The Grattan Institute’s proposed policy priorities deserve wide support. However, how to pay for them is not adequately addressed, and their implementation would require the incoming government to raise additional revenue.
In a recent article in Pearls and Irritations (2 March) Danielle Wood and Stephen Duckett from the Grattan Institute summarised the Institute’s recently released Orange Book which presents an ambitious and comprehensive reform agenda. Going into an election which seems likely to be almost policy-free, this reform agenda is to be especially welcomed.
There is, however, an important omission from the Orange Book’s presentation. There is no discussion of the total cost of the proposals and how that total sum will be financed.
This is surprising, given that the model for Grattan’s Orange Book is the briefing prepared by the public service for the incoming government, which would always address the costs of the proposals. Furthermore, the political parties themselves are obliged to provide comprehensive information on the budgetary impact of their election platform before the election.
So is the net cost of Grattan’s reform agenda significant?
Perhaps the Grattan Institute felt it could ignore the costs of its agenda because they would net out to an insignificant sum. However, as will be argued below, that seems unlikely.
The Orange Book proposes significant improvements in health services, school education, and aged care, which as is acknowledged will cost significant amounts. The access and take up of childcare are to be improved by substantially easing the means tests for assistance, and that too comes at a cost. And increased budget costs will result from the proposals for extra assistance to the most-needy people on welfare, those who are renting or are unemployed.
Many of the other reforms proposed mainly involve changes to regulation and their budget costs would not be significant. While potentially budget savings might result from the proposal to stop spending on infrastructure projects that do not represent value for money, but it might just result in a better selection of projects.
Most importantly, while the Orange Book does not provide costings for its taxation proposals, there is a high risk of a substantial loss of revenue.
The most significant tax recommendation is to increase and/or broaden the GST to fund lower income taxes and support state government reforms, such as swapping stamp duties for land taxes. The Orange Book implies that this reform would leave money to help finance some of the other spending proposals, but this must be doubtful.
At present there is a legislated requirement that all the revenue from the GST goes to the states. In that case there would be a substantial net loss of revenue from this proposal.
Of course, that requirement could be changed, but it would not be easy. Even if the states could be persuaded to forego gaining 100 per cent of the extra GST revenue, they would still insist on getting more than now. In addition, past experience suggests that providing adequate compensation to households for the increase in prices from this enhanced GST would use up all the remaining revenue or more after funding the proposed income tax cuts.
Grattan’s other major tax recommendation is to take the opportunity to combine the legislated Stage 3 tax cuts due to take effect in 2024-25 with a redesign of the tax concessions that are not meeting their economic aims – the capital gains tax discount, negative gearing, and superannuation tax concessions. That would gain additional revenue, but probably not enough to cover the costs of the rest of the reform package, and as the last election showed, removing these tax concessions is politically very difficult.
In sum, the conclusion is that there would be a significant net budgetary cost from the Grattan reform package as proposed in the Orange Book.
How will this cost be financed, and does it matter?
The Orange Book rightly argues that some of the recommendations will increase workforce participation or productivity, and that will enhance economic growth.
There is no modelling, however, of how much more economic growth could be expected to rise, but it is doubtful that any increase in growth would be sufficient to make the total cost of these proposals self-financing. Indeed, as the Orange Book acknowledges, the Government’s growth projections are optimistic as they ignore the marked slowdown in productivity performance in recent years.
Thus, the starting point for what governments can afford is that the official projections are for quite large budget deficits in the next few years and for continuing deficits for the next forty years. Furthermore, these deficits are probably under-estimated as economic growth is likely to be lower.
The Orange Book (correctly) argues that “The Government should maintain its current fiscal strategy until we see healthy wages growth”. But as is then acknowledged, “The more challenging question is the right way to manage fiscal policy after the recovery has been secured”.
The Orange Book’s conclusion is that “the Government is right to abandon its budget surplus objective”. Instead, the Orange Book argues that Australia should “reduce the focus on balancing the budget and target debt sustainability”.
As the Orange Book correctly observes, Australia has low debt by international standards, and the Orange Book then concludes that with low interest rates Australia’s debt is quite sustainable.
Thus, the Orange Book seems to be implying that its package of proposals can be financed without raising increasing taxes, but to the extent necessary by more debt finance. But that conclusion begs the question of how low interest rates will stay after the economy is fully recovered. The risk is that with continuing substantial budget deficits after full economic recovery, inflation and interest rates would be so high that the debt would not be falling relative to GDP.
Furthermore, the official forecasts show a return to full employment in the next twelve months, which means that the recovery is most likely to have been secured around the end of the next financial year (2022-23). After that the government will no longer need to be supporting demand.
Instead, all past experience is that following a sustained return to full employment, private demand should match the capacity of the Australian economy. In that case, governments should not be contributing a net addition to total demand and therefore be balancing their budget.
In other words, governments need to manage demand and cannot afford to ignore the budget balance and just focus on their debt. Indeed, that is the reason why, as laid out in John Howard’s Charter of Budget Honesty, governments are expected to pursue balanced or surplus budgets when the economy is operating at full capacity.
However, Australia is looking at a very substantial budget deficit, equivalent to as much as 4.4 per cent of GDP in 2022-23 and 3.6 per cent in 2023-24. By then the economic recovery should be well and truly complete, and yet these budget deficits are projected to continue. Consequently, without fiscal tightening the government’s present policies present a high risk of excessive future inflation, and these risks will be increased if the Orange Book’s package of proposals is accepted without addressing how to pay for them.
Conclusion
It would be nice to think that the reform package proposed by the Grattan Institute in its Orange Book will be largely supported by the incoming government.
This package does involve a major improvement in services, and improvements in workforce participation and productivity. But realistically these changes will require an increase in revenue to finance those improvements. That should not surprise anyone when we consider how low taxes in Australia are compared to other developed economies and similar societies.
Consequently, tax reform needs to be much more ambitious than as proposed in the Orange Book.
As the Orange Book, itself, recognises the proposed Stage 3 tax cuts will result in a flatter but less progressive set of tax scales, which substantially favour the rich. The Orange Book proposes to trade this change off against removal of distorting tax concessions that also mainly favour high incomes. However, it is instead suggested that there needs to be a complete review of the tax system with the objective of both raising more revenue and ensuring that the amount each taxpayer pays better reflects their taxable capacity.
Michael Keating is a former Secretary of the Departments of Prime Minister and Cabinet, Finance and Employment, and Industrial Relations. He is presently a visiting fellow at the Australian National University.
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