Reform and reduce: A hopeful tax mantra

Tax reform is a desirable goal but only if the effect is a net reduction in the overall burden. Accompanied by spending reductions, resultant efficiencies could promote structural surpluses.

Tax reform seems destined to return to the policy agenda whoever wins the election, and so it should if the incoming government is serious about a productivity-based economic revival.

But being in favour of reform is one thing; what shape the reforms should take is another.

Tax experts seem almost unanimous in wanting a higher and/or broader GST to pay for reductions in less efficient taxes. This is meant to be a revenue-neutral restructuring exercise; if that is how it turns out it would produce some economic benefits. But a realistic increase in GST revenue on its own is never going to be enough to pay for all the desirable reforms on the tax reduction side of this trade-off. There are also grounds to fear that in the longer term, an increase in the GST would result in a higher overall tax burden as successive governments fail to deliver revenue neutrality.

What the economy needs is tax reform that not only restructures the tax system but also sets out to lower the overall tax burden. Restructuring and reduction is the best kind of reform. It will maximise benefits by sparking incentive and investment and lead to more efficient resource allocation.

A reduction in the tax burden may seem just wishful thinking at a time of persistent Commonwealth and state budget deficits. But in my latest report, Shrink Taxation by Shrinking Government! I present a realistic path to lower taxation over a 10-year period. The key, as the title hints, is tighter control of government spending. The TARGET30 campaign of The Centre for Independent Studies advocates a reduction in the size of general government in Australia (measured by expenses at all levels of government as a proportion of GDP) from 35 per cent to 30 per cent over the next 10 years. My report traces the implications of such a target for taxation.

If TARGET30 were achieved, not only could the existing structural fiscal deficits be eliminated and converted to structural surpluses, but the lower spending load would also create enough fiscal headroom to cut tax by $37 billion a year in 2011-12 terms. Combined with increased revenue from the GST and a few other sources, as outlined in the report, this would create a pot of $50 billion-$60 billion a year to fund the reduction and removal of the most economically harmful taxes.

Even this would not be enough to do everything desirable, but it would buy a lot of revenue-reducing reform. Slashing personal and company income tax rates and the fringe benefits tax for around $30 billion a year should be at the top of the list. Once a sensible personal income tax rate scale is put in place, the thresholds should be automatically indexed to inflation.

Next is a group of inefficient state taxes, such as stamp duties on insurance, motor vehicles, and real property transfers, for around $20 billion a year. These should not just be reduced but removed altogether in the trade-off against higher GST revenue. A broader state land tax could help complete the trade-off.

Then there are various misguided Commonwealth taxes that should be axed, such as the minerals resource rent tax, the luxury car tax and the targeted superannuation tax surcharges.

The Commonwealth should also adopt a broad-based discount for taxation of savings income, as advocated by the Henry review, and rationalise indexation of excises, which would mean restoring indexation of fuel excise.

These ambitious reforms cannot all be accomplished in the short-term. Eliminating structural deficits must take priority. But the full reform plan could be implemented progressively over 10 years in step with the gradual reduction in the share of government spending in the economy.

If government spending remains where it is – at 35 per cent of GDP – or rises further as it has in the broad sweep of economic history, revenue-neutral reform is the best we can hope for; in fact, the tax burden may even need to increase if deficits are to be contained and a spiral in government debt avoided. A larger public sector supported by a higher tax burden would not be the end of the Australian economy, but it would condemn us to weaker productivity and economic growth, and lower living standards, than would otherwise be possible.

Robert Carling is a senior fellow at The Centre for Independent Studies and author of Shrink Taxation by Shrinking Government!