Inside Story

Time to talk about tax

A grown-up conversation about how we fund better services is long overdue

Tim Colebatch 14 October 2022 3618 words

We need to face the inevitable, says former Australian Competition and Consumer Commission head Rod Sims. Bianca De Marchi/AAP

Rod Sims wasn’t mincing his words. Launching the Australia Institute’s revenue summit at Parliament House the former competition watchdog began by proposing the event be renamed the “What Do We Want Australia to Be?” summit.

To Sims, and many others around Australia, that’s how crucial the new tax debate is. It’s no longer just about whether Labor waves through Scott Morrison’s stage three tax cuts, amends them or abandons them. There is a much wider question, with much greater consequences for our country.

Governments can never satisfy us all. But from hospitals to defence, from childcare to aged care, from schools to fixing potholes, government services are falling way short of what Australians need and expect from their country. That shortfall helped Labor get into government. Now Labor’s there, what is it going to do about it?

Labor came to office as the flagbearer of many Australians’ hopes for a government that would end the chronic underfunding of education, health and welfare, not to mention the miserly $47.74 a day we give the unemployed to live on.

Some of those areas have now reached the point where things fall apart. GPs, tired of being cast as the poor cousins to specialists, are deserting country towns and suburban practices, and young doctors are not replacing them. Aged care homes and childcare centres are perpetually short-staffed because low pay and high workloads create constant turnover. Across the board, Australia is short of skilled workers because apprentice wages are so low that only half of them stay on to complete their training.

We could all add more examples. To me the most important is that Australia now finds itself in the most dangerous environment since the second world war, yet the Coalition kept defence spending to just 2 per cent of GDP (lower than in the 1960s when we faced no real threat) and settled on submarines that will be delivered between 2038 and 2050.

Faced with all these needs, Labor nonetheless went to the election with a platform of relatively modest, tightly targeted new spending, promising no new taxes and a big tax cut primarily for those in least need.

You can understand why. It wanted to be elected, so it played safe. And in 2025 it wants to be re-elected, so it doesn’t want to risk breaking any promises now. At least, not yet.

You see what Rod Sims meant? All those spending goals require more money, much more money. In the short term, the only way governments can get more money is by raising taxes, to reallocate spending from private purposes to public ones. What do we want Australia to be?

The looming budget is the government’s first test — and the timing is not good.

The fallout from Russia’s invasion of Ukraine (amid other factors) has lifted global food prices almost 50 per cent above pre-Covid levels, blown global energy prices to several times pre-Covid levels, provided cover for businesses everywhere to sneak their prices up — and could throw some big economies into recession.

The International Monetary Fund this week estimated that after decades of low price growth, global inflation has jumped to 8.75 per cent. Even with central banks slamming the brakes on hard (which the IMF applauds), it predicts global prices will rise 6.5 per cent next year before returning to something like normal in 2024.

Contrary to some commentary, the IMF is not forecasting a global recession; its half-yearly World Economic Outlook is towards the optimistic end of the spectrum. It predicts the global economy to grow by a relatively low 2.7 per cent next year, dragged down by global supply disruptions, a permanent slowing of China’s growth rate (to 4.4 per cent) and the fallout from the war in Ukraine.

It expects the United States to keep growing, albeit slowly (1 per cent); other forecasters expect much worse. The IMF envisages some big developing economies like India (6.1 per cent) and Indonesia (5.0) more or less hurdling the upheaval, while Brazil, Russia and Turkey now seem to be doing better (or in Russia’s case, less badly) than was forecast six months ago.

If there is a recession, it would be in the advanced economies — whose growth collectively is expected to slump to 1.1 per cent — and centred in Europe. Germany, Italy and Sweden are forecast to experience mild recessions: no upsurge in unemployment, just a year without growth.

On the IMF’s forecast, Australia will also be hit. It expects our growth to fall to 1.9 per cent next year and 1.8 per cent in 2024, and to stay low thereafter. Unemployment would gradually edge back towards 5 per cent, per capita growth would total just 4 per cent over five years. Governing Australia would not be fun.

These are only forecasts. But clearly the budget outlook is far worse than the one Josh Frydenberg unveiled in his budget in March. And even that projected a string of hefty deficits as far as the eye can see. At a time of record mineral prices and low unemployment, there is no good reason why Australia should have run up new debt of $32 billion in 2021–22.

A cardinal rule of budgeting is that, by and large, you pay for what you spend. If you don’t, you are leaving the bill for the new generation to pay. There are exceptions: you run deficits in bad times and cover them by running surpluses in good times. Infrastructure spending largely benefits the next generation, so it is fair to borrow to build. But at federal and state level — especially in Victoria and the ACT — governments have simply lacked the courage to make us pay for what they spend.

This combination of a grim global outlook, a grim state of the budget and a government still new to the job does make it likely Labor’s first budget will be, as treasurer Jim Chalmers keeps saying, responsible.

I assume he means that Labor will give priority to reducing the budget deficit. And that in working out the numbers, Treasury will err on the side of caution in guessing future energy prices, and hence company tax revenue. And that any new taxes and spending will implement the commitments Labor made in the campaign, and little else. And, of course, that Labor will go after the Coalition programs it has identified as rorts.

All that buys time. But circumstances are conspiring to force Labor to confront Rod Sims’s question: what does it want Australia to be? To deliver First World services, you need a First World revenue base. And for Australia, that means higher taxes.

Let’s take the long-term issue first. Australia is a low-tax country. At the government’s recent jobs summit, economist Ross Garnaut cited OECD figures showing that total federal, state and local government tax revenue as a share of GDP was 5.7 percentage points lower than the developed country average. That’s a shortfall of almost $140 billion a year.

The IMF’s data for total revenue reports a similar gap: governments in Australia raise 5 percentage points of GDP less revenue than the median advanced economy. In 2019 federal, state and local governments raised 34.6 per cent of GDP, well below 40.7 per cent in Canada (the country we most resemble), 46.5 per cent in Germany, and an average of 50.6 per cent in Scandinavia.

In part, that’s because retirement income in Australia is semi-privatised through superannuation, whereas retirees in almost all other Western countries, even the United States, rely on government-run retirement benefits funded by a separate social security tax on income. (The reason Australia appears to rely so much on income tax is that we have only one income tax. Most other Western countries have two, under separate names.)

But the OECD’s data show Australia also has the highest private spending on education of any OECD country, and the third-highest “voluntary” private spending on healthcare. Unemployment benefits are among the very lowest in the Western world.

Once, Labor ministers might have rebelled against this two-stream system in which the best services are reserved for those who can pay the fees demanded in the private sector. Now, as we saw when the Gillard government squibbed on the Gonski report’s school funding reforms, preference to private schools is one British tradition Labor still loyally supports.

In theory, Labor could use more desirable ways to meet the cost of bringing Australia’s services to the standards we expect. It could reduce spending on lesser priorities and reallocate the savings. Or it could take on the politically difficult economic reforms needed to speed up Australia’s sluggish rate of productivity growth.

In reality, speakers at the revenue summit agreed, the gap between today’s service levels and those we expect in aged care, the health system and so on is too vast to be filled by cutting services in other areas. Sims called it “self-evident” that savings from those cuts, while they could and should be made, are not on the scale needed to get us where we want to be.

For ten years until recently, Sims chaired the Australian Competition and Consumer Commission. The experience has made him sceptical of the potential for dramatically improving our productivity and hence growing a bigger economy. Rapid productivity growth, he said, requires increased competition — and the reality is that business is reducing competition, not increasing it.

“Our political debate always favours low taxation,” he said. “We have to point out that what comes with that is low expenditure. And we have to keep asking the question: is that what we want? If you want to spend extra money, you have to raise extra revenue. There’s just no avoiding that.”

He went on: “If you are against higher taxation, then you are against higher government expenditure… Many do not realise that in opposing taxation they are opposing extra spending on health, education and much else. I think we need higher taxation. I think it’s unavoidable.”

Why? Sims and other speakers at the summit gave several reasons:

1. Australians need better services

Annie Butler of the Nurses Federation cited the findings of the aged care royal commission: neglect and substandard care are widespread and systemic in aged care because the industry is underfunded by $10 billion a year. “Ridiculously low” wages lead to high staff turnover and hence shortages.

ACTU secretary Sally McManus argued that a lot of the crises Australia is experiencing in health and other services result from years of “chronic underfunding.” Economists predict that 30 per cent of all jobs created in the next decade will be in caring for others, but unless those jobs are better paid, workers will not stay in them. Our priorities have to change.

2. The transition to a low-carbon economy

The big economic reform facing Labor is going to be an expensive one: valuable in the long term but costly upfront. Business and government will need to invest tens of billions of dollars in building the solar and wind farms that will generate the power, the batteries that will store that power, and the transmission lines that will bring it from the inland to the cities. And if our coal stations are to close down by 2035, this money needs to be spent in the next decade or so to guarantee that we will still be able to turn on the lights.

The task is made even bigger and more crucial by the need to transition cars from oil to electricity and households and businesses from gas to electricity. Tim Washington, chair of the Electric Vehicle Council, told the summit that electric vehicles comprise, at best, 3 per cent of Australian car sales, compared with 15 per cent in other Western countries. With a global shortage of EVs likely to persist, he urged business and government to manufacture them here, using Australian designs, software, metals and lithium to create an entire value chain. He’s not likely to get that.

Fortunately, there is an ideal solution. Unfortunately, only the Greens, teal independents and economists support it. It is a carbon tax.

Sims confessed he found it baffling that so many Australians want action on climate change but instantly condemn the idea of a tax on carbon. Governments are going deeper into deficit to subsidise solar panels and electric vehicles, whereas the carbon tax would give the whole economy an incentive to decarbonise while raising taxes to fund the investments required.

“No such transition can be painless,” he said. “We need to decide whether we are serious about climate change. If we are, then it can be funded by a tax that will have the benefit of directly changing behaviour while insulating low income earners [through compensation].”

3. Get out of deficit and start paying down debt

Australia has less government debt than most Western countries, but only because the Hawke, Keating and Howard governments made fiscal responsibility a priority from 1985 until 2005. In both 2009 and 2021, as a resilient Australia emerged from the global financial crisis and Covid lockdowns respectively, our governments kept piling on stimulus as if money were no object. And the pollies’ fear of tax rises — much of it due to the vicious hostility of the Murdoch press towards anyone, especially anyone from Labor, brave enough to impose them — has kept us in deficit ever since.

Federal government revenue in this century peaked at 25.6 per cent in 2005–06, when it was 24.1 per cent of GDP. Since then spending has swollen to 26.8 per cent of GDP. Yet, far from keeping pace, revenue has fallen — because governments are frightened of raising taxes.

As ANU economist Ben Phillips put it, “We have plans for increased expenditure, but not for increased revenue. All we’ve got to increase revenue is bracket creep: it’s sneaky, but it works.”

(Bracket creep is the additional tax you pay when inflation pushes more of your nominal income into a higher tax bracket. The stage 3 tax cuts are often defended as simply handing back that extra tax. But only the high income earners will get their bracket creep back, and they get back more than they lost.)

Phillips estimates that Australia faces a revenue gap of $25 billion to $50 billion a year for the next decade. The summit heard lots of suggestions on how to close that gap: one that Labor has flagged for this budget, and others that we should be debating and putting to a new tax review.

Sims alone proposed five:

• Crack down on multinationals avoiding tax by non-commercial transfer pricing, including paying ridiculously high interest rates or “marketing fees” to a head office in a tax haven.

• Ensure Australians benefit when our mineral and energy resources are extracted. Norway takes almost 80 per cent of the revenue from its oil and gas fields, yet Australia allows companies to take those resources for virtually nothing. The petroleum resource rent tax, which is meant to do the job, desperately needs big repairs — and an extension to cover coal and iron ore.

• Introduce an excess profits tax, as the European Union has done recently. Australian Bureau of Statistics figures show that in the Coalition’s nine years in office, mining output rose by $195 billion but wages in the industry by just $5 billion. Net profits by the mining industry grew by $190 billion, yet taxes on mining shrank by $0.1 billion. If there is ever a time for a tax on excess profits, it is in Australia now.

• A carbon tax. (See above.)

• At state level: a comprehensive land tax covering all private property except farmland, to replace stamp duty on conveyancing. Economists generally see land tax as a most efficient tax. Sims called it a progressive tax, “based on assets that cannot be moved,” that produces a steady revenue flow.

• Road-user charges will be inevitable as electric vehicles replace petrol-driven cars. Their advantage is that they can be fine-tuned for vehicle type (trucks pay for the damage they do to roads) and time of day (peak-hour pricing).

Other speakers added at least another five:

• Prune tax breaks for superannuation.

• Prune or phase out negative gearing of property investments.

• Scrap fossil fuel subsidies, including the mining industry’s exemption from fuel excise.

• End concessional tax rates for family trusts.

• Increase the Medicare levy to pay for extra spending on aged care.

Sims emphasised that the reforms would need to be sold as a package, with compensation where appropriate, as the Hawke government did when it reformed tax in 1985. That package was preceded by a tax review by Treasury and a tax summit where a wide range of groups put their case.

Albanese has pledged no new taxes in this term apart from the ones Labor took to the election (primarily a crackdown on tax avoidance by multinationals — no votes lost by tackling that). But independent MPs Allegra Spender (Wentworth, NSW) and Zoe Daniel (Goldstein, Victoria) both urged a new tax review “with everything on the table” — with Spender adding “including the GST” and a hopeful plea: “We need to have grown-up conversations about tax.”

Well, good luck with that. I suspect most tax economists would agree that the GST rate should be raised, or its field widened, or both. New Zealand lifted its GST rate to 15 per cent back in 2010 without suffering any visible social collapse, and its GST is far more comprehensive than ours. That’s the main reason its government can spend more than ours.

The left needs to stop demonising the GST and think of tax reform as a package. You can introduce or increase or widen a GST fairly so long as you design the right package — as we saw in 1999 after the Australian Democrats stopped the Liberals using the GST to shift more of the tax burden onto lower and middle income earners.

But so long as we are unable to see any bipartisanship on tax, the GST will remain a no-go area. And bipartisanship is probably off the agenda as long as Peter Dutton is Liberal leader.

Where does that leave the stage 3 tax cuts? It looks like this movie has ended now, with treasurer Jim Chalmers apparently losing the fight despite his skilful attempts to persuade colleagues to revise, reduce or even scrap the cuts — which would be in line with his theme of protecting the budget in increasingly dangerous times and giving support only to those who really need it.

But good movies these days have a sequel, and these tax cuts won’t take effect until mid 2024. Given his impressive debut in the role, Chalmers has time to perfect it when he plans his next budget. He knows the case for either abolishing the cuts or reducing and retargeting them is very strong.

Stage 3 contains three elements:

• abolish the 37 per cent marginal tax rate on income earned between $120,000 and $180,000

• raise the threshold for the 45 per cent top rate from $180,000 to $200,000

• reduce the standard 32.5 per cent rate to 30 per cent — which would then be a flat tax rate for all income from $45,000 to $200,000.

Modelling by the Parliamentary Budget Office and by Ben Phillips found the first and the third are the expensive items. And the consensus at the summit seemed to be that if there is compromise, we should keep the third while scrapping the first.

A few points are important to note.

First, these tax cuts were proposed by treasurer Scott Morrison way back in 2018, six years before they would take effect. Since then, we have had a global Covid pandemic and the global inflation breakout. Committing to tax cuts six years before they took effect had no economic rationale. What drove it was politics. Morrison assumed the budget in 2024 could afford it. He was wrong.

Second, the cuts follow stage 1 (in 2018), directed to lower-middle income earners, and stage 2 (in 2020), focused on upper-middle incomes. Stage 1 was small, and has since been abolished by the Coalition itself. Stage 2 was bigger: it cut taxes for people earning less than $90,000 by $10 a year, and taxes for people earning over $120,000 by $1890 a year. The idea that high earners have been kept waiting while others have had tax cuts is quite untrue.

Stage 3 is seriously big money. The Parliamentary Budget Office last year estimated their cost at $18 billion in year one (2024–25), then more than doubling to $37 billion by year nine (2032–33). Treasury is now revisiting those numbers — and the cost will almost certainly be even higher now.

But even on the PBO’s 2021 estimate, that would reduce total government revenue by 3.5 per cent initially, and by more than 4 per cent by the start of the 2030s. That is a huge cut in revenue at a time when the budget is unable to cope with Australia’s existing spending needs, let alone the new ones coming over the horizon from the ageing of our population, China’s attempt to assert hegemony over the region, the excesses of the NDIS, and so on. We need tax rises, not tax cuts.

Third, the PBO estimates that 78 per cent of those billions of dollars would go to the richest 20 per cent of Australians. That’s largely because they pay 68 per cent of all income tax — but that in turn is because they get such a high share of the nation’s income. They would rank low on a list of those in need.

That said, it seems fair to say that the threshold of $180,000 for Australia’s top tax is too low. If Chalmers and his colleagues want to compromise, one option they might consider is to reduce the 37 per cent rate to 35 per cent with the same thresholds as now — but add a new 40 per cent rate for income from $180,000 to $200,000, and a timetable to raise that threshold to $250,000. Over time, that would save the budget a lot of money, without taking everything from those who would gain from the plan Labor promised them. •