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Tony Abbott’s new budget strategy – and how Bill Shorten will respond

14 April 2015

Fixing the federal budget might not be as hard as we think, argues John Edwards. And the Intergenerational Review shows we have the breathing space to choose how to do it

Right:

Both major parties have assumed a similar ceiling on tax receipts. Penny Bradfield/AAP Image

Both major parties have assumed a similar ceiling on tax receipts. Penny Bradfield/AAP Image


Speculation about the May budget is building, but much of its direction is already revealed in last month’s 2015 Intergenerational Report, or IGR. That unusual document unexpectedly illuminates the path to the next election and probably the one after that. Taken in the context of our evolving economic circumstances, it is the contemporary political map for Tony Abbott and Bill Shorten, and for the rest of us as well.

The three previous IGRs – in 2002, 2007 and 2010 – came and went. They got dutiful attention, elicited thoughtful head-shaking, and provoked salutary editorials prompting us to think more about future hazards. Each of them depicted a difficult fiscal situation, forty years in the future.

This IGR is very different. It is an analysis not only of the future, but also of the present. It portrays where we end up, but also how we might get there, year by year. And it does this in the unusual context of a political debate almost entirely about choices for Australian government spending and revenue.

My reading of the IGR suggests that far from Australia’s becoming ungovernable we might well find ourselves making reasonably rational choices, informed by more pertinent analysis and debate than usually attaches to the great spending and revenue issues at the core of Australian politics.

To do so, however, we need to get beyond the hype and misrepresentation and see what the IGR is actually telling us. When we do so we make the surprising discovery that resolving Australia’s fiscal problems might not be all that hard. The IGR also shows us that we will have a federal election or two to choose between rival solutions.

But before turning to the IGR it will be useful to consider the economic context in which it is presented.

The Australian economy

It is sometimes supposed that the problems in the federal budget are reflections of a wider problem in the Australian economy. Though there is a despondent tone to much of the commentary, the Australian economy is actually in pretty good shape. Public demand is weak and likely to remain so. Mining investment is falling. But exports last year set a new record high, in both values and volumes, and have continued strongly into this year. Gains in iron ore and coal have been important, but farm exports are also doing well. Service exports have increased spectacularly, especially tourism and education but also professional services such as finance, construction services, architecture and so forth. Manufacturing export volumes have increased in each of the last three years. Exports will get another significant lift when LNG shipments ramp up over the next few years.

Dwelling construction, too, was quite strong last year and likely to be even stronger this year. The sector is being helped along by low interest rates and a decade in which the population increased by over a tenth but dwelling construction stayed much the same from year to year. Household consumption is not dazzling, but is growing consistently faster than GDP as a whole.

It is widely thought that the mining sector has begun dragging the economy down, but the real case is the opposite. Mining as a share of GDP is bigger today than it has been at any time in the last quarter century. By volume, mining exports are higher now than ever; by value, last year they matched the peak year, 2011. It is certainly true that mining investment is well down and has quite a lot further to fall. But it is also true that the gain to GDP from the increase in coal and iron ore exports since the mining investment peak in 2012 is twice as big by volume as the loss to GDP from the fall in mining investment. And while mining investment has been falling, so too have capital equipment imports. Last year their volume fell by about half of the fall in mining investment, a ratio that probably reflects the general estimate that about half of mining investment spending is on imported equipment.

It would help to have stronger non-mining business investment. Even there, however, there are encouraging signs. Last year, in the Australian Bureau of Statistics category that includes finance and insurance, wholesale and retail trade, water, power and gas, construction, transport, and professional scientific and technical services, business investment increased in volume or real terms by 17 per cent. Investment in these industries is now eight times bigger than manufacturing industry investment. It is getting close to the level of mining investment, and sometime this year will likely exceed it. Last year the wider national accounts measure of business investment (which also includes private health and education investment, and farm investment) continued to drift down – though if mining is excluded it did pick up in the fourth quarter of last year.

Stronger household consumption might do it but otherwise it is unlikely we will see output growth reaching 3 per cent until non-mining business investment picks up further, or the decline in mining investment slows, or both. But there are good reasons to think that the expansion of non-mining business investment will continue. Meanwhile, the global economy is a little stronger. The expansion of the US economy is solidly based and likely to continue, growth has picked up in Germany, Britain and (a little) in Japan, and China has a pretty good chance of attaining its target of 7 per cent growth for another few years.

Interest rates, meanwhile, are at record lows, and the Australian dollar has come down (though not far enough). Without much remark, labour productivity has increased by an annual average of more than 2 per cent for the last three years, and wage increases are running at around the same rate. The combination of relatively high productivity growth and relatively low wages growth means that the labour cost per unit of production is stable or falling. In combination with the declining Australian dollar, these influences are making Australia more competitive in the world economy.

All that said, output growth at around 2.5 per cent, the average for the past five years, is not enough to keep unemployment from rising, let alone reduce it. Australia still has high net migration and a quite high rate of growth of the workforce. With current levels of productivity growth and workforce growth we need output to grow at 3 per cent or better to stop unemployment rising. This means there is a pretty high risk that while output growth will be quite firm over the next year or two and may even pick up, the unemployment rate will continue to slowly increase through this year and next. This is the most pertinent political implication of the current economic trajectory. In the fifteen months or so before the next election, the prime minister and his treasurer must find a way of talking about the economy that is consistent with the evident fact of rising unemployment.

Whatever narrative the prime minister develops also needs to be consistent with the government’s fiscal circumstances. While real output growth is likely to be firm and may even strengthen, the growth of wage incomes and profits, and thus of Australian government tax revenue, is likely to remain slow. Much of this is already built into published Treasury revenue forecasts, and some of it will be offset by a lower rate of growth in age pensions, disability support payments and other indexed payments. Even so, the very slow growth of revenue (and the periodic downward revision of revenue forecasts) is a major constraint on political choices. The likelihood of a revenue boost is remote. All the risks are that revenue will be less than forecast, rather than more.

These fiscal circumstances also constrain the opposition. They mean that for both major parties net tax cuts are pretty well impossible for the next few years, and so is any new program spending not offset by an equivalent cut.

The economic context dictates that the deficit should be reduced gently. That is the pattern already indicated in the most recent Mid-Year Economic and Financial Outlook, or MYEFO. (The IGR suggests that the deficit reduction path will be even gentler.)

The 2015 Intergenerational Report

As the former head of the prime minister’s department, Michael Keating, has pointed out, this year’s IGR is distinctive. Earlier IGRs used a single set of projections, based on present policies, to reveal how much additional spending as a share of GDP would be attributable to ageing in forty years’ time. The new IGR is quite different. It is essentially a year-by-year projection of budget outcomes for three different sets of spending policies over forty years. The three share the same economic forecast or projection, and each assumes that tax revenue rises to 23.9 per cent of GDP in 2020–2021 and is then held there for the rest of the forecast period.

The effect of using a single economic scenario over three different spending projections is to focus attention on the different trajectories of the spending projections and draw attention away from the economic projections, which are based on trends in population, workforce participation and labour productivity. Part of the national conversation prompted by previous IGRs was about how to get workforce participation or productivity up. This time round, such conversation as we are having is almost entirely about the fiscal choices implied by the three spending scenarios.

One scenario, labelled “previous policy,” purports to project the evolution of deficits under the policy in place prior to the changes to taxes and spending in the 2014–15 budget. But although the previous budget was brought down by treasurer Wayne Swan before the Coalition took office, three-quarters of the 2013–14 fiscal year was presided over by his successor, Joe Hockey. The incoming government could and did make changes to the budget, so even the polemical point of this “previous policy” comparison is obscure.

The second scenario is more useful, at least as a point of comparison. It shows how the deficit would evolve if all of the Abbott government’s proposed spending and tax proposals in the 2014–15 budget were adopted.

The third scenario is the most interesting because it comes closest to what is likely to happen and what that might imply. It shows the evolution of the budget balance given the spending and tax changes already legislated, or able to be implemented without legislation. This is the timeline that matters most to Tony Abbott and Bill Shorten.

None of the three outcomes has much to do with ageing. The biggest difference between them is the rate of debt accumulation, of which more below. Other differences involve funding for schools, defence and foreign aid, none of it related to ageing. Differences in health funding emerge but, like earlier IGRs, this IGR points out that health spending pressures mostly arise from technology and the demand for better services, not from ageing. Certainly there are differences in age pensions, but they do not account for a large share of the divergence of the three trajectories.

(Ageing does effect the Australian government budget indirectly through a changing rate of workforce participation. But since all three scenarios share the same economic assumptions, this aspect of ageing doesn’t affect the distinctions between the three trajectories. Nor does participation make an enormous difference because the IGR assumes that better education, better health and changing work patterns will increase the participation rate of older workers.)

The IGR forcibly demonstrates that the big driver of deficits, and of government spending as a share of GDP, is not an ageing society at all. Nor is the budget balance driven by defence or childcare or education. The main driver of deficits is deficits, and of debt, debt. The IGR is far more about the effect of compounding debt on political choices than it is about the effect of ageing.

The IGR shows that currently legislated policies lead to a 2054–55 deficit of 6 per cent of GDP when net interest is included, and 2.4 per cent of GDP when net interest is excluded. More than half of the deterioration in the fiscal position is thus due to the cost of additional debt, in turn due to the sequence of deficits. By 2054–55, under current policies, net interest costs would account for something closer to 10 per cent of budget spending compared to around 1.5 per cent today.

An implacable conclusion for either major party is that the sooner the deficit is eliminated, the sooner government will have more discretion to spend on what it thinks is important.

Most importantly, the projections show that managing the fiscal challenge is not too difficult so long as the groundwork is done sometime during the next five or six years. Under current legislation, and excluding debt interest costs, the projected federal deficit of 2.4 per cent of GDP for 2054–55 is much the same as the deficit currently projected for this year, 2014–15.

Using similar methodology, the 2010 report projected a deficit of 2.75 per cent of GDP forty years on, and the 2007 report projected 3.5 per cent. The 2002 report, the first, projected a deficit of 5 per cent of GDP.

The conclusion must be that the budget gap, excluding debt servicing, is narrowing rather than widening – at least in the long-term projections. The stability of the revenue assumption across four reports released for Labor and Coalition governments over thirteen years demonstrates a broadly similar outlook between the major parties.

The revenue assumptions are similar in all four IGRs (although Peter Costello’s 2002 and 2007 IGRs netted out the GST). In all cases revenue, including GST, is held at just over 25 per cent of GDP. Wayne Swan’s 2010 IGR assumed a tax ceiling of 23.6 per cent of GDP; in Joe Hockey’s it is 23.9 per cent of GDP. Non-tax revenue is typically 1.5 per cent of GDP.

All this means that the long-run budget challenge for both major parties is to implement a set of revenue and spending changes that will together amount to 2.4 per cent of GDP in forty years’ time. They must be implemented soon enough to prevent accumulating debt from taking over as the deficit driver. Weighing the choices depends to a large extent on what is included in or excluded from the “currently legislated” trajectory in the IGR, a question I address below.

In the meantime, government is faced with a short- or medium-term budget problem. Basically, the IGR shows the deficit will get better before it gets worse, a pattern that influences political choices over the next few years.

The short-term fiscal problem

Thinking about the fiscal problem through the next two elections is clouded by the big gap between what the government says it is doing and what it is actually doing. In particular, the importance of increased tax revenue in reducing the deficit over the next five or six years is occluded. It is now the essential element in the Abbott government’s fiscal strategy.

The Abbott government was in office and making budget decisions for three-quarters of the fiscal year 2013–14. The current budget, 2014–15, is entirely its own. In the outcome of the 2013–14 budget and the projected outcome for this year’s budget, spending as a share of GDP has increased. Part of the increase in 2013–14 was due to a capital payment to the Reserve Bank, but this year spending as a share of GDP is likely to be markedly higher than it was in the previous budget. At a projected 25.9 per cent of GDP, spending would be a whisker below the recent record set by Wayne Swan’s 2009–10 budget, which included the crest of the spending measures in response to the global economic downturn. Leaving that budget aside, spending has not been as high as a proportion of GDP as it is today since 1993–94, when Australia was pulling out of recession.

Another way of seeing the real fiscal circumstances of the Abbott government through the haze of declaratory policies is to look at the evolution of the deficit since the last completed budget before its election. Comparing the 2012–13 budget outcome with the prospective outcome for the current budget shows that the deficit has increased by 1.3 per cent of GDP. The increase is not due to a collapse of revenue: it is the outcome of an increase in spending-to-GDP of 1.8 per cent, offset by an increase in revenue-to-GDP of 0.5 per cent. The Abbott government has increased spending as a share of GDP, even on a 2014–15 projection that assumes most of the savings measures in the last budget are implemented. It has offset part of the increase with an increase in tax revenue.

As the prime minister and treasurer rightly say, this deficit will be wound back over the next few years. But spending cuts make only a small contribution to deficit reduction. Last December’s Mid-Year Economic and Financial Outlook depicts the deficit declining from 2.5 per cent of GDP this year to 0.6 per cent of GDP in 2017–18. Most of the improvement comes from increased revenue rather than decreased spending. On the MYEFO figuring, increased revenue accounts for nearly two-thirds of the fall in the deficit between now and 2017–18. Of the increased revenue, nearly two-thirds is increased personal income tax.

In reality, personal income tax will probably contribute a higher share of a smaller improvement, because the MYEFO includes some spending cuts that won’t happen. In the IGR projections covering the same period, the goal posts seem to have shifted. On the basis of “currently legislated” policy, the deficit in 2017–18 is around 1 per cent of GDP. This deterioration probably reflects the removal of spending cuts and revenue increases in MYEFO that still require legislation to implement. These would include the Medicare co-payment, the beginning of state school funding cuts, and the beginning of the freeze on the real value of age pensions.

The impact of increasing tax revenue in cutting the deficit continues for many years, a trend that recasts the future budget problem. MYEFO shows the deficit declining through to and including 2017–18, the last year of the forward estimates period in the current budget. The IGR shows that in the “currently legislated” path, the deficit will continue to narrow as a share of GDP until around 2021–22, when it peaks and then begins to slowly deteriorate. Tax increases will again account for most of the improvement. On this scenario, the deficit appears to be around 0.4 per cent of GDP by 2023–24, an improvement of 2.1 per cent of GDP over 2014–15. The tax-to-GDP ratio will then have reached its assumed ceiling of 23.9 per cent of GDP. Adding the usual 1.5 per cent of GDP for non-tax revenue, we can say that in 2023–24, when the deficit will be 2.1 per cent of GDP lower than today, revenue will be 1.8 per cent of GDP higher than today. Between now and that fiscal year, higher revenue thus accounts for more than four-fifths of the reduction in the deficit under current legislation. All of the revenue increase as a share of GDP is additional tax.

The politically crucial point for both the government and the opposition is that the deficit reduction through to 2021–22 will occur without any new taxes or legislation. According to the IGR projections, it will occur without most of the nasties proposed in the 2014–15 budget. It will occur without a Medicare co-payment, without freezing the real value of pensions, without cutting federal funding for state schools, and without deregulating university fees.

These are the numbers the prime minister and the treasurer are looking at, probably thoughtfully. They are now at the core of Tony Abbott’s political strategy for the next election. They will also be at the core of the political strategy for opposition leader Bill Shorten and shadow treasurer Chris Bowen. The government and the opposition share the same forecasting framework, and will see the same constraints and opportunities in the evolution of spending and deficits over the next six or seven years. The opposition’s policy-costing advice from the Parliamentary Budget Office will use much the same data and the same methods as the advice Treasury will give the government.

As Abbott has indicated, the May budget will not be especially tough. It doesn’t need to be. The deficit will continue to narrow over the next six or seven years, with no increase in tax rates and no spending cuts beyond those already legislated or not requiring legislation.

Under existing policy, according to the IGR, the narrowing of the deficit will halt in 2020–21 and then begin to slowly widen. This is mostly because revenue from that year forward is constrained to grow at the same rate as GDP, while spending continues to grow a little faster than GDP. But that development falls outside the forward estimates of the coming budget and the next. Each budget includes four years of estimates, the first two of which are forecasts and the last two projections. Estimates in the May budget this year will go through to 2018–19; in next year’s budget, likely to be the last before the election, they will go through to 2019–20. On IGR figuring, and without any new spending cuts, each budget will show a path of steadily falling deficits.

This will be true even if the government dumps its proposal to eliminate real increases in the pension, as it is highly likely do. It will be true if it also dumps or postpones its cuts in the forward estimates of school funding, and if it dumps university fee deregulation.

The deterioration of the deficit will not be in the forward estimates until the first budget of a government elected in late 2016, assuming it adheres to the normal timetable and brings its first budget down in May 2017.

The prime minister can abandon cuts to the pension, put off cuts in school funding and forget about Medicare co-payments, but he does have one medium-term fiscal problem. Treasury and Finance have included in both the forward estimates and in the IGR’s “currently legislated” path quite big cuts to hospital funding, from 2017. These cannot now be taken out without a marked deterioration in the forward estimates to be presented in next month’s budget. The advisers to Abbott and Hockey are probably giving a bit of thought to this right now.

With GDP growth below the rate required to prevent unemployment rising, there is no economic case over the next several years to cut the deficit more rapidly than the IGR projects on current policy. While it won’t be in the forward estimates, the deterioration of the deficit beyond 2020–21 will be apparent in the medium-term fiscal path that is now published in the budget. Both the opposition and the government will need some sort of narrative to meet this emerging deficit, even though these measures need not begin to take effect for six or seven years.

The long-term fiscal problem

The projected recovery of tax revenue solves the deficit problem over the next five or six years but it then re-emerges. The deficit stabilises around 2020–21 and then deteriorates from 2023–24. This is not because program costs suddenly explode. As mentioned, it is because the IGR projection holds tax to 23.9 per cent of GDP and total revenue to 25.4 per cent of GDP from 2020–21, while spending grows a little faster than GDP. The pattern is probably influenced by the diminishing importance of cuts to foreign aid.

The size of the longer-term problem is evident in the trajectory of the “currently legislated” spending projection, excluding debt interest. The deficit of 2.4 per cent of GDP in 2054–55 is the long-term gap between revenue and spending that has to be bridged plausibly with some combination of spending cuts and revenue enhancements.

Though that gap is a long way away, the emerging gap needs to be plugged quite soon to prevent interest costs on accumulating deficits claiming a higher and higher share of spending.

In figuring out the size of the problem presented by the 2.4 per cent gap in 2054–55 we need to know what Treasury has included in or excluded from the path of “currently legislated” spending. We especially need to know how many of the big spending cuts sought by the government in the 2014–15 budget have been included. The IGR is not as helpful as it might be on this point, but it does tell us a lot of what we need to know.

Treasury has included all current and proposed spending plans except those requiring legislative change that has either been denied or not yet sought. Following this rule, it has included the cuts in proposed hospital funding, but not the Medicare co-payment, in “currently legislated” policy. The change in hospital funding planned from 2017 onwards doesn’t need legislation; the Medicare co-payment does. (For all the difficulty it caused the government, the Medicare co-payment makes very little difference to the trajectory of healthcare costs.)

The hospital funding cuts seem to be the only real nasty left in the “currently legislated” projection. The cuts to foreign aid are included, but they are not politically fraught. Specifically excluded are the freezing of the real value of the age pension from 2017, and the proposed increase in the pension age to seventy. (Treasury imposed the assumption that the pension freeze starts in 2017 and ends about a decade later.)

The biggest single exclusion from “currently legislated” policy is in education and training. The proposal to hold school funding to CPI plus population from 2017 seems to be worth 0.6 per cent of GDP by 2054–55.

It may be that the major parties can avoid having to explicitly deal with the long-term deficit in the run-up to the 2016 election. It is far enough down the track for both sides to promise to examine the problem and present to the electorate a package of measures at the election after next. It is not entirely satisfactory, but it may well be what happens and there are worse possible outcomes. After all, we are talking about a problem that doesn’t begin to arise for the best part of another decade. Given the calamity of the 2014–15 budget, evading the issue may be the only way through.

It would be very much better, however, if both major parties presented to the electorate packages to close the deficit that re-emerges after 2020–21. They could then move on to a contest over the merits of different spending and taxing options, instead of a tedious contest of rival claims over debt and deficits. Nor should it be too hard for both sides to find an electorally tolerable set of measures that would produce a budget balance beyond 2023–24. On the IGR’s “current policy” scenario the deficit reaches 2.4 per cent of GDP only in forty years’ time, and only very gradually. In twenty years’ time it is still only half a per cent of GDP. The minimum task then is to put together a package that would amount to half a per cent of deficit reduction in twenty years’ time, so long as the measures start sometime in the next five or six years and are worth 2.4 per cent of GDP in forty years time.

Despite all the blather and hype, that is it. Addressing Australia’s fiscal problem does not require a fiscal or tax revolution, it is very far from a crisis, and it is not beyond the capability of our political system. The IGR makes that clear. Any half dozen fair-minded and well-informed people could produce a set of reasonable options, broadly acceptable to a majority of Australians, as long as they had an official from Treasury or the Parliamentary Budget Office sitting by with the relevant spreadsheets.

Through to the next election

In the 2016 budget, the one prior to the next election, the prime minister will be able to show a path of declining deficits in the forward estimates through to 2019–20. But unless he is vastly more popular than he is now, which seems unlikely, he can’t go to the next election with a plan to freeze the real growth of age pensions for a decade. He can’t promise to bring in a Medicare co-payment. In fact, he will have to deny and forswear these cuts, explicitly and repeatedly, because Bill Shorten will certainly accuse him of planning them. Given that they are already in the forward estimates and treated as currently legislated policy in the IGR, he may have no choice but to stick with the proposed cuts to hospital funding. He could probably argue that he will make it up to the states in some other, yet-to-be-determined way. Since the school funding cuts are not yet counted they are more easily repudiated, though he will be very reluctant to let them go.

Regardless, Shorten’s attack lines are already pretty clear. He will say the prime minister plans to cut funding for hospitals and schools, and freeze the real value of old age pensions. This line is now an inescapable given. Nor will it be seen as baseless rhetoric. After all, Abbott ruled out cuts in the last election campaign, and then in office proposed them. These are all policies he approved, proposed and supported, and will recant only reluctantly. In opposing cuts to hospital and school funding and a freeze on the real value of pensions Shorten will not have to offer compensatory cuts elsewhere, because the government will probably have already dropped them from the forward estimates.

For his part, Abbott will say that the budget mess is Labor’s fault, and he has now resolved it – witness the small deficit predicted for the end of the forward estimates period.

In terms of actual programs and spending outcomes over the next three or four years the difference between the parties may well be decidedly thin. It is already apparent that the Abbott government is moving along the lines dictated by the IGR. He has dropped the Medicare co-payments, and is looking for a way to drop the pension freeze without losing all the savings it promised. The likely way forward for both government and opposition is to toughen the means test for both full and part pensions while keeping the current indexation arrangements intact. Similarly with family assistance and other transfers. On school funding Labor could make savings from the IGR’s “current legislation” path by retaining increased funding for disadvantaged schools partly or wholly at the expense of other schools. (The Gonski review’s hands were tied by the Labor government’s instruction that no school could be worse off.) On hospitals, either or both of the major parties will need to restore a higher level of funding to the “current legislation” path of the IGR, perhaps minimising the increase by claiming they would require greater efficiency from hospital administrations.

If all these and other possible economies are not enough to eliminate the prospective deficit then there is the option of a tax increase to balance the books. Since we are looking for a package that amounts to only 0.5 per cent of GDP in twenty years, the tax increase would be hardly noticeable. But I think the option of a net tax increase is unlikely to be chosen by either side. The government will certainly not propose an increase in the tax take beyond 23.9 per cent of GDP. Labor would be suicidal to propose a net increase, especially since the IGR makes it fairly plain that a quite acceptable spending path can be mapped without one. And a tax increase would only temporarily narrow the deficit. Unless the proportion of tax to GDP is allowed to rise indefinitely, deficits will arise so long as spending growth outruns GDP growth.

The prime minister’s apparent tolerance of debt at 60 per cent of GDP is unlikely to be reiterated. This is the outcome produced by the “currently legislated” scenario, which specifies that in 2054–55 government spending including debt servicing reaches 31.2 per cent of GDP, compared to 25.9 per cent today. That is not a usual Liberal position. Social security minister Scott Morrison also recently wandered off script in floating the suggestion of increased taxes on superannuation to pay for higher pension indexation. In the Abbott government script, tax increases in one area can only be permitted if they pay for tax cuts in another.

If Abbott is replaced by Turnbull nothing much changes except perhaps the timing of the next election. The fiscal and economic circumstances are just as constraining for Turnbull as for Abbott, though he would not have quite the baggage of the broken promises. His best bet might well be to go for double dissolution as soon as he can. It is unlikely that a double dissolution would improve the government position in the Senate and it would certainly see its majority in the House reduced, but that would be a price Turnbull would be happy to pay to restart the fiscal debate on his own terms in a new parliament. The implacable logic of the IGR arithmetic would remain.

Changing Taxes

As the Financial Review’s Laura Tingle has pointed out, the response of the government and the opposition to Treasury’s recent tax information paper was surprising and telling. Both sides have effectively ruled out an increase in the GST, or its extension to fresh food, education and health. Both sides have shown a willingness to discuss increased taxes (or less concessionality, which is the same thing) on superannuation and capital gains.

Both sides have a long history of constraining the growth of taxation revenue as a share of GDP. This was part of the Hawke and Keating governments’ “troika” commitment and part of Peter Costello’s “fiscal framework,” and was adopted by Wayne Swan as treasurer. The vast share of the continuing fiscal problem while Swan was treasurer was that tax revenue fell well below the ceiling. The relatively easy path for the next three or four budgets is almost entirely due to the projected recovery of tax revenue to a ceiling long accepted by the two major parties.

If both sides also accept a maximum tax take of 23.9 per cent of GDP, then what they are talking about is using additional revenue from sources such as capital gains and superannuation tax reforms to fund cuts in other taxes, most likely personal income tax. On the revenue side as on the spending side there is far less difference between the major parties than the stridency of the public debate suggests.

As John Quiggin has rightly remarked, there hasn’t been much new in the tax debate since the Asprey report forty years ago. It urged a form of the GST and a capital gains tax, and made a case for a fringe benefits tax. In the preliminary report recommending a value-added or goods and services tax Asprey and his colleagues said that once introduced, it would be easy enough to increase. This remains Treasury’s central goal, along with a reduction in company tax and a shift in health and education spending to the states.

While there is certainly no room for net tax cuts for many years to come, it is quite possible to change the mix in various ways.

In this respect Labor probably has more options than the government. Paradoxically, Labor’s policy problems in tax have been eased by falling demand for (coal-fired) electricity, and the continuing decline in commodity prices. These trends mean that a both a carbon tax and a mining super profits tax are off the table. Business and household electricity demand is already doing the work of a carbon tax, and the super profits in mining won’t be there.

I think it is fanciful to imagine either side will look at a serious extension of the goods and services tax, though both sides could if necessary look to picking up a bit more revenue (for the states) by extending the GST to financial services.

Treasury is again pressing for the elimination or reduction of dividend imputation, with the revenue gain used to reduce the company tax rate. Labor might be able to look at this. My guess is that there is no chance whatsoever that the Liberal Party would accept it. There are hundreds of thousands of Liberal-voting self-managed super fund trustees who like the combination of big dividends and imputation credits. There are hundreds of thousands of small businesses benefiting from imputation. They are both core Liberal constituencies. The main beneficiaries of reducing company tax by reducing imputation credits are foreign shareholders in businesses paying Australian company tax. If it is tax neutral in the medium term, the foreign shareholders must be benefitting at the expense of Australian shareholders.

The concessional taxation of capital gains is a standout distortion. Its reform could fund some reduction in personal income tax rates. Either side could look at this, but Labor would find it easier. It was Labor, after all, that introduced capital gains tax at the taxpayer’s marginal rate, and a Liberal government that later halved it.

Finally, there is the biggie – super tax concessionality. Both sides could fund some personal income tax cuts by more heavily taxing superannuation, and may well do so. As Malcolm Turnbull has remarked, it is odd to have a tax system that imposes tax disincentives on additional work in the most active period of people’s working lives and then removes them when their working lives are over.

As the IGR makes plain, the Australian government does have a fiscal problem. Over the next five or six years, though, the immediate problem will solve itself through the increases in tax revenue that come with increasing income. Beyond 2020–21, deficits will increase so long as tax revenue is constrained to its average share of GDP in recent decades. That longer-term problem can be met with modest changes to spending programs, amounting to 0.5 per cent of GDP in twenty years’ time and 2.4 per cent of GDP in forty years’ time. There are vastly more important issues in Australian politics than this fiscal arithmetic, and the sooner it is addressed the sooner we can move on to debate them. •

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The new rules sought by premier Colin Barnett would have cost the state $7 billion during the boom years, writes Tim Colebatch. Is this an attempt to make the current mechanism for carving up the GST unworkable?

Right:

Raising the stakes? WA premier Colin Barnett. Alan Porritt/AAP Image

Raising the stakes? WA premier Colin Barnett. Alan Porritt/AAP Image