Tax and the Budget (Crikey repost)
In the Sherlock Holmes story, Silver Blaze, the crucial clue was that of the dog that did not bark in the night. In the 2009-10 Budget, tax policy is surely the dog that did not bark. Despite the near-unanimous view of the economics profession that the tax cuts promised at the 2007 election, irresponsible even at the time, should now be scaled back or deferred, the government made no move in this direction, preferring to achieve a somewhat similar outcome by tightening means tests for higher income earners.
As Wayne Swan said in his tax conference, the first round of the tax cuts, which mainly benefitted low and middle income earners turned out to be very well timed. But the stimulatory effect of the second round, which gives the biggest benefits to high income earners is likely to be much smaller. And even if this was seen as necessary, it is hard to see any justification for retaining the third round due next year, especially as the inflationary bracket creep for which it was supposed to compensate will now be much reduced.
An equally striking silence in the night is the absence of any significant measures to enhance tax revenue. The budget contains only two tax measures of any substance: a further crackdown on non-commercial business losses such as hobby farms and a tightening of the tax exemption for overseas workers.
The explanation, presumably, is that the government is waiting for the report of the Henry Review of the tax system. Policy measures arising from the review will have to be implemented in an election year (assuming an early double dissolution election does not intervene).
Under normal circumstances, tightening of the tax system in an election year would be unthinkable. But circumstances are far from normal
One way or another the government is going to need more revenue. The proposed path back to surplus depends on a degree of restraint in general expenditure that will prove all but impossible to deliver. After the stimulus package has been wound back in 2010 and 2011, expenditure growth is supposed to be constrained to 2 per cent real, or about 1 per cent per capita. Given that the cost of providing government services typically rises in line with real wages, the proposed strategy implies stringent cuts in service delivery.
Moreover, the surplus path makes no allowances for unexpected shocks. But in the current environment, the most unexpected possible outcome would be for nothing unexpected to occur. And the likelihood is far greater that unexpected shocks will necessitate new expenditure than that they will deliver revenue windfalls or cost savings.
The only way to square this circle is for the Henry Review to deliver substantial improvements in revenue, presumably subject to the constraint that the promised tax cuts must be delivered. Fortunately, this is not an unreasonable expectation. After exhausting its energy on the GST, the Howard government’s last two terms saw little action to improve the tax system and many ad hoc measures that compromised it. Having deferred substantial action until Henry reports, the Rudd government will have little option but to act swiftly to implement the necessary improvements.