Opinion & Commentary
Tax reform: we have barely scratched the surface
As preparation of the 2007-08 Commonwealth budget moves into top gear, it is timely to remind policymakers of the taxpayer’s stake in the outcome. There are real grounds to fear that the taxpayer will be trampled as government and opposition race to bid up expenditure on their favourite programs. The Treasurer has already lowered expectations of tax relief. We can only hope this is more budget ritual than reality.
In the lead-up to last year’s budget, calls for income tax relief became so loud and the flood of revenue from the resources boom so great that the government responded. But the reduction in marginal rates – confined to two percentage points shaved off the 48.5 and 43.5 per cent rates – was small in contrast to large increases in upper thresholds and a generous approach to superannuation. Was the case for cutting rates so feeble as to be so easily satisfied?
The best quality tax cuts are cuts in tax rates. The relief provided by threshold increases is too easily eaten up by inflation of incomes, whereas cuts in rates are of lasting benefit. Over the last ten years the four marginal personal income tax rates have been cut by five percentage points at the bottom, then by four, three and two percentage points respectively to the top. The cuts in the middle and higher rates have been modest, particularly as they were partly in compensation for the introduction of the GST in 2000.
One excuse for inaction this year is that last year’s tax cuts rendered Australia’s personal income tax scale ‘internationally competitive’. But so what if Australia’s top marginal rate approximates the OECD average? It is not clear why we should be content with the mediocrity of that average, which is pushed up by the traditional high tax countries of ‘old Europe’. If international competitiveness were the test, why wouldn’t we want to keep company with the low tax countries? More tellingly, despite the Treasurer’s clever crafting of the issue last year, the case for tax reduction has never rested solely or even mainly on international comparisons.
Tax reform is unfinished business. Over twenty years Australia has made progress towards a ‘best practice’ tax system but we are not there yet. Reform has left those in the higher brackets, or aspiring to be there, still facing incentive-sapping marginal tax rates. The company tax rate is another good candidate for the chop. Or if the government wants to be more egalitarian in an election year, there is also a good case for cutting the 31.5 per cent personal rate.
Conventional wisdom says that now is not the time for further tax cuts because they will push up interest rates. Last year’s tax cuts were criticised on these grounds, but the connection between tax cuts and interest rates is not simple. Interest rates depend on the totality of fiscal policy, not just tax policy. Tax cuts need not be inflationary provided the expenditure side of the budget is well managed.
The issue is not whether there should be a surplus in current economic conditions, but how big it should be and how it is arrived at through revenue and expenditure policy changes. Tax cuts at the expense of a realistic surplus are a straw man in this debate. But tax cuts paid for by surging revenues and expenditure restraint are not. And there is a limit to the surplus that the government is willing to budget for – probably around $10 billion. Given this, the choice last year was not between tax cuts and a bigger surplus, but between tax cuts and wastefully higher government spending.
In any case, the budget surplus is but one of many determinants of interest rates, making the relationship between the two very imprecise. In a $1 trillion economy, a few billion dollars one way or the other is unlikely to make any difference other than in the minds of commentators obsessed with day-to-day reassessments of the outlook for short-term interest rates.
Another proposition is that increased government spending should take priority over tax cuts because of the current demands from water, infrastructure, education, skill shortages and other issues of the day. One commentator has said that last year’s tax cuts ‘squandered’ funds that would have been better spent by government and another has claimed that increasing government expenditure would have supply-side benefits (which, presumably, tax cuts lack!).
Such statements turn a blind eye to the growth in spending that has actually occurred. Commonwealth outlays have increased by 6 per cent annually since 2000-01 (a period that excludes the GST distortion to state grants). How much is enough?
The slight fall in spending as a share of GDP is nothing to boast about. That share is cyclical, rising when the private sector economy is in recession and falling when it is booming. The surprising thing is that government spending has not shrunk more as a share of the economy during a period of private sector prosperity and a record-breaking gain in the nation’s terms of trade.
A government serious about tax relief as a high priority would have no difficulty creating room by thoroughly reviewing expenditure and weeding out the deadwood, while still meeting high priority spending needs and keeping the budget in surplus. Perhaps this is too much to ask in an election year, but we can at least hope that there is no election-induced surge in spending.
The extent to which tax relief is possible in the coming budget will depend on revised estimates to which only the policymakers are privy. Much will depend on whether revenue estimates are revised up substantially as was the case in the last two budgets. But there is no reason for tax relief to be ruled out even before the budget process begins, and no reason to favour another surge in government spending.
Robert Carling is a Visiting Fellow at The Centre for Independent Studies.
