Last week the independent Parliamentary Budget Office (PBO) released a new report on Trends affecting the sustainability of Commonwealth taxes. The key conclusion is that taxation receipts are likely to trend down in future relative to GDP, ‘given current policy settings and recent consumption and structural trends’. On the basis of its detailed analysis of past revenue trends, the PBO finds that ‘there is a likelihood that taxes on consumption will continue to trend downwards, taxes on capital will be flat or trend downwards and an increasing proportion of labour income will be taxed concessionally through the superannuation system’. The PBO then concludes that ‘If these risks to tax receipts eventuate, and in the absence of other taxation reforms, maintaining Commonwealth Government revenue at recent levels as a share of GDP will lead to an increasing reliance on taxes on labour income through the personal income tax system’.
This latest PBO Report provides much more authoritative support for the conclusion that I reached in my first post-budget comment, The Economic Impact of the Tax Cuts and their Sustainability, posted on Pearls & Irritations on 11 May. In my comment I too questioned the latest Budget’s revenue projections. Specifically, I queried the Budget assumptions for wage and productivity growth and argued that a lower rate of growth for each would impact on the revenue from both consumption and income taxes. I also questioned whether the surge in revenue experienced in the last two years would be sustained. Instead, I suggested that this surge may reflect a one-off increase in mining taxation as the deductions by miners for previous losses have now been used up. By contrast, the Budget projections for revenue assume that this increased rate of growth in revenue will be sustained and that revenue will continue to grow faster than GDP. Clearly the PBO is also not convinced.
Implications for the Government
Both the Government and the Opposition have chosen to ignore this warning from the PBO about the outlook for future budgets. Indeed, the Government has argued in support of its proposed tax cuts in the medium to longer term that they will be necessary to keep receipts below the Government’s self-imposed ceiling of 23.9 per cent of GDP, which the Budget papers project will be reached in 2021-22. However, what the PBO analysis has opened-up is the possibility that in the longer run the future rate of increase in tax revenue relative to an increase in incomes may well be less than proportionate. This analysis therefore raises fundamental questions about whether the Government’s proposed future tax cuts can be afforded.
What should be done
The PBO for understandable reasons does not canvass what should be done in the likely event that there is a shortfall in future revenue, although it does suggest that the budget will become more reliant on taxes on labour income – which really means on the personal income tax.
This does not, however, necessarily mean an increase in personal income tax rates. At least some of the increase could be achieved by reducing concessions, as the Labor Party has proposed. And most importantly, this is yet another reason for not proceeding to lower company taxes further, and for reducing the present opportunities for large companies to avoid paying their fair share of company tax. Equally, the nation cannot afford the Government’s proposed future revamping of the personal income tax scales in favour of high-income earners; a policy change that is not only unfair but is equally unlikely to add to economic growth which is principally being constrained by a lack of demand caused by low wage increases.
The outlook for expenditure
The discussion in the PBO report and here has so far been limited to the revenue side of the budget, but really revenue is only raised to pay for the desired expenditure, and the two sides of the budget should be considered together.
While this PBO Report does not consider the outlook for Commonwealth expenditures, in an earlier report released at the end of last year, the PBO did release forward projections of future expenditure. I used these projections in my article, How Useful and Reliable are the Budget Projections, posted on this blog on 29 May, to arrive at my conclusion that over the medium term, present policies are likely to result in government expenditures increasing by half to one percentage point faster than GDP. That of course means that unless policies are changed so that revenue increases faster than presently projected we are likely to face increasing budget deficits and consequent instability. Alternatively, major policy changes could be introduced to reduce spending in the big areas of health, education, welfare and infrastructure. However, on its track record, it seems more likely that the government will not want to take measures to increase revenue, nor radically change expenditure policies. Instead, this Government will do nothing and allow the budget deficit to drift out further. In other words, this Government will once again place its faith in a discredited ideology linking tax cuts and growth ahead of its responsibility to ensure that the budget does return to surplus.
The PBO has performed an important service in its assessment of the evidence showing that on present policies, tax receipts are unlikely to rise sufficiently to achieve that necessary budget repair.
Michael Keating is a former Head of the Department of Prime Minister and Cabinet.