Are we heading for a perfect storm?

Households will need to get ready for a decade of lower incomes, higher taxes and less tax breaks, according to noted economist, Ross Garnaut.

Garnaut has warned of a long and tough China-induced downturn in Australia, that will require restraint in government spending and wages growth for the rest of the decade, according to today’s Australian Financial Review.

Professor Garnaut believes that tax cuts and benefits introduced since 2004 would need to be reconsidered, and that older people who had become used to virtually no taxation may be faced with having to pay taxes.

If he is correct, we may see the government forced to increase taxes and cut spending for several years. Tax breaks for superannuation could be wound back, which could see more retirees forced to pay taxes, while companies could see an increase in company tax rates and other levies.

Australia’s terms of trade (the measure of our exports compared to imports) would be hit by three “mutually reinforcing negatives”, he said.  China’s shifting focus away from heavy industrial investment and exports, which has driven demand for commodities and energy down. The second wave is Australia’s reforms including the Minerals Resource Rent Tax (MRRT) and carbon tax schemes, potentially making Australia less competitive, and the third is the current global economic downturn.

A potential fourth driver is China’s leaders being unwilling to unleash a repeat of the economic stimulus such as during the GFC, which would temporarily support demand for Australia’s resources.

Australia’s terms of trade have fallen by at least 10% over the last 12 months, according to economists, hit mainly by falling coal and iron ore prices, and more declines are likely. Falling commodity prices have seen our biggest resource stocks take a hammering. While the S&P ASX 200 Index is up almost 10% in the last 12 months, BHP Billiton Limited (ASX: BHP) has fallen 5.4%, Rio Tinto Limited (ASX: RIO) is down 13.7%, Fortescue Metals Group (ASX: FMG) has slumped 20.8%, while Atlas Iron Limited (ASX: AGO) has seen its share price halve.

The Foolish bottom line

Australia’s economy needs to go through tough periods every now and then, despite the short-term pain it may cause – otherwise we could end up facing the same issues as Greece is currently, later on down the track.

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Motley Fool writer/analyst Mike King owns shares in BHP. The Motley Fool’s purpose is to help the world invest, better. Take Stock is The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it’s still available. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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