Inside Story

Financing government in uncertain times

Talking tax is tough. But offering false choices about revenue, spending and globalisation won’t lead to better outcomes, writes Sam Hurley

Sam Hurley 22 April 2016 3309 words

Stormy weather: Australia goes to the polls with economic challenges gathering and a bipartisan commitment to limit revenue. Mick Tsikas/AAP Image

You couldn’t blame ambassador Joe Hockey if he watched recent events back home with a sense of smug satisfaction. The day before the 2013 election, his leader promised on national TV that an Abbott government would not cut education, health, pensions or public broadcasters. The rash commitment that so hopelessly undermined Hockey’s time as treasurer was made at the home ground of the NRL’s Penrith Panthers, in the marginal electorate of Lindsay.

Late last month, at the same venue, the Coalition’s first-term fiscal frippery came full circle. Malcolm Turnbull unveiled “the most fundamental reform to the Federation in generations,” designed to plug some of the health and education funding gaps opened up in Hockey’s first failed budget. The catch was that the states would have to shoulder responsibility for raising taxes themselves. The staging of Turnbull’s rambling announcement was hasty, and the backdrop of a snarling, pouncing panther only added to the sense of absurdity. Scott Morrison, Hockey’s replacement as treasurer, sounded decidedly unbriefed and the response from the premiers at the April Fools’ Day COAG two days later was emphatic. No, we will not take the political hit for your self-inflicted problem. What’s for morning tea?

If Malcolm Turnbull meant what he said last September about respecting the intelligence of the Australian people, now would be a good time to level with them. And a good place to start would be the fact that tax receipts are going up. That’s a good thing, and it would be even better if the next government seized one of the many options to make that happen more efficiently and equitably.

Next, he could try something bolder, and revisit the bipartisan commitment to keeping Australia’s tax-to-GDP ratio at the lower end of OECD tables. Yes, we face tough trade-offs and choices. No, they are not as simple as choosing either higher tax or better spending, either “jobs and growth” or a decent safety net, or either a global economy or a thriving, fair society. The public investments most threatened by a focus on shrinking government – hospitals, education, disability services and public sector capability – are precisely those requiring more revenue so that Australia can deliver growth and fairness at the same time. A bit more tax would be a small price to pay if higher revenue and better government sustain Australia’s social compact and ensure that the grand globalisation bargain sticks for the long term.

Instead, just in time for another budget, the Coalition’s new economic leadership has reverted to form: Australia must live within its means, and this can only be done by cutting government spending. For this treasurer, like the last, the only way is down: lower taxes, smaller government and, so far, worsening polls. We’re back to the absolutes – only without, so far, catchy slogans like “stop the taxes.”

Yet it’s unclear what “no tax increases” actually means. Last week, chatting on ABC Radio’s AM a day after fifty prominent Australians urged the government not to cut company taxes, Scott Morrison was unequivocal. Cutting spending will “strengthen our national finances against external shocks.” Lifting taxes “only weakens the national economy.” What, he might have asked, would the agencies that issue Australia’s cherished AAA credit rating think of that?

Only he didn’t have to. If Joe Hockey took in the non-event in front of the Panthers’ shiny new gymnasium with a touch of schadenfreude, an overworked Moody’s analyst somewhere in East Asia with half a hemisphere to monitor was closer to exasperation. While Morrison was on the air, the Bloomberg wires were carrying an unhelpful headline: “Australia debt will rise without revenue measures, Moody’s warns.” Having witnessed the fierce democratic resistance to spending cuts, and observed the persistence of the debt the government promised to end, Moody’s had come to the logical conclusion. To safeguard Australia’s credit outlook, a bigger tax take has to be part of the picture.

The good news is that, whatever the government’s low-tax pretensions, revenues have actually been increasing under both Hockey and Morrison. The government has been adamant that whatever the problems we face in matching community expectations with government resources, more tax isn’t part of the answer. That hasn’t stopped them from banking on a big recovery in government coffers to do just that. Between 2007–08 and 2010–11, the ratio of tax receipts to GDP dropped from 23.7 to 20.0 per cent – the biggest fall since the 1950s. Since then, albeit in painfully slow fashion, the tax take has been rising. Tax receipts are projected to recover to 23.9 per cent of GDP by the early 2020s. If the Coalition happens to remain in government that long, it will have presided over the biggest trough-to-peak rebound in revenues in at least three decades.

Any recovery in revenue undermines the near-term narrative about the pressing need to slash expenditure. But Morrison (like Hockey before him) is more concerned about how tax is increasing – or more precisely, which taxes are doing the heavy lifting. Collections from the GST are declining in relative terms, while revenues from personal and company income taxes are growing. On last year’s budget projections, income taxes will account for almost 70 per cent of total tax receipts by the end of the decade, the highest proportion since the GST was introduced in the late 1990s. The recovery might be even larger if bracket creep remains intact and if tax commissioner Chris Jordan’s stark warnings to corporate tax dodgers that “enough is enough” bear fruit.

Some economists say that taxing “mobile” labour and capital is inefficient, but income and company taxes do lots of the redistribution that makes for a fairer system overall. They are popular targets for tax cuts for both reasons. With the Coalition ruling out any increase to the GST, however, a major shift away from these direct taxes is unlikely. That is unless government embraces some more ambitious ideas. Australia’s leading economists are practically falling over themselves with suggestions for raising money in ways that would be fairer and more efficient. Proposals include shifting more revenue towards taxes on land, rents and pollution, as well as plugging huge holes in the existing tax bases and removing overly generous concessions. Many of these are realistic options for closing the deficit sooner, in a way that shores up the budget for the long term. If advocates of personal and company tax cuts are not prepared to explore better alternatives than the long-debated and frequently decried revenue-neutral switch from income tax to GST, they can hardly blame the politicians for deciding to play it safe.

If tax revenues do recover to 23.9 per cent of GDP without being derailed by the next round of tax handouts or another global crisis, then the medium-term budget projections assume, consistent with recent practice, that revenue will be capped at that point. Last year’s Intergenerational Report made the same assumption for its longer-term projections. This benchmark is equivalent to the average (that is, below the highs) of the 2000–07 period, described by the Committee for Economic Development of Australia’s Balanced Budget Commission as the level that governments of both colours have pegged as the “maximum average that would be sustainable.” On current projections, this would be enough revenue to deliver tiny and temporary surpluses in the mid 2020s. After that, the budget would return to deficit, or more aggressive spending cuts would be needed to keep the books balanced.

There is another way to match government resources to community expectations, though it poses a question that neither of our major parties is inclined to ask: is it time to revisit their commitment to a tax-to-GDP ratio that places Australia at the low-tax end of the spectrum compared to its developed-economy peers? What if, as well as reprioritising and reviewing spending, we raised a bit more revenue overall when and where we decide it is justified? Governments of both stripes have been willing to make the case for extra revenue in the right circumstances. The Abbott government’s temporary budget repair levy on the highest-income earners was a rare, pragmatic and largely uncontroversial departure from the reverse class warfare favoured in 2014. More notably, the National Disability Insurance Scheme – a popular bipartisan expansion of the role of government into facilitating disability services – has been funded in part by a 0.5 percentage point increase in the Medicare levy. And despite the current government’s low-tax fixation, the upcoming budget looks set to include revenue-boosting measures involving the tobacco excise, superannuation concessions and multinational tax avoidance. Even in an era characterised by a relentless debt-and-deficits narrative and anti-tax scare campaigns, there have been indications that the answer to this question of greater revenue is not so straightforward as to be dismissed out of hand.

The progressive design of our tax system, combined with a parallel set of decisions on social expenditures, reflects another important choice Australia has made. We have decided to direct our taxes and transfers towards achieving fairness in a way that few other countries either attempt or achieve. These measures are relatively cheap: as with tax revenues, our social expenditures are well below the OECD average as a share of GDP. They are typically subject to asset and income tests, and funded out of general revenue rather than linked to how much someone has contributed in social security taxes from his or her earnings. As a result, our social expenditures are more targeted to the poor than is the case in any comparable nation: for each dollar we spend, we get more bang for our buck reducing poverty and inequality. As ANU Crawford School professor and Centre for Policy Development fellow Peter Whiteford puts it, Australia is “closer to the Robin Hood end of the spectrum than any other country.”

This means that when government cuts social expenditures as part of an undifferentiated attack on welfare or entitlement, or in the name of budget sustainability, the impacts inevitably fall disproportionately on the poor. The effect is accentuated if cuts extend to investment in public education and health services, which are an equally crucial part of Australia’s redistributive bargain. Unless you believe that the impact of such cuts will be more than offset by a resultant increase in employment, higher wages, or more efficient and effective schools and hospitals, then the implication is higher inequality. And, as the International Monetary Fund has found, inequality is itself bad for medium-term growth.

These are complex issues, and there are important policy challenges stemming from an ageing population and the interactions between income-tested payments and incentives to work. But a good starting point is to recognise that the sustainability of social expenditures involves not only their affordability in the budget, but also their adequacy and effectiveness as policy tools. As Peter Whiteford argued in Inside Story in November, it is not true that government spending is growing out of control; the bulk of Australia’s social expenditures are broadly sustainable even within anticipated revenue constraints. Despite the tabloid chatter, the share of the working-age population receiving basic social security payments fell from one-in-four in the mid 1990s to one-in-six by 2008, and has been broadly stable since, despite slower growth and higher unemployment. But benefits provided, particularly in the case of unemployment, are low and they are only growing slowly: because they are indexed to the CPI rather than wages, benefits will rise at a rate that will see the living standards of the least well-off fall relative to the wider population, even as Australia becomes richer over time. (The Newstart payment for unemployed people has increased only fractionally in real terms since 1994.)

In these areas, the real question about sustainability isn’t whether we can afford what we have but whether the low level of resources we currently devote is enough to provide a safety net that is worthy of the vision and values that once underpinned it.

This takes us back to Scott Morrison and the idea that, even if we wanted to make different decisions about tax and spending, Australia can’t get ahead in the global economy with more revenue or more redistribution. As Morrison claimed repeatedly in various formulations on AM, in a global economy, “increasing the tax burden on the economy” is incompatible with “jobs and growth.” It’s an old and well-rehearsed view. Last year’s Re:think tax discussion paper skipped straight to the point. Paragraph 1.1 read:

In recent decades, changes in the global economy have put strain on tax systems around the world and Australia has been no exception. Key factors include technological change (particularly the rise of the digital economy), highly mobile investment and greater labour mobility. These developments pose two critical issues for tax systems: they can weaken the ability of tax systems to raise revenue from traditional tax bases and they can increase the economic costs of taxation, dampening economic growth.

These arguments have to be taken seriously, especially for an economy that relies heavily on foreign trade and investment. But there is another side to the story. Effective income redistribution and good government, and the revenue to pay for it, are absolutely fundamental to the political and economic bargain that makes globalisation possible. Economic openness and free markets can be a powerful force for improving efficiency and living standards if harnessed correctly. But the practice doesn’t live up to the promise unless government gets its role right. The gains from trade are distributed unevenly. There are winners and losers. Big exposures create big risks. Effective redistribution and regulation is required to ensure that the risks are mitigated, the gains do not accrue to a privileged few and most people are better off. And a strong safety net is needed to protect those who lose out.

Failure to deliver on both sides of this bargain discredits the policies that make broadly shared benefits from globalisation possible. It also undermines the political systems and institutions that are responsible for maintaining this balance.

We only have to look to the United States to see how fragile things can become when government gets the balance wrong. On paper, the United States has one of the more progressive tax and transfer systems in the OECD. But the amounts it raises in tax and spends on the safety net are relatively low, meaning that taxes and transfers do little to narrow the high and rising gap between rich and poor. This dynamic exploded, economically and politically, when an under-regulated financial sector tipped the United States into its longest and deepest recession since the second world war, taking much of the world down with it. Working-class Americans who battled through the downturn, and those young enough to have missed out on the boom years altogether don’t need to have read the fine print in the Trans-Pacific Partnership Agreement to see the writing on the wall. When government strips itself of the mechanisms for managing risks and sharing the benefits of trade and globalisation, those people lose.

Understandably, many Americans are revisiting the “small government” choices that an earlier generation of purists, insiders and ideologues made on their behalf. The rush away from mainstream candidates in this presidential primary season reflects the frustration of those who got a bad deal. This is an exciting prospect for progressives who want to re-examine the baked-in inequities of the post-1980s liberal order. You don’t have to agree with the platform to be energised by the policy freedom apparent when a leading contender for the White House is a democratic socialist from Vermont. But the mood that has carried Donald Trump and his wall-building promises to the top of the Republican presidential pecking order also carries unmistakable risks.

Australia might seem a long way from its Trump moment. But it is hard to be complacent when almost 40 per cent of eligible Australians vote for minor parties or independents, or informally, or not at all. Four years ago, before he was ousted by the incoming Coalition government, then Treasury secretary Martin Parkinson said that the shift to a post-boom economic footing required a considered and informed national debate about “what governments can and should provide, and how these will be funded.” By the time he was restored to influence as the head of the Department of Prime Minister and Cabinet, Australia had cycled through four prime ministers, abandoned white papers on tax and Federation reform, and confirmed that blunt cuts to pensions, health and education were not only an unoriginal but also a decidedly unpopular answer to fiscal challenges.

In the meantime, Australians’ living standards have gone sideways and, as all treasurers like to remind us, the challenges we face are becoming ever more daunting in a competitive global marketplace for finance, investment and ideas. This is precisely why it is so pernicious to present the public with false choices on revenue, spending and globalisation. Cloaking ideological positions in arguments of economic orthodoxy or inevitability shuts down debate and politicises issues when all sides might otherwise be prepared to engage in good faith. Blunt populist attacks on welfare and public spending privilege existing winners and damage the redistributive mechanisms that make our social compact and openness to the global economy sustainable.

Such an approach also comes at a spectacular cost to the policy expertise and capacity that the public sector needs to help Australia do better in that global economy. It’s hard to imagine the Australian Taxation Office doing a better job cracking down on tax-dodging multinationals, the Australian Securities and Investments Commission improving its oversight of the financial sector, or CSIRO offering up cutting-edge science and innovation when in the past few years these three agencies alone have lost almost 6000 jobs between them. That is just the prominent tip of an iceberg that includes sweeping cuts to public service funding and permanent staffing levels in state and federal government departments. The resulting policy amnesia and rundown public sector capability undermine the effectiveness of governments to do exactly what we expect them to: safeguard future generations and plan for the long term.

Voters in Australia and elsewhere seem to be saying that if this is the best we can do in the contest of ideas, we might as well try some new combatants. At a minimum, we could try some fresh thinking for some old problems. The opposition’s decision to take some big risks in the tax reform debate has raised the stakes. As February’s brouhaha over negative gearing showed, unprincipled opposition to good ideas can make even the most agile opponents look ordinary. When the country’s political leaders next descend on Lindsay it will be on an election footing, with every sign that their parties will be neck and neck in the polls – a situation that was a long shot just a few months back. With everything on the line, the odds of some long-overdue straight talk on tax and spending are not that great. But stranger things have happened. If they can dispense with the lines we’ve all heard before, including that higher revenue cannot be part of the answer, then the next political leader standing in front of a snarling panther might find an audience that is willing to listen. •