MICHAEL KEATING. This election offers a very real choice. Part I

The two major issues in this election are climate change and the economy and cost of living pressures. In both cases the two major parties are offering very different strategies.

In these two articles I will focus on the economic choice being offered to voters. In this article, I will compare the two Parties’ fiscal plans, and in a second part to be posted tomorrow I will comment on the likely economic impacts of these respective plans.  

The economic challenge

The economy has not been performing well. Indeed, Shadow Finance Minister, Jim Chalmers, understandably contends that the greatest lie in this campaign is that the Coalition are good economic managers. In the last two quarters for which we have data, per capita GDP actually fell and productivity growth has been stagnant for some years now. The key reason has been the slow rate of wage increase and the rise in inequality.

In response, Labor has proposed the most and comprehensive and coherent set of policies ever offered by an Opposition, other than John Hewson for the Liberal Party back in 1993. The thrust of Labor’s policy package is to restore and improve government services and improve the living standards of low and middle-income earners, financed by increasing taxation paid by the top 10 per cent of taxpayers. Labor’s policies do involve redistribution, but this is inevitable if we are to squarely address the problem of low wages and inequality, and thus improve the rate of economic growth.

By contrast, the Coalition is running on its record, and essentially offering more of the same. The only significant policy initiative put forward by the Coalition in this election is its proposal to simplify the income tax structure and reduce the top marginal rates. But these tax changes do not take effect until after two elections, by which time economic circumstances will very likely have changed.

Comparing the Fiscal Plans

Taxation

Central to Scott Morrison’s pitch is the assertion that Labor is addicted to higher taxes, and that taxation will always be lower under the Coalition. But in fact, for the next three years at least, that is not true for the vast majority of taxpayers. As the table below shows, for the next three years all taxpayers with an income up to $120,000 per annum would pay the same or less income tax under a Labor Government. In the next three years, it is only taxpayers in the top 3 per cent whose tax rates would be higher under Labor because Labor will retain the deficit levy paid by high income earners with incomes above $180,000 until the Budget returns to a surplus equivalent to 1 per cent of GDP, which under Labor is predicted to be by 2022-23.

Size of tax cut for individuals 

Taxable Income Liberals’ Plan Labor’s Plan
25,000 255 350
30,000 255 350
35,000 255 350
40,000 480 549
45,000 855 881
48,000 1,080 1,080
80,000 1,080 1,080
100,000 915 915
120,000 315 315

From 1 July 2022 – after two elections – and again from 1 July 2024, the Coalition is offering further tax cuts that will flatten and simplify the tax structure. Research by the Australia Institute shows, however, that more than half the benefit of these cuts will go to the top 20 per cent of taxpayers, and only 3 per cent to the bottom 20 per cent. Similarly, the Grattan Institute has shown that these changes will make the income tax system less progressive. Thus in 2029-30 middle income earners in the third to seventh deciles of the income distribution will pay more – 23 per cent of total taxation compared to 20 per cent today, while high income earners in the top fifth of the income distribution will pay 65 per cent compared to 68 per cent today.

A critical question is whether it will be possible to afford the above tax cuts which are estimated to cost the budget $230 billion over the seven-year period from 2022-23 to 2029-30. No-one can forecast the economy with much certainty that far ahead, and Labor has stated – properly in my view – that it will consider the scope for further tax cuts that it might make in the medium term much closer to the event. A policy that until now had been followed by all previous governments, precisely because that is the only prudent course.

The other areas where the two Parties differ substantially on taxation is that Labor’s overall strategy is based on closing tax loopholes in order to pay for additional investment in human capital and to reduce the cost of living for the majority of households who are not in the top 20 per cent. The Government has sought to make a great deal of the impact of closing these loopholes on particular groups, but the ATO data underpinning the costings by the Parliamentary Budget Office (PBO) suggests that, with one exception, less than 5 per cent of taxpayers will be affected and almost all of the additional revenue will be raised from the top 5 per cent of the income distribution. (The exception is future investors in shares and property, but 90 per cent of taxpayers don’t negatively gear at all, while almost 70% of all capital gains go to the top 10% of income earners.)

Expenditures

Because of the additional revenue that Labor raises by closing tax loopholes it can afford substantial increases in expenditures, costing an extra $32 billion over the next four years. These spending initiatives are targeted at health, education – especially early childhood education – and other measures to reduce the cost of living pressures on low to middle income households.

It would be quite unfair, however, to characterise Labor as a big spending government. Under Labor, government payments would rise slightly faster than projected GDP over the next four years, from 24.9 per cent of GDP in 2018-19 to 25.1 per cent in 2022-23.

Much of Labor’s proposed expenditure will help restore expenditure in areas, such as health and education, where the Coalition Government has made cuts in the last six budgets. Thus, under the Coalition government, real government payments have increased at an average annual rate of only 1.8 per cent. None of this tightening has been achieved by genuine reform of government programs to improve their effectiveness and efficiency: instead the expenditure restraint is mainly achieved by requiring clients to pay more and/or experience a decline in the quality of service. By comparison, in its 2015 Intergenerational Report, which was produced after its disastrous 2014 Budget, the Coalition Government pledged that on its “proposed policy” scenario real spending would grow at an average of 2.7 per cent per annum. In other words, that was the rate of spending growth that the Government considered was necessary to provide decent services then – a rate of spending growth which was half as much again as they have actually spent.

Nevertheless, although the last six years have seen a deterioration in government services, even more tightening is to come. Over the next four years the Pre-election Economic and Fiscal Outlook (PEFO), released by the Treasury and Finance Departments, shows that under the present government’s policies, real government payments will increase at an annual of only 1.3 per cent, half a percentage point lower each year than the fiscal restraint that has already led to service deterioration and increasing numbers of poor people missing out because they cannot afford the higher co-payments now demanded.

Furthermore, while data on the exact expenditures by the Coalition are not available in the PEFO beyond 2022-23, a chart shows that the rate of restraint increases further, with government payments increasing even more slowly after 2022-23. According to analysis by the Grattan Institute limiting spending to this extent will require spending cuts increasing to about $40 billion by the final year – something that is quite incredible, especially when it is considered that the Parliamentary Budget Office estimates that by 2028-29, ageing could add as much as $36 billion to total government spending.

Returning to Labor’s spending policies, while the increase in spending on health and education is welcome, there remains a question over how well the extra money will be spent. Labor has focussed on various specific targets for its additional spending that may well be politically attractive, but what is really needed is a reform strategy in health, education and infrastructure to ensure that the money is well spent. So the immediate task for a new Labor Government should be to develop a comprehensive reform strategy for each of these functions, and this additional money should then be made contingent on the various States and interest groups involved agreeing to implement that reform strategy.

The Budget Balance

The extra revenue resulting from Labor’s tax policies is more than sufficient to cover its additional spending: it also results in bigger budget surpluses than projected for the Coalition. Thus over the four years of the forward estimates to 2022-23, Labor’s surpluses add to $57.9 billion, which can be used to pay down debt and reduce the interest bill.

By comparison, the Coalition’s polices are projected to only generate surpluses that sum to $40.8 billion over the same four-year period. Furthermore, the Coalition’s projected budget surplus relies on expenditure restraint that is both unbelievable and undesirable. Thus further underlining why the second and third stages of the Coalition’s planned tax cuts are irresponsible.

Can we believe Labor’s numbers?

Immediately after Labor released its fiscal plan detailing the cost of all its policies and the revenue to pay for them, the Coalition alleged that Labor’s numbers were not to be trusted. The truth, however, is that Labor’s policies were costed by the Parliamentary Budget Office, using the same sources and modelling that the Treasury and Finance Departments used in costing the Government’s policies. Furthermore, the costing of Labor’s policies was audited by an independent expert panel (which included myself), and the inevitable assumptions underpinning those costings were closely scrutinised and debated when necessary. As a result, this panel concluded that:

All of the costings in Labor’s Budget Plan are of a similar quality as Budget estimates generally, and therefore represent a reasonable basis for assessing the net financial impact on the Commonwealth Budget.

In fact, the critical issue in considering the affordability of the policies of both the major political parties in this election is the future outlook for the economy, and how their policies will impact on that economic outlook. These issues will therefore be discussed in tomorrow’s post.

Michael Keating is a former Head of the Departments of Prime Minister & Cabinet, Finance, and Employment & Industrial Relations. He is presently a Visiting Fellow at the Australian National University.

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