Penny-pinching is just a first step for the budget

According to the Business Council of Australia, tough spending cuts, increased taxes and extensive economic reform will be needed to get the federal budget back to surplus. The reality is the government will have to address not just spending but also revenue, tax loopholes and welfare if it hopes to create a long-term sustainable budget.

Last night the BCA released its 2014-15 budget submission and for the most part it is filled with sensible solutions to address the growing fiscal gap. Predictably it pushes for cuts in government spending but more importantly the council recognises that the growing fiscal deficit reflects a narrowing of the tax base itself.

For those who follow budget matters closely, it became obvious that government spending was not the sole reason for the deteriorating budget balance; arguably it was not even the most important reason. Instead, revenues fell sharply during the global financial crisis and simply never properly recovered – a combination of subdued income growth, spending activity and an ageing population limiting tax revenues.

The BCA recommends that Australia moves away from more inefficient taxes, such as the income and company taxes that account for most government revenue and instead generate more income through the Goods and Services Tax.

The GST is a fairly efficient tax that leads to relatively few distortions to economic activity compared with income and company taxes. In an ideal world we would have a higher GST and lower average income and company taxes, though raising the GST is politically difficult and likely to be hugely unpopular with the electorate.

For expenditure, the BCA believes that government expenditure should be aimed at maintaining a sustainable safety net and lifting productive capacity. Predictably it favours careful regulation but the council also says that government spending needs to maintain intergenerational equity.

There is no shortage of unnecessary tax loopholes and middle and upper-class welfare which could be wound back to improve the budgetary outlook. Simply addressing our inefficient housing policies would free up billions of dollars each year, which could be used to reduce debt or provide essential services.

A recent IMF report suggested that Australia forgoes revenues of around 8 per cent of GDP annually due to selective and differential tax policies – more than enough to turn the budget to surplus, reduce debt and provide widespread infrastructure investment (It’s time to fix Australia’s leaky tax sieve, January 31).

The BCA believes that the greatest cuts to expenditure can be achieved through addressing structural issues, many of which result from an increasing share of Australians heading into retirement. Australia desperately needs to address the aged pension and superannuation policies, and while both could prove to be politically unpopular they are also incredibly important to addressing the long-term sustainability of the budget.

Other recommendations are less successful. The BCA pushes for the government to recommit to explicit fiscal rules, including a cap on government taxation of 23.7 per cent of GDP and restraining real spending growth to 2 per cent per year until the budget returns to substantial surplus.

Hard tax or spending rules rarely work in practice. Why 23.7 per cent of GDP exactly? Why not 25 per cent or 12 per cent or 40 per cent? A hard cap does not tell me what services a government should provide, nor does it tell me what the demand for government services is.

Instead I’d argue that taxation should be high enough to fulfill the reasonable demand for government services. The reality is that the demand for government services have gone up in recent years and is set to increase further as our population ages. Any hard cap on government taxation will either result in government spending failing to meet the needs of the Australian people or alternatively running increasingly large government deficits. Neither sound like a good idea.

Although I disagree with a hard cap on taxation, most of the suggestions laid out by the BCA in its budget submission are sensible and practical. In order to reign in the budget deficit, the Coalition must address the issue from every angle – spending, revenue and structural.

To date the focus has almost entirely been on the expenditure side but that will do little to create a sustainable budget balance. Penny pinching will only get the government so far and there are far greater gains to be made by broadening the tax base, removing tax loopholes and addressing the aged pension and middle and upper-class welfare.