Michael Keating. Part 4. Long-term Fiscal and Social Sustainability and TaxationMay 22, 2014
Fundamentally there is a problem with the rhetoric from the government and its cohorts such as the Commission of Audit. They insist on describing taxation as a ‘burden’ that should be lightened at every opportunity; thus implying that taxation is somehow illegitimate. On the contrary, however, taxation represents our mutual obligation to one another as citizens. Instead of being a ‘burden’, taxation is what we should pay to ensure the sort of society that we want.
It is only by changing the rhetoric and accepting the legitimacy of taxation that we can hope to match the community’s expectations for publicly funded services and assistance with our willingness to pay for them. This inconsistency between our expectations and willingness to pay is the fundamental budget problem that I highlighted in my initial comment. Furthermore, the longer we delay the worse that problem risks becoming because there are good reasons why the public’s expectations will rise further and even faster over the next decade or more.
Future Expectations for Expenditure
The Government itself often refers to the impact on demands for public expenditure as a result of the population ageing; indeed the Treasury has documented these demands in its Intergenerational Reports. But the evidence is that population ageing is relatively unimportant as a source of future expenditure growth.
More important factors influencing the demand for publicly funded services are
- rising living standards which tend to translate into a switch in consumer demand in favour of services such as education and health that are largely publicly funded, and
- technological change that has improved the quality of health care and to some extent education, but at increasing costs.
Beyond these factors, and more generally, Thomas Picketty has recently provided comprehensive evidence that over the last forty years the distribution of private incomes in capitalist economies, including Australia, has become increasingly unequal and that there are good theoretical reasons to expect that this trend towards greater inequality will continue. On the other hand, the evidence also shows that governments can intervene to maintain equality if they are willing to use the tax-transfer system pro-actively.
In addition, in Australia’s case over the last three decades we have significantly de-regulated the economy, and while the additional competition did increase productivity and living standards of the “winners’, the quid pro quo should have been a willingness to assist the “losers” to adapt. So those “parrots” calling for more economic reform need to also accept that not everyone will benefit and successful reform may well depend upon a willingness to support and assist those who are disadvantaged to adapt to the changes being imposed upon them.
Taxation and the risks to economic growth
Of course, those who are calling for lower taxes always claim that it will be in the public interest because it will lead to higher economic growth. But frankly where is the evidence?
Internationally the advanced OECD countries with the fastest rate of growth in per capita GDP, like the Scandinavian countries and Germany and the Netherlands, are not the countries with low rates of taxation revenue relative to GDP, while the US with a low ratio of taxation has had very low growth in productivity and participation over the last thirty years. In addition, the econometric evidence regarding individual behaviour does not support much impact from lower taxation on work or saving effort. Indeed some of us can remember when the top marginal rate of income tax in Australia was 60 per cent compared to 46.5 per cent now, but nothing much has changed in the savings or work patterns of the people concerned. In short any objective analysis shows that there is plenty of scope to increase taxation without damaging economic growth.
So how should taxation be increased over time to achieve a sustainable budget? Fundamentally there is a choice between:
- Introducing more effective anti-avoidance measures,
- broadening a tax base, by removing a variety of concessions, or
- increasing tax rates.
It is to the discredit of the Coalition Government that they immediately scrapped the legislation introduced by the previous Labor Government to tighten up on avoidance where in particular many major foreign owned companies pay a ridiculously small amount of tax in Australia. But even strict anti-avoidance measures are unlikely to be sufficient, and more substantial action will be needed over time. In that case, many of the present income tax concessions operate like subsidies on the expenditure side of the budget, but they are subject to far less scrutiny, should be reviewed. So in the same way as expenditure should be closely examined for its effectiveness before resorting to increased taxes, the same is true of taxation concessions. Nevertheless, in the end some increase in tax rates may also be necessary.
Second, the two biggest sources of revenue are the taxation of incomes (company and personal income taxes) and expenditure (GST). Given that all the GST revenue goes to the states, the balance between increasing the two may partly depend upon which level of government most needs assistance. But looking ahead both taxes will need to be increased over time.
This Budget and future revenue needs
This Budget projects a return to a budget balance in 2018-19, building to a surplus equivalent to at least 1 per cent of GDP by 2023-24, assuming that taxation revenue is capped at an average of 23.9 per cent of GDP. In other words the Government’s future fiscal strategy does not allow for any increase in revenue relative to GDP and expenditure will need to be further reduced relative to GDP despite the future demands identified above. Equally it also means that, like all previous governments, this government envisages that ‘tax reform’ will be revenue neutral, and will instead be limited to changing the tax mix.
Furthermore, considering what we know so far, this future change in the tax mix is likely to further re-enforce the trend to greater inequality. Already the Government’s first priority has been to cut the rate of company tax which principally favours the rich. The alleged justification is that we have to remain competitive with the rates of company tax in other countries, but this sort of simplistic comparison is not really justified. It takes no account of the fact that Australia is the only country that offers dividend imputation, so that effectively Australian residents pay no company tax on the majority of corporate profits because more than half are typically distributed as dividends. Quite frankly if the foreign shareholders are not benefiting from dividend imputation does that really matter, especially if as I have argued in a previous comment we should be saving more and relying less on foreign investment.
The two taxes that are actually increased in this Budget are
- the so-called “temporary Budget repair levy”, but this is temporary and thus provides no help in resolving our longer-term and more fundamental fiscal problems. And most importantly it is far too small an adjustment to income tax rates and consequently raises far too little extra revenue.
- a long over-due increase in petrol excise, which on scarcity and environmental grounds should never have been de-indexed in the first place. In addition, what revenue it does raise is to be hypothecated for investment in roads, much of which will not provide an economic rate of return, is therefore unproductive, and makes no contribution to ensuring fiscal sustainability.
Finally, the Government has given every indication in this Budget that it is contemplating increasing the revenue from the GST, but wants the States to wear the blame. Again, whatever, the merits of such an increase, and there are some, the fact is that it will further lead to a redistribution of spending power from the poor in favour of the rich.
In sum we do need tax reform, but any such reform should start from a consideration of the revenue needed to meet Australia’s long-term fiscal needs. At present we are trying to provide an adequate social safety net and a decent cohesive society with just about the lowest amount of taxation in the OECD – for example, according to the latest OECD statistics, in 2011 total tax revenue in Australia was 26.5 per cent of GDP, compared to an average of 34.1 per cent for the OECD as a whole, and 30.4 per cent in Canada, 31.5 per cent in New Zealand, 35.7 per cent in the UK; all countries with similar traditions to us and with whom we readily identify. And while this ratio of revenue to GDP was only 24.0 per cent in the US, if allowance is made for the much larger Budget deficits in the US, our taxation is effectively lower than there as well. So in effect, and unlike the US, we are trying to maintain a decent social safety net with extremely low levels of taxation. We have been getting away with this because, as I explained in my second comment on Tuesday, we have the most efficient income support system in the world. But there is little more that can be extracted by efficiency of the welfare system, and looking further ahead into the future, it seems pretty certain that unless we increase our revenue we risk finishing up with the sort of inequality and rundown in social infrastructure that is too often experienced in the US.
It is therefore a matter for considerable regret that this Budget gives us little hope that the Government understands the risks to society that it presents, and the associated doubts about whether this government is capable of delivering the tax reform that we actually need.