The highest taxing government?

Is this, as Simon Crean has repeatedly told us, the highest taxing government in Australian history? Before answering this question, I’ll make a more important point. If this isn’t the highest taxing government in Australian history, it ought to be. The demand for the kind of services provided by government (health, education, protection against income risk) rises more than proportionally with income. So the share of income allocated to publicly-provided services, as opposed to private consumption, should increase as income grows.

Update I’ve fixed a broken link to OECD data

Is this, as Simon Crean has repeatedly told us, the highest taxing government in Australian history? Before answering this question, I’ll make a more important point. If this isn’t the highest taxing government in Australian history, it ought to be. The demand for the kind of services provided by government (health, education, protection against income risk) rises more than proportionally with income. So the share of income allocated to publicly-provided services, as opposed to private consumption, should increase as income grows.

The big problem facing governments everywhere is how to reconcile this basic economic fact with the equally intractable fact that the marginal cost of raising revenue rises with the rate of tax (and therefore with the ratio of tax to income). Historically, an important part of the answer has involved policy innovations that reduce the cost of raising revenue, either by making taxes less distorting (value-added taxes as a replacement for turnover taxes) or by reducing compliance costs and making evasion more difficult (Pay as you Go).

Now, back to the issue of the day. The debate in Australia has been tangled in knots by the issue of whether the GST is a state or federal tax. In a system with as much vertical imbalance as we have, the distinction is meaningless. For all practical purposes, the Commonwealth controls taxation at all levels, and what matters is the aggregate tax rate.

It’s surprisingly hard to get good data on this. The best available seems to be the OECD, which showed that the ratio of tax to GDP in 2000 was 31.5 per cent. I’ve posted the PDF file here. Although there isn’t a complete time series in the table I have here, I’m pretty sure the high for the 1990s was about 31 per cent. In the absence of any substantial tax cuts, and with some improvements in compliance associated with the BAS system, revenue should have grown relative to income since 2000. So, the Howard government is indeed the highest taxing in Australian history, and a good thing too.

The same table reinforces the well-known point that Australia is among the lowest-taxing of the OECD countries. Not too much should be made of this. Most of the difference reflects the fact that we have compulsory private superannuation and a flat rate means-tested age pension, rather than, as in most OECD countries, a universal public system of social security.

What is interesting though is the oft-repeated claim that we need to look at our Asian competitors rather than the OECD as a whole. Japan has a slightly lower ratio than we do, but the budget there has been in massive deficit for years. Once they get over their decade-long slump and start repairing their finances, this gap will disappear. Much more interesting is (South) Korea where the ratio of tax to GDP has gone from 19 per cent to 27 per cent in a decade. The same pattern can be observed throughout the region (even Hong Kong has started raising taxes). The basic reason is the one I set out above. If a government is to provide the services a modern society demands, it needs tax revenue and lots of it. The Asian tigers have no magic formula that would let them escape this basic reality.

20 thoughts on “The highest taxing government?


  1. Most of the difference reflects the fact that we have compulsory private superannuation and a flat rate means-tested age pension.

    Hmm I can remember that .au was one of the lowest taxed OECD nation for quite some time, even before the growths in superannuation.
    I’ve always assumed that it was the high urbanization (since urban areas tend to have to subsidise rural areas, generally) that allowed .au to have such low taxes.

  2. “as opposed to private consumption”?

    I think the point here is that much public spending is for private consumption purposes, but only after having taken away consumer choice through public provision. The “demand” for public services is pre-determined by this denial of choice.

  3. As I recall Prof Q, you have defended Simon over the Big Man on the basis that his policies are an improvement. Yet this is precisely the kind of cretinous populist opportunist politics that were pushed by Big Kim, and it is this fundamental and apparently absolute addiction to short-term political point-scoring, in contradiction to the Labor constituency’s long term interests, that is exactly what is crippling the ALP, in my humble …

  4. A good post. It leads you to ponder on the errors of both left and right. On the left, they can’t see the very real problems for both economic efficiency and individual liberty of ever increasing levels of taxation (the second of these is, IMO, much the bigger worry). On the right they’ve never heard of the Baumol effect and its corollaries (though Baumol himself is a conservative).

    The point is there’s a problem here that can’t be solved by the nostrums of either the right or the left – and dogmatism just blinds people to that problem.

  5. The point is not only that the demand for these services rises more than proportionately with income, but that because it’s very hard to get productivity improvements in education and health, the real cost of providing them goes up and up and up.

    Private providers get around this problem by putting their prices up and up and up — private school fees always go up much faster than inflation — but governments don’t charge for the provision of the services they provide, so they can only be financed by higher taxes.

  6. Philosophically I am a ‘small’ government man however theologically I realise this is impossible as high income people would bludge on their responsibilities under such a systen as happened in the past.
    Reducing government expenditure is regressive so until I see some way high income people would assist the poor directly or indirectly I think I will stay with the present system.
    The other big problem is if you really do want to reduce big government you have to reduce Government welfare which again brings me back to my original problem.
    As I recall income taxes were brought into the UK mainly to pay for the war against Napolean but also to get the Government to do things that the Wealthy were supposed to do alah the bible.

  7. “If a government is to provide the services a modern society demands, it needs tax revenue and lots of it. The Asian tigers have no magic formula that would let them escape this basic reality.” What about Singapore? Your .pdf file link is down so I can’t check the tax/GDP ratio, but income tax is ridiculously low and GST about 5% (from memory). The PAP govt has trotted out their ‘Asian values’ theme as a cheaper (and more effective) alternative to the Western welfare state. They also have the Central Provident Fund (CPF) which contributes a huge amount to national saving.

  8. Crean didn’t promise to cut taxes by much last night, mind – he promised to return the money to us as a mix of tax cuts and services.

    In other words, he’s promising to abolish the surplus and tax and spend – entirely counter to the current orthodoxy.

    As surpluses are useless anyway, I reckon this is great – but I haven’t seen any screaming from the usual suspects about this yet, which surprises me…

  9. Some of the other discussion posts prompt me to the observation that as income rises, demand for non-public provision of services, such as private education, rises. No one wants to go to a public school or hospital if they can help it. So public services are inferior goods, consumption falls as income rises.

  10. “Philosophically I am a ‘small’ government man however theologically I realise this is impossible as high income people would bludge on their responsibilities under such a systen as happened in the past.”

    What responsiblities? This is building in some assumptions. They may or may not exist, in absolute terms or under particular circumstances, but you really shouldn’t just slip this sort of thing under the radar.

    As it happens, in certain circumstances (not ours)government funds can be obtained without any direct personal taxes at all, and sometimes even without anything in the form of tax (though there has to be an equivalent). That rather shows that there can’t be any absolute responsibility to do what need not always be done.

  11. John – good post. I have thought (and said) for a while that you should be a big John Howard fan because you wanted high tax and he was the highest taxing PM Australia has seen. If you like Whitlams’s spending levels… you should love Howard & Costello!

    One small note – the year in which commonwealth tax levels were the highest for Australia was 2001/02. So Howard is the highest taxing PM – but we aren’t currently in the highest taxing year. The proper way to determine commonwealth tax burden in a consistent way pre- and post-GST reforms is to take the commonwealth tax burden (budget papers) and add the difference between FAGS (financial assistence grants) and BBA (budget balancing assistence) to the years post-GST. Of course, once the GST revenue exceeds the GMI (guaranteed minimum amount), the BBA will be zero and the calculation will lose meaning.

  12. pay as you earn is fine for the poor slobs (like us) that pay tax…

    but what about the rich, all PAYE/PAYG did was make it harder for the poor to evade taxes, and thus relatively (even) easier for the rich to evade them.

    vidal says, among other things, that what we have is socialism for the rich, and capitalism for the poor.

    this seems moreover right.

  13. also kirchner point is right…

    taxation doesnt create any new money, it just takes money out of peoples pockets (where they can choose to spend it) into the government where they tell you where to spend it…

    tax really only has a few purposes:

    *to move money from rich to poor.

    *to fund defense and the police court system, so we can get on with the business of capitalism.

    *to fund projects that no individuals or companies have the foresight to fund.

    theres really no point taxing people under a certain wage, since all it does is take their money which they would spend with some choice, and put it into jokes like medicare where the cost of the service is free, and thus gets totally abused, then they bear the cost indirectly later in takes.

    plus the government inefficiently subsidises transport (both public and road) which just encourages people to live far from their work and distorts prices in real estate markets.

    in fact the current taxation system pretty much fails on two of those points. it probably transfers next to no money from rich to poor, it doesnt do much in the way of funding long term infrastructure anymore (why would politicians bother with only 4 year terms), but it probably pumps a lot of money from the middle class and below into defense…and thats about it

    i should maybe back this up with figures sometime…

  14. “…it probably pumps a lot of money from the middle class and below into defense…”

    Actually, it doesn’t. Not a lot goes into defence around here, nowhere near world standard. As a proportion it’s somewhere around mid-18th century best practice.

  15. more seriously lawrence is right,

    according to the new budget, australia spends a very reasonable 8% of revenue on defense.

    http://www.budget.gov.au/2003-04/overview/html/overview-19.htm

    i think the US spends 50% of federal revenue on defense, to keep the empire going so to speak (vidal is contagious, although if youve read his stuff about the s11 failures you might want to check out this post at my blog, http://www.zip.com.au/~zzz/blog/archives/000085.html#000085

  16. Actually US defense spending is running about 19% of Federal gov’t outlays. (roughly $400,000,000,000 out of a $2,000,000,000,000+ budget) It’s easy to forget just how BIG the US Federal budget is. Toss in another trillion or so for state and local Gov’ts, which are (I think) a larger fraction of total gov’t spending in the US compared to most OECD nations. That would put it at roughly 12% of overall spending.

    Fed source : http://frwebgate3.access.gpo.gov/cgi-bin/waisgate.cgi?WAISdocID=10912516152+13+0+0&WAISaction=retrieve

    shows defense spending vs budget for last 50 years or so.

  17. Spending a reasonable amount on defence depends on what goals you have for your defence force. As it stands, the only country in the region that could succesfully invade Australia is the United States, and despite their recent behaviour I still find that an unlikely scenario.

    Of course, with Defence issues you have to plan today for what may happen in 10-15 years… but I still think that we are marginally over-defended at the moment. Though maybe being over-defended is a necessary part of believing in the defence strategy of ‘walk softly and carry a big stick’?

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