Getting to the root of the 'tax crisis'

Talk of a government revenue crisis has focused on the need for higher taxes, but the real issue is that politicians are making promises that just can’t be honoured from the existing tax base.

The national conversation we had to have about the size of government and the appropriate level of taxation has started -- but from the false premise that there is a shortage of government revenue and therefore a need for higher taxation.

Inevitably, much of the commentary is coloured by ideology and value judgments about the appropriate role and scope of the state. Those who like bigger government see chronic deficits as a problem of too little taxation, while those (such as this commentator) favouring smaller government see too much spending. Ideas are important to the debate, but so are facts -- and the facts do not point to a shortage of revenue.

The evolving narrative maintains that the revenue base has been hollowed out by past tax cuts and concessions -- and that governments are facing, if not already experiencing, a revenue crisis.

Tax revenue is a smaller percentage of GDP now than when the current tax system was established in 2000-01; therefore, the deficit is a revenue problem and one that is only going to get worse. Proponents of this view blame the income tax cuts and superannuation concessions of the Howard-Costello era, the freezing of petrol excise in 2001, and the impotence of the mining tax. Constituencies in favour of more social spending, or protecting existing spending, are only too eager to embrace this narrative.

But the facts show that the base period used in such comparisons was one of unusually-high tax revenue, boosted by the froth and bubble that developed in the lead-up to the global financial crisis. Moreover, the current shortfall relative to that base period does not account fully for the deficit. Shortfall or no shortfall, Commonwealth tax revenue in nominal dollar terms has in fact doubled since 2000–01, representing a compound annual growth rate of 3 per cent in real terms for 13 years. That has happened notwithstanding the abovementioned tax reductions and the impact of the global financial crisis, which produced a two-year revenue drought. Tax revenue has recovered quite strongly since that drought and it will recover further as the lingering effects of the financial crisis pass.

Over the same 13 years, Commonwealth spending has grown faster than revenue and faster than the economy. No doubt there are those who think that is entirely appropriate and that tax revenue should now be increased to close the deficit, but to the rest of us, the facts speak to excess spending being at least part of the problem.

The underlying problem is that politicians have made promises that cannot be honoured from the existing tax base. Call that a revenue problem if you like, but it is actually a spending problem. The full impact of those promises will be felt in a few years’ time.

If nothing is done to bring down the projected growth path of government spending, before the end of this decade the tax burden will need to be substantially higher (through income tax bracket creep and discretionary tax increases) to satisfy the public sector’s appetite and balance budgets. If that is to be avoided, we need specific measures to carve about 2 per cent of GDP out of projected baseline Commonwealth spending over the next few years. Even then, the level of government spending would be merely restored to the average in the five years before the financial crisis. There is a good case for lowering it further in the longer term.

None of this is to deny that the tax system needs reform to make it more supportive of productivity growth and revenue more resilient against future corrosive forces such as population ageing. However, there is no case for reform to increase the tax burden beyond its current size.

Robert Carling is a senior fellow at The Centre for Independent Studies.

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