Opinion & Commentary
We must cut taxes for rich and poor
After eight years of Liberal government, federal taxation is more onerous than ever. Last year federal taxes rose another 7per cent, and personal income tax is now 34per cent higher than the OECD average (weighted by gross domestic product). Commonwealth spending has gone up by 48per cent since 1999-2000.
Responding to this record, a group of Liberal backbenchers is calling for radical tax cuts. The Prime Minister, however, is unimpressed. He claims to have been "very generous in relation to tax", and his Finance Minister, Nick Minchin, has challenged the backbenchers to explain how tax cuts can be funded.
In The Weekend Australian (January 29-30), Terry McCrann took up this challenge. He suggested scrapping the tax-free threshold, which would save $7billion per year, and using this money to reduce the top marginal rate. This proposal directly challenges the backbench ginger group, which wants thresholds raised as well as cutting marginal rates.
Seen purely in tax terms, McCrann's argument makes sense, for giving everybody a tax-free threshold is very expensive. If everyone paid tax from the first dollar earned (as they do in New Zealand ), rates could be cut without having to reduce government spending.
But this ignores the problem of work incentives. When people seek to move from non-employment into low-paid work, or from part-time to full-time work, they often lose a huge chunk of each extra dollar they earn because they start paying more tax at the same time as they lose means-tested welfare benefits. The combined effect can mean it's not worth working.
The only solution to this problem is to disentangle the tax and benefits systems so that workers who pay tax do not receive welfare, and those who get welfare do not pay tax. And the only way to achieve this is to raise tax-free thresholds above the welfare floor -- above $12,500 for a single person and above $19,500 for any couple electing to be taxed jointly.
Scrapping tax-free thresholds would make things even worse than they are now, for low-income households would pay tax on every dollar and would then have to be compensated with more welfare transfers. McCrann suggests "genuinely low income earners" could be given rebates, but this would increase the means testing that lies at the heart of the problem. As soon as they improve their earnings, the rebates would be withdrawn and their take-home pay would be little better than before.
Scrapping the tax-free threshold is not, therefore, the answer to Minchin's challenge. Almost certainly, it would exacerbate our already appalling levels of welfare dependency. This is what happened in New Zealand when the tax-free threshold was scrapped there.
The Liberal backbenchers are therefore right to insist on rate cuts as well as threshold increases. But how can we afford this?
Part of the answer is that ministers must control their spending urges (especially around election time). The government should declare that any new spending must be funded by reduced expenditure elsewhere. Governments should live within their budgets, just as everybody else has to do.
Secondly, ministers must start to identify wasteful and counterproductive spending. Minchin says this is the "hard part", but insiders throughout the public sector know that billions of dollars could be saved without any adverse impact on the quality of services to the public.
When I worked in higher education I could see how much public money was being squandered on activities the public would never have agreed to fund if only it knew about it.
It's the same elsewhere. It is perfectly possibly to cut health spending without harming patients, defence spending without leaving us defenceless, and welfare spending without hurting those who genuinely need help.
Third, we should simplify the tax system by trimming the $30 billion worth of special concessions and allowances that taxpayers claim each year. These allowances have only evolved because taxes are so high. Reduce marginal rates and many of them could be scrapped.
Finally, encourage the golden goose to keep laying eggs. Even the most cautious economists agree that revenue lost through tax reductions is to some extent recouped by reduced tax avoidance and increased economic activity. Precisely because it strengthens work incentives, tax-cutting stimulates growth.
Serious tax reform is on the agenda, but it must involve more than cutting the top rate. It is just as important to solve the problem of work disincentives at the bottom end, and for that we need to raise thresholds. The key question is not whether we can afford to do this; it is whether, after eight years in power, this Government has the spirit and vision to see what needs to be done, and to do it.
Professor Peter Saunders is social research director at The Centre for Independent Studies.
