MICHAEL KEATING. Tax Reform and the Need to Raise More Revenue

This article considers the future Budget outlook and argues that the key issue for tax reform is how best to raise the additional revenue that will be needed. The article builds on Ian McAuley’s recent post arguing that well-designed taxes can actually improve economic resource allocation, and this article further argues that if the additional revenue is spent on tackling inequality this can increase economic growth.  

In a recent post on this blog (1 August), Ian McAuley raised the question, ‘Can Labor hold its nerve on tax reform?’. Ian made the legitimate point, that given the state of our public debate ‘no (political) party aspiring to office would explicitly state that it intended to raise taxes’. As Ian went on to argue, however, well-designed taxes can actually improve economic resource allocation.

This article is intended to complement Ian McAuley’s arguments that Australia needs to improve the integrity and fairness of its tax system. My focus however will be on how much revenue Australia will need to raise in the future and why measures to increase the efficiency and fairness of taxation are critical to meeting that revenue goal.

My starting point is that taxation is raised for a purpose. It is raised as the means of financing services and transfers that we as a community are demanding. Without taxation there would be no such services and transfers. How much revenue should be collected, should therefore not be determined by some arbitrary limit such as that set by the present government. Instead, logically the amount of taxation revenue to be collected needs to be based on a consideration of what services and transfers we want government to support.

Of course, different people have different views about the responsibilities of government and therefore on how much revenue government needs. Nevertheless, I want to suggest that these differences of opinion about the range of government responsibilities are mostly at the margin. Indeed, the outstanding fact is how much agreement there is about the range of government responsibilities, and what we should be able to expect from government. That is exactly why successive governments have found it so hard over the last several years to cut government expenditure by the amount needed to get the budget back into surplus and keep it there without increasing taxation.

The reality is that the big public expenditure items are health, education and welfare, infrastructure and national security, and if we are to significantly cut public expenditure then significant savings must be found in these areas. Furthermore, successive governments have exhausted the opportunities for cutting the funding for science, the arts, various community groups, foreign aid, and the public service. These functions have been heavily cut already, because they have less political influence, and the savings achieved relative to the total budget task are miniscule.

On the other hand, when we consider the opportunities for more savings in health, education and welfare, we find that most proposals will be strenuously resisted. Past savings options have focussed heavily on tightening the eligibility conditions for government assistance and to a lesser extent on increasing user pay arrangements, but the opportunities for further such savings are doubtful. Australia already has the most tightly targeted income security system among all the advanced economies, and that is the principal reason why the levels of government expenditure and taxation are lower in Australia than in all other advanced economies. In addition, user pay arrangements mean that the private cost of health is higher than in most of the other countries (notwithstanding the ineffective public subsidies for private health insurance), while Australia led the way in introducing loans to finance tertiary education fees.

Further savings could be achieved by improving the efficiency of these various human services, but they would take a lot of time and effort. Most importantly, it is very unlikely that such “efficiency savings” would be anywhere near sufficient to ensure sustained budget surpluses over the next few decades. Quite large savings could be achieved by better evaluation of infrastructure and defence projects, but there would be enormous pressure to redeploy these savings to other infrastructure or defence projects; especially in the latter case as Australia’s international security situation is deteriorating. Finally, if we consider why the Australian budget has got into a state of continuing deficits, it is apparent that it is more due to a shortfall in revenue than an excess of expenditure relative to past norms.

Accordingly, independent experts, such as the Grattan Institute and a group of budget experts commissioned by the Committee for the Economic Development of Australia, have concluded that restoration of the Australian Government Budget to a continuing surplus over time will require action on both the expenditure and revenue sides of the budget. Indeed, the Grattan Institute is quite adamant that ‘governments will not be able to restore budgets to balance without also boosting revenues’.

In our forthcoming book, Fair Share: Competing Claims and Australia’s Economic Future, to be published early next year, Stephen Bell and I explore in some detail the balance between possible public expenditure savings and increased revenue that will be required in future to maintain a small budget surplus over the course of the business cycle; which is the declared aim of government policy. In short, we note that the Commonwealth Budget presently has a deficit equivalent to around 2 per cent of GDP. We also note that the Government’s own forward projections of expenditure over the next four decades, as published in the 2015 Intergenerational Report, and assuming no policy changes, show Australian government expenditures increasing at an average annual rate of 3 per cent, which is a bit faster than the long-term projected growth rate of GDP at an average annual rate of 2.8 per cent. Thus, using the Government’s own projections, the budget deficit could be as high as 6 per cent of GDP or more by 2054-55 unless the Budget is returned to a sustained surplus within a few years. In addition, in our view prudence demands that allowance also be made for some inevitable new policies in future that will further add to projected expenditure. In particular, our analysis of rising inequality leads us to conclude that additional government intervention, including expenditure, will be needed to restrict and ameliorate this increase in inequality.

In sum, combining these projections of future revenue demands with our assessment of possible expenditure savings, our book, Fair Share, argues that some increase in revenue will be necessary in any possible scenario. We also consider at some length the evidence regarding the impact of increasing taxes on economic growth, and conclude, like Ian McAuley, that the sorts of increases we propose will not have any discernible impact. Indeed, the argument that tax reductions are needed to stimulate economic growth is no more than a fig leaf for self-interest. For example, the international evidence strongly suggests that the increased after-tax profits following company tax cuts have mostly been returned to shareholders and management via share buy-backs, and have not been used to finance new investment. Another recurring mistake is to argue that lower taxes are needed without any consideration of how taxes will be spent. Most importantly, higher economic growth would be achieved by spending the proceeds from extra revenue on investment in human capital. In particular, we need to spend more on encouraging the adoption of new innovations and technological change, and this can be promoted by assisting those who will be most disadvantaged to adapt.

Furthermore, technological change is the principal cause of increasing inequality, and both the IMF and the OECD have concluded that inequality is bad for economic growth. The IMF found that increasing the income share of the bottom 20 per cent by one percentage point is associated with 0.38 percentage point higher growth rate. Similarly, the OECD found that increasing inequality at the average rate recorded in the OECD over the last two decades would drag down economic growth by 0.35 percentage point per year for 25 years, a cumulated loss of GDP at the end of the period of 8.5 per cent. And the counter-part of this finding, as reported in our book, Fair Share, is that reducing the negative impact of inequality on economic growth would be larger than what would be achieved by the proposals for further structural economic reform.

As a nation we therefore need to stop the fiction that tax cuts are needed and possible. Instead we need to face up to the fact that good government requires more revenue, and that the critical question for our political parties is how best to raise that necessary additional revenue. In my view the Labor Party has made an excellent, albeit modest start. Restraining negative gearing for real estate investment, reducing the presently excessive capital gains discount, and taking action to reduce tax avoidance through trusts are all excellent measures to help enhance the revenue and return the budget to surplus. Each of these policy changes will also improve resource allocation and will certainly not reduce economic growth – indeed they may well assist future growth depending on how the additional revenue is used.

But what Australia needs most of all is a serious national conversation about the future role and responsibilities of government and the consequent revenue requirements consistent with those roles and responsibilities. This conversation will be critical to restoring trust and the efficacy of the Australian political process. The present absence of any such understanding and community consensus about the range of government responsibilities and their financial implications is, I suggest, the major reason for the present distrust in government and politics in general. So long as the present myth and expectation is fostered that tax cuts are necessary and can be afforded, governments will inevitably be seen to be promising what they, and the rest of us, subsequently find out they cannot deliver. It is this failure to honour their most basic promises that is the root cause of distrust in politicians and politics. If we want to restore good government, then we need a better understanding of what we really expect from government in terms of services and responsibilities, and how we are prepared to pay for them.

Michael Keating, AC, is a former Secretary of the Departments of Employment and Industrial Relations, Finance, and Prime Minister and Cabinet.

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6 Responses to MICHAEL KEATING. Tax Reform and the Need to Raise More Revenue

  1. Peter Graves says:

    Many thanks to Dr Keating for this conclusion: “But what Australia needs most of all is a serious national conversation about the future role and responsibilities of government and the consequent revenue requirements consistent with those roles and responsibilities”.

    Unfortunately, economic advice in Australia prioritises balanced budgets and the acts of “government” have become a simple annual accounting exercise of ensuring that expenditure is less than revenue. As Dr Keating highlights, there is a dearth of innovative advice about finding new sources of revenue, after the negative outcomes of the “mining tax”.

    Let me raise therefore for further consideration, an innovative source of the revenue needed for good government – what is popularly called a Tobin Tax, in this case on foreign exchange transactions (FOREX).

    This alternative revenue source is a Tax of about 0.01% applied to high-frequency foreign exchange transactions. Several years ago, the Chairman of the Australian Securities and Investment Commission (ASIC) claimed that “Australia is being picked off by highly-leveraged, online foreign exchange brokers”. [http://www.smh.com.au/business/markets/currencies/asics-greg-medcraft-says-foreign-exchange-brokers-are-picking-off-australia-20150322-1m499a.html]

    As some background evidence on the volumes of these dealings, the Reserve Bank calculated FOREX trades in April 2013 averaged US$182 billion each day. By contrast, the Australian Department of Foreign Affairs and Trade reported Australia’s two-way trade in 2012 was $623.8 billion, or about 4 days FOREX trading.

    This suggests over 90 per cent of these trades are speculative. Taxing the speculators also means extra revenue for health care, aged care, education and our aid budget, for child immunisation, clean water and education overseas. These are some of the areas nominated by Dr Keating as not able to bear further reductions.

    In 2015, The Australia Institute estimated that a Tobin Tax (on a different source) could raise about A$1 billion each year: “While many designs are possible, tax of between 0.01 per cent to 0.4 per cent on all wholesale capital market secondary transactions would discourage excessive speculation and market manipulation without distorting the primary function of the market. The rate could depend on the instrument in question and would be adjusted every five years in response to changing market conditions. A well designed Tobin tax could significantly reduce costs for workers with superannuation accounts and retail investors, as well as improving the functioning of capital markets and raising significant government revenue”. http://www.tai.org.au/sites/defualt/files/P134%20Australia’s%20Tobin%20Tax%20arguments%20and%20evidence_0.pdf

    The very traditional argument against a Tobin Tax is that it would distort the free markets. I understand that the Henry Tax review found that a financial transactions tax would not increase financial market stability, and in fact could potentially reduce stability. However, this is not the objective, which is raising the revenue needed to sustain programs that help build this nation and support Australians.

    Alternative revenue sources have so easily disappeared into Panamanian companies and the banks are being held to account by ASIC for distorting the market in interest rates:“The Australian Securities and Investments Commission (ASIC) launched a Federal Court action against Westpac for unconscionable conduct in relation to the bank’s involvement in setting the bank bill swap reference rate (BBSW) over a two-year period between April 2010 and June 2012. The action followed similar charges bought by ASIC against the ANZ Bank last month”.http://www.abc.net.au/news/2016-04-06/asic-hauls-westpac-into-court-on-rate-rigging-regulations/7302340

    This is a tax on FOREX trading, including those movements off-shore and on-shore (for whatever reasons). Taxing unproductive financial speculation seems a good start ?

  2. David Morawetz says:

    Great idea, a Tobin Tax!

  3. michael lacey says:

    Beardsley Ruml Papers 1917-1960 at the University of Chicago Library
    Taxes for revenue are obsolete

    “But a national government is unique in a fiat currency monetary system. Ruml considers two developments to that point (in the last 25 years) had “substantially altered the position of the national state with respect to the financing of its current requirements”.

    Final freedom from the domestic money market exists for every sovereign national state where there exists an institution which functions in the manner of a modern central bank, and whose currency is not convertible into gold or into some other commodity.

    The United States is a national state which has a central banking system, the Federal Reserve System, and whose currency, for domestic purposes, is not convertible into any commodity. It follows that our Federal Government has final freedom from the money market in meeting its financial requirements. Accordingly, the inevitable social and economic consequences of any and all taxes have now become the prime consideration in the imposition of taxes. In general, it may be said that since all taxes have consequences of a social and economic character, the government should look to these consequences in formulating its tax policy. All federal taxes must meet the test of public policy and practical effect. The public purpose which is served should never be obscured in a tax program under the mask of raising revenue.

  4. Peter Lynch says:

    I can’t fault a word in Dr Keating’s excellent article. If makes great sense except that it stops before getting to the important part, namely, what sort of taxes he is thinking of and how much tax is reasonable. I guess these matters will be discussed in a future article. In anticipation of this, I offer some thoughts.

    Firstly, any theory of taxation should be built on a philosophical base. If we don’t have a clear concept of what fundamental rules should underpin our society, all discussion of taxes and transfers degenerate into random musings. I subscribe to the philosophy of John Rawls who makes a powerful argument based on the fundamental idea that, while humans have differing circumstances and abilities, justice and fairness demands that in a well ordered society all members should be considered as having equal intrinsic worth. As such all have a basic right to share in society’s “goods”. Flowing from this is the idea that, unless there are special reasons, all people should all be treated equally. On the grounds of justice, if there are special reasons for some people to receive better economic treatment than others, for example tax breaks to particular income groups but not to others, the unequal treatment should be arranged such that the greatest expected benefit goes to the least advantaged. This concept is in contrast to utilitarianism, under which theory anything which increases the overall benefit to society is good even if it treats some individuals unfairly. With regard to taxation, Rawls would say that principles of fairness and justice trump considerations of Pareto efficiency or ease of collection. This does not mean that a government can’t introduce a tax such as our GST which penalises the poor more than the rich but has the useful quality of spreading the tax base. It simple means that those who are unfairly penalised by the tax must be compensated for the penalty they have paid.

    Secondly, it makes no sense to talk about what percentage of person’s income it is reasonable for the government to take as tax. As Dr Keating points out, the government’s tax take should be based on a calculation of the funds needed to provide desirable public services and transfers. But I would go beyond this. For some individuals to have many times more wealth than they could reasonable need or spend, when others don’t have enough to meet their reasonable needs, is not compatible with a well ordered society. Even if a person’s wealth has been obtained purely by merit and even if their contribution to the overall welfare of society matches what they earn, there is no justification for them to be allowed to accumulate unlimited wealth. For example, it can be argued that the benefit the founders of Google have given the world is at least equal to the wealth they have gained. Despite this, their government could still reasonably take whatever percentage of that wealth is required to ensure that no other citizens are struggling. In short, the question is not what the government takes but how much you have left after tax. If you have greatly more than you need, you are being undertaxed.

    Thirdly, in assessing what a minimum income after transfers should be, it is necessary to make comparison’s between the circumstances of citizens living in the same society. It is not enough to ensure that a person should have enough to cover basic food, shelter, travel needs and some extra for entertainment – i.e. a safety net. By accepting the principle that all citizens, regardless of their skills and aptitudes, or even their contribution to society, have intrinsic worth as human beings, we must also accept that the gap between the richest and poorest should not be excessive. The poorest must have enough to maintain their self respect by comparison with their peers. Moreover, it doesn’t help to tell a poor people they are richer than Croesus because Croesus didn’t have a television set – the “you never had it so good” claim by politicians. What is more relevant is that the poorest shouldn’t know that they will never be able to afford nearly everything they see advertised on TV.

    Fourthly, there is a practical aspect to tax and transfer that does not get enough discussion. I believe it is unarguable that it is not in the interests of a democratic nation for any citizens to be allowed to accumulate so much wealth that they gain an inordinate power to influence government decisions. You can argue that some wealth is necessary to encourage entrepreneurship and to promote investment in new enterprises. But even if some multi-billionaires are philanthropic there is never a guarantee that they won’t use their wealth to subvert democratic processes or against the interests of the state.

    Fifthly, it is one thing for hard-working and talented people to be rewarded for their effort and accumulate reasonable wealth. It is another for them to pass their wealth on to their children when they die. Those children generally have the benefit of the best upbringing and the best education. They probably have an assisted pathway into good jobs. There is no reason why the community should facilitate their acquisition of wealth they have not earned on the death of their parents.

  5. Doesn’t good debt promote growth so why do we need a budget surplus?
    From what I’ve read budget surpluses just drains money out the economy.

    Would trickle down economics have worked if the trickle wasn’t diverted to the Caymans?

    Also it would be interesting to know of Dr Keating’s views on Modern Monetary Theory.

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