In Part 1 of this series, posted yesterday, the conclusion was that restoration of a sustained Budget surplus would require a combination of expenditure cuts and tax increases. This second Part 2 finds that the projected swing from Budget deficit to surplus requires a swing of 3 per cent of national income. It then explores the scope for expenditure cuts and tax changes to achieve this swing. The conclusion is that most of the required swing will have to be achieved by a net increase in taxation revenue relative to GDP.
Taxation versus Expenditure Cuts
If the Government were to rely purely on expenditure cuts to restore and maintain the Budget surplus, it would need to make cuts over time equivalent to as much as 3-4 per cent of GDP. Furthermore, that calculation assumes no new policy initiatives, which is not realistic over such a long period of almost forty years.
In 2014 the Government tried to make expenditure cuts which were in fact only equivalent to ½ per cent of GDP in a full year, and even these relatively modest expenditure savings were offset by new spending initiatives which halved the net savings in a full year. Nevertheless, these expenditure savings, which went nowhere near achieving the Government’s fiscal objectives, were rejected by the public and the Parliament. As a result, the Government has given no indication that it would ever be prepared to embark on this type of expenditure cutting again.
While all of us can think of programs where expenditure savings might be possible, they never add up to the sums required to achieve on-going budget surpluses. In addition, there is the difficulty of getting a majority to agree on which programs could be cut. Instead, realistically it would seem that most Australians want and expect the government to continue to supply the present range of services and support, and that major expenditure savings are just not possible.
Other expert enquiries have come to a similar conclusion. For example, both the Grattan Institute and a group of independent experts assembled by the Committee for the Economic Development of Australia (CEDA) have insisted that budget repair will require action on both the revenue and payments sides of the Budget. Indeed, the Grattan Institute was quite adamant that ‘governments will not be able to restore budgets to balance without boosting revenues’ (Grattan Institute 2015: 1). Furthermore, both the CEDA experts and the Grattan Institute considered that most of their recommended fiscal adjustment to restore the Budget surplus would need to come from increased revenue.
And if further proof were needed, the Government itself seems to have come to the same conclusion. Thus the projected shift from Budget deficit to surplus between 2016-17 and 2020-21 represents a swing of 3 per cent of national income, of which 2½ per cent comes from revenue and only ½ per cent from accumulated spending cuts over the four years.
The Possible Shape of Tax Reform
But if as we have argued, there is a need for more revenue, not less, what can we expect from tax reform? The highest priority after Budget repair would be to offset the effects of bracket creep, whereby under a progressive income tax system, people’s average tax rates rise as their incomes rise even if that increase in income only matches inflation and they are no better off in real terms. Using the wage rates projected in the last 2017 Budget, the average tax rates for middle-income people will increase by between 1.9 and 2.9 percentage points by 2021, but even adjusting the tax scales to prevent this increase would cost almost all of the projected revenue increase that is required to return the Budget to surplus. Thus, there is a critical need for additional alternative sources of revenue, if even the most modest income tax cuts are to be affordable.
First, there would be some scope to raise additional revenue by closing certain concessions. For example, the discount on capital gains should be reduced from 50 per cent to 25 per cent, and the deduction of mortgage interest on housing loans should only be a deduction from the rental income, and not from labour income. In addition, many people have suggested reigning in the size of the superannuation concessions. However, the estimated amount of revenue lost through these concessions is dependent on what benchmark is used to measure them, and if – as I would argue – an expenditure benchmark is used, then superannuation is no longer concessionally taxed following the Government’s recent tightening of the access to this form of saving.
Second, there are a variety of new taxes that could be introduced to raise additional revenue, including:
- A carbon tax
- Removing the tax credit for fuel excise, and increasing that excise
- Reintroducing an inheritance tax and taxation of bequests, and accompanying action to tighten the taxation of discretionary trusts.
Of course, many of these proposals would be very politically contentious, and the amount of revenue raised would be relatively small – nowhere near enough to restore the budget surplus and finance an income tax cut as well. Instead the main justification for these tax changes would be to improve the equity of the tax system, and to achieve a more efficient allocation of resources.
But the critical conclusion that emerges is that income tax cuts can only be paid for by increasing the GST; otherwise there is no scope to afford them. And increasing the GST is not without problems if all the extra revenue will continue to be received by the States and Territories. In that case, the extra GST revenue makes no contribution to restoring the Commonwealth Budget to surplus nor to financing income tax cuts. The Commonwealth might be able to make some off-setting savings in its specific purpose transfers to the States, if the State’s GST revenue were increased, but the scope for savings in these specific purpose programs is also limited, and again not enough to finance income tax cuts and maintain a small budget surplus over time.
One really wonders why Malcolm Turnbull would so risk his credibility that he would seek to divert public attention from an immediate problem by raising expectations of income tax cuts that he can’t possibly responsibly deliver.
The truth is that Australia is a very low-taxed country; the second lowest behind Ireland among all the advanced member countries of the OECD. In the last thirty years Australia has had two major episodes of tax reform – 1985 and 2000/01 – and on neither occasion was the ratio of total taxation revenue relative to GDP reduced. Instead, each of these episodes was notable for the changes in the tax mix which did provide scope for modest reductions in personal income tax rates. But as I have outlined above, the scope for another similar round of changes to the tax mix is very much reduced; not least because of the success of the previous reforms. While all the evidence from the past is that no government has succeeded in reducing the size of government, and there may well be pressure to increase the level of taxation relative to GDP, given the standards of public services and welfare that Australians apparently expect.
In that case, it seems stupid to continue a tax debate that in this country always starts from a presumption that lower taxes should be the aim. Instead we should be mindful of the remarks by the great American jurist, Oliver Wendell Holmes, who is reputed to have said: ‘I like to pay taxes. In this way I buy civilisation’. And as I have written previously:
In reality taxation reflects our mutual obligation to one another as citizens. Taxation underpins an inclusive society and is an efficient way of paying for those services that enrich society and are collectively consumed. Moreover, many of the services paid for by taxation add to the quality of life and are a natural way to spend incomes as they increase through economic growth (Keating, 2004: 1).
Grattan Institute, 2015, Fiscal Challenges for Australia, Melbourne, no. 2015–4.
Keating M. 2004, ‘The Case for Increased Taxation’, Occasional Paper, no. 1/2004, Academy of Social Sciences in Australia, Canberra.
Michael Keating, AC, was Head of the Department of Finance and was responsible for advising the Government on expenditure control from 1986 to 1991. During that period the real outlays in the Commonwealth Budget fell in three consecutive years.