Taxes are not a burden: they provide many of the good things in life

by | Aug 19, 2020 | Finance & Tax

Coalition spending over the past six years has been nearly half that of the past 40 years and is forecast to drop further. With many services already cut to the bone, even the Parliamentary Budget Office has warned such ‘spending restraint’ is likely to be unsustainable. In a post-pandemic world, bringing forward tax cuts that only benefit high earners would be irresponsible, writes Michael Keating.

The Covid-induced recession has turned out to be worse than initially hoped with the recent Reserve Bank Statement on Monetary Policy finding that “the pace of recovery is expected to be slower than previously forecast“.

The initial success in dampening the pandemic’s effect on the economy largely reflected the JobKeeper and JobSeeker programs but this support was intentionally temporary, on the assumption that trading conditions would be returning to normal by the end of next month.

However, the latest official thinking is that a full economic recovery will be much slower than anticipated. While JobKeeper and JobSeeker are to be extended, the Reserve Bank still expects unemployment to rise over the next six months. In its base-case scenario, the Bank expects the rate to average as much as 10% in the December quarter, and still be 8.5% a year later.

Tax cuts top the wish list

Most pundits are calling for additional stimulus to counteract the fall in demand for goods and services. Topping the wish-list is for the next two stages of the legislated tax cuts to be brought forward from July 1, 2022, and 2024 respectively.

However, these tax cuts only benefit high earners. No one earning less than $90,000 will benefit from the second tranche, while the third tranche will only benefit people earning more than $120,000.

Half the tax-paying population of Australia earns less than $50,000, so the vast majority of taxpayers will get no benefit from either tax cut. Furthermore, the beneficiaries tend to have high savings rates, so these tax cuts will do relatively little to increase demand.

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Responsible policy makers should also keep in mind the nation’s longer-term requirements. Given Covid-19, there are good reasons for running budget deficits. Nevertheless, policy also needs to have regard for the longer-term.

An eye to the longer term

Therefore, stimulus measures should ideally only continue for a limited time and end as the economy recovers. Yet tax cuts are permanent and cause lasting problems to the Budget.

Too often any discussion of taxation starts from the premise that it is a burden, but this fails to recognise the purpose of tax. And that is to pay for the services we all want and to support a socially inclusive society with reasonable equality of opportunity. As the great American jurist, Oliver Wendell Holmes put it: “I like to pay taxes. In this way I buy civilisation.”

But taxes can be a disincentive if rates are set too high. Supporters of tax cuts argue that they create incentives, and can spur such economic growth that tax cuts are self-financing. The most famous such example was President Reagan, whose policies caused enduring damage to the US Budget and resulted in a blow-out in the balance of payments with too high an exchange rate, thus damaging the economy.

Among developed nations Australia has the lowest rate of tax revenue relative to GDP, but our rate of growth in per capita GDP terms is lower than in Scandinavia, which has much higher tax rates. So lower taxes, per se, do not necessarily lead to higher per capita GDP growth.

Health, education spending aids growth

Instead, the key to assessing the desirable rate of tax is to start by considering how the money will be spent. Spending on education, research and development, infrastructure, health, and more generally maintaining an egalitarian society can add to economic growth.

The Morrison government’s last plan, before Covid-19 hit, projected a budget surplus, but this was based on an exceptionally low rate of growth in public spending. In fact, real government payments in the past six Coalition budgets increased at an average annual rate of just 1.8%. By comparison, in the previous 40 years, government payments grew at an average real rate of about 3.25 per cent, nearly double.

Furthermore, this tightening in spending has been achieved not by genuine reform of programs to improve their effectiveness but by a combination of meanness, requiring people to pay more, and/or a decline in the quality of service, of which aged care is only the latest telling example.

Indeed, in its latest review, the independent Parliamentary Budget Office concluded: “The spending restraint seen over the past few years may be difficult to maintain … given the length of time in which restraint has been applied, [and] the pressures emerging in some spending areas.”

Spending plans are draconian

The government’s plans for the future are even more draconian. According to the Pre-election Economic and Fiscal Outlook (PEFO), released by the Treasury and Finance departments just before the last election, real government payments over the next four years were expected to increase at an annual rate of just 1.3% – even lower than the rate that had already led to a deterioration in services.

Before Covid-19, I had argued that to ensure adequate services, tax would need to rise by as much as 3% of GDP in the medium term. But even this would still leave our tax levels well below the OECD average.

High priority areas that will require significantly more funding include:

  • defence, foreign aid and diplomacy in response to the deteriorating international situation;
  • aged care;
  • education and training; with universities not able to rely on fees from foreign students to cross-subsidise domestic students;
  • increasing the childcare subsidy from 85 to 95% for low-income households to improve female workforce participation;
  • health; spending for which the PEFO has projected would grow annually by just 0.7%, which is just one-quarter of past increases (2.7% a year) and much lower than the rate of population growth;
  • rental assistance and income support for people who are unemployed; and
  • cultural institutions and the arts.

Tax reform inevitably involves winners and losers. Previous packages generated enough revenue to compensate the losers, ensuring wide support. However, generating that sort of revenue in a post-pandemic environment is likely to prove much more difficult.

It is therefore irresponsible to give a few high-income people a tax cut now. Instead broader reform should be considered, with possible trade-offs that include proper taxation of capital gains and closing the negative gearing loophole – both of which disproportionately favour high-income people.

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ABOUT THE AUTHOR

Michael Keating

Michael Keating

Michael Keating is a former Head of the Departments of Prime Minister & Cabinet, Finance, and Employment & Industrial Relations. He is presently a Visiting Fellow at the Australian National University.

10 Comments

  1. Avatar

    Government spending is less because they have privatised everything they can, and we pay more. Electricity, roads, insurance, internet etc etc etc.

    The government is totally useless, instead of providing services to the people at cost, they outsource them to private enterprise so they can make huge profits, and the government thinks that will get them some extra taxes.

    All well and good except, the companies dodge tax, outsource our jobs overseas, and we get poor to non-existent service that we pay a premium for, and the government announces company tax cuts to help the “struggling” private companies.

  2. Avatar

    Despite performing an excellent response to the Covid-19 pandemic, the conservative Morrison government is setting us up to be less egalitarian with a dismantling of our progressive income tax system.

    In regard to income tax cuts, table 5 of https://www.aph.gov.au/Parliamentary_Business/Bills_Legislation/bd/bd1920a/20bd001 discloses that tax on taxable income in 2024 compared with 2018 will be less by:
    $50,000 $1205 (median taxable income)
    $80,000 $1,955
    $120,000 $4,440
    $180,000 $8,640
    $200,000 $11,640
    Those who are fortunate to have a taxable income of $200,000 or more will have their legislated obligation to share with and support their less fortunate neighbours reduced. They already have satisfied all their needs for services and widgets, so their extra after tax cash will go into increasing asset prices of shelter, shares and bonds etc.

    So combined with stagnant wages growth, the necessity to reduce debt and balance the budget will result in less support and services for the 50% of taxpayers below the median taxable income of $45,882 (2017-18 most recent ATO report).
    https://www.theguardian.com/business/grogonomics/2020/jul/21/middle-australia-earns-100000-and-has-a-negatively-geared-property-not-true

  3. Avatar

    Another instance of economic mismanagement by the Coalition Government. Most studies i have read conclude the ALP have been better economic managers than the Coalition. The Coalition seems to becoming more incompetent with serious repercussions for the Australian economy and society

  4. Avatar

    It’s been shown again and again that aiding the least affluent in the society trickles upwords through the economy, giving to the most affluent only trickles down to tax shelters like the Caymans.

  5. Avatar

    A good article except for a significant error in the opening sentence that makes it highly misleading. Once you read the entire article you realise the article should start: Coalition spending GROWTH over the past six years has been nearly half that ….

  6. Avatar

    This is not a great read. The first sentence should say that Coalition spending is growing at half the rate …. It is corrected later, but is still misleading in that inflation has been lower. In fact, there is evidence that government spending as a percentage of GDP has been rising under the Coalition https://www.theglobaleconomy.com/Australia/government_size/ . You could argue that the cuts they have made have been in the wrong place, but that requires a bit more detailed argument.

  7. Avatar

    The Coalition reflects the views of the IPA and their ilk who assert that tax cuts are the government giving you your money back. The government doesn’t have its own money to give away. The wealthy in particular are prone to believing that everything they earn and own is their just entitlement, their reward for their wise agency, and that redistribution through the tax system is for the meek.
    But an honest account would concede the predominant role of luck. It is good fortune to be born with brains, drive, and ambition. If you grew up in a settled and supportive family, went to a reasonable school, got a satisfactory degree, are connected, able bodied, not subject to racial or other forms of discrimination, have good physical and mental health, you are lucky. It is also good fortune to be taller, or better looking. Contemporary research in behavioural genetics shows the genes we are born with are fundamental to who we are and our prospects in life. Yes, we are all very lucky just to have been born – but some of us are much luckier than others.
    We live in an inter-connected collective world, and we all benefit from public goods. We all benefit from a healthy and educated population. We all benefit from quality public infrastructure. We all benefit from generosity, from other regarding behaviour. And we all benefit from serious self-reflection – on the fortune of our birth, on the many things, people and influences that got us to where we are today. We live in a very wealthy and stable country. There is a great deal – an incredible deal – that we have to be grateful for. If we are in a position to afford to pay more tax we should embrace that – it is a privilege. We are all in this world together.

  8. Avatar

    As usual with articles of this type, it ignores who is presently paying the bulk of the income tax way disproportionately to share of income earned And it isn’t the bottom 50% on income earners.

  9. Avatar

    Yes, if you don’t want to pay tax, then go and live by yourself on a deserted island and see how much wealth you can accumulate there. Tax is the price you pay for living in civil society. And wealth is socially created – there is no such thing as a ‘self-made man’ – every dollar that goes into your pocket has come from someone else’s. The top-rate tax payers assume that there is some God-given justification for their higher pay, but as we’ve learnt from the pandemic, it’s actually the low-paid workers that make the economy work. The obscenely paid fat-cats have been useless at stopping the recession – which has exposed the myth that it is their brilliance that created the good times.

  10. Avatar

    Taxes need to be properly targeted, need to be purpose-bound. If taxes are merely levied on the prudent, diligent, organized to be transferred to the profligate, lazy, and chaotic, then that is not a good tax. I am in principle opposed to direct income-related taxes and prefer user-pays taxes, especially environmental taxes. We must also consider what we want to fund from general taxes and what from special levies. For example: all social security should be funded as social insurance, not as social welfare. On the other hand, the top important education system should be publicly funded from the cradle to the grave, subject to strict regulation. Further, if handouts are given to people (people on social welfare), they should account for them, which they do not do at the moment.

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