The Grattan Institute has released an excellent new report, entitled Fiscal Challenges for Australia, which examines Australia’s weakening budgetary position and some of the revenue measures needed to address it.
The report finds that both major parties have been relying on bracket creep (aka ‘fiscal drag’) and favourable economic conditions to deliver a balanced budget. However, their short- and medium-term projections have all contained highly optimistic assumptions from the Treasury about revenue growth and spending restraint.
In particular, Treasury has assumed that income taxes will rising from 11% of GDP in 2014-15 to 12.1% in 2018-19. And on these projections,
personal income tax will grow faster than the historical average for each of the next four years.
Treasury’s forecasts around the terms-of-trade are also too bullish, projecting a fall of 9% in 2015-16 and then stabilisation at a level about 50% higher than their long-run average.
Yet, for the past six years, Federal Budget outcomes have been worse than projected by the Treasury, and over that time period, the Budget has run deficits, five of which have been larger than 2% of GDP.
The reliance on bracket creep to restore the Budget to health will also create adverse consequences, since it is middle income earners that suffer the biggest rise in tax rates.
To make matters worse, Grattan believes Budget deficits are unlikely to improve anytime soon because of the terms-of-trade crash, which will lower nominal GDP growth and drag Budget revenues down more than anticipated. Grattan forecasts that the drag on per capita incomes will be around 0.5 percentage points over the next decade as the terms of trade returns to long-run norms:
Grattan also estimates that each $40 billion dollar deficit increases the lifetime tax burden for households headed by a person aged 25 to 34 by $10,000. And given this, hard decisions are required to improve outcomes for future generations, as well as fund new policy initiatives.
State Government budgets, too, are under increasing pressure from strong population growth (immigration), growing interest burdens to fund infrastructure, the rising costs of health and education, as well as the federal government’s decision to no longer contribute to real increases in spending per person in health and education from 2017-18.
Overall, Grattan believes the task to repair Australia’s Budget position is immense, and will require both cuts to costs as well as new taxes to boost revenues.
However, to achieve this, Australia needs brave politicians – something that is notably absent – and first the broad acknowledgment from our political class that problems exist.
I cannot fault this report, which captures the budgetary situation facing Australia beautifully.
As I have argued frequently, the most obvious path to fiscal repair is to first reform Australia’s world-beating tax concessions (e.g.superannuation, negative gearing and the capital gains tax discount), which cost the Budget many billions of dollars in foregone revenue and are skewed towards the wealthy and high income earners. Fundamental reform in these areas would also dramatically improve the progressiveness of the tax system and would counter concerns that budgetary reform is unfair and is placing the burden of adjustment unfairly on lower income households.
Second, Australia must look to broaden the tax base so that it is built around more efficient and equitable sources. This requires a shift in sources from productive effort (e.g labour and corporations) towards taxes on land, resources, and consumption, along with adequate compensation for the poor (in the case of raising/broadening the GST). Under this approach, the overall tax take could be raised at less economic cost than via bracket creep. The tax burden would also be shared more evenly across the population, rather than relying on a diminishing pool of workers to shoulder the load.
Unfortunately, by ruling-out reforms to Australia’s tax concessions, such as superannuation, negative gearing, and the capital gains tax discount, the Abbott Government seems happy to let the Budget deficit blow-out and the tax burden on younger Australians to rise inexorably. Of course, Labor are no better, given they opposed sensible reforms to the Aged Pension.
Australia needs real leaders. Not opportunistic hacks that set policy via ‘captains calls’ and whichever way the wind is blowing.
