“We have never been in a situation like this before. It is quite possible that we will not find our way through without serious social breakdown and/or mass emigration of the most mobile and productive people.”
That scary quote is a frank assessment of the UK’s fiscal position, by Philip Booth, director of the Institute of Economic Affairs. His free-market think-tank, set up in 1955 to promote the ideas of economist Friedrich Hayek, has just released a report describing the ghastly future Britain faces if it does not get its fiscal house in order.
And although Australian government debt is much lower than Britain’s, there is also a yawning chasm here between the structure of our taxation system and the future liabilities it has to fund -- remembering that at present less than 50 per cent of retirees are fully funded by their superannuation nest eggs.
The IEA report, ‘The government debt iceberg’, is a lucid description of the dilemma facing much of the developed world.
As our post industrial societies age, a top-heavy demographic profile will see the young work harder and harder (and consumer relatively less) in order to service the pension and healthcare requirements of the old. Booth writes: “In modern democracies people of voting age have voted themselves benefits to be paid for, not by sacrifices that they make through funded provision, but by sacrifices that will be made by the next generation of taxpayers, who may not have even been born when the benefits were promised.”
This is easy to do, as successive federal budgets do not take account of the ballooning costs of pensions and healthcare for oldies living decades longer than they did half a century ago.
The budget is a snapshot of fiscal flows, whereas assets such as the Future Fund (which funds only public servant pensions) and superannuation balances are the stocks that will pay for our retirements -- or not.
The report’s lead author, Jagadeesh Gokhale, sees this as first an accounting problem. He writes: “If a private insurance company promised to pay out £3 billion of annuities over the next 30 years and did not include them on its balance sheet, it would be closed down. Yet this is precisely how the government does its accounting.”
And so Gokhale has applied normal private-sector actuarial and accounting standard’s to Britain’s retiring generations and come up with some startling figures on how current budgets should be run. Her Majesty’s government, he says, would have to cut one-quarter of total spending to bring projected revenues into line with projected spending. That would be equal to over half the UK’s present health and welfare spending. Ouch.
This problem is a ticking time-bomb in two ways. Firstly, demographic principles ensure that the bomb will go off. Secondly, the time available to fix this fiscal nightmare, and the social chaos it would cause, is short. That’s because bringing future liabilities and current tax revenues back into harmony must be done gradually – and so commenced very, very soon.
Waking up in 2025 and saying “okay, better hike taxes by 25 per cent!” just wouldn’t work. The economic damage inflicted by the tax hike would cause tax receipts to shrink, not grow. The fiscal trap faced by many developed nations would then be virtually inescapable.
Gokhale writes: “If countries do not address their fiscal imbalances now, the size of the necessary adjustment will increase over time, undermining investor confidence and generally worsening the conditions for maintaining economic growth. Instead, appropriate and timely structural changes to bring the finances of public programmes into balance would be likely to spur economic growth.”
Bringing this back to Australia, the first thing to note is that the small federal gross debt – $308bn, or approximately 21 per cent of GDP – can be deceptive, as state government debts add substantially to the fiscal burden we hand on to future generations. Queensland, for instance, owes $80bn, and WA owes about $20bn.
Secondly, although at a federal level the Abbott government has promised to address growing structural deficits through cutting expenditure, the problem cannot be fixed only on that side of the budget – broadening the tax base is unavoidable.
Former Treasury secretary Ken Henry, author of the Rudd government’s tax review, said this week that GST -- a highly efficient tax in so far as it does least to distort markets and therefore the flow of capital, goods and services – will inevitably rise to cover structural deficits in future. If that is not done, he argued, Australians can forget about paying for the NDIS, greater levels of funding for public education and the generous paid parental leave scheme that is Abbott’s signature policy.
Both Labor and the Coalition have baulked at promoting the GST as the revenue-side solution for budget deficits into the future. In response to Henry’s comments this week, the Coalition responded that it’s a “state tax” and called on the states to start agitating for a broadening and increase in the rate of the GST.
Fat chance. Somebody at a federal level is going to have to show the leadership that scared premiers fail to exhibit. John Howard did this, winning a mandate for the tax at the 1998 election, and then getting at least a compromised version of it through parliament with the help of the Australian Democrats.
But GST is not the only place to bolster revenues. The NDIS, pension increases and general health spending will disproportionately benefit retirees – when you get older, sickness and disability increase. The paradox is that there are major holes in the current tax base that older Australians enjoy.
The main one is the tax concession older Australians make the most use of close to retirement - so called ‘super tax concessions’. At the highest earning point of their careers, taxpayers salt away thousands in private super at a rate of 15 per cent tax, knowing full well they will take a lump sum to spend on a range of things after retirement – renovations, a boat, camper van and so on.
This is where moral arguments get confusing. The line of ‘it’s my money, so hands off’ fails to take account of a couple of points.
Those that spend similar thousands before retirement – on, say, renovations, a boat, camper van – were taxed at their highest marginal rate. Those that put it away for a couple of years in super, don’t. Both groups, on average, will be roughly the same burden on public health resources and – human nature being what it is – those that have decent super nest eggs are adept at spending, gifting and hiding super money to get as much pension as possible in future years.
For instance, one former RBA official estimated in 2012 that on average, retired couples have $50,000 literally hidden in cash (Time to shut down our greatest tax rort, September 2012 ). While some $10,000 of cash can be gifted to children per year without harming a retiree’s pension prospects (larger gifts do), there are far larger transfers of wealth going on in cash, or undeclared bank transfers, which increase the pension payments to retirees who have small income streams.
And on top of all that, the tax concessions enjoyed by those wealthy enough to stash away money in their last few years of work can be passed tax free to their offspring when they die through the family home -- renovations that increase the value of the family home are a good way of squirreling away super tax concessions to pass onto one’s offspring.
Such spending also decreases the income stream available from a retiree’s superannuation, meaning that in many cases they will get larger amounts of pension, sooner.
Excluding the very wealthiest retirees, most older Australians enjoy their pension entitlements, health care subsidies and -- one day -- will enjoy benefits from the NDIS. And retirees’ life expectancy continues to increase.
On the other side of the coin, the same retirees love the super tax concessions they got in their last few years of work. They love that their primary residence (the house they’ll leave to the kids) is not part of the pension asset test, and that by spending superannuation dollars on it they’re channeling low-tax dollars to their children’s inheritance and hastening the day they’ll get a chunk of pension income.
That impossible tension cannot last – voters loving both their tax concessions and the benefits the missing tax dollars would have helped pay for.
That is why tax reform is inevitable. The most likely starting point is for one or other side find the guts to say that the GST has to rise. I suspect strongly that by the 2016 election, the Coalition will have found a way to convince voters they’ll be better off paying a higher rate of GST on a broader range of goods.
And if that doesn’t happen, older Australians will have to be convinced that the argument of “it’s my money, so hands off!” must be followed by the corollary “so please tax my children more!”