Opinion & Commentary
Use tax cuts to boost super
The Rudd government’s commitment to personal income tax cuts from July 2008 is being questioned by the OECD and some local economists on the grounds that the cuts will be inflationary.
But the tax cuts can be implemented without stoking inflation. In fact, Rudd and Swan should surprise us by committing up-front to a multi-year path of personal income tax reform, and packaging it with a parallel but voluntary increase in superannuation contributions to be paid directly by employees.
Labor put forward a two-part tax policy in the election campaign: a firm commitment to lifting the 30 per cent threshold to $37,000 and lowering the 40 per cent rate to 37 per cent over three years; and an “aspirational” 15/30/40 per cent scale which they hoped to implement some time after 2010. The first component is essentially a continuation of the Howard government’s approach of doing a lot to lift thresholds but very little to lower tax rates. The “aspirational” scale is much more interesting and would do more to improve incentive.
The government should legislate up-front to implement both its firm commitment and the “aspirational” part of its tax policy, even with a five or six year phase-in. It should do so for three reasons.
First, the revised scale represents a vital economic reform that will have supply-side benefits, boosting the economy’s productive capacity. Putting something into legislation does not, of course, guarantee that it will happen, but if people are encouraged to believe that tax rates will come down over the next several years, they will start to respond now.
Second, a legislated program of tax cutting reform will impose much needed self-discipline on government expenditure (including tax expenditure). The Howard government enjoyed too much revenue growth for its own good. Even with a phased move to Labor’s “aspirational” scale, revenue and spending will still grow, but less rapidly than it has over the last several years.
Third, all experience suggests that the alternative to tax cuts would not be the much larger surplus ($20 or $30 billion) that some economists dream of, but a higher level of spending. The reality, beyond the very short term, is that the more revenue government takes in the more it is tempted to spend. In any case, the effectiveness of a larger surplus in countering inflation is debatable.
It is widely recognised that the current standard superannuation contribution rate of 9 per cent is not sufficient to provide for retirement. It will leave retirement provision in a half-way house between a predominantly taxpayer-funded public pension scheme and a predominantly self-funded private pension system.
Contributions need to rise to 12 or 15 per cent, but the increase should be gradual and made optional for employees under the so-called “soft compulsion” model which would free individuals to opt out of any increase in the standard rate of contributions beyond 9 per cent. The details of such a scheme would have to be worked out, but the basic idea is that individuals would be free to tailor their marginal saving rate to their own circumstances.
There is much to be said for the optional increases in superannuation contributions coming directly out of the employee’s pocket, instead of being an add-on to wages. Even though the end result may be the same, with additional employer contributions being offset by lower wage costs, it takes time for the trade-off to work its way through the system, and direct employee contributions would foster a sense of employee responsibility for retirement. The shift to employee contributions would be eased by the link to simultaneous personal income tax cuts.
Combining tax cuts with employee-funded increases in superannuation contributions would help avoid the stimulatory effects on aggregate demand that may be an unwelcome short-term effect of tax cuts in isolation. Higher superannuation contributions would not represent a dollar-for-dollar increase in household saving, because they would partly offset saving that would have occurred anyway. But there would be a significant positive net effect on household saving.
Higher superannuation contributions would result in a faster build-up in household financial assets, eventually putting households in a better position to self-fund their retirement and health care, and shifting the emphasis away from tax-financed provision.
Robert Carling is a Senior Fellow at the Centre for Independent Studies.
