Taxes are not a burden: they provide many of the good things in life

by Michael Keating | Aug 19, 2020 | Finance & Tax

Coalition spending over the past six years has been nearly half that of the past 40 years and is forecast to drop further. With many services already cut to the bone, even the Parliamentary Budget Office has warned such ‘spending restraint’ is likely to be unsustainable. In a post-pandemic world, bringing forward tax cuts that only benefit high earners would be irresponsible, writes Michael Keating.

The Covid-induced recession has turned out to be worse than initially hoped with the recent Reserve Bank Statement on Monetary Policy finding that “the pace of recovery is expected to be slower than previously forecast“.

The initial success in dampening the pandemic’s effect on the economy largely reflected the JobKeeper and JobSeeker programs but this support was intentionally temporary, on the assumption that trading conditions would be returning to normal by the end of next month.

However, the latest official thinking is that a full economic recovery will be much slower than anticipated. While JobKeeper and JobSeeker are to be extended, the Reserve Bank still expects unemployment to rise over the next six months. In its base-case scenario, the Bank expects the rate to average as much as 10% in the December quarter, and still be 8.5% a year later.

Tax cuts top the wish list

Most pundits are calling for additional stimulus to counteract the fall in demand for goods and services. Topping the wish-list is for the next two stages of the legislated tax cuts to be brought forward from July 1, 2022, and 2024 respectively.

However, these tax cuts only benefit high earners. No one earning less than $90,000 will benefit from the second tranche, while the third tranche will only benefit people earning more than $120,000.

Half the tax-paying population of Australia earns less than $50,000, so the vast majority of taxpayers will get no benefit from either tax cut. Furthermore, the beneficiaries tend to have high savings rates, so these tax cuts will do relatively little to increase demand.

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Responsible policy makers should also keep in mind the nation’s longer-term requirements. Given Covid-19, there are good reasons for running budget deficits. Nevertheless, policy also needs to have regard for the longer-term.

An eye to the longer term

Therefore, stimulus measures should ideally only continue for a limited time and end as the economy recovers. Yet tax cuts are permanent and cause lasting problems to the Budget.

Too often any discussion of taxation starts from the premise that it is a burden, but this fails to recognise the purpose of tax. And that is to pay for the services we all want and to support a socially inclusive society with reasonable equality of opportunity. As the great American jurist, Oliver Wendell Holmes put it: “I like to pay taxes. In this way I buy civilisation.”

But taxes can be a disincentive if rates are set too high. Supporters of tax cuts argue that they create incentives, and can spur such economic growth that tax cuts are self-financing. The most famous such example was President Reagan, whose policies caused enduring damage to the US Budget and resulted in a blow-out in the balance of payments with too high an exchange rate, thus damaging the economy.

Among developed nations Australia has the lowest rate of tax revenue relative to GDP, but our rate of growth in per capita GDP terms is lower than in Scandinavia, which has much higher tax rates. So lower taxes, per se, do not necessarily lead to higher per capita GDP growth.

Health, education spending aids growth

Instead, the key to assessing the desirable rate of tax is to start by considering how the money will be spent. Spending on education, research and development, infrastructure, health, and more generally maintaining an egalitarian society can add to economic growth.

The Morrison government’s last plan, before Covid-19 hit, projected a budget surplus, but this was based on an exceptionally low rate of growth in public spending. In fact, real government payments in the past six Coalition budgets increased at an average annual rate of just 1.8%. By comparison, in the previous 40 years, government payments grew at an average real rate of about 3.25 per cent, nearly double.

Furthermore, this tightening in spending has been achieved not by genuine reform of programs to improve their effectiveness but by a combination of meanness, requiring people to pay more, and/or a decline in the quality of service, of which aged care is only the latest telling example.

Indeed, in its latest review, the independent Parliamentary Budget Office concluded: “The spending restraint seen over the past few years may be difficult to maintain … given the length of time in which restraint has been applied, [and] the pressures emerging in some spending areas.”

Spending plans are draconian

The government’s plans for the future are even more draconian. According to the Pre-election Economic and Fiscal Outlook (PEFO), released by the Treasury and Finance departments just before the last election, real government payments over the next four years were expected to increase at an annual rate of just 1.3% – even lower than the rate that had already led to a deterioration in services.

Before Covid-19, I had argued that to ensure adequate services, tax would need to rise by as much as 3% of GDP in the medium term. But even this would still leave our tax levels well below the OECD average.

High priority areas that will require significantly more funding include:

  • defence, foreign aid and diplomacy in response to the deteriorating international situation;
  • aged care;
  • education and training; with universities not able to rely on fees from foreign students to cross-subsidise domestic students;
  • increasing the childcare subsidy from 85 to 95% for low-income households to improve female workforce participation;
  • health; spending for which the PEFO has projected would grow annually by just 0.7%, which is just one-quarter of past increases (2.7% a year) and much lower than the rate of population growth;
  • rental assistance and income support for people who are unemployed; and
  • cultural institutions and the arts.

Tax reform inevitably involves winners and losers. Previous packages generated enough revenue to compensate the losers, ensuring wide support. However, generating that sort of revenue in a post-pandemic environment is likely to prove much more difficult.

It is therefore irresponsible to give a few high-income people a tax cut now. Instead broader reform should be considered, with possible trade-offs that include proper taxation of capital gains and closing the negative gearing loophole – both of which disproportionately favour high-income people.

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Michael Keating is a former Head of the Departments of Prime Minister & Cabinet, Finance, and Employment & Industrial Relations. He is presently a Visiting Fellow at the Australian National University.

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