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.

23 thoughts on “Tax and the Budget (Crikey repost)

  1. One way or another the government is going to need more revenue.

    Crap. The revenue predicted for the coming year (2009-10) is higher than the revenue that produced a surplus in 2006-07. All they need to do is moderate spending. They don’t need more revenue.

  2. Terje

    You keep making the observation that revenue in 2009-10 will be higher than in 2006-07 – but don’t mention that it will be $20 billion lower than in 2007-08 the last Howard Costello Budget.

    In any case, you are only referring to inflation adjusted tax levels, which are of limited relevance to expenditure needs, since they don’t take account of any population growth at all, or any effects of the ageing of the population. In addition, very large shares of the budget go to items that increase in line with wages not prices.

    The estimated tax shortfall is relative to the forward estimates which is the commonly agreed measure.

  3. But in the current environment, the most unexpected possible outcome would be for nothing unexpected to occur.

    Those _unknown unknowns_ are back, and hungrier than ever.

  4. Peter,

    I’d be very happy to have a discussion centred around per capita real tax revenue. The ABS started publishing this trend a while ago but has not updated it for 2009-10 as far as I know. However what it has published is here:-

    Clearly the price of government is on an upward trend. This means that there is loads of scope for balancing the budget by simply freezing spending for a year or so. Personally I’d love to see it frozen in real per capita terms every year with any increase in the real per capita revenue subject to a referendum.

    You indicate that large parts of the budget are wages. However if government wages are to rise in line with wages in the private sector then it is quite reasonable to expect comparable productivity improvements.

    Yes the 2007-08 budget had higher revenue than 2009-10. The year on year changes in revenue (including projections) are as follows:-

    2006-07 +7%
    2007-08 +9%
    2008-09 -3%
    2009-10 -2%
    2010-11 +1%
    2011-12 +9%
    2012-13 +9%

    If your point is that Howard raked in more revenue year after year then there is no argument from me. I even helped make a movie about it in 2007 for the election (a bit crude I’ll admit but the message is there).

    In real per capita terms John Howard provided a 34% hike in taxes during his time in office. What an utter bastard. I even bailed him up on the issue when he campaigned in Bennelong in 2007. He said he was happy to talk but when I put the question to him in front of the TV cameras he slithered away between body guards and decided that the happy people in the shops probably had easier questions.


  5. p.s. A large part of what we pay in grocery prices at Coles or Woolworths is based on wages. However Kevin Rudd thought it reasonable to make a big fuss about the rising price of groceries at the last election. However he was stone silent on the rising price of government. Does he really think that tax bills hurt households less than grocery bills?

  6. Terje – you are so anti government it shows in the colour of your shirt! Woolies and Coles are ripping us off blind and so may be the government but at least we can change the latter…

  7. You can change between Coles and Woolies much more readily than you can change between the ALP and the Liberals. And even if we could change between the ALP and the Liberals more easily than we change between Coles and Woolies I’d still be struggling to see how the choice regarding government is better.

    Alice – you have never seen my shirt.

  8. Terje – I have not seen your shirt but Im betting it has small horse on the front? Come now – choice Woolies ? Coles? ALP ? ALP? Hmmm maybe you are right. There isnt much free choice all round.

  9. Why is tax that big of an issue? We have private debt running at something like 160% of GDP and people want to complain about a measly 6% of GDP in public debt. What’s really stifling government income and consumer spending is the massive private debt.

  10. Why is tax that big of an issue?

    Because we pay too much of the stuff. Because it carries a dead weight cost of 40%. Because it makes households poorer. Because a lot of it gets wasted. Because it is spent on things people could pay for themselves but wouldn’t. Because it is administered perversely. Because it invades our privacy, saps our energy and empowers morons that tell us what to do.

  11. What’s really stifling … consumer spending is the massive private debt.

    Amazing logic. So if we had less private debt would consumer spending be less stifled? More to the point why do you presume that “stifled” consumer spending is a problem. Are you part of some sort of materialism religion?

  12. Amazing logic. So if we had less private debt would consumer spending be less stifled?

    In the past no, in the future most definitely.

    Are you part of some sort of materialism religion?

    Ah… no, I’ve actually never borrowed a cent from a bank in my life. Next to my parents, I’m probably the most austere person I know.

    Unfortunately allowing everyone to rack up huge debts just seems to be a bigger problem than government spending. Deregulating banking here and elsewhere has been a huge disaster.

    Because it is administered perversely. Because it invades our privacy, saps our energy and empowers morons that tell us what to do.

    Ahem… I’m sure we can find a libertarian paridise for you somewhere Terje.

  13. Terje

    My main point relates to the argument that it is spending increases not falling tax revenue that is the source of the deficit.

    If you look at the series you give, lets say that Treasury was assuming that revenue would grow by 9% per year as part of their revenue forecasts i.e. what it was before the GFC and what is projected from 2001-12 onwards. Compound this from 2008 onwards and compare it with the “actual” figures and you will see that the projected shortfall in expenditure by 2010-11 is close to 30% of what would otherwise be projected. The cumulative effect over 4 years is about 25% – this means that over the next four years the government is going to lose the equivalent of one year’s revenue. I would call this a massive revenue hit.

    Now obviously you may think that revenue growth of 9% per year is unnecessary, or from another perspective over-optimistic, but zero real growth is unrealistic The population grows by between 1.25 and 1.5% per year, so without any change in the mix of revenue/spending needs this is what would be needed to keep effective revenue per person stable. As I mentioned you also then have to factor in the ageing of the population which raises effective expenditure needs per person, plus the fact that a high share of spending is effectively either wage costs or indexed to wage costs. As a result, what you are presenting as a superficially reasonable objective actually requires a very significant cut in government spending.

  14. The crucial difference between tax cuts and higher government expenditures is that tax cuts tend to be temporary, while government programs tend to create a more permament burden on the budget.

    If governments go too far in cutting income tax, it is relatively easy to reverse the situation. All the government has to do is sit back and allow the wonders of inflation and bracket creep to bring the tax scales back to where they want and effectively wipe out the tax cuts.

    On the other hand, if governments introduce some new expenditure item which steadily increases in cost, it is much harder for the government to reduce the cost without making tough decisions and suffering political pain.

    Many of the government’s expenditure measures (like increasing pensions) will create long-term budget problems (especially as the population ages and people have less incentive to save for retirement or not draw down retirement savings earlier) long after the effects of the current income tax cuts have washed out of the system.

    To label tax cuts as irresponsible without considering the sustainability of expenditure increases has more to do with ideology than good fiscal policy.

  15. Whoever said “diamonds are forever” or “true love never dies” got it badly wrong.

    Government entitlements survive long after those things are but a faded memory.

  16. Alice – I have never played polo. I suspect it is outside my budget. Is it any fun?

    Peter – revenue is way below what was forcast however that is not the same as saying there has been a massive decline in revenue. The numbers are there for all to see however most will simply accept the spin and never look at the numbers. That is why I challenge the spin.

    If yesterday the temperature was 24 degrees and I had forcast that today the temperature was going to be 47 degrees but in fact it turned out to be 23 degrees then it would be extremely misleading if I got on TV and stated that we had suffered an unprecedented drop in temperature. Exactly the same can be said about the presentation of what has happened with revenue. Even allowing for inflation and population we have at most suffered a very, very modest temporary decline in revenue. Perhaps this might be unprecedented (it sure wouldn’t surprise me because government almost never seems to shrink) however it is hardly massive.

  17. 19# Terje – only the Packers and Prince Charles actually play Polo. Other than you wear Polo. Where have you been Terje?

  18. Alice – I don’t wear polo or play polo or watch polo. I know it is a game where people in teams chase a ball on horseback however beyond that your point is too obscure for my tiny brain to figure out what you are getting at.

  19. Terje – its late. Im tired. It was a joke…and you are right. So obscure way back up there.. I forgot what it was about..

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s