Michael Keating

  • MICHAEL KEATING. The Productivity Commission on more effective government. Part 2 of 2.

    The Productivity Commission’s findings regarding the effectiveness of Australia’s public services reflect the findings of many previous reviews. Fundamentally a change of culture is needed in favour of well-calculated risk taking and, I would add, greater independence based on the pursuit of evidence through comprehensive program and policy evaluation.  (more…)

  • MICHAEL KEATING. The Productivity Commission on more effective government. Part 1 of 2.

    This article, the first of two which discuss the Productivity Commission’s recommendations for more effective government, focuses on how to improve Commonwealth-State relations, and fiscal disciplines and accountability. The conclusion is that the Commission’s recommendations are for the most part disappointing. They fail to take account of the practical difficulties in better matching taxable capacity with expenditure responsibilities, and the extent to which governments are already held to account for achieving budget targets.  (more…)

  • MICHAEL KEATING. Tax Cuts: What can we expect? Part 2 of 2

    In Part 1 of this series, posted yesterday, the conclusion was that restoration of a sustained Budget surplus would require a combination of expenditure cuts and tax increases. This second Part 2 finds that the projected swing from Budget deficit to surplus requires a swing of 3 per cent of national income. It then explores the scope for expenditure cuts and tax changes to achieve this swing. The conclusion is that most of the required swing will have to be achieved by a net increase in taxation revenue relative to GDP. (more…)

  • MICHAEL KEATING. Tax cuts – what can we expect? Part 1 of 2.

     

    The evidence suggests that Malcolm Turnbull just doesn’t have the fiscal room to responsibly offer income tax cuts, which means it was very irresponsible to raise expectations in this way. Part 1 in this series of two articles examines the relationship between taxes and economic growth, and the demands upon the revenue to repair the Budget. In the following Part 2, the scope for expenditure cuts and the future of tax reform is discussed. The conclusion is that Australia will need to increase the share of tax revenue relative to GDP.  (more…)

  • MICHAEL KEATING. Should VET be contestable?

    The introduction of contestability into training markets is often cited as a prime example of the failures of privatisation. However, the totality of the evidence is rarely examined in support of this allegation. This article aims to fill this gap. It finds that a contestable training market can fail if not properly regulated, but now that Australia’s training market is being properly regulated, the quality of training is being preserved, while competition is reducing costs and increasing choice and responsiveness to customer needs. (more…)

  • MICHAEL KEATING. Trump’s Economic Policies: Part 2 of 2

    In Part 1 of this series of two articles, yesterday I examined the impact of President Trump’s economic program on the American economy. Today’s article discusses the impact of the Trump economic program on the rest of the world, and Australia in particular. The key danger is that Trump will further encourage a rise in protectionism, that will damage the foundations of the open economy that in the last seventy years has delivered the biggest rise in living standards in human history. However, continuing economic growth inevitably involves economic transformation, and maintaining support for the open economy will depend upon programs that better assist workers to adapt to structural adjustment pressures, from whatever source. (more…)

  • MICHAEL KEATING. Trump’s Economic Policies: Part 1 of 2

    President Trumps economic policies have so far received much less attention than his foreign and national security policies. The examination here and in a following article concludes that the economic policies are based on fundamental contradictions and are therefore bound to fail. This failure will be felt by Americans and by the rest of the world. (more…)

  • MICHAEL KEATING. Can Parliament control Government Expenditure?-The Use of the Advance to the Minister of Finance

    The High Court has upheld the Government’s decision to use the Advance to the Minister of Finance to pay for its survey of attitudes regarding same-sex marriage, and notwithstanding that funding for this survey was unlikely to gain parliamentary approval.  Furthermore, the Court found that while the Finance Minister’s decision must be “formed reasonably”, he “is not obliged to act apolitically or quasi-judicially” in determining access to the Advance. My concern is that this High Court decision may have tipped the balance too far against parliamentary control of government expenditure, which is a key feature of our democracy ever since Magna Carta. The question we now face is what should and can be done to restore this parliamentary control, while still allowing governments to respond to unforeseen and urgent circumstances? (more…)

  • MICHAEL KEATING. Contestability and Defence Advice

    Major defence decisions have long been made with a minimum amount of consultation. That is certainly true of the recent decision to give the French Naval Group a monopoly over the design and build of Australia’s next submarine. The way this decision was made seems to reflect a long-standing view that civilians are not competent and cannot be allowed to question military expertise. This post suggests this is not good enough as many relevant considerations in defence planning and acquisitions range well beyond military expertise. (more…)

  • MICHAEL KEATING. Is it legitimate to pay for a postal plebiscite using the Advance to the Minister of Finance?

    This article questions the legitimacy of by-passing the need for Parliament’s approval by using the Advance to the Minister of Finance to pay for the Government’s postal plebiscite regarding attitudes to marriage equality for same-sex couples. (more…)

  • MICHAEL KEATING. Electricity Prices.

    Electricity prices are a hot topic at present. Amidst the welter of claim and counter-claim as to what is the cause of higher electricity prices, there has been remarkably little use of the available evidence.   (more…)

  • MICHAEL KEATING. Why Blame Neo-Liberal Economics: A Response

    My previous article on Why Blame Neo-Liberal Economics, which argued that neo-liberal economics was not a main cause of increasing inequality, drew an unusually large and mostly critical response. While it is not feasible to respond to all the detailed points that my many critics have raised, in this response I propose to focus on two big issues: (i) what is neo-liberal economics and how does it influence policy outcomes, and (ii) why has inequality increased since the 1980s. I will also briefly discuss the policy implications that flow from my analysis. (more…)

  • MICHAEL KEATING. Why Blame Neo-Liberal Economics?

    The claim is frequently made that neo-liberal economic policies are responsible for an increase in inequality. However, no supporting analysis is ever offered to sustain such claims; the obvious reason being because they reflect the author’s imagination and prejudices. (more…)

  • MICHAEL KEATING. An appreciation of Ian Marsh.

    Ian Marsh who passed away last week, was a highly original thinker with the genuine curiosity of a true intellectual.

    Ian liked to describe himself as one of the last ‘Deakinite Liberals’. This apt description reflected:

    1. Ian’s contributions to industrial policy, and especially how the state can help foster innovation, and
    2. Ian’s preference for a more consensual negotiated approach to policy making, such as applied during the first decade of the Australian parliament. 

    (more…)

  • MICHAEL KEATING. The British Election and Brexit

    Mrs. May called the election ostensibly to strengthen her mandate in the forthcoming Brexit negotiations. Although she failed to strengthen her majority, it is doubtful if the election result will have any impact on the Brexit negotiations. (more…)

  • MICHAEL KEATING. The 2017 Budget – A welcome change in direction. Part 1 of 2

    This Budget represents a welcome change in direction. Forget the politics, it deserves to be supported. This latest Coalition Budget finally reflects a realistic appraisal of Australia’s fiscal needs.  (more…)

  • MICHAEL KEATING. The 2017 Budget – A welcome change in direction. Part 2 of 2

    Budget repair was never going to be easy. That is one reason why it has taken so long with quite a few false starts. While some of the individual decisions in this Budget are debateable, overall the quality of the policy changes is good. Probably a greater concern is that some very significant policy issues haven’t been adequately addressed.  (more…)

  • MICHAEL KEATING. Mid-Year Economic and Fiscal Outlook, 2016

    The Government’s Mid-Year Economic and Fiscal Outlook (MYEFO) released yesterday contains few changes and no surprises. The critical question is whether the path back to surplus is actually credible, especially given the many failed promises in the past. This post examines the government’s economic forecasts that underpin the budget numbers and whether the government’s approach to Budget repair is really viable.

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  • MICHAEL KEATING. Donald Trump and the ANZUS Alliance – Quo vadis series.

    Quo vadis – Australian foreign policy and ANZUS.

    Summary. Dennis Richardson, the Secretary of the Defence Department, recently informed us that the ANZUS Alliance was ongoing, irrespective of who was President of the United States. Of course, this is true, but so what? What was the point of Richardson’s admonition, and what was he hoping to achieve? It would be most unfortunate If Richardson’s comment was a crude attempt to stop the much-needed debate in Australia about how we should adjust to changing circumstances in the Asia-Pacific region and develop a more independent foreign policy as advocated in numerous articles posted on this blog. To my mind it is now more important than ever for Australia to forge an independent foreign policy, given the uncertainties attaching to future American policies and priorities under President Trump. (more…)

  • MICHAEL KEATING. Superannuation Tax Concessions

     

    Almost everyone agrees that Budget repair will only be possible if both the revenue side of the Budget is reviewed as well as the expenditure side. In that context, the tax concessions for superannuation have loomed as a prime target.

    Indeed, the Treasury Statement of Tax Expenditures shows that the annual cost of the present superannuation concessions is almost $30 billion and rising. Furthermore, it appears that 37 per cent of the total value of these concessions flows to people in the top decile of the income distribution. (more…)

  • MICHAEL KEATING. The Future Outlook for Economic Reform

     

    In a recent article in the Sydney Morning Herald, Ross Gittins pronounced that we are ‘staring at the end of the era of economic reform. It has ended because it is seen by many voters as no more than a cover for advancing the interests of the rich and powerful at their expense.’

    Gittins then goes on to cite a lot of evidence that people are disaffected. Thus the size of the support for Trump in the US and Brexit in the UK, and to a lesser extent, the success of minor parties favouring more economic autarchy in Australia, all point to a threat to economic reforms aimed at deregulation and open markets. In addition, Gittins argues that the reform agenda has been captured by the supporters of small government bent on privatising those services that remain funded by government, often with what Gittins claims to be dubious results or worse.

    But according to Gittins, ‘the reformers’ greatest failure has been [to] … ignore their reforms’ effect on fairness’. Indeed, ‘at a time when technology and globalisation are shifting the distribution of market income in favour of the top few per cent of earners they’re pushing “reforms” to make the tax system less redistributive’.

    There is much that resonates in Gittins critique of the present reform agenda and why it is foundering. Nevertheless, I would like to offer a somewhat different perspective. (more…)

  • MICHAEL KEATING. Taxation Reform

     

    Taxation reform is a continuing and topical issue. With a new government and the need for budget repair I am reposting below an earlier article in the policy series by Michael Keating.  John Menadue

    Oliver Wendell Holmes, the great American jurist, is reputed to have said, ‘I like to pay taxes. In this way I buy civilisation.’ However, in contrast to Holmes’ noble ideal, too often today we hear people railing about the burden of taxation, as though it is in some way an unfortunate even illegitimate imposition upon ourselves, our economy, and our way of life.

    Lower taxation has been embraced by all political parties without any evidence that, given our already low starting point, less taxation will in fact lead to higher economic growth, let alone pay for itself. Indeed there is no evidence that the advanced economies with high growth rates of per capita income have lower levels of taxation. Nor have past cuts in our income tax led to faster growth, such as when the top income tax rate was reduced from 60 per cent to 45 per cent. (more…)

  • MICHAEL KEATING. Improving employment participation.

    This is a repost of an article by Michael Keating last year which was part of the Fairness, Opportunity and Security policy series.  John Menadue

    The rate of employment participation and the productivity of those employees together determine the average per capita incomes of Australians, and therefore our living standards. In addition, being employed creates many of the social contacts and sense of self-esteem that are vital to our individual well-being. While arguably the best way to reduce inequality is to create the conditions where those disadvantaged people who are presently on the margin of the workforce get work, or in other cases get more work.

    In short increasing employment participation is most important if governments want to improve living standards, individual well-being, and equality. (more…)

  • MICHAEL KEATING. The role and responsibilities of government.

     

    With the election of the new government, I have decided to repost several articles from our policy series that are still relevant.  One of these is by Michael Keating (below) on the role and responsibilities of government.  John Menadue

    Different possible conceptions of the responsibilities and roles of government are an important backdrop to the policies that will be examined later in this series of articles. The purpose of the present article is to show that despite the ideological debate between the extremes on the Right and the Left of the political spectrum, in practice:

    • The responsibilities of governments have changed little in the last thirty years
    • The roles have changed, but changes in regulatory regimes and the ‘marketisation’ of some services has enabled governments to better fulfil their continuing responsibilities. 

    (more…)

  • MICHAEL KEATING. Brexit – What does it mean?

     

    To the evident surprise of most of the pundits the UK has voted decisively to leave the European Union (EU). The question now is what follows next? (more…)

  • Michael Keating[i]. From Deficit to a Balanced Budget

    The issue of budget repair has not been addressed adequately in the current election campaign. See below an earlier article by Michael Keating on various revenue and expenditure items that need to be considered.  John Menadue

    A Report by the CEDA Balanced Budget Commission

    The Committee for Economic Development of Australia, which has a long history of independent public policy engagement, this week released an important report discussing the options for restoring the Australian Government Budget to balance. (more…)

  • Michael Keating. The 2016-17 Budget. Part 1 of 2.

    The Turnbull Government’s Budget for 2016-17 reflects an essentially ‘steady as she goes’ fiscal strategy. Not that that is a fault – indeed it can be a virtue, especially when matched against the give-aways in other previous pre-election budgets.

    Furthermore, we could not have realistically expected any other sort of Budget, given the extent to which the Government had narrowed its options before Budget day. In addition, a policy of matching every new spending initiative by a saving, is bound to produce minimal change; not least because cutting existing programs typically generates more opposition than the support for the new initiatives. But that said there are a few interesting and useful initiatives in this Budget.

    First, the changes to superannuation go further than just about anybody expected. While the big super funds will not welcome the consequent reduction in the funds that they have to manage, the changes should be widely supported by all but the top 4 per cent of superannuants, as better targeting the tax concessions and improving equity. In particular, I welcome the changes that should help women with broken work patterns. I think, however, that it would have been better to have reduced the threshold for the increased 30% tax on superannuation contributions to $180,000 rather than the proposed $250,000 per annum; the lower $180,000 threshold would then correspond with the threshold for the maximum income tax bracket.

    Second, the other useful initiative is the new approach to assisting young unemployed people make the transition into employment. This represents a marked improvement on the Abbott Government’s harassment of these young people, as if their unemployment was purely their own personal fault. Of course, there are risks that the new approach might be exploited by unscrupulous employers – and that has happened in the past – but this approach does seem worth trying. My main concern is that governments tend to spread the funding too thinly with labour market programs, in favour of assisting more people with the limited funds available, but at the risk of dropping the quality of the assistance to the point where it loses effectiveness.

    Nevertheless, overall, and in stark contrast to the 2014 Budget, this Budget does seem to generally pass the test of ‘fairness’. Perhaps the biggest future concern for fairness is that the Government clearly intends to increase the fees paid by university students to cover an average of 50% of course costs, instead of the present average of 40% of course costs. So far as I am aware there is no evidence that the private benefit from a university education is as high as 50% of the course costs, in which case this change will be unfair and it will very likely particularly impact on enrolments by disadvantaged students.

    I also think that it would have been fairer if the Government had kept the deficit repair levy in place which affects the people in the top tax bracket. After all the deficit is as far as ever from being repaired, and lower income people have been called upon to make bigger sacrifices to help repair the deficit in the past, and they are not now going to get any relief.

    The major criticism of this Budget, however, is that it does not really represent any further progress towards achieving fiscal repair and a return to surplus. On the relatively optimistic Budget projections we are being promised that a surplus will be achieved by 2021. But we have heard that one before, and many have ceased to believe such projections.

    Of course, some will say why should we worry? Certainly Australian Government debt is not high. Even at its projected peak in 2017-18 it will still represent only 19.2 per cent of GDP, much less than half the ratio for the US. And as for the rating agencies they lost all credibility after their incredibly optimistic ratings leading up to the Global Financial Crisis, and they still seem happy to give the US Government a AAA rating.

    Instead, the real concern about continuing budget deficits is that they have already greatly reduced Australia’s capacity to respond to the next external shock to our economy. Furthermore, these deficits are continuing even after twenty-five years of uninterrupted economic growth in Australia. While on the other hand, the risks of an external shock are if anything increasing as the world economy continues to be highly volatile and uncertain, with the outlook for China – our most important trading partner – being perhaps especially problematic.

    Frankly Australia needs a more ambitious medium-term approach to Budget Repair. The Government, however, continues to proclaim that this repair must come from more restraint on the expenditure side, and rules out increases in taxation; even if this is achieved by reductions in tax concessions, which really are an alternative form of expenditure.

    The reality is that on the evidence in this Budget, this Government is running out of options to further reduce expenditure. The Government has made great virtue of its claim that since the 2015-16 MYEFO all policy decisions have been more than fully offset, resulting in a small surplus over the four years of $1.7 billion. But this claim is itself suspect. The claimed surplus of $1.7 billion over the next four years is dependent on a projected net surplus from policy decisions of $5.9 billion in the final year, 2019-20. In the other years, policy decisions have in fact added to the budget deficit, including as much as $3 billion in the forthcoming financial year. While the likelihood of the net $5.9 billion saving being achieved in the last year is highly problematic.

    In addition, this budget is continuing to factor in $13 billion of previous expenditure savings and $1.5 billion worth of revenue increases that have not passed the Parliament. Maybe that will change after the election, and maybe it won’t. In fact, the likelihood seems to be that following the election even if the Government is returned it will not have a majority in the Senate, in which case it really needs a better fiscal strategy to repair the Budget.

    Instead of continuing to remove funding from a lot of small programs, with a loss of services – especially cultural and welfare services – the Government needs to refocus on achieving improvements to the efficiency and effectiveness of the big spending areas such as education, health, infrastructure and defence (as discussed in my article “Fixing the Budget – Part Two” and published in Fairness, Opportunity and Security). But even if the rate of growth in the Forward Estimates for these expenditure functions were reduced by as much as a feasible two percentage points per annum, it is doubtful that would be enough to restore a Budget surplus equivalent to around 1 per cent of GDP which is the medium term target.

    Furthermore, this pre-election Budget strongly suggests that this Government does not envisage that the majority of Australians actually want smaller government. Thus the overall Budget outcome according to the Government’s own figuring is that, even in four years’ time, in 2019-20, total receipts will still represent 25.1 per cent of GDP and payments will represent 25.2 per cent of GDP – both higher than under Labor’s last year in office in 2012-13 when they were 23.0 and 24.1 per cent respectively.

    As the Balanced Budget Commission of experts, appointed by the Committee for the Economic Development of Australia, found Australia has a revenue problem rather than just an expenditure problem. Furthermore, that Commission identified sufficient revenue options that had a reasonable chance of gaining majority support to play the major role in restoring the Budget to a satisfactory surplus (see my post 29 March 2016).

    In sum, sooner or later politicians will find that they have to talk about the revenue options if we want to maintain the present nature of our society and the social obligations that involves. And frankly the sooner that conversation begins the better. But unfortunately don’t expect that conversation to happen over the next two months of this election campaign.

     

  • Michael Keating. The Government’s Plan for Jobs and Growth. Part 2 of 2.

    On Tuesday night the Treasurer announced that this year’s Budget was like none other – this Budget represents the Government’s Plan for Jobs and Growth. Presumably the Government hopes that its Plan will represent such a compelling narrative that it can then sail to victory in the forthcoming election. Accordingly, in this article I propose to assess how the Government’s Plan measures up in terms of its probable impact on jobs and growth.

    As stated in the Budget the Government’s Plan for jobs and growth is based on:

    1. A ten year enterprise tax plan
    2. Continued investment in the national innovation and science program
    3. Securing an advanced local defence industry
    4. Opening up more export opportunities through trade agreements
    5. Its plan to get more than 100,000 young people into jobs.

    According to the Government’s own Budget forecasts, however, the growth in output over the next four years is expected to be relatively poor, and notwithstanding its Plan. In fact the forecast growth in GDP has been revised down yet again, and is now expected to continue growing by less than its potential in the next 2016-17 financial year. Indeed it is precisely because of this weak economic outlook, that the Reserve Bank took its decision on Budget Day to reduce interest rates to the lowest level ever for the cash rate of 1.75%. Of course, the Bank and the Government attributed the timing of this decision to the recent low inflation numbers, but those numbers only provided the opportunity to reduce interest rates. The need to reduce them was occasioned by the inadequate level of aggregate demand, and especially the poor rate of business investment in the economy.

    The good news, as the Government keeps reminding us, is that around 300,000 jobs have been created in the last year or so. But these new jobs are predominantly due to the very low rates of wage increase that have pertained in the last few years. Furthermore, according to the Budget these low rates are expected to continue, with nominal wages forecast to increase by only 2½ per cent and 2¾ per cent in the next two financial years, representing a forecast real annual increase in wage rates of only ½ per cent each year.

    No wonder employment is growing rapidly, but this has little to do with the Government’s strategy for growth and jobs. Rather what we are experiencing is how, following the reforms of the labour market by the Keating Government, the labour market is now much more flexible and how the price of labour is now much more responsive to economic conditions. But the counterpart of this success in creating jobs is that the rate of productivity increase has dropped to around only ½ per cent in each of the last two years, and is not expected to increase by much more in 2016-17.

    In that context, what is surprising and disappointing about this year’s Budget Statement on the Economic Outlook is that there is no section dealing with productivity, and this despite productivity having been at the centre of all discussion about economic reform for the past couple of decades.

    In addition to our poor productivity performance, what is also worrying about the economic outlook is that non-mining investment is projected in the Budget to continue to remain sluggish. To some extent both phenomena may be related. But this non-mining investment is precisely the area that one would expect the Government’s Plan and especially its innovation agenda to have an impact on if that Plan is to succeed.

    So what is the problem with the Government’s Plan, that its own forecasts do not seem to provide much evidence that it will be successful?

    First, one would have to be extremely sceptical about the claim that ‘the tax and superannuation plan can be expected to lift the level of GDP by just over one percent in the long term’. Frankly it is difficult to see how this claim could be modelled given the shortage of empirical evidence. Furthermore, it is most curious that this modelling was not done by the Treasury, but by private consultants, who too often assume what they have to prove. Perhaps it is therefore no accident that it is still not possible to find out how this modelling was done. But what we do know is that whenever the company tax rate has been changed, it has never made a perceptible difference to investment, either here in Australia, or anywhere else. And even if we were to accept this dubious self-described “modelling”, a one percent difference over twenty years is next to imperceptible, and Australia needs a much faster pick-up in non-mining investment than that.

    Instead the required pickup in investment will mainly depend upon the demand for each firm’s products. The profit share and the rate of return on investment is high enough, but the lack of demand is why so many firms are engaging in share buy-backs and acquisitions of existing assets, rather than expanding through new investments to create new assets. In this regard a credible path to accelerate the restoration of a sustainable budget surplus would make more difference than these tax cuts. A Budget surplus would reduce the relatively high real interest rates in Australia and would probably also lead to some further reduction in the exchange rate over time. Therefore the ten-year funding for the tax plan should be progressively re-deployed to bring the Budget back into surplus quicker.

    Second, there is the issue of what can realistically be expected from the innovation and science package. The most important elements of this package aim to improve:

    1. the collaboration between industry and researchers which according to an OECD study is worse in Australia than in any other advanced economy, and
    2. Australian business attitudes to risk and experimentation, and the incentives for early stage investment in start-ups.

    These are worthy aims, but how much difference can government make, especially when the funding largely comes from a re-arrangement of existing programs, and overall the funding has been cut for business assistance, and cut significantly.

    The third leg of the Plan is the support for an advanced local defence industry. Readers of this blog will have seen previous articles querying the suitability of the submarines to meet our defence needs and their cost. (The mistaken decision on submarines and A more efficient submarine solution.)  In brief, building the wrong boats at a cost at least a third higher than purchasing them off the shelf, is not the future for a competitive manufacturing industry. Australia does need to, and I believe can, have a future in advanced manufacturing which produces high value added products based on technological leadership. On the evidence, however, building these submarines in Australia does not meet these criteria and cannot be expected to ensure our industrial future.

    The other legs of the Government’s Plan identified above – opening up exports through trade agreements and the plan to get 100,000 young people – are also worthy endeavours, but again cannot realistically be expected to have a large impact on the economy as a whole.

    Instead having a comparative advantage in skills is the most critical element if Australia wants to pursue high value added industries based on technological leadership. The Prime Minister’s Innovation Statement did in fact recognise the importance of skills, but unfortunately his words haven’t been matched by action. Instead the funding for education and training, along with research, has been cut.

    A second critical element in improving Australia’s comparative advantage in high value industries is to make better use of the skills that are available. This is also the key to enhancing future productivity growth. But unfortunately there is considerable evidence that most firms in Australia are not at the frontier of best practice when it comes to making the best use of the skills of their workforce. What is needed is a renewed management focus on achieving improvements in the organisation of work, a principle source of innovation, and less focus on cost cutting, which at worst can lead to lower productivity.

    Closely related to this second element, and its focus on improving the organisation of work, is the scope to improve the effectiveness of education and health services, and consequently their productivity, by re-organising how they are delivered. This means breaking down some of the silos, developing teams, and particularly in the case of health it will require changes in the payments systems and consequent incentive structures.

    Finally, a good plan for jobs and growth would require much more carefully targeted infrastructure investment, based on the introduction of proper pricing signals and proper evaluation. While the use of infrastructure continues for the most part to be free, we should not be surprised if there is over-demand. Instead in future infrastructure investment (which is a huge drain on the Budget) should be guided by what will deliver the greatest economic returns, having regard to the value that users are prepared to pay for, and not in response to political whims.

    In sum, one can applaud the Prime Minister’s enthusiasm for innovation and his efforts to encourage the embrace of new technology. However, the agenda for jobs and growth needs to broadened as there is much more to do, and the funding is inadequate to support many of what the Prime Minister himself has identified as priorities.

     

     

  • Michael Keating. The Turnbull Proposal for State Income Taxes

    Prime Minister Turnbull says his proposal for the States to levy their own income tax ‘is the most fundamental reform to the Federation in generations’. Well maybe. It certainly would be a significant change, but reform? Furthermore, even if this proposal were ever implemented, it is hardly new. For example, the Fraser Government actually legislated to allow the States to raise their own income taxes, but none took up the opportunity.

    In principal I agree that governments would be more accountable, and possibly more responsible, if they raised all or most of the revenue needed to fund their expenditures. Consequently, I accept that a move towards reducing the present degree of vertical fiscal imbalance and better match revenue and expenditure responsibilities should be seriously considered.

    At this stage, however, Prime Minster Turnbull is only proposing to transfer 2 percentage points of the income tax rate to the States; effectively an annual transfer between the Commonwealth and the States of about $14 billion. This compares with the $8 billion a year that the Abbott Government took away in the notorious 2014 Budget, and if nothing else changed this extra $14 billion would be quite a carrot to induce the States to agree.

    The Turnbull Government, however, is indicating that it is prepared to restore around $3 billion of these cuts to State payments, and so allowing the States to raise $14 billion in income tax revenue would leave the Australian Government Budget a net $9 billion down. Further savings would therefore be necessary, either from the Commonwealth’s own programs or from payments to the States. In this context it is not surprising that the Treasurer has floated the idea that another $6 billion could be clawed back by the Commonwealth ceasing its funding of State schools as part of the $14 billion package.

    But apart from this fiscal problem, realistically much more would be needed to realise the Prime Minister’s vision of the States taking over full responsibility for a variety of functions and thus ending the ‘blame game’. Indeed, the $14 billion a year that has so far been floated would not even cover the cost of the Commonwealth contribution to hospitals as well as schools.

    Most importantly, in this context, is that $14 billion is well short of the total of $50 billion paid each year to the States to cover all presently tied grants. For the States to be fully responsible for funding all their services would therefore require a far larger share of the income tax than has so far been mentioned, or alternatively allowing them much more freedom and capacity to increase income tax rates.

    But until the States get the taxable capacity to raise all or most of this annual $50 billion does anyone seriously believe that this relatively small change to give them a 2 percentage point income tax rate would make the States much more accountable and responsible?

    In my opinion there is some further scope to rationalise the respective roles and responsibilities of the Commonwealth and the States. For example, if Mr. Turnbull is fair dinkum why doesn’t he offer to return to the arrangements established by the Keating Government under which the Commonwealth was totally responsible for funding national highways, while the States and local government had total responsibility for all other roads. This arrangement was a sensible separation of responsibilities, but it fell foul of the pork-barrelling National Party, and so the Howard Government reversed it.

    As both John Menadue and I have emphasised, however, for many joint government programs there are good reasons why we have adopted our present shared funding arrangements (see my earlier article on Federalism, reposted on 31 March, and John Menadue’s post on the same day).

    Most importantly, in many cases the Australian Government has responsibilities that cannot be separated from those of the States. For example, education and training is vital for the future of innovation, productivity, employment participation, and economic growth, all of which are key Commonwealth responsibilities. While health necessarily involves both levels of government, as the Australian Government responsibilities for Medicare and aged care necessarily interact with the State Government responsibilities for hospital care.

    Indeed, the Turnbull Government seems to be prepared to acknowledge that separating the roles and responsibilities of the two levels of government presents a particular problem. According to some media reports the Australian Government may not withdraw from health funding, but it could withdraw totally from having any responsibility for Schools. Certainly the Australian Government has less at stake in schools, where its intervention has never achieved a great deal in the past. But in that case, maybe the Australian Government should take over total funding responsibility for vocational education and training which is necessarily closely related to the needs of industry, and where most of the funding is increasingly being provided to both private and public providers using a competitive model.

    Perhaps the most important Australian Government responsibility that would be compromised by the States setting their own tax rates would be the potential impact on fiscal policy. In the immediate future this is not expected to be a problem as the proposal envisages that the States would initially only be getting what would effectively be a share of the income tax, and the change would be revenue neutral. But once the States start setting their own income tax rates then this would compromise the necessary independence of the Australian Government to determine fiscal policy for the nation. Indeed, time is of the essence with fiscal policy and we cannot afford to have it run by some sort of Federal-State Committee. While on the other hand if governments set tax rates independently of one another, there is a risk that any time the Australian Government lowers its tax rates, then the States would seize the opportunity to take advantage of the extra taxation capacity available, and raise their own State income tax rates.

    In addition, although the Australian Tax Office would continue to be responsible for administering the tax system, and each taxpayer would continue to file only a single return, there would be a number of administrative problems with the Prime Ministers’ proposal that would not be easy to resolve. Thus, unlike the GST revenue, which has a common tax rate and can therefore be distributed on a per capita basis, this per capita distribution makes no sense for income tax revenue if rates of taxation differ among States. Accordingly, companies are already demanding that the states should not have a share of company tax because of this sort of complication. Many individuals, however, also derive income in more than one state, and it still remains to be worked out how their income tax payments can be distributed between two or more States where the rates of taxation vary.

    As John Menadue points out in his accompanying post, given its many problems and lack of clarity, this proposal by the Prime Minister is essentially a diversion from what is or should be the major concern of the Council of Australian Governments (COAG). The most critical challenge, which all Australian governments are facing, is first to repair the substantial Budget deficit, and in the longer-run to reconcile the demands for public services that are presently projected to run well ahead of likely government revenues.

    What COAG should therefore be discussing is how to raise more revenue and/or reduce the demand for services or improve their efficiency. Personally, and as I have argued in other postings, I think it will prove to be impossible to meet reasonable demands for future services without at least some increase in overall taxation in the decades ahead (see, for example, my recent article posted 28 March).

    In this regard the response by the Labor leader, Bill Shorten, to any suggestion that income tax might rise sometime in the future was most unhelpful. Mr. Shorten has already ensured that the possibility of raising the necessary extra revenue by increasing the GST was taken off the table, and now he seems to be intent on doing the same to any possible increase in the income tax in the decades ahead. One wonders how Labor could deliver its vision of society, and what it has supported, without increasing the overall tax take in the future – certainly Mr. Shorten has so far not told us.

    By contrast, allowing the States to determine their own tax rates raises the risk that at worst the States may enter a new race to the bottom. This is what happened after payroll tax was handed over to them by the McMahon Government in 1971. The States have since dropped the payroll tax rate and increased the tax threshold and exemptions. Ostensibly this was in response to tax competition generated by a perceived need to attract new firms, but most of the changes did little to attract industry because they mainly helped small business which is not geographically mobile.

    On the other hand, this time the Australian Government may force States to raise taxes by further squeezing their remaining tied grants. In that case the Australian Government would continue to solve its own fiscal problems by short-changing the States so that they are forced to raise taxes and thus take the blame for solving a problem of the Australian Government’s own making.

    A better alternative would be to adopt the proposal by SA and NSW that the States all get a fixed share of the income tax. This hypothecated share of the income tax could then be increased if all governments agreed to raise the rates for this purpose. Furthermore, by thus achieving an agreed increase in the overall level of taxation nationally, it would help to resolve Australia’s most important longer-run fiscal problem.

     

  • Michael Keating. Federalism (repost)

    The Government’s Commission of Audit, which preceded this Budget, recommended that policy and service delivery should as far as practicable be the responsibility of the level of government closest to the people receiving those services, and that each level of government should be sovereign in its own sphere, with minimal duplication between the Commonwealth and the States. The Government for its part has insisted that it does not run schools or hospitals and that the States are ultimately responsible for them and what happens to them.

    This conception of the Australian Federation with its emphasis on States’ rights and separate roles and responsibilities is of course not new. Malcolm Fraser enunciated it before he became Prime Minister, and its supporters insist that it was what the framers of our Constitution intended.

    Furthermore, there is considerable intellectual attraction in separate roles and responsibilities for each sovereign government. It should enhance democratic accountability and help improve efficiency if the buck can no longer be passed backwards and forwards between the two levels of government. But why then has our Federation evolved in favour of greater national involvement in the provision of services that were originally the sole responsibilities of the States? The Commission of Audit seems to believe that centralism can and should be reversed, but I will argue below that there are good reasons why the national government has become more engaged in what were originally the prerogatives of the States.  Consequently, although there is probably some modest scope for redefining governments’ respective roles and responsibilities and reducing duplication, we will be best served by preserving the core features of our national system.

    In my view there are three key reasons for the pre-eminence of the national government. First, a fundamental reason why the States agreed to federate was to remove tariffs as a first step towards the creation of a national market. But now that we have a national market and indeed are facing global competition, businesses want common standards and licensing across a wide variety of fields; for example, everything from rail gauges, regulation of heavy road transport, company law and national competition, to food standards and the recognition of qualifications.

    Second, the responsibilities of government have grown. At the time of Federation pensions did not exist, but the Australian government now has constitutional responsibility for income support, including subsidising critical needs such as medical services, pharmaceuticals, and rental housing. Equally since World War II the Australian government has been expected to manage the macro-economy to ensure full employment and reasonable price stability.  Allied to this the Australian government also has responsibility for population policy, especially through migration, and for the growth in productivity and workforce participation which together determine the overall growth of the economy.

    However, these various national functions and responsibilities are not self contained. Today the various functions of government are heavily inter-related in a way that was much less true one hundred years ago, when we were all much less closely connected. For example, productivity is heavily dependent on the skills of the workforce, but these skills are in turn dependent on the quality of the education and training systems of the States. It is simply not possible for the Australian government to meet its responsibilities while being unconcerned about the effectiveness of various State government services.

    The third and final reason for national government pre-eminence is of course the national government’s domination of taxation, widely described as ‘vertical fiscal imbalance’ or VFI. Paul Keating called VFI the glue that holds our nation together, but for the States and the champions of States’ Rights, VFI is regularly trotted out as the root cause of centraliam. In the past the national government has passed payroll tax back to the States, and more recently they receive all the proceeds of the GST, but it seems unlikely that either of these taxes will ever be changed by so much as to make the States financially self-sufficient.

    In that case the removal of VFI would require that the States have access to the income tax. Legally there is nothing to stop them doing that now, but they have never taken up the opportunity, and indeed there are very important efficiency gains in only one government being responsible for administering any particular tax.  So the alternative is for the Australian government to raise the income tax and then to share the proceeds with the States. But why would sharing a tax result in clearer lines of responsibility than sharing responsibility for other functions of government which require expenditures? There would still be the same arguments about who should get how much and whether the States have adequate revenue. Alternatively if the States were allowed to add a surcharge to the Commonwealth tax, then there is the risk that the Commonwealth’s independent use of taxation policy for macro-economic policy would be compromised.

    In short it is not surprising that proposals to return to the past and increase State rights have got nowhere over a very long time. The truth is that a form of power sharing which we call ‘cooperative federalism’ is the only realistic way of managing inter-governmental relations. In Australia, for good or for ill, we have these two levels of government (plus local government), and power will inevitably need to be shared for a variety of functions where both have a legitimate interest. By contrast one cannot help being suspicious about the Commission of Audit proposals and whether their real intention is to provide a fig-leaf for the Commission’s smaller government agenda, with little or no concern for the impact on the availability and quality of publicly funded services.

    Instead a more productive discussion, than endless repetition of State’s Rights, would be to formulate better arrangements to guide the necessary future power sharing between the Australian Government and the States. To their credit that was what the Hawke, Keating and Rudd Governments were attempting to do with some success through COAG.