Michael Keating

Tony Abbott has finally achieved another “triumph” with the end of the mining tax.  Of course mining royalties continue, and have even been increased recently, and oil and gas are subject to a similar sort of resource rent tax that Abbott decried when it was applied to mining.

No doubt the mining industry, their largely foreign owners and the cheer squad in the Murdoch press are pleased, but what about the rest of the Australian community? After all it is we who are the actual owners of the resources, and we have now lost a useful source of revenue. And what does this sorry saga say about the chances of getting genuine tax reform in this country in the future?

Why we need a mining tax

The Government and the mining industry would have us believe that a resource rent tax on mining will reduce investment and cost jobs. Nothing could be further from the truth. Of course for most industries a tax on profits will generally reduce the rate of return on the investment, leading to less investment and fewer jobs. But mining, which involves the extraction of non-renewable resources is different for the following reasons:

1. The resources are owned by the community, and the community should receive a return for allowing the private firms to exploit those resources
2. Present taxation arrangements frequently fail to collect a sufficient return for the community because they fail to reflect and obtain a fair share of the super profits, or economic rents, that mining can generate
3. The reason why mining, unlike other industries, can generate these super profits (or economic rents) is because the supply of the resource is finite; that is the supply of minerals cannot be readily increased, so if demand rises relative to that supply it will sell at a price that more than covers its cost of production and thus generate super profits. Even if other mines later come on stream in response to these super profits, this normally takes a lot longer than for most other goods and services, and the new mines typically involve less attractive deposits that cost more to mine. Consequently the market will settle at a new price that exceeds the costs (including a normal return on capital) of the most productive mines, which are thereby enabled to generate super profits, especially in the short run and even in the long run.
4. Given that a properly designed resource rent tax is only ever taxing super profits over and above the normal rate of return on the investment then, contrary to the Government’s and the industry’s protestations, such a resource rent tax cannot deter investment nor lead to a reduction in employment. Indeed, if further empirical evidence in support of this logical conclusion is needed, think of the history of the Petroleum Resource Rent Tax, which is now nearly thirty years old, and during this time there has been massive investment in the oil and gas industry in this country.

Indeed the Henry Review of Australia’s Future Tax System, considered the amount of taxation revenue that we have been missing out on by not having a resource rent tax for the mining industry. Thus back in 2001-02 taxation absorbed almost 50 per cent of mining profits, but as minerals prices and profits rose in the mining boom, by 2008-09 taxation’s share of the profits fell to a bit less than 15 per cent of mining profits. By comparison in the petroleum industry that had a resource rent tax, taxation’s share of profits stayed fairly stable fluctuating between around 30 and 40 per cent over this decade. Of course the prices of some important minerals have now fallen compared to 2008-09, but they are still higher than a decade ago and we are still missing out on an important potential source of revenue.  Indeed, at the height of the mining boom a rough estimate is that the Government missed out on about $10 billion in a single year compared to if it had taxed minerals in the same way as oil and gas are taxed.

How best to tax mining super profits

In 2010 the Rudd Government introduced the ‘Resources Super Profits Tax’ (RSPT) covering all minerals, based on the recommendations of the Henry Review. Furthermore, the intention was that this new tax would replace the existing State Government royalties with consequent efficiency gains.  Overall this RSPT appeared to be an academically elegant way of raising revenue while having a perfectly neutral impact on future investment decisions. It was, however, complex and difficult to explain. Furthermore it depended on the government being accepted as a full (but silent) partner in each mining project, taking 40 per cent of both the losses and the profits. However, as the government postponed taking on its share of the losses, and only contributed its share of the capital as the mine was written down through depreciation, there was a legitimate question as to whether the cost of capital to a mining company was in fact as low as assumed in these taxation arrangements.

In any event, in the face of strenuous opposition from the mining industry, the Labor Government panicked and the new Prime Minister Gillard and Treasurer Swan negotiated with just the three biggest mining companies – BHP Billiton, Rio Tinto and Xstrata – a replacement ‘Minerals Resource Rent Tax’. This tax only applied to iron ore and coal, had a lower tax rate, allowed accelerated depreciation, and brought in far less revenue.

What is surprising, and not only in retrospect, is that the Labor Government did not elect to just extend to all minerals the existing petroleum resource rent tax (PRRT), which also has a 40 per cent tax rate. This would have been much easier to explain, and as acknowledged by the Henry Review, the PRRT can approximate the impact of the RSPT, although the particular features of the present PRRT are a bit more generous to the mining companies than under the proposed RSPT.

Clearly Gillard and Swan’s Minerals Resource Rent Tax (MRRT) was inferior to the PRRT. Its coverage was limited, and as no attempt was made to rationalise the interaction of MRRT with the State’s existing royalties, the tax rate for the MRRT had to be kept low. Another criticism was that the MRRT did not raise the expected revenue. However, a principal reason for lower than expected revenue was the accelerated depreciation, so while mining investment was booming, the miners were able to write down their profits for taxation purposes enormously.  But that also means that these new assets will be depreciated quickly and then these allowances will cease. Now the irony is that the MRRT could have been expected to raise more revenue from here on if it had not been abolished. Thus despite its flaws, the Parliamentary Library has estimated that the MRRT would have raised a handy $1 billion this year, $1.4 billion next year, and $2.2 billion in 2016-17. 

State taxes and their role

The RSPT as proposed by the Henry Review and subsequently by the Rudd Government was intended to supersede the existing State royalties, with the States receiving adequate compensation from the new Commonwealth RSPT revenue.  That compensation would, however, have been fixed so that the Australian Government did not fund any future increases in State royalties. Indeed it may have been necessary for the Australian Government to introduce financial penalties on the States so as to discourage them from introducing any such future increase in royalties. Unfortunately the States, possibly sensing the political winds, showed no inclination to negotiate with the Rudd Government so as to achieve a better rationalisation of mining taxes.

In the rush that followed the change in Prime Ministers, the new Gillard Government did not even consider the value of rationalising the State royalties so that they were absorbed into a profits-based system of mining taxation. Instead there were two systems: with the new Commonwealth MRRT co-existing alongside the pre-existing State royalties which were typically based on the quantum of production or its value, and which accordingly paid no regard to the profitability of the mine. As such the opportunity to shift to a more neutral system of mining taxation was lost, thus foregoing a principal objective of the Henry Review. Furthermore, despite Abbott’s hysteria about taxing resource rents, two conservative State governments have seen fit to increase their mining royalties since the introduction of the MRRT, thus adding to the confusion, and the Gillard Government apparently felt unable to intervene.  

The flawed policy process and how this mess eventuated

Nevertheless, whatever its faults, the MRRT was still better than nothing. But now with the abolition of the MRRT that is where Australia has returned, with the additional disadvantage that it will now be that much more difficult in the future to introduce a more adequate and neutral system of mining taxation. So how did this sorry situation come about and what does it say about the policy process in Australia at this time.

In my view the principal culprits are first, the Henry Review’s proposals which while academically elegant were clearly too complicated for any government to sell. Instead the Review, and later the Rudd Government, should have had the wit to embrace an extension of the existing PRRT. This would have been relatively easy to sell, especially as it clearly had not damaged investment or employment in the oil industry, thus negating Tony Abbott and the mining industry’s main stated reasons for opposing the tax.

Second, the Rudd Government clearly failed to consult, as promised, before introducing this major tax change. This led the industry to lose trust in the Government, and may have helped the industry to justify its opposition – at least to itself.  Instead the Rudd Government should have released the Henry Report much earlier when it was received, and then used it as the basis for consultation. The recommendations in the Report would have given the Government the necessary authority, rather than trying to impose a tax that neither the Prime Minister nor the Treasurer ever seemed to really understand, and certainly could not explain.

Third, the Gillard Government put quickly ending the dispute with the mining industry ahead of obtaining a good policy outcome. As a consequence that Government far too readily accepted the terms devised by three big mining companies with insufficient thought and expert advice regarding the consequences.

Fourth big business was distinguished by its silence through all this process. While quite prepared to pontificate about lower taxes for themselves, it seems that big business will shy away from any engagement, let alone taking some responsibility, for the difficult decisions and trade-offs that genuine tax reform will inevitably require. Indeed judging by its performance over recent years, big business is more a hindrance than a help in the pursuit of tax reform.

Finally the Australian Government for the most part ignored the States in introducing its mining tax proposals. But like it or not, the States are necessary partners in mining taxation (and in a number of other important policy fields) and reform is difficult unless they are brought into the consultations fairly early.

Michael Keating was formerly Secretary of Prime Minister and Cabinet.

 

Faced with the rejection of a significant part of its Budget, the Government is reportedly looking around at alternative compromises. Essentially the Government wants to ensure that the Budget is balanced by 2017-18. Consequently if some of the present savings are rejected the Government wants to insist that alternative expenditure cuts are adopted or there are more tax increases, or we finish up with some combination of alternative expenditure savings and tax increases.

Unfortunately, however, there is considerable public confusion about what the Budget delivered last May actually does and how it achieves its apparent return to balance in 2017-18. In order to properly debate Budget alternatives it is essential that we all have a clear understanding of the Government’s original Budget as it will be the starting point for any future negotiations.

First, there appears to be considerable agreement about the desirability of returning to a balanced budget. Certainly the Labor Party was equally committed to restoring fiscal balance, and the projected rate of fiscal consolidation over the next four years – an annual average of 0.6 per cent of GDP – seems about right given the present softness of the economy.

Second, of the actual policy decisions in the Budget, 77 per cent of the savings come from changes to expenditure programs, and only 23 per cent from decisions to increase revenues, such as the increase in petrol excise and the 2 per cent “temporary Budget repair levy”. In fact the level of public expenditure by all governments in Australia is lower than in any other developed country relative to GDP. Thus there is no compelling economic case for reducing public expenditure, and given the already tight targeting of the Australian welfare system, further reductions in public expenditure in Australia are difficult.

Nevertheless, when it took office, the Government was facing a large increase in expenditure, with real outlays projected to increase by as much as 5.9 per cent between 2016-17 and 2017-18, mainly because of the large increases in expenditure associated with the Gonski reforms of school funding and the National Disability Insurance Scheme.  In the circumstances it is not altogether surprising that the Government focussed so heavily on trying to reduce its expenditures. Instead my criticism is that the Government has focussed far too heavily on reducing people’s access to assistance and services, whereas it would have been better to achieve expenditure savings by improving the efficiency of services and the value for money, especially in relation to school education, health and infrastructure (see my posting on May 21).

Third, an often unremarked feature of this Budget is that despite the focus of decision-making on expenditure savings, total government expenditure is still projected to be 24.8 per cent of GDP in 2017-18, which is actually more than it was in 2012-13 when Australian Government outlays were only 24.1 per cent of GDP[1].  In effect without the Government’s expenditure savings decisions, the projected budget balance would have been $20.3 billion worse in 2017-18, which would have meant a projected Budget deficit in 2017-18 equivalent to 1 per cent of GDP.

Fourth, because the Government has in net terms only been able to stabilise the growth of expenditure and not actually reduce it relative to GDP, this has meant that much of the real heavy lifting to restore the Budget balance in this Budget is on the revenue side. Furthermore, this increase in revenues does not come from actual decisions to increase taxes, but rather from bracket creep as peoples’ incomes rise and they move into higher tax brackets. Thus Budget receipts are projected to rise from 23.1 per cent of GDP in 2012-13 to 24.9 per cent of GDP in 2017-18. That is over this period receipts are projected to rise by 1.8 per cent of GDP whereas expenditures are projected in the Budget to fall only marginally as a percent of GDP and arguably they will actually rise a little, depending on the base date chosen.

So what are we to make of these key facts describing the Government’s Budget? Perhaps the most important conclusion is that the Government does not really have a plan to restore the Budget to surplus even if it could get its Budget passed in its entirety. This is because as it stands the Budget is relying heavily on increasing taxes through bracket creep, rather than adjusting the tax scales for inflation, and it must be questioned whether this is really sustainable.

Indeed the Secretary of the Treasury, Martin Parkinson, has pointed out that the Government’s present budget projections, which keep the income tax scales fixed, will ‘pull someone on average full-time earnings into the 37 per cent tax bracket from 2015-16, and will increase the average tax rate faced by a taxpayer earning the projected average from 23 to 28 per cent by 2024-25 – an increase in their tax burden of almost a quarter’.  Furthermore, Deloitte Access Economics has calculated that fixing the Budget in this way will be highly regressive. For example, someone earning between $35000 and $40000 will be paying 25 per cent more tax by 2017-18, with their average tax rising from 13 per cent to 16.3 per cent, while high income earners with salaries of $200000 or more will face only a 1.8 per cent lift in their tax.

Realistically it must be expected that in the next few years the Government will feel compelled to introduce tax cuts at least sufficient to offset these effects of bracket creep. But that means that the Government’s projected budget balance by 2017-18 then disappears unless there are further expenditure cuts or there are other forms of tax increases.

In a previous comment on an ‘Alternative Budget Strategy’ (posted July 22/ 23) I showed how additional revenue totalling some $42 billion could be raised in 2017-18 by real tax reform that reduced various tax expenditures (ie concessions) and closed a number of tax loopholes that are presently used to avoid paying tax. This alternative approach would result in a much fairer budget and would still restore the budget balance. Furthermore this alternative would be much more credible than the Government’s budget which rests on increases in taxation that cannot be sustained. Instead for the moment the Government’s budget projections of a return to balance represent a sleight of hand, and really cannot be believed. Sooner or later the Government will have to introduce further measures, but after all the recent fuss and distrust, what chance will these have?

For months the government and its various spokesmen in the Australian have been warning us that the nation faces a catastrophe if the Budget does not pass the Parliament intact. Essentially we were told that there was ‘no alternative’ if economic progress and certainty were to be maintained. Indeed Paul Kelly, to the considerable delight of many in the business community, waxed eloquent in the Australian about how the country risked becoming ungovernable if the government did not get its way.

For the government, this line made political sense so long as the government was confident that its Budget would eventually pass, after the Senate changed on 1 July. In effect its strategy was to characterise the Labor Party and the Greens as being irresponsible, while it could soon expect to bask in the glory of achieving its chosen path to restoring the Budget surplus over time.

Now, however, the government has had to recognise that the new Senate since July is just as obdurate as the last, and possibly even less predictable.  Instead, compromise is now the order of the day. Accordingly the spin also has to change. So now the story, faithfully reported in today’s Australian, is that most of the Budget has already been passed by the Parliament. The measures still outstanding will no doubt be watered down in the present negotiations, but despite the previous dire warnings, none of the still-to-be-announced changes will matter.

Well I agree they will not matter much. Indeed they may matter even less than the government lets on as the proceeds of the higher fuel excise and the medicare co-payment were going to be spent on extra road funding and health research respectively, and in themselves did not represent a saving to the budget bottom line; now that extra money can be saved, which probably represents a better economic outcome.

But what does matter to the government is that it will declare another victory as it properly moves to restoring the Budget surplus. And what should matter to the rest of us is that this required restoration of the Budget surplus over time could have been achieved more efficiently and fairly in other ways, with much less of the burden being imposed on the most disadvantaged members of our community, by relying more on real tax reform. See my three earlier postings ‘An alternate budget strategy’ on July 21, 22 and 23.

 

Part 3. An Alternative Budget Strategy 

The previous comment in this series showed that there are alternatives to the Government’s particular strategy for restoring a Budget surplus over the next four years. In particular, it was shown that action to protect the revenue could raise around $42 billion in 2017-18. That is about 2¼ per cent of 2017-18 GDP and meets the Government’s Budget targets. Furthermore this objective is achieved without relying on bracket creep that would move a full-time male worker on average earnings into the 37 per cent tax bracket from 2015-16.

However, it was also recognised in the first part of this series, that Australia faces a continuing budget problem of matching expenditure and revenue over the longer term. On the basis of Treasury projections in its last Intergenerational Report (2010), it is estimated that resolution of this problem will require further budget tightening in some form or other roughly equivalent to another 2¼ per cent of GDP between 2017-18 and 2049-50. The aim of this third comment is therefore to briefly discuss some of the alternatives which might need to be considered in the future. It is further suggested that these alternatives will essentially involve improving expenditure program effectiveness so that more is achieved with less, or if then necessary, increasing existing taxes.

Improving expenditure effectiveness

The projected increase in public expenditure relative to GDP over the next 30 years or so mostly reflects increasing health expenditures, much of it associated with an aging population, and similarly increases in age related pensions and aged care. Indeed expenditures on these three areas were projected by Treasury to increase by 5 per cent of GDP between 2010 and 2050 if then present policies were continued, and so far that is pretty much the case.

The introduction of superannuation was intended to limit future demands for the age pension, and some further tightening up of superannuation to further limit dissipation of superannuation entitlements would help further reduce expenditure on age pensions. But the big demands for additional expenditure are concentrated in health, and that is where there are the greatest opportunities for future expenditure restraint by improving the cost effectiveness of care.  Already the introduction of activity based funding by the Rudd Government provides the opportunity to move to funding on the basis of cost effectiveness, noting that very substantial differences in costs have been sustained over long times for what are the same procedures. In addition, there are other ways of funding health care, particularly for those suffering chronic conditions, that would improve the incentives for cost effective care, compared to the incentives towards over-servicing with fee for service arrangements.

Schools represent another major area whose demands for funding might be reconsidered. Real public funding per student in primary government schools increased by 31 per cent between 1999 and 2011, while there was a 20 per cent increase for government high schools. There is no evidence that this increase in funding (and the further increase since 2011) has led to improved student results. Instead the key equity objectives of the Gonski reforms should be capable of being realised by redeployment of funding within the education system. In short, instead of promising that no school should ever lose through funding changes, we need to accept that genuine reform has to involve some of the funding to the schools that are most generously funded relative to need should be transferred to other more needy schools. Not to do so is the worst possible example of ‘middle-class welfare’.

The final major area of expenditure that stands out as a source of potential waste is the sacred cow of infrastructure. Australia has a history of over-investing in public infrastructure in the sense that proposals have been poorly evaluated, or not at all, and the returns (including the non-financial returns) have been totally inadequate relative to the costs. Indeed, as Bert Kelly, the former ‘modest member of Parliament’ remarked many years ago, he knew an election was coming on whenever he heard an announcement for a new dam.

In the last ten years expenditure on infrastructure by Australian governments has grown at twice the rate of GDP, and in the present Commonwealth Budget the Abbott Government’s extra spending on infrastructure reduced the total medium term expenditure savings achieved by about one third. Now this might be a good outcome if that additional infrastructure spending were warranted, but in fact a number of the infrastructure proposals that have been approved for funding in this Budget have not completed a proper cost-benefit evaluation.

Increasing taxes

The balance between expenditure restraint and increasing taxation is of course a matter of political values and an area for some discretion.  If in the event, a decision is reached that expenditure restraint should not be solely relied upon to achieve fiscal sustainability there are really only three substantial taxes capable of raising the amounts of additional funding that might then be needed in the longer term out to 2049-50:

• GST
• Company tax, and
• Personal income tax

As has been widely remarked the Abbott Government’s Budget does seem to envisage allowing the States to demand an increase in the GST if they consider that they cannot restrain their health and education expenditures sufficiently. So an increase in GST revenue seems quite possible sometime in the future, either through base broadening to include at least food, or through an increase in the rate or both. That may represent a reasonable solution, although the way in which it is implemented might have been better if there were a proper conversation in COAG (and more widely) about how best to proceed and the possible alternatives.

The common view is that company tax should be reduced rather than increased. The argument relies heavily on the view that capital is highly mobile, and so competitively we need to match the company tax rates of other countries or we will lose investment. This view however deserves a little more scrutiny. First it takes no account of the fact that Australia is unique in allowing dividend imputation. That means that Australian investors have much less incentive to invest overseas than their equivalents in other countries. Second, it is arguable whether we need lower company tax rates to attract overseas investors. In most instances the rates of returns here are high enough after allowing for risk. Indeed right now the Reserve Bank is on record as considering the present exchange rate to be too high, and the most obvious reason is the attractiveness of Australia to foreign capital. So while an increase in company tax may not be likely, there is a good case, especially given the long term fiscal outlook, for resisting any decrease in company tax.

Finally, it may be that an increase in personal income tax will (eventually) be considered to be at least part of the optimal approach to sustaining a balanced Budget in the longer-run, if we want to maintain our traditional social values and the services that we expect from government. In that case it is suggested that an increase in income tax should be achieved by an increase in the tax rates, rather than by stealth through bracket creep leading to effectively lower tax thresholds.

There is nothing sacrosanct about the present income tax rates. First, the top rate has been as high as 60 per cent in the past, compared with a current 48.5 per cent rate[1], and no great change in any behaviour was observed when that 60 per cent was lowered. Second, other countries operate successfully with markedly higher personal tax rates than we have in Australia. Third, we are already raising income tax rates, but failing to recognise it, as the adjustments are described as temporary (the deficit levy) or hypothecated (the Medicare levy). Instead maybe we would be better off if our government(s) just came clean and acknowledged that we will not be able to pay for what we want in the way of future public services without a modest upward adjustment of the income tax rates.

Conclusion

Like most countries, Australia is facing a potential long-term structural problem with its public finances.  With the modest resources available to the author it is not possible, nor even desirable, to propose a complete and detailed solution. Rather the point of this series is to show that there are a range of plausible alternative strategies for achieving long-term fiscal sustainability.  The argument that the Government’s proposed Budget strategy is the only way forward is false.

Moreover as a nation we are unlikely to succeed in charting a viable way forward to fiscal sustainability until governments are prepared to subject their views to a proper conversation based on a clear appreciation of the pros and cons of the different alternatives.  Only in that way can the public support be built that is required to achieve future fiscal sustainability.  In present circumstances it is hardly surprising that this necessary support is not forthcoming, when less than twelve months ago the government promised in the election to both spend more and tax less and now seeks to impose a most unfair Budget on the community with no prior warning nor any such mandate.

If, instead, we are to chart a way forward and establish the necessary public understanding and consensus, we particularly need to drop the ideology surrounding the merits of taxation versus expenditure and consider the claims of each tax and expenditure proposal on their merits. Unfortunately for the moment at least the Government, egged on by its cheer squad, seem determined to prevent any further discussion of other alternative fiscal options and strategies on the basis that only the present government can be trusted to fix a mess that they themselves have helped create.

Part 2. An Alternative Budget Strategy 

In the previous part of this comment, I suggested that the Budget did need to return to surplus over much the same time path as intended by the Government. There is nothing new in that, and as previously noted, Labor also had the same intention when it was in Government.  The issue in dispute is whether an alternative Budget Strategy is available to restore a Budget surplus over the next four years and which would be more equitable and less damaging to future economic growth. What follows shows that such alternatives are available; in particular the alternative explored here would rely more on taxation and would avoid the cuts to welfare and education and to research and innovation that are central to the Government’s Budget.

The scope for increasing taxation

In the most recent financial year, 2013-14, government receipts represented 23.0 per cent of GDP compared to a long-run average over the previous twelve years of 24.3 per cent. Some of this current low level of receipts reflects the soft economy, and the ratio of receipts to GDP can be expected to improve somewhat as economic growth recovers. Indeed the Government’s Budget projects that revenue will rise to 24.9 per cent of GDP by 2017-18; that is by almost 2 percentage points, which on its own goes a long way to removing the present Budget deficit.

As John Daley at the Grattan Institute has pointed out, however, three quarters of this improvement in receipts and the budget bottom line represents the impact of bracket creep as (with no tax indexation) people find themselves moving into higher tax brackets as their incomes rise with inflation. As a result someone on average full-time earnings will be pulled into the 37 per cent tax bracket from 2015-16, and the average tax rate faced by a taxpayer earning this projected average income will rise by nearly a quarter from 23 to 29 per cent by 2024-25[1]. Accordingly it seems prudent to assume that any government is likely to raise the tax thresholds from time to time and that the projected income tax receipts will be reduced accordingly.

So what are the other options for improving the revenue? It is suggested that these broadly comprise action to:

• Reduce tax expenditures which in many cases are equivalent to outlays
• Limit tax avoidance
• Restore the Carbon Tax and the Mining Resources Rent tax
• Removing the tax rebates for the fuel excise for miners and farmers and the private health insurance rebate
• Lift tax rates but in a considered way

The potential for each of these actions are considered briefly below. 

Reduced tax expenditures

Many of the largest tax expenditures would be seen as justified and/or have considerable popular support. For instance the list of tax expenditures published by the Treasury includes no capital gains tax on people’s principal residence, deductions for philanthropic gifts, and the exemptions of education and health from the GST, and it seems unlikely that any government will want to remove these “concessions”. Instead it is suggested that reform of tax expenditures should focus on only two – the special taxation treatment of superannuation contributions and earnings and the capital gains discounts for individuals and trusts. Some might question adding negative gearing, but it is not included, as it is not considered by Treasury to be a tax expenditure, and there are legitimate issues of principle for allowing interest deductions against a taxpayer’s income irrespective of how that income was earned.

In 2013-14Treasury estimated that the revenue foregone from the concessional tax treatment of superannuation was $32.1 billion. Rough projections by the author suggest that this amount might increase to around $39 billion in 2017-18 if there is no change to these concessions. However, not all of that $39 billion would be saved if the concessions were removed because some behavioural response could be expected. Even more significantly, some concessional treatment of superannuation savings is probably justified, given its compulsory nature and the restrictions put on accessing superannuation accounts. Clearly a number of options for possible reform of the tax treatment of superannuation are available for further consideration, but further exploration of those options would be a major exercise in its own right. For present purposes it is the author’s judgement that savings of the order of the order of $15.5 billion should be available in 2017-18 if the tax treatment of superannuation were reformed. Savings of this order would not be so much as to change the incentive for people to continue to save through superannuation.

As part of its 2001 tax reform package, the Howard Government introduced a 50 per cent deduction for capital gains for individuals and trusts. Realised capital gains are just as much income as any other form, and there was never any justification for this 50 per cent discount, especially in a tax system which ensures that there is no double taxation of dividends accruing to Australian residents.  Furthermore, the Murray Inquiry into Australia’s Financial System concluded last week that the concessional treatment of capital gains “encourages leveraged and speculative investment – particularly in housing”.  The resulting high levels of household debt represent the major financial risk to the economy – much more than government debt.  Accordingly there is a strong case for   restoring the full taxation of capital gains, which is projected here to save around $5 billion in 2017-18.

Reducing tax avoidance

Before the Labor Government fell last year it introduced legislation to protect the corporate tax base from various loopholes. The most significant of these was “thin capitalisation” whereby the operating Australian subsidiary of an overseas company is loaded up with debt to its parents, so that it makes little or no profits in Australia. The Abbott Government has seen fit to drop these reforms, but if they proceeded the author projects (on the basis of information provided by the Labor Government last year) that these anti-avoidance measures could produce around $1.5 billion extra revenue in 2017-18.

In addition, with the third biggest mining corporation operating in Australia (Glencore) reportedly paying next to no tax in Australia, it would seem that the time is ripe to review the tax treatment of transfer pricing arrangements. These arrangements occur when Australian subsidiaries sell at below market prices to their parent company so as to minimise their profits and tax paid in Australia. However, in the absence of more precise information, no allowance has been made for extra revenue from this source.

Restore the carbon and mining resource rent tax

While these taxes seem to have been contentious, there is a very good economic case for both of them. Indeed most economists strongly favour pricing carbon as the best way to reduce the harmful effects of carbon pollution. And the MRRT is only levied on above normal profits and as such cannot be a disincentive to mining investment. Indeed, if any further proof were needed, the experience over almost 30 years since the PRRT was introduced for offshore petroleum and gas shows that properly constructed resource rental taxes do not affect resource investment.

Based on information in the 2012-13 Budget, the author estimates that in 2017-18 restoration of the carbon tax and the MRRT would bring in around an extra $3 billion and $2.5 billion respectively.

Removing tax credits for fuel and private health insurance

There is no economic justification for providing tax credits to farmers and miners for their fuel use. First, why subsidise the use of any particular input into the production process? And if fuel is subsidised why not also subsidise other input costs, including for example, labour costs? Second, why subsidise some of the costs of two particular industries – farming and mining – but not other industries, including other industries that are competing with these two industries for resources such as labour.

Equally many evaluations have pointed to the cost ineffectiveness of the subsidy for private health insurance. Contrary to the alleged justification for this subsidy, more patients would be treated if the same amount were spent on public hospitals rather than subsidising the inefficient operations of the private health funds and the overcharging by private medical practitioners.

Technically these two subsidies are not regarded as tax subsidies and instead are reported on the expenditure side of the Budget. On the basis of the forward estimates of these expenditures it is projected by the author that in 2017-18, $7.6 billion and $7.2 billion could be saved by abolishing the fuel credits and the private health insurance rebate respectively.

Total revenue savings

The sum of the budget savings identified above is estimated to be around $42 billion in 2017-18 or equivalent to about 2¼ per cent of the projected GDP (see table below). This structural saving to the Budget of an annual $42 billion by 2017-18 is about the same as the total turnaround that the Government expects to achieve in its Budget.

 

Possible Budget Savings on the Revenue Side

2017-18, $billion

Tax Expenditures
Reduce favourable treatment of superannuation	15.5
Capital gains discount for individuals & trusts	5
Restoring anti avoidance measures dropped	1.5
Restoring tax measures dropped
Carbon pricing	3
MRRT (net after allowing for impact on Company tax)	2.5
Removing tax credits
Fuel excise rebate	7.6
Private health insurance rebate	7.2
Total budget savings	42.3

Of course, the list of revenue measures identified here can only be illustrative of what can be achieved on the revenue side of the Budget.  It may be that others would want to amend the list in various ways. For example, it may be that in the present political climate the carbon tax would not be renewed, but even if not all the measures identified were taken up or only partially adopted, what is clear is that there is a lot of scope for raising additional revenue and achieving a fairer Budget outcome.

In addition, as noted above, most of the Government’s Budget turnaround is also achieved through higher income tax revenue, but that revenue is brought about by bracket creep rather than efficient decisions.   Indeed, after allowance for the one-off payment of $8.8 billion to the Reserve Bank last year, and for various additional expenditures principally on new infrastructure and defence, the Government’s budget actually achieves very little in expenditure savings on a net basis, amounting to only 0.3 per cent of GDP in 2017-18. By contrast the proposals presented here do not make the unrealistic assumption that bracket creep in the tax system will be allowed to continue to bring in extra revenue without any of those proceeds being handed back through tax cuts. Instead if most of the measures proposed in this comment were substituted for the government’s budget then there would be scope for tax cuts by increasing tax thresholds to offset the impact of bracket creep.

Nevertheless, as pointed out in the first part of this Alternative Budget Strategy, Australia faces a longer term fiscal problem, and the assessment is that over time by 2049-50 further structural savings will be needed of the order of another 2¼ per cent of GDP – that is as much again.  Those issues will be discussed further in the next part of this series.

Suffice for now to say that while clearly more work would be needed to determine the details of where savings should be made to achieve the necessary restoration of the Budget surplus by around 2017-18, enough has been shown here to establish that credible alternative budget strategies are available. Conservatives should not be allowed to hide behind the convenient myth that their strategy is the only one, and that any questioning of it is irresponsible and a failure of governance and our political system.

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In May this year I posted five articles by Dr Michael Keating on the economic and social consequences of the recent Hockey budget. Over the next three days I will be posting three follow-up articles by Michael Keating on an alternative budget strategy.  Dr Michael Keating was formerly Secretary of the Department of Finance and Secretary of the Department of Prime Minister and Cabinet. John Menadue

Part 1. An Alternative Budget Strategy 

 Two months later and the Abbott Government’s Budget is the worst received in living memory. There is widespread community agreement that this Budget is basically unfair.

Readers will not need reminding of the various cuts to welfare, health and education, but in the absence of the usual Budget information from the Government, perhaps the best summary of the distributional impact of this Budget has been provided by NATSEM. In short, NATSEM modelling found that by 2017-18, “Low income families with children (bottom 20 per cent) are worse off by around 6.6 per cent while single parents are worse off by around 10.8 per cent”.  In contrast “High income families are marginally better off thanks to the carbon tax removal”. And this analysis does not include other measures such as the Medicare copayment, the cuts to education and training, and possibly the harshest measure of all, the denial of access to any income support for young unemployed people every other six months.

But is there an alternative to the Government’s budget strategy  –  contrary to the assertion by the Government and its supporters that in fact ‘there is no alternative’ (which is of course a familiar refuge for conservatives)?

First, the Government is right that we do need to restore the Budget to surplus; indeed the previous Labor Government was equally committed to that, and over much the same time-frame. Furthermore, the projected rate of fiscal consolidation over the next four years – 0.6 per cent of GDP – is not draconian and seems to get the balance about right in terms of its impact on a still soft economy.

Second, Australia also faces longer term fiscal pressures, partly because of our aging population, but more importantly because of rising expectations for increasing public services as incomes rise, combined with new technological enhancements impacting particularly on health services. In short, the Treasury estimated in its most recent 2010 Intergenerational Report that these structural budget pressures were likely to add as much as a net 4½ percentage points of GDP to total outlays by 2049-50 if the (then) present policies were maintained. And since then spending pressures under the previous Labor Government probably further increased, notwithstanding some savings initiatives, because of big new spending programs associated with the Gonski reforms of schools funding and the National Disability Insurance Scheme. Three years out from now, in 2017-18, these fiscal pressures start biting significantly, and given the long lead-times in effecting budget reform, prudent budgeting would start making preparations for financing these demands now by some combination of greater revenue and/or greater efficiencies.

Where the Government and its cheer squad are wrong, however, is their assumption that their proposals represent the only tenable strategy to achieve the goal of a budget surplus. In effect the Government asks us to believe that the Government’s ‘tough’ budget decisions were absolutely necessary because no alternative course was possible. For example, the retiring Secretary of the Treasury, Martin Parkinson, in an almost unprecedented intervention into the political debate, has seemed to suggest that ‘vague notions of fairness’ should not be invoked to oppose the government’s program of fiscal consolidation.  Equally Paul Kelly has pontificated in the Australian that our budgetary problems are such that the ’harsh medicine’ being handed out is necessary, and that opposition ‘reveals an immaturity in political debate that the nation was meant to have left behind decades ago’.

In fact, quite to the contrary, it is a sign of the maturity of our democratic system if there is a proper debate about the best policies for the future.  We should not be silenced by claims that any opposition to the Government’s particular strategy for restoring a budget surplus is irresponsible. Equally, however, that proper debate does require some appreciation of what are the alternatives to the Government’s proposed fiscal strategy.

Clearly the country needs something better than the present approach by the Senate. The necessary budget surplus cannot be restored while the Senate rejects so many of the Government’s savings measures, while passing most of the tax reductions. Indeed at the time of writing it is reported that the Senate’s votes have led to a situation where so far the Budget will be $7 billion worse off over the next four years than if the Budget had contained no policy changes at all.

In the following comment I therefore sketch the outlines of an alternative approach to restoring the Budget to surplus over the next four years and sustaining that surplus in the long run. Fundamentally this comment attempts to sketch how a fairer outcome could be achieved by relying more on measures to increase the revenue, and less on cuts to welfare.  By comparison, of the decisions taken in the Government’s Budget, 77 per cent of the projected improvement reflected decisions to reduce spending.

It is contended that this proposed rebalancing in favour of higher taxation can be done without damaging economic growth. In fact there is no correlation between levels of taxation and the rate of growth in GDP per capita among the developed OECD countries. Of course, there is likely to be a point where a particular tax is so high that it could affect economic growth and/or employment, but the ratio of government revenue to GDP is lower in Australia than in almost all other Western democracies, and our starting point fiscal position is also much better (see Table below). Indeed, spending some of the proceeds from higher taxation, so as to avoid the cuts to tertiary education and training and research and development, would even help to improve the rate of future economic growth.

Country*	Total Tax Revenue as a proportion of GDP 2011 (%)	General Government Net Lending as proportion of GDP 2013 (%)	General Government Net Financial Liabilities as proportion of GDP 2013 (%)
Australia	26.5	-1.4	11.8
Canada	30.4	-3.0	40.4
Japan	28.6	-9.3	137.5
United Kingdom	35.7	-5.9	65.4
United States	24.0	-6.4	81.2
OECD	34.1	-4.6	69.1

*The figures for each country refer to all levels of government, and the net lending by general government is equivalent to the Budget deficits of all governments

Source: OECD Statistics, http://www.oecd-ilibrary.org/economics/government, accessed 13 July 2014.

Note that Australia is the lowest on each of the three indicators except for tax revenue, but if borrowing is added tax revenue then Australia is the lowest at about 28% of GDP compared to more than 30% in the US.

In this blog in May this year I posted a five-part series by Michael Keating on the government’s May budget and the economic and social consequences.  There has been a great deal of discussion and confusion, particularly in the senate, over this budget. This has caused Joe Hockey only a few days ago to warn that he is ready to bypass parliament and force through new spending cuts if Labor and the Greens do not come to the table on millions of dollars of budget savings.

Next week I will be posting three-part series by Michael Keating on an alternative budget strategy. In that series, Michael Keating says ‘there is an alternative to the government’s budget strategy – contrary to the assertion by the government and its supporters that in fact “there is no alternative”.’

This three-part alternative will be posted on Monday, Tuesday and Wednesday next week.  John Menadue

Fundamentally there is a problem with the rhetoric from the government and its cohorts such as the Commission of Audit. They insist on describing taxation as a ‘burden’ that should be lightened at every opportunity; thus implying that taxation is somehow illegitimate. On the contrary, however, taxation represents our mutual obligation to one another as citizens. Instead of being a ‘burden’, taxation is what we should pay to ensure the sort of society that we want.

It is only by changing the rhetoric and accepting the legitimacy of taxation that we can hope to match the community’s expectations for publicly funded services and assistance with our willingness to pay for them. This inconsistency between our expectations and willingness to pay is the fundamental budget problem that I highlighted in my initial comment. Furthermore, the longer we delay the worse that problem risks becoming because there are good reasons why the public’s expectations will rise further and even faster over the next decade or more.

Future Expectations for Expenditure

The Government itself often refers to the impact on demands for public expenditure as a result of the population ageing; indeed the Treasury has documented these demands in its Intergenerational Reports. But the evidence is that population ageing is relatively unimportant as a source of future expenditure growth.

More important factors influencing the demand for publicly funded services are

• rising living standards which tend to translate into a switch in consumer demand in favour of services such as education and health that are largely publicly funded, and
• technological change that has improved the quality of health care and to some extent education, but at increasing costs.

Beyond these factors, and more generally, Thomas Picketty has recently provided comprehensive evidence that over the last forty years the distribution of private incomes in capitalist economies, including Australia, has become increasingly unequal and that there are good theoretical reasons to expect that this trend towards greater inequality will continue. On the other hand, the evidence also shows that governments can intervene to maintain equality if they are willing to use the tax-transfer system pro-actively.

In addition, in Australia’s case over the last three decades we have significantly de-regulated the economy, and while the additional competition did increase productivity and living standards of the “winners’, the quid pro quo should have been a willingness to assist the “losers” to adapt. So those “parrots” calling for more economic reform need to also accept that not everyone will benefit and successful reform may well depend upon a willingness to support and assist those who are disadvantaged to adapt to the changes being imposed upon them.

Taxation and the risks to economic growth

Of course, those who are calling for lower taxes always claim that it will be in the public interest because it will lead to higher economic growth. But frankly where is the evidence?

Internationally the advanced OECD countries with the fastest rate of growth in per capita GDP, like the Scandinavian countries and Germany and the Netherlands, are not the countries with low rates of taxation revenue relative to GDP, while the US with a low ratio of taxation has had very low growth in productivity and participation over the last thirty years. In addition, the econometric evidence regarding individual behaviour does not support much impact from lower taxation on work or saving effort. Indeed some of us can remember when the top marginal rate of income tax in Australia was 60 per cent compared to 46.5 per cent now, but nothing much has changed in the savings or work patterns of the people concerned. In short any objective analysis shows that there is plenty of scope to increase taxation without damaging economic growth.

Taxation opportunities

So how should taxation be increased over time to achieve a sustainable budget? Fundamentally there is a choice between:

• Introducing more effective anti-avoidance measures,
• broadening a tax base, by removing a variety of concessions, or
• increasing tax rates.

It is to the discredit of the Coalition Government that they immediately scrapped the legislation introduced by the previous Labor Government to tighten up on avoidance where in particular many major foreign owned companies pay a ridiculously small amount of tax in Australia. But even strict anti-avoidance measures are unlikely to be sufficient, and more substantial action will be needed over time. In that case, many of the present income tax concessions operate like subsidies on the expenditure side of the budget, but they are subject to far less scrutiny, should be reviewed. So in the same way as expenditure should be closely examined for its effectiveness before resorting to increased taxes, the same is true of taxation concessions. Nevertheless, in the end some increase in tax rates may also be necessary.

Second, the two biggest sources of revenue are the taxation of incomes (company and personal income taxes) and expenditure (GST).  Given that all the GST revenue goes to the states, the balance between increasing the two may partly depend upon which level of government most needs assistance. But looking ahead both taxes will need to be increased over time.

This Budget and future revenue needs

This Budget projects a return to a budget balance in 2018-19, building to a surplus equivalent to at least 1 per cent of GDP by 2023-24, assuming that taxation revenue is capped at an average of 23.9 per cent of GDP. In other words the Government’s future fiscal strategy does not allow for any increase in revenue relative to GDP and expenditure will need to be further reduced relative to GDP despite the future demands identified above. Equally it also means that, like all previous governments, this government envisages that ‘tax reform’ will be revenue neutral, and will instead be limited to changing the tax mix.

Furthermore, considering what we know so far, this future change in the tax mix is likely to further re-enforce the trend to greater inequality. Already the Government’s first priority has been to cut the rate of company tax which principally favours the rich. The alleged justification is that we have to remain competitive with the rates of company tax in other countries, but this sort of simplistic comparison is not really justified. It takes no account of the fact that Australia is the only country that offers dividend imputation, so that effectively Australian residents pay no company tax on the majority of corporate profits because more than half are typically distributed as dividends. Quite frankly if the foreign shareholders are not benefiting from dividend imputation does that really matter, especially if as I have argued in a previous comment we should be saving more and relying less on foreign investment.

The two taxes that are actually increased in this Budget are

• the so-called “temporary Budget repair levy”, but this is temporary and thus provides no help in resolving our longer-term and more fundamental fiscal problems. And most importantly it is far too small an adjustment to income tax rates and consequently raises far too little extra revenue.
• a long over-due increase in petrol excise, which on scarcity and environmental grounds should never have been de-indexed in the first place. In addition, what revenue it does raise is to be hypothecated for investment in roads, much of which will not provide an economic rate of return, is therefore unproductive, and makes no contribution to ensuring fiscal sustainability.

Finally, the Government has given every indication in this Budget that it is contemplating increasing the revenue from the GST, but wants the States to wear the blame. Again, whatever, the merits of such an increase, and there are some, the fact is that it will further lead to a redistribution of spending power from the poor in favour of the rich.

In sum we do need tax reform, but any such reform should start from a consideration of the revenue needed to meet Australia’s long-term fiscal needs. At present we are trying to provide an adequate social safety net and a decent cohesive society with just about the lowest amount of taxation in the OECD – for example, according to the latest OECD statistics, in 2011 total tax revenue in Australia was 26.5 per cent of GDP, compared to an average of 34.1 per cent for the OECD as a whole, and 30.4 per cent in Canada, 31.5 per cent in New Zealand, 35.7 per cent in the UK; all countries with similar traditions to us and with whom we readily identify. And while this ratio of revenue to GDP was only 24.0 per cent in the US, if allowance is made for the much larger Budget deficits in the US, our taxation is effectively lower than there as well. So in effect, and unlike the US, we are trying to maintain a decent social safety net with extremely low levels of taxation. We have been getting away with this because, as I explained in my second comment on Tuesday, we have the most efficient income support system in the world. But there is little more that can be extracted by efficiency of the welfare system, and looking further ahead into the future, it seems pretty certain that unless we increase our revenue we risk finishing up with the sort of inequality and rundown in social infrastructure that is too often experienced in the US.

It is therefore a matter for considerable regret that this Budget gives us little hope that the Government understands the risks to society that it presents, and the associated doubts about whether this government is capable of delivering the tax reform that we actually need.

Each day this week I will be running a series of blogs by Michael Keating on the Budget and its repercussions. The posts will be 

• Australia’s Fiscal Challenge
  
• The Budget and our Values
• A Better Alternate Budget Structure
• Taxation
• Federalism

I am sure that these five posts will make a substantial contribution to our understanding of the Budget and its implications for Australia. Mike Keating was formerly Secretary of the Department of Prime Minister and Cabinet. Perhaps more relevant to his comments on the Budget is that he was Secretary of the Department of Finance under the Hawke/Keating governments, during which time real outlays were reduced in three successive Budgets. This has never happened before or since. These reductions in real outlays occurred while still introducing many of Labor’s major reforms of social welfare that led to substantial increases in assistance to the poor. Much of the credit for this of course belongs for the Cabinet, particularly to Paul Keating and Peter Walsh. But I know that quite a few of the ideas that were implemented came from the Department of Finance when Mike Keating was Secretary.  John Menadue

Mike Keating. Part 1. The Budget and what it means for Australia’s Future

In the run up to the last election Tony Abbott told us that the nation’s finances were in a mess, but notwithstanding that mess he promised to match all Labour’s new spending initiatives, protect education and health, increase defence spending, and all without any increases in taxation.  Frankly none of us, not even the fawning Murdoch press, should have believed him.

Understandably Labor is now tempted to harp on about the broken promises. But that would be to miss the real point.  The real point is that for several decades Australia, like many other developed countries, has had a continuing problem of meeting the public’s expectations for publicly funded services and how to pay for them.   Trust in government will not be restored until one or other political party offers a credible way forward that reconciles these conflicting public expectations of government.

So what is the immediate fiscal challenge that this budget needed to address and how well has it responded to that challenge? In this series of comments I want to consider:

1. how bad is our fiscal situation and the fiscal strategy required from  here on
2. the choices before us in terms of the values that we espouse and what the Budget decisions and Audit Commission recommendations imply for the future nature of our society
3. the consequences and efficacy of many of the specific policy decisions in the Budget

 

Australia’s fiscal challenge

Is public debt a problem?

The Government has talked incessantly about Australia’s debt problem, and government debt is undeniably higher than when the previous Coalition Government lost office in 2007. The Commission of Audit for its part thought that low or even zero debt is such an important objective that the first priority for the fiscal strategy should be the achievement of an arbitrarily chosen debt ceiling.

Others, however, have noted that Australia has a triple AAA credit rating, whatever that is worth. More pertinently general government net financial liabilities in Australia in 2013 represented only 11.8 per cent of GDP, compared to an average of 69.1 per cent for the OECD as a whole, including 81.2 per cent in the US, 40.4 per cent in Canada, 65.4 per cent in the UK, and as high as 137.5 per cent of GDP in Japan, and all these countries have low interest rates and no particular difficulty in financing their debt. Furthermore, although low debt is properly seen as providing increased scope to intervene in the event of an economic downturn, each of these countries had much higher debt than Australia in 2008 and they were still able to intervene and further increase their debt in response to the Global Financial Crisis (GFC).

Instead Australia’s problem is not so much the financing of its government debt, but the extent to which we rely on foreign capital to finance total investment in Australia. Essentially our national savings from all sources, both public and private, fall well short of the investment opportunities. In particular, Australian households increased their borrowing very substantially during the Howard Government years up to the onset of the GFC. Consequently by the end of 2013 the amount that Australian households owed was nearly 1.8 times the amount of household disposable income received in that year. Moreover this level of household debt in Australia was not only high by Australian standards, but also by international standards, with household debt in Italy and Germany, for example, being less than a year’s worth of disposable income.

So on balance the Government’s fiscal target to achieve budget surpluses on average over the course of the economic cycle seems a worthwhile goal, but it is not an absolute imperative and should not be pursued at all costs.

How quickly should the Budget return to surplus and how?

The Government acknowledges that at present the economy is soft, although some improvement is expected through the next financial year. Accordingly something close to a neutral budget in terms of its impact on the economy might have been the best strategy, with monetary policy left to fine tune the level of economic activity. By contrast, Treasury project that the structural Budget deficit will decline by about 1 per cent of GDP. On the face of it this is a fairly rapid rate of contraction of government support for the economy, although probably not devastating. Furthermore, the projected rate of fiscal consolidation over the next four years – 0.6 per cent of GDP – is reasonably well paced, so overall in terms of its impact on the economy this Budget seems to have got it broadly right.

How fair is the fiscal strategy

In the current financial year, 2012-13, government payments are expected to represent 24.1 per cent of GDP; a bit less than their long term average over the previous twelve years since 2000-01 of 24.5 per cent. By comparison, government revenue represents only 23.1 per cent of GDP compared to an average of 24.3 per cent over the previous twelve years. In other words if we have a fiscal problem it does not seem to have been caused by excessive expenditure, but by a drop in taxation revenue, and the prime cause of that was miscalculations by the Howard/Costello Government when they embarked on their 2001 tax reforms, which have turned out to cost more than expected at the time.

So in the first instance it might have been expected that restoration of a fiscal surplus would have been sought primarily by way of increases in revenue. But consistent with government rhetoric and the demands of its supporters, 80 per cent of the projected budget consolidation  is from net savings in expenditure, and only 20 per cent from increased taxation. This in itself raises basic questions of fairness, which will be explored in the next comment.