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Where's the money coming from ?

June 13th, 2004

The classic problem facing an opposition is that of funding its promises. In most election campaigns, the government has first move by virtue of its capacity to bring down a pre-election budget. The government can snaffle appealing Opposition policies, while leaving little in the way of a Budget surplus to fund any new promises from the other side.

Here are some suggestions as to how Labor could answer the question “Where’s the money coming from”, and fund up to $10 billion in tax cuts and new expenditure

h4. Duplication and waste

The Opposition has some advantages of its own. In particular, it can promise to finance at least some of its promises through cuts in vaguely specified duplication and waste. Howard and Costello made claims of this kind before the 1996 election and it would be reasonable for Labor to do the same. But there’s only so far you can go with this. It’s necessary to identify some targets. Labor could reasonably aim to find $1.5 billion per year, with specific targets including
* government advertising ($200 million per year, much of which is propaganda)
* consultants (hard to get a total but at least $500 million per year, some useful but quite a lot that is little more than CYA. The growth in spending on legal services is particularly notable)
* pork barrel grant programs – the Natural Heritage Trust, which got $300 million in the last budget is a typical example. Substantial savings could be made if much of this money was rolled into general environmental spending
The typical pattern is that spending in these areas is cut hard by newly-elected governments, then gradually increases over the time a government is in office.

h4. The health insurance rebate

It’s big, expensive and not very effective. The annual direct costs are about $2.5 billion. In addition, the incentive to seek treatment in higher-cost private hospitals costs about $0.5 billion in extra Medicare payments (estimates by Julie Smith TAI and Leonie Segal). Finally, there’s an implicit $1 billion or so in tax expenditures associated with the Medicare levy surcharge on upper income earners. Against this, there is some reduction in use of public hospitals, which benefits the states.

Savings of $1billion to $2 billion could be made by cutting the rebate to 15 per cent and making part of the Medicare levy surcharge payable whether or not private insurance was taken out.

h4. Negative gearing and capital gains

The combination of unrestricted deductibility of interest costs and concessional treatment of capital gains is a recipe for encouraging speculative investment in housing and the biggest single factor in .. Latham to his credit, was the only member of the Labor caucus to speak against the disgraceful deal under which Labor supplied the Senate votes needed to pass the Howard governments guttiing of capital gains tax.

There are two basic ways of addressing this problem. Logically, the most satisfactory is to reverse the cut in capital gains tax. The alternative is to follow the US practice of ‘quarantining’ losses on investment housing, so that tax deductions can be claimed only against profits from the same activity and not from general taxable income.

The potential revenue gain here is large. The ATO pays out about $700 million more in deductions on housing investment than it takes in tax revenue. Bearing in mind that investments are supposed to make a profit, and that at least some investors in housing do pay tax, quarantining of losses would save at least $1 billion per year and possibly $2 billion.

h4. Motor vehicle FBT

Elimination of the concessional treatment of company cars would save around $500 million per year and a similar amount could be gained from further restrictions on salary packaging for a total of $1 billion per year

h4. Cancelling the second round of the Budget tax cuts

Latham has promised wider tax cuts than those in the government’s budget package. This will clearly be unaffordable if it is interpreted to mean giving the whole of the government’s tax cuts and more on top. On the other hand, it’s hard to see Labor promising to take back cuts that have already been given out. The most reasonable basis for proceeding, therefore, is that Labor should scrap the second round of the government’s proposed tax cuts and use the proceeds to finance an alternative. The obvious option is to make no further changes to the top threshold and instead to raise the thresholds for the the 30 per cent and 42 per cent marginal tax rates.

This would provide revenue of around $2.5 billion per year as the basis for an alternative tax cut. \

h4. Tackling tax avoidance through trusts and companies

Under the deal that induced Labor to go along with the capital gains tax cut, the government was supposed to introduce a range of measures to reduce business tax avoidance through personal-service companies and family trusts (the same measures had previously been promised to the Democrats in return for support on the GST). But the government caved in to pressure from its supporters in business and withdrew most of the measures. The government’s own estimates at the time [1999] suggested in could raise $1.5 billion a year from these measures. It would be reasonable for Labor to aim for $2 billion.

Overall, this gives a menu of options that could raise between $9 billion and $11 billion a year when fully implemented[1]. Even if some of them fall victim to political sensitivity, that’s plenty to fund a ‘big target’ campaign.

fn1. At a tactical political level one important issue arises from the provisions of Clause 29 of the “Charter of Budget Honesty”, under which either party may request costings of their election programs from the Departments of Finance and Treasury. Obviously Labor will come under pressure to seek such a costing, pressure to which Kim Beazley succumbed last time around. Although it’s hard to predict the politics in advance, Labor would probably be better advised to get an independent costing from a consultancy like Access Economics before issuing its policies. Government pressure to submit policies to Treasury and Finance could be the occasion for an attack on the politicisation of the Public Service.

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  1. daz
    June 13th, 2004 at 23:11 | #1

    Dear John,

    Would quarantining property investment losses would have a impact on the availability of rental properties?

    I’ve read that Hawke did this in 1985, but the mass exodus from the investment property market that followed caused a rent squeeze that forced them to repeal it in ’87.

    This is a seperate political issue to the ‘costings’, but it’s something I’ve wondered about for some time, and this seems a good forum for getting some information.

  2. Harry Clarke
    June 14th, 2004 at 10:17 | #2

    Quarantining losses is not something that needs to be practised inside firms so it would be a specific discriminatory measure imposed on households that presumably can be thwarted with some transaction costs.

    From a realpolitic viewpoint negative gearing anyway is the sort of policy you would want to announce after you win an election rather than before.

    And I think daz is right restricting negative gearing should reduce the supply of rental properties since it raises the costs of providing such accommodation.

  3. Brian Bahnisch
    June 14th, 2004 at 10:32 | #3

    I wonder whether, as an alternative, we could borrow say about $150 billion and use the $10 billion to pay the interest. According to an article ‘Why Australia is so scared of public debt’ by John Breusch and Cherelle Murphy in the Weekend AFR (subscription required) we are effectively approaching zero public debt compared with an OECD average of over 50% of GDP.

    We have, in corporate terms, a lazy balance sheet. In the corporate world such companies are often taken over.

    We could spend half of it in improving our physical infrastructure – roads, rail, rivers, broadband accessible to all etc.

    The rest we could invest in our human capital, R&D, universities, a Knowledge Nation type initiative.

    Our efficiency across the nation would improve, more tax revenue would flow in from increased economic activity and down the track we might even square our balanve of payments.

    There must be a catch somewhere, or we’d do it, wouldn’t we?

  4. Harry Clarke
    June 14th, 2004 at 14:10 | #4

    Brian, It seems to me that repaying the debt has a substantial equivalence to setting up an intergenerational fund (IGF) that will enable us to go into increased debt in the future if we need to meet particular transitional costs of population aging. At lease its better to go into such a phase with public debt on the low side.

    It has been pointed out to me that there are differences between an explicit IGF and debt repayment related to the composition of the government’s balance sheet and the useful social role that a deep local bond market plays in achieving overall capital market effectiveness.

    But overall Mr Costello and the Liberals seem to be doing essentially what some Labor supporters have proposed.

  5. June 14th, 2004 at 21:17 | #5

    If Latham is going to reduce the tax and revenue shares of GDP, increase spending on health and education and run a budget surplus for his first three years, as he has indicated, then he will have to put up the most aggressive expenditure reduction program from an opposition since Fightback. The ALP claim to be sitting on $8bn in savings already.

  6. woodsy
    June 16th, 2004 at 17:01 | #6

    Two other areas that spring immediately to mind;

    (1)Inefficiencies in the Pharmaceutical Benefits Scheme. Perhaps the PBS Advisory members could seek feedback from the pharmacists that work at the coal face. My wife could show them where to save millions on cholesterol and blood pressure drugs; conditions that should be treated by modifying lifestyle. And remove FREE medication. There should be a co-payment for every prescription. Free medicine simply increases abuse of the system

    (2)Reduce waste in the Australian Defence Forces. It’s the lack of accountability that causes the ridiculous blow outs over budget.

  7. Brian Bahnisch
    June 18th, 2004 at 09:59 | #7

    Harry, I understood early on from Fred Argy and others that the intergenerational problem wasn’t as big a problem as Peter Costello would have us believe. In today’s Courier Mail Ross Guest writes:

    “First, the costs of population ageing will be modest and will be overwhelmed by positive influences on living standards.

    “The main reason is future productivity growth due to technological improvements and innovations.

    “This is not just a shy hope. Productivity growth is incredibly persistent in the long run and it is the ultimate source of rising living standards.

    “No economist (as far as I am aware) denies that living standards will rise in the long run by more than enough to offset the costs of population ageing.”

    My idea was to use borrowings to boost our productivity, our competitiveness and our earning potential so that we would have more resources at our disposal when the Intergenerational thing started to bight. If a capitalist can’t borrow money, leverage the company to from 30 to 60%, and improve earning thereby it’s because a lack of opportunities or imagination or both. It seems to me that our infrastructure and our knowledge/skills base may be approaching a point where if we don’t invest to improve them they are likely to become a negative.

    But maybe I’m being too simple-minded.

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