. To the chagrin of perpetual Treasurer Peter Costello, Prime Minister John Howard yesterday announced that after a decade in office he would be seeking a fifth straight term at next year's federal election. According to Reuters:

"I remain enthusiastic and keen to ensure that the coalition achieves a fifth electoral victory," Howard, who turned 67 last week, said in a letter to parliamentary colleagues.

Just check out the smug grin in this photo. I'm not sure Treasurer Costello is smiling though...once again Howard has out-flanked, out-witted and out-muscled him.

3. New central bank governor announced. Glenn Stevens, deputy governor of the Reserve Bank of Australia, will take over as RBA Governor from Ian Macfarlane, who is to retire in September. Stevens was one of the architects of the bank's move to inflation targeting, and understands the monetary policy decision-making process backwards. Don't expect greater transparency from him, though. In the above story, he is dismissive:

Reserve Bank Deputy Governor Glenn Stevens said recently that releasing the minutes of board meetings would not reveal significant additional information. "We're open-minded on these things, we're just not persuaded,'' Stevens told economists in Sydney on July 13. "That doesn't mean that at some future time we won't reconsider, but thus far we haven't found the arguments in favor of that form of additional disclosure to be all that convincing, given the amount of information that is already out there.''

Somehow I doubt the RBA will be prepared to abandon its secretive inclinations. Its rather unimpressive Board is a key reason - those transcripts could prove embarrassing!

Stevens has a passion for cars, and has recently got his pilots licence. But at heart he appears to be a conservative, bible-bashing man of the suburbs (much like fellow Baptist Peter Costello). David Uren at The Australian has a profile of the man who has a head for figures:

He is in many respects an average suburban man, having spent nearly all his life in the southern Sydney suburbs. At university he drove one of the famous Holden Sandman panel vans that inspired the slogan "If it's rockin', don't bother knockin". Today, he prefers the German precision of a top of the line Audi, which costs as much as the average mortgage.

...Stevens lives in Sylvania Waters, the suburb made internationally famous by a 1992 reality television documentary of the same name. His home, which can best be described as modest for the location, is just a two-minute walk from a lawn bowls club and a hop, skip and jump from the Georges River. He lives there with his wife and two daughters, one of whom is in the work force. It is a large dwelling, but not in the same league as the nearby waterside palaces.

...But the most telling aspect of his personal life is his deep religious commitment. He is a member of the Heathcote Baptist Church, and fellow economist Bird says his religion is associated with a deep integrity. "By being a good public servant there is the idea that he's serving his God," Bird says.

With annual inflation running at 4% and the pace of economic growth picking up, Australia's official interest rates are set to go higher as early as tomorrow morning. Longer term, Stevens will very likely face a recession at some stage in his 7 year term.

UPDATE 3/8: Citing a strengthening in demand and output, capacity constraints, a tight labour market conditions and rising inflation, the RBA raised rates by 25 bp to 6.0%. The press statement concludes:

Overall the Board's assessment, based on the gradual increase in underlying inflation this year, and the wider background of above-average global growth and strong domestic demand, was that underlying inflation in the period ahead was likely to exceed previous forecasts.

Given these circumstances, the Board judged that an increase in the cash rate was warranted in order to contain inflation in the medium term.

Yes, UK rates are going up

A slew of recent economic data have suggested the British economy is finally perking up. That did not cause the Monetary Policy Committee to raise official UK rates yesterday, but it does mean we are seeing headlines like this in today's press: Data bolster belief that next UK rates move is up, by Jamie Chisholm in the Financial Times.

Expectations of an interest rate increase later this year hardened on Thursday after data showed an acceleration in economic activity that might prompt the Bank of England to apply a cautionary touch on the brakes.

Although the Bank’s monetary policy committee said on Thursday it would leave its main interest rate unchanged at 4.5 per cent for the ninth consecutive month, robust surveys on manufacturing, the service sector and the housing market led money markets to price in a quarter point hike before December, with the possibility of more to follow.

And City expects rate rise this year, by Larry Elliott in The Guardian

The City was last night betting on at least one increase in interest rates before the end of the year after a strong performance by the service sector raised the prospect of anti-inflationary action from the Bank of England.

Despite leaving the cost of borrowing unchanged for the ninth successive month, the best performance by the service sector in more than two years prompted speculation that the monetary policy committee would soon be forced to raise rates. Money markets were signalling rates of between 4.75% and 5% by the end of 2006 compared with the current level of 4.5%. Upbeat economic data this month, culminating in yesterday's survey of the service sector from the Chartered Institute of Purchasing and Supply, prompted analysts to suggest there was an increased chance of tightening of policy.

I agree with these assessments, though expect to see the first 25 bp rate hike sooner than the market expects. This follows recent rate hikes in the United States, Australia and Canada. New Zealand aside, there is little sign yet that interest rates in the anglo-saxon economies have peaked.

Alan Greenspan's "monetary myopia"

"The accolades bestowed upon Alan Greenspan ahead of his retirement on January 31st have a strong whiff of irrational exuberance", while his policies have "encouraged drunk and disorderly asset markets and intoxicated consumers." So claims this week's Economist, in a special report on Greenspan's Monetary Myopia (a companion piece to its cover story on the dangers facing the American economy).

The report is available free online, so I only provide extracts. On Greenspan's record, the assessment is predictably mixed: he helped save the world economy from calamity at critical times "by pumping in liquidity when it was vulnerable". But his economic record is less impressive than it at first appears:

On the surface, America's economic performance has been remarkable on his watch. Not only has inflation been reduced, but America has enjoyed the two longest expansions on record, marred only by two mild recessions. The previous 18 years, by contrast, suffered four recessions, including the two severest since the Great Depression of the 1930s.

On closer inspection, however, Mr Greenspan's record looks less impressive. The drop in America's core rate of inflation has in fact been no greater than the average for all the industrialised countries in the Organisation for Economic Co-operation and Development (OECD). Global disinflationary pressures have made fighting inflation easier for all central banks.

Nor has Mr Greenspan done a much better job than foreign central banks at smoothing the business cycle. It is true that America has enjoyed faster GDP growth than other big OECD economies, but that should not be attributed to the Fed. Long-run growth rates are driven by structural factors not monetary policy, which mainly affects output over the cycle. America's potential growth rate is higher than that of the euro zone and Japan, thanks largely to faster population growth and more flexible labour and product markets.

The authors are highly critical of Greenspan for encouraging asset price inflation:

The Economist's long-running quarrel with Mr Greenspan is that he chose not to restrain the stockmarket bubble in the late 1990s or to curb today's housing bubble. He has declared himself vindicated in not pricking the equity bubble with higher interest rates, but instead to let it burst and then cut rates sharply to “mop up” the damage. The economy has fared better than we expected since share prices slumped, with only a mild recession in 2001. But a better test of Mr Greenspan's policies is not whether America escaped a deep recession, but whether the economy would today be on firmer foundations if the Fed had acted against that bubble.

...The deepest flaw in Mr Greenspan's policy towards asset prices is its asymmetry. If the Fed always cuts interest rates when asset prices tumble, but never raises them when they soar, then investors will be encouraged to take bigger risks. That makes bubbles more likely.

...Mr Greenspan's past reluctance to tackle asset prices is partly understandable: central banks do not have a mandate to pop bubbles. It is therefore hard to justify an increase in interest rates to Congress when inflation is low, as it was in the late 1990s. Nevertheless, views change over time. In the 1960s the main objective of monetary policy was full employment, not inflation. Persuading the public today that asset bubbles are as dangerous as inflation is surely no harder than switching focus from unemployment to inflation.

But first, Mr Greenspan and other central bankers need to start arguing the case for raising interest rates in response to rising share and house prices—and to be prepared to live with the unpopularity that would follow. Mr Greenspan would certainly not be so popular today if he had spoken out and leant more firmly against the stockmarket and housing bubbles.

...Investors' exaggerated faith in his ability to protect them has undoubtedly encouraged them to take ever bigger risks and pushed share and house prices higher. In turn, American consumer spending has become dangerously dependent on unsustainable increases in asset prices and debt.

In December Mr Greenspan was made a Freeman of the City of London. One of the traditional perks of this honour is that he can be drunk and disorderly without fear of arrest. The snag is that his policies have also encouraged drunk and disorderly asset markets and intoxicated consumers. When the party ends, Mr Greenspan will not be there to clean up the mess. But end it surely will.

And they fear that incoming Chairman Ben Bernanke will be even less keen to tackle asset bubbles:

Ben Bernanke, his successor, believes that interest rates should not respond to movements in asset prices unless they affect forecast inflation. Research co-written by Mr Bernanke in 1999 concluded that if a central bank responds to asset prices it risks only creating more economic instability compared with pursuing an inflation target. However, his model assumed that bubbles just happen. In reality, monetary policy can contribute to the inflating of a bubble—not least if investors expect the Fed to cut interest rates when share prices fall, but to do nothing to prevent their rise.

Alongside his views on bubbles, Mr Bernanke is keen to introduce a formal inflation target, which could reduce the Fed's room to respond to asset prices. So it would seem that at the very moment when the gap between Mr Greenspan and other central bankers was narrowing, the Fed might unfortunately be about to take a step back under Mr Bernanke.

While I can see the validity of those concerns, three inflation-targeting central banks - in the UK, Australia and New Zealand - have nonetheless managed to slow down their respective housing booms, as the article points out:

The Bank of England and the Reserve Banks of Australia and New Zealand have raised interest rates in recent years by rather more than inflation alone justified, because of concerns about house prices. ...In both Britain and Australia, rate increases of just 125 basis points, along with clear warnings from the central banks that house prices were overvalued, were enough to slow the annual pace of house inflation from around 20% to close to zero.

If they can manage it, then so too can the new Fed Chairman.

New book: Beyond our Shores

Austrade chief economist, Tim Harcourt, launched his new book today, Beyond our Shores: Essays on Australia and the Global Economy. Chapters can be downloaded or the book ordered for free online.

I have written a series of essays since 1999 on the amazing events witnessed, and in some cases experienced, and their effect on Australian exporters. The essays have been brought together in this book and arranged by topic – ‘Globalisation and Export Performance’, ‘The Information Age’ and by Australia’s trading regions. And for those, like me, who like the big occasion, there is also a chapter on special events like the Olympic Games, the Rugby World Cup 2003 and the Oscars.

Trade views from down under don't often get a hearing (aside, of course, from trade blogger Peter Gallagher), but some of these essays are worth a look. I particularly like his pieces on globalisation. For a different Aussie take on trade, read Pete's Predictions for 2006.

Rorting the RBA Board*

All central banks have their quirks. The Reserve Bank of Australia's is that its Board - which sets monetary policy - tends to be full of 'captains of industry' and other luminaries. Or as Stephen Kirchner puts it:

In the absence of reform to the governance arrangements for Bank, the main qualification for most Board appointments will remain a lack of expertise in monetary policy.

Stephen's criticism is in response to a press report that the Australian government is considering appointing a former treasurer of the governing Liberal Party, Ron Walker, to the RBA Board. I don't understand why a country like Sweden can appoint a half decent central bank board, while Australia's is rife with vested corporate interests and (potentially) party hacks. Ron Walker would know about as much about monetary policy as my local cafe's barista. Time for some governance reform.

* Definition of a rort

RBNZ overshooting once again

New Zealand was the first central bank to introduce inflation targeting, so you would think they'd have got the hang of it by now. But no - even with Don Brash safely relegated to the Opposition benches, the Reserve Bank of New Zealand still manages to get it wrong. Today they raised the Official Cash Rate by another 25 basis points to 7.0%, the highest in the OECD (aside from Mexico). In today's statement Governor Bollard explained the rate hike thus:

...medium term inflation risks remain strong. Persistently buoyant housing activity and related consumption, higher oil prices and the risk of flow-through into inflation expectations, and a more expansionary fiscal policy are all of concern. While there has been a noticeable slowing in economic activity, and a particular weakening in the export sector, we have seen ongoing momentum in domestic demand and persistently tight capacity constraints. Hence, we remain concerned that inflation pressures are not abating sufficiently to achieve our medium term target, prompting us to raise the OCR today.

Bollard noted "the continuing strength of household spending, supported by a relentless housing market and rapid growth in mortgage lending", along with "a worsening current account deficit, now 8 per cent of GDP." For those hoping for some respite, he warned of "the prospect of further tightening" and added:

Certainly, we see no prospect of an easing in the foreseeable future if inflation is to be kept within the 1 per cent to 3 per cent target range on average over the medium term.

True, annual inflation is 3.4%, breaching the central bank's target band of 1%-3%. But the pick-up in inflation in large part reflects higher oil prices. The pace of economic growth has already slowed significantly, down from over 4% to around 2.5%, with June quarter private consumption growth the slowest in three years. Softer domestic demand will help ease medium-term inflation pressures.

The RBNZ look like they are once again going to overshoot by raising rates more aggressively than they need to - just as inflation is peaking and the economy heads into sub-trend growth. Stephen Kirchner at Institutional Economics agrees, writing that RBNZ Governor Bollard Has Lost the Plot:

Raising the official cash rate will only attract further capital inflow, already very strong, putting further upward pressure on the exchange rate and making the current account deficit even worse.  This is exactly the policy mistake the RBA made in the late 1980s, when it sought to target the current account deficit with tighter monetary policy, resulting in a recession in the early 1990s.  Both Governor Bollard and the Finance Minister have been trying to talk the NZD lower, yet monetary policy has been driving it higher.  This can only cause credibility problems for the Bank.

Australia's flat tax that never was

Australia nearly adopted a flat tax this year - until common sense prevailed. David Uren of The Australian today reports on Costello's secret 30pc flat tax:

When Peter Costello left Canberra for his Christmas break last year, he had before him modelling for the most radical reform to income tax in 60 years. The ambitious plan, prepared for this year's budget, would have replaced all the existing tax scales with a single flat rate of tax of 30 per cent.

The current tax-free threshold of $6000 would have been abolished and replaced with a rebate to ensure low-income earners were no worse off. Treasury modelled a number of tax plans, including proposals from the Australian Chamber of Commerce and Industry, accounting body CPA Australia and the Government's backbench tax ginger group.

The most detailed work, however, was completed on the proposal for a flat tax. It included an analysis of winners and losers and an outline of legislation, covering other tax rebates and pensions, that would need to be amended.

The plan was clearly affordable without pushing the budget into deficit, with the cost rising from $7.7 billion in 2005-06 to $10.1 billion in 2008-09. ...Treasury projects that the budget will be in surplus by $8.5 billion in that year, so the pot from which tax cuts could be drawn totalled $15.2 billion.