Michael Keating. An alternative budget strategy – part 3

Part 3. An Alternative Budget Strategy 

The previous comment in this series showed that there are alternatives to the Government’s particular strategy for restoring a Budget surplus over the next four years. In particular, it was shown that action to protect the revenue could raise around $42 billion in 2017-18. That is about 2¼ per cent of 2017-18 GDP and meets the Government’s Budget targets. Furthermore this objective is achieved without relying on bracket creep that would move a full-time male worker on average earnings into the 37 per cent tax bracket from 2015-16.

However, it was also recognised in the first part of this series, that Australia faces a continuing budget problem of matching expenditure and revenue over the longer term. On the basis of Treasury projections in its last Intergenerational Report (2010), it is estimated that resolution of this problem will require further budget tightening in some form or other roughly equivalent to another 2¼ per cent of GDP between 2017-18 and 2049-50. The aim of this third comment is therefore to briefly discuss some of the alternatives which might need to be considered in the future. It is further suggested that these alternatives will essentially involve improving expenditure program effectiveness so that more is achieved with less, or if then necessary, increasing existing taxes.

Improving expenditure effectiveness

The projected increase in public expenditure relative to GDP over the next 30 years or so mostly reflects increasing health expenditures, much of it associated with an aging population, and similarly increases in age related pensions and aged care. Indeed expenditures on these three areas were projected by Treasury to increase by 5 per cent of GDP between 2010 and 2050 if then present policies were continued, and so far that is pretty much the case.

The introduction of superannuation was intended to limit future demands for the age pension, and some further tightening up of superannuation to further limit dissipation of superannuation entitlements would help further reduce expenditure on age pensions. But the big demands for additional expenditure are concentrated in health, and that is where there are the greatest opportunities for future expenditure restraint by improving the cost effectiveness of care.  Already the introduction of activity based funding by the Rudd Government provides the opportunity to move to funding on the basis of cost effectiveness, noting that very substantial differences in costs have been sustained over long times for what are the same procedures. In addition, there are other ways of funding health care, particularly for those suffering chronic conditions, that would improve the incentives for cost effective care, compared to the incentives towards over-servicing with fee for service arrangements.

Schools represent another major area whose demands for funding might be reconsidered. Real public funding per student in primary government schools increased by 31 per cent between 1999 and 2011, while there was a 20 per cent increase for government high schools. There is no evidence that this increase in funding (and the further increase since 2011) has led to improved student results. Instead the key equity objectives of the Gonski reforms should be capable of being realised by redeployment of funding within the education system. In short, instead of promising that no school should ever lose through funding changes, we need to accept that genuine reform has to involve some of the funding to the schools that are most generously funded relative to need should be transferred to other more needy schools. Not to do so is the worst possible example of ‘middle-class welfare’.

The final major area of expenditure that stands out as a source of potential waste is the sacred cow of infrastructure. Australia has a history of over-investing in public infrastructure in the sense that proposals have been poorly evaluated, or not at all, and the returns (including the non-financial returns) have been totally inadequate relative to the costs. Indeed, as Bert Kelly, the former ‘modest member of Parliament’ remarked many years ago, he knew an election was coming on whenever he heard an announcement for a new dam.

In the last ten years expenditure on infrastructure by Australian governments has grown at twice the rate of GDP, and in the present Commonwealth Budget the Abbott Government’s extra spending on infrastructure reduced the total medium term expenditure savings achieved by about one third. Now this might be a good outcome if that additional infrastructure spending were warranted, but in fact a number of the infrastructure proposals that have been approved for funding in this Budget have not completed a proper cost-benefit evaluation.

Increasing taxes

The balance between expenditure restraint and increasing taxation is of course a matter of political values and an area for some discretion.  If in the event, a decision is reached that expenditure restraint should not be solely relied upon to achieve fiscal sustainability there are really only three substantial taxes capable of raising the amounts of additional funding that might then be needed in the longer term out to 2049-50:

  • GST
  • Company tax, and
  • Personal income tax

As has been widely remarked the Abbott Government’s Budget does seem to envisage allowing the States to demand an increase in the GST if they consider that they cannot restrain their health and education expenditures sufficiently. So an increase in GST revenue seems quite possible sometime in the future, either through base broadening to include at least food, or through an increase in the rate or both. That may represent a reasonable solution, although the way in which it is implemented might have been better if there were a proper conversation in COAG (and more widely) about how best to proceed and the possible alternatives.

The common view is that company tax should be reduced rather than increased. The argument relies heavily on the view that capital is highly mobile, and so competitively we need to match the company tax rates of other countries or we will lose investment. This view however deserves a little more scrutiny. First it takes no account of the fact that Australia is unique in allowing dividend imputation. That means that Australian investors have much less incentive to invest overseas than their equivalents in other countries. Second, it is arguable whether we need lower company tax rates to attract overseas investors. In most instances the rates of returns here are high enough after allowing for risk. Indeed right now the Reserve Bank is on record as considering the present exchange rate to be too high, and the most obvious reason is the attractiveness of Australia to foreign capital. So while an increase in company tax may not be likely, there is a good case, especially given the long term fiscal outlook, for resisting any decrease in company tax.

Finally, it may be that an increase in personal income tax will (eventually) be considered to be at least part of the optimal approach to sustaining a balanced Budget in the longer-run, if we want to maintain our traditional social values and the services that we expect from government. In that case it is suggested that an increase in income tax should be achieved by an increase in the tax rates, rather than by stealth through bracket creep leading to effectively lower tax thresholds.

There is nothing sacrosanct about the present income tax rates. First, the top rate has been as high as 60 per cent in the past, compared with a current 48.5 per cent rate[1], and no great change in any behaviour was observed when that 60 per cent was lowered. Second, other countries operate successfully with markedly higher personal tax rates than we have in Australia. Third, we are already raising income tax rates, but failing to recognise it, as the adjustments are described as temporary (the deficit levy) or hypothecated (the Medicare levy). Instead maybe we would be better off if our government(s) just came clean and acknowledged that we will not be able to pay for what we want in the way of future public services without a modest upward adjustment of the income tax rates.

Conclusion

Like most countries, Australia is facing a potential long-term structural problem with its public finances.  With the modest resources available to the author it is not possible, nor even desirable, to propose a complete and detailed solution. Rather the point of this series is to show that there are a range of plausible alternative strategies for achieving long-term fiscal sustainability.  The argument that the Government’s proposed Budget strategy is the only way forward is false.

Moreover as a nation we are unlikely to succeed in charting a viable way forward to fiscal sustainability until governments are prepared to subject their views to a proper conversation based on a clear appreciation of the pros and cons of the different alternatives.  Only in that way can the public support be built that is required to achieve future fiscal sustainability.  In present circumstances it is hardly surprising that this necessary support is not forthcoming, when less than twelve months ago the government promised in the election to both spend more and tax less and now seeks to impose a most unfair Budget on the community with no prior warning nor any such mandate.

If, instead, we are to chart a way forward and establish the necessary public understanding and consensus, we particularly need to drop the ideology surrounding the merits of taxation versus expenditure and consider the claims of each tax and expenditure proposal on their merits. Unfortunately for the moment at least the Government, egged on by its cheer squad, seem determined to prevent any further discussion of other alternative fiscal options and strategies on the basis that only the present government can be trusted to fix a mess that they themselves have helped create.


[1] This rate of 48.5% includes the 1.5% Medicare levy and the Government’s proposed 2 per cent ‘temporary budget repair levy’.

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One Response to Michael Keating. An alternative budget strategy – part 3

  1. John Thompson says:

    Michael Keating’s three part presentation is a very good contribution to the debate on where we as a nation should be heading. It would be good to see his package of recommendations more widely and publicly debated so that our political parties are required to explain more widely their reluctance to act in some of these areas of obvious and long-standing concern.

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