No crisis, but taxes still need to rise

The last thing the country needs is European-style fiscal austerity. Despite the deficit fearmongering, Hockey needs to prepare the public for a benign full year budget – one with fewer spending cuts and tax hikes than anticipated.

There’s a pretty funny joke in the detail of yesterday’s Mid-Year and Fiscal Economic Outlook: the repeal of the minerals resource rent tax produces a net GAIN to the budget over four years of $9.5 billion … and this was supposed to be a tax.

Abolishing the carbon tax, on the other hand, will cost real money – $13.7 billion over four years – because unlike the MRRT it would have actually worked. Then again, its repeal is being blocked in the Senate, so maybe that will end up being a saving too.

Anyway, jokes aside, it’s generally agreed that the MYEFO is the first of a two-part series, with the Federal Budget next May due to provide the answers to yesterday’s questions.

The main job of Treasurer Joe Hockey and the Prime Minister Tony Abbott is to prepare the public for what’s to come, but not in the way you think.

Having beaten up the ALP about what an emergency/crisis/disaster they have left, the most difficult part of the government’s fiscal challenge is not to prepare the nation for tax increases and spending cuts next year, but for the lack of them.

It is not a crisis, and the last thing the economy needs is rapid fiscal consolidation involving European-style austerity. The deficit is 3 per cent of GDP, declining to 1 per cent in three years, and debt will rise to 16 per cent of GDP, using a much more conservative approach to the projections than before. Most private forecasters reckon they will be too conservative.

Spain’s deficit is 7 per cent and debt is 100 per cent of GDP: now that is a fiscal problem, and Spain’s austerity is justified – up to a point.

So now that the point has been made about what fiscal mugs those opposite are, the Treasurer needs to tone down the rhetoric and prepare the nation for a relatively benign budget in May, so that he doesn’t look weak when he brings it down.

The budget needs to implement any waste removal ideas from the Commission of Audit and set out a long-term plan for a return to surplus, but a horror budget is not required.

That long-term plan should include the rebuilding of the tax base, which has been drastically eroded by 10 years of income tax cuts and offsets, plus the repeal now of two significant taxes – carbon and resources rent tax (although the latter was botched so that it subtracted from revenue instead of adding to it).

Increased spending has been locked in by the 2013 election campaign promises – on infrastructure, education, disability, asylum detention and childcare, on top of the ever-ballooning health care budget, not to mention the Reserve Bank recapitalisation.

Spending in other areas should be reduced where possible, but as the governor of the Reserve Bank, Glenn Stevens, suggested last week, the focus of fiscal policy – a “long conversation”, he called it – now needs to be about revenue.

Conservative politicians have a habit of cutting taxes for ideology and then increasing spending for electoral victory. It’s why Presidents Reagan and the two Bushes ended up with huge deficits.

The theory that tax cuts are economic magic dust that creates growth which then more than makes up for the revenue loss, sounds good but doesn’t work in practice because economic growth is a matter of far greater complexity than increasing take-home pay.

In Australia, it seems that income taxes have been cut not because of supply-side Reaganism but because of RIM syndrome (which stands for Rolling In Money, as a result of the terms of trade boom). But the result is the same.

Earlier this year, the Parliamentary Budget Office reported that the structural level of receipts between 2003 and 2011-12 had declined by 5 percentage points of GDP. Over two-thirds of that, it said, was due to the cumulative effect of successive personal income tax cuts between 2002-03 and 2008-09 – that is by both Coalition and Labor governments. A quarter was due to the decline in excise duties as a proportion of GDP because of the cancellation of excise indexation in 2001-02 by John Howard.

In 2003, the top marginal tax rate was 47 per cent on income over $60,000; today it’s 45 per cent on income over $180,000. The next rate down was 42 per cent on $50-60,000; now it’s 37 per cent on $80-$180,000. The bottom rate of 17 per cent kicked in at $6882; now the bottom rate of 19 per cent kicks in at $20,542, after taking into account the low income tax offset.

These are big cuts to the personal income tax base that now look irresponsible in the light of 10 years of projected deficits because of the decline in the terms of trade.

And while increasing the rate of GST and/or closing its holes should not be off the table, doing that would hit poor people the hardest. Increasing income taxes – gradually, over time – would raise more money and be fairer.