To tax or not to tax

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By Leith van Onselen

Warwick Smith, a research economist at the University of Melbourne, has published an interesting article in The Age today claiming that the Government’s focus on small government and expenditure cuts are ill-founded, and instead Australia should look to increase its tax take to fund essential social services:

Joe Hockey has been talking non-stop about how the country is running out of money for Medicare, for the ABC, for welfare and for education…

…If we look at the 20 countries with the highest GDP per capita we find quite a few have much higher rates of tax as a proportion of GDP…

Most of these high taxing, high GDP per capita countries have low unemployment, low inflation and score very well on various measures of life satisfaction and wellbeing. Their existence and their success prove Abbott and Hockey wrong and demonstrate that there is another path to prosperity, one that also leads to less inequality while maintaining very high living standards for the overwhelming majority…

We can easily pay for all the things Joe Hockey claims we cannot afford if we are prepared to increase government revenue. In my opinion, the first place to start would be tax expenditures (tax deductions or exemptions).

Treasury forecasts that next financial year we will spend over $45 billion in total on superannuation tax concessions, around $17 billion of which will go to the top 10 per cent of income earners.

We also spend over $8 billion a year giving concessional treatment to capital gains earnings and allowing negative gearing.

…there is plenty of cash to pay for Medicare, education and the ABC if Joe Hockey is prepared to look around.

Smith makes some valid points. To a large extent, the Budget is suffering from a revenue problem, brought about by tax cuts introduced as coffers were flowing from the once-in-a-century commodity boom. And now the boom is over, tax receipts have plummeted (see below charts).
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Certainly, a good place to start to restore the revenue side of the Budget are cutting back egregious tax concessions like superannuation and negative gearing, which overwhelming flow to higher income earners and/or serve no social purpose.
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That said, the Budget is also facing a demographic time bomb as the baby boomer generation retires and the ratio of workers supporting non-workers declines (see next chart).
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Changing demographics means the tax base will shrink over time just as expenditures on age related pensions, medical care, and other items balloons.
In such an environment, it is entirely appropriate for the Government to seek to cut expenditure, so that assistance is targeted towards those in genuine need. The key is to ensure that the burden of adjustment is shared across the economy, rather than being concentrated on those with less political representation (e.g. the poor and vulnerable).
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The entitlement system set-up during the Howard and early Rudd years was never sustainable once the temporary wealth from the once-in-a-century mining boom ended. And like it or not, Australia will need to tighten its belt, along with finding new revenue streams, including by abolishing egregious tax lurks.
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About the author
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.