Short-sightedness on tax reform will stifle Australia

The Australian budget has deteriorated considerably since the global financial crisis, mostly on the back of a narrower tax base and inadequate revenue collection. Unfortunately major tax reform is not on the agenda for either major party and that spells trouble for the Coalition’s plan to get the budget back to surplus.

The budget debate in Australia typically focuses on government spending but little consideration is given to whether the federal government raises a sufficient level of tax revenue. For example, the 2014-15 federal budget featured no shortage of spending cuts but offered no major tax reform.

The budget did introduce a couple of new taxes, including an increase to the fuel excise and a deficit tax on high-income earners, but those proposals were offset by repealing both the carbon and mining taxes.

Similar to the former Labor government, the Coalition underestimates the challenge of returning to surplus. For no identifiable reason, it are assuming that tax revenue will increase by 2 percentage points of nominal GDP over the next four years, near its 2000 to 2007 average.

Without significant tax reform, receipts are unlikely to meet the federal government’s forecasts. That level of revenue was the norm during the glory days when the terms of trade was high and demographics were favourable.  They will not be replicated going the other way. Our politicians are naïve if they pretend otherwise.

The ageing population will continue to hollow out our tax base, forcing the economy to rely on an increasingly smaller share of the population to support government spending. Meanwhile, the terms of trade is falling more quickly than the government anticipated, as the Australian resource sector floods the global iron ore and coal markets.

At the same time, the demand for government services continues to rise. Spending on aged care services and healthcare are forecast to increase significantly over the next few decades. We have also introduced legislation such as the National Disability Insurance Scheme that is costly but necessary to improve the living standards of many Australians.

Logically this necessitates widespread tax reform to widen our tax base and improve the efficiency of the existing system. Unfortunately tax reform appears nowhere on the agenda of either major party.

As former Liberal Party leader Dr John Hewson recently noted, “both are opposed to any change in the GST, housing or superannuation (the big concession areas) and both are committed to reducing personal and company taxation, even in the face of increasing demands for public services”.

Ideally we should reduce personal and company taxes -- two inefficient sources of tax revenue which distort labour participation and decision-making -- but that should not be pursued unless our politicians possess the political courage to support widespread tax reform.

Our priority should be reducing our reliance on inefficient taxes and transitioning towards a system that relies more on consumption taxes and taxing fixed assets such as land. For example, a report from KPMG in 2010, based on the Henry Tax review, shows that increasing personal tax revenue by an additional dollar incurs a marginal cost of 24 cents; for company taxes that excess burden is 40 cents.

By comparison, increasing the revenue raised by the GST by a dollar results in an additional cost of just 8 cents. Transitioning from personal taxes towards consumption taxes would initially save 16 cents per dollar generated (slowly dropping to 8 cents per dollar if you abolished personal taxes altogether). Those savings are nothing to sneeze at given personal taxes amounted to $164bn in 2013-14.

Such a system would obviously reduce the progressiveness of the gross tax system since the GST is a regressive tax, but that is easily addressed by greater redistribution so that in net, the tax system remains progressive.

Is such reform likely given the current political environment? Of course not, but this is the type of vision that the Liberal and Labor parties should be taking to the next election. It is the vision necessary to return our budget to surplus and address our long-term budget problems.

Hewson doesn’t believe that widespread tax reform is possible; he believes that we should introduce an independent tax commission to take power away from parliament. I’m sympathetic to that view, but it’d be nice for our politicians to defy expectations, act in the public interest and prove Hewson wrong.