“This Government isn’t dreaming,” the Treasurer told us in his speech yesterday. He is right that “the scope for tax reform is limited in this economy.” As he bluntly says, “we don’t have a surplus to fund reductions in taxes.” In fact, we have a $35 billion deficit.
The Treasurer might be dreaming when he says he wants a “friendly” tax system: “Growth friendly, earner friendly and profit friendly.”
Much as I admire our Australian Tax Office, you are not supposed to be friends with your tax collector. Just pay what’s required like everyone else does so we can raise sufficient revenue to fund the public goods and services that people want.
Dreaming about spending?
Based mostly on bracket creep in the income tax, without any change, the budget is projected to reach a small surplus by 2021. The Treasurer aims instead to return to surplus with expenditure restraint, which is going to be tough. Even if expenditure is successfully “controlled” over the next five years, over the medium term that surplus is projected to decline again into the red. In the long term, the Intergenerational Report projected a growing deficit, on more heroic economic growth assumptions.
The times are not right for a GST
The Government has already said it’s not the right time for a GST increase, or a major “tax mix switch” between GST and personal income tax, finding that there would only be a modest growth effect. That seems sensible now – but we should not be looking to the GST to deliver significant growth. That does not mean the GST is irrelevant: the main thing it is good for is revenue.
In the medium term (see above on budget) – or even in the next term of either a Liberal or a Labor government – we are going to have to look again at increasing the GST rate or broadening the base. We will need to support an ageing population; fund education, retraining and early childhood human capital investment needed for a transitioning economy; let alone the true cost of the National Disability Insurance Scheme.
Will there be tax cuts aimed at “bracket creep”?
Bracket creep affects everyone because tax brackets are not indexed so your total tax payable as a percentage of income (the average tax rate ) increases with nominal and real wage growth. Is bracket creep a “killer” of economic growth? It’s far from clear. The Treasurer conspicuously did not express concern for people at the top rate of 45 per cent plus the 2 per cent temporary budget repair levy plus the 2 per cent Medicare levy (that is 49 per cent if you are counting). That temporary levy comes to an end on June 30, 2017 unless it is extended.
Instead, the Treasurer focused on the average wage earner moving into the “second top” tax bracket of 37 per cent (plus the Medicare Levy) at a threshold of $80,000. An increase in that threshold would, in fact, benefit higher bracket taxpayers too. Average full time male earnings are above the 37 per cent threshold now, but average full time female earnings are a lot lower, and most workers sit below about $60,000 in wages.
It’s been suggested that bracket creep is a disincentive to work. The Treasurer did not say this, but Treasury modelling assumes that bracket creep does affect work behaviour to some degree (it assumes work elasticity of 0.2). Yet empirical studies consistently show that most men are very unlikely to change their work behaviour because of tax rates(e.g. see a recent analysis of 30 studies around the world).
More importantly, women have much higher work responsiveness (estimated at more than four times that of men). That suggests that if the Treasurer really wants to help workers and growth by cutting taxes, he should focus on women with children working part-time and on the interaction between the tax and transfer systems.
A tried and tested approach
Tax reform does not have to be big bang. The Treasurer indicated that “modest” personal tax cuts would have to be funded from other tax changes. The biggest benefit would come from broadening the income tax base. This would help prevent the increased tax planning that we know is a behavioural response to bracket creep (as demonstrated in a US study).
The Treasurer criticised the Labor Party’s proposals to limit negative gearing to new housing construction and reduce the capital gains tax concession. But he seemed to leave open the option of capping deductions for higher income earners, possibly both interest and work expenses. He also did not rule out increased tax on superannuation contributions and earnings.
Unlimited negative gearing of rental losses against other income, in a context of easy finance and rising property markets, has become one of our most widely used tax shelters for wage earners. It is indeed true that some nurses, teachers and police negatively gear to reduce their taxes, although high earners get about 10 times the tax benefit from negative gearing and get much higher capital gains at a reduced tax rate. The Treasury chart below shows that a much smaller fraction of 10-15 per cent of taxpayers in income bands under $80,000 are negatively geared, compared to 24 per cent of high income taxpayers.
It’s time to apply a sensible limit, just as we did on introducing Fringe Benefits Tax in 1986 to crack down on tax-free fringe benefits. The Henry Review recommended reducing the capital gains tax discount to 40 per cent and quarantining investment expenses – both still worthwhile reforms. Deduction of property losses against wages was halted in the US by Ronald Reagan in 1986. In the UK, such losses are limited to rental income and the government announced in 2015 it would cap this deduction at a 20 per cent tax rate.
What about the federation?
It was disappointing to hear the Treasurer speak of the states as sovereign governments responsible for their own affairs (and hospital funding), when the Commonwealth continues to pick up the lion’s share of tax revenues. John Freebairn and I have previously argued that state tax reform could make the biggest contribution to economic growth through land, payroll and transport tax changes, but this needs national coordination.
And one last word… er… climate change?
The Treasurer spent quite a while talking about the global context for Australia’s tax system, but he failed to mention one aspect: climate change. Specifically, the legally binding Paris Agreement of December 2015 to keep global warming to 2 degrees.
The unpleasant reality in which the Government finds itself is partly because the Abbott-Hockey government abolished the carbon pricing mechanism, or carbon tax. It raised more than $6 billion and growing in the single year of 2012-13, with less pain per household than a GST increase, while having a positive impact on transitioning – to use the Treasurer’s word – Australia to a new economy for the 21st century. I wonder if it’s time to revisit that idea?
Professor Miranda Stewart is director of the Tax and Transfer Policy Institute at ANU.
This article was originally published at ABC’s The Drum.