MICHAEL KEATING. Why Australia Needs A Stronger Revenue Base

Apr 19, 2018

Earlier this week the Australia Institute released an open letter signed by 48 eminent Australians calling for an increase in taxation. As we might have expected, the Treasurer, Scott Morrison, without any reflection, dismissed this call for higher taxes as “a numpty of an idea”, adding that “The idea that you increase taxes to grow the economy is stupid”. This article argues that instead it is the Treasurer who is wrong, and that full budget repair will not be possible over the medium term unless deliberate action is taken to increase government revenue.  

On Tuesday of this week, the Australia Institute released an open letter signed by 48 eminent Australians which stated that “Australia needs a stronger revenue base”. The letter was accompanied by research that showed that “Australia is a low taxing country”, and it called “upon all political leaders to reject a tax cuts race to the bottom”.

I was a participant in this initiative by the Australia Institute, and in this article I would like to say why I support the Institute’s conclusion that we need more taxation revenue, not less.

Fundamentally the reason for taxation is to pay for the services that we all want and to support the type of socially inclusive society, with reasonable equality of opportunity, that we also want. As the great American jurist, Oliver Wendell Holmes put it, “I like to pay taxes. In this way I buy civilisation”.

A standard defence, however, by those who support tax cuts, is that this will incentivise people and businesses, and in that way increase our economic growth, and thus our capacity to pay for the services that we demand. Of course, we can all think of specific taxes, that if they are levied at a high rate, will change behaviour; indeed, that is the intention of taxes on cigarettes and carbon, and charges on congestion. But experience shows that there is no correlation between present overall levels of taxation and any country’s economic growth rate: many high taxing countries in northern Europe for example, have a higher growth rate in their per capita GDP than low taxing countries such as America. Furthermore, as the research recently released by the Australia Institute shows, Australia is one of the lowest taxing countries among the developed nations of the OECD.

Instead, what really matters is what a country does with its taxation revenue, and if it is spent wisely on functions, such as research and development, education and training, and infrastructure, then this taxation can actually increase the nation’s economic capacity. Furthermore, recent experience has demonstrated how increasing inequality can damage economic growth[i], and reducing that inequality may well require some increase in government expenditure.

Accordingly, before we consider the scope for tax cuts we need to consider what are the expenditure needs of the country. Of course, opinions differ about the relative priorities of different government expenditures and also about how much in total should be spent. However, public opinion surveys typically find that a substantial majority of Australians would prefer to pay higher taxes than have public expenditures cut.

Furthermore, the government’s own spending plans over the long-term, as published in its 2015 Intergenerational Report, show total government payments increasing faster than GDP. Consequently, this means that if the Government’s current programs were continued in line with then legislation (and nothing material has changed since that Report was released in 2015), then we are headed for a Budget deficit equivalent to 6 per cent of GDP by 2055. Thus, while the Government would have us believe that the Budget will return to surplus in the next few years (the latest forecast is 2021), in the longer term, according to the Government itself, its present policies will result in the Budget returning to deficit a few years later and that deficit will continue to increase over time.

The only way out of this deficit trap would be to cut expenditures by around 3 percentage points of GDP, or to increase revenues by the same amount[ii]. However, the reality is that no-one has ever come forward with a package of expenditure savings that would achieve that savings target of 3 per cent of GDP. The Abbott Government tried in its first 2014 Budget but failed, and following the universal rejection of those expenditure cuts, the Coalition Government has not returned with any fiscal package that would be sustainable over the longer term.

Instead, independent experts such as the Grattan Institute, and a committee of experts assembled by the Committee for the Economic Development of Australia, have both concluded that Budget repair will require action to be taken on both the revenue and payments side of the Budget, and that most of the proposed fiscal adjustment will have to come from increased revenue. Indeed, the Grattan Institute is quite adamant that “governments will not be able to restore budgets without also boosting revenues”[iii].

The reality is that the demand for public services is growing strongly. In particular, the demand for services such as education and health tend to rise more than proportionately as incomes rise over time. In addition, technological change has driven much of the increasing demand for health services, but unlike technological change for goods, this hasn’t resulted in an improvement in efficiency and a reduction in costs – rather the new health technologies are more expensive, but it is difficult for governments to deny them to people who are otherwise suffering or even dying. Fundamentally we need to accept that as our incomes increase over time, it is quite natural to want to spend more on services that governments provide, and equally that will require governments to raise more revenue over time.

Accordingly, my conclusion is that it is quite irresponsible for the Government to be talking about possible tax cuts and trying to legislate for company tax cuts when they have no plan for paying for them, other than going deeper into debt. Indeed, nothing could be more indicative of a failure of leadership than handing out tax cuts that can’t be afforded.

[i] See Stephen Bell & Michael Keating, 2018, Fair Share: Competing Claims and Australia’s Economic Future, Melbourne University Press, Melbourne.

[ii] The reason why a correction equivalent to only 3 per cent of GDP and not as much as 6 per cent of GDP is required, is because if action is taken early enough and progressively over time there would be major savings in interest payments as debt would rise more slowly.

[iii] Grattan Institute, 2015, Fiscal Challenges for Australia 

Michael Keating is a former Secretary of the Departments of Prime Minister and Cabinet and Finance. In this capacity he was closely involved in the preparation of many Budgets in the past.

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