Futile to resist rise in tax

I’m still working through the backlog that built up while I finished my book manuscript. In the process, I forgot to post my Fin column from Thursday 25 March, which points out that we will, sooner or later, need more tax revenue. Here it is

Futile to resist rise in tax

In the early 1970s, radical American economist James O’Connor was among the first to detect the arrival of what he called ‘the fiscal crisis of the state’. As O’Connor realised, the combination of growing demands for services such as health, education and publicly-funded pensions with the costs of the US military machine could not be met from available tax revenue.

Connor anticipated that the resulting crisis would provide an opportunity for the left. In fact, of course, the ‘tax revolt’ which began in the late 1970s paved the way for a resurgence of market liberalism in the 1980s. The resurgence was led by Ronald Reagan and Margaret Thatcher, and emulated around the world

The advance of social democracy, which had seemed unstoppable for most of the 20th century was halted and then put into reverse. Governments everywhere reduced taxes, and particularly top marginal rates of income tax. The welfare state was cut back. Governments tried to shed their responsibilities for infrastructure, handing them over to ‘Public-Private Partnerships’ assembled by financial institutions.

For a while this seemed to be working. Deficits were reduced and debt levels stabilised. But in the wake of the global financial crisis, the fiscal crisis of the state has re-emerged with a vengeance. Governments everywhere are looking at empty coffers and wondering if they will be able to repay their debts.

A fairly common set of responses is emerging. First, governments around the world have finally bitten the bullet on the need to increase the eligibility age for pensions. This process is painful and uneven, but it looks likely that a pension age of 70 will be the norm in most countries by 2050. That is, broadly speaking enough, to restore the solvency of publicly-funded pensions.

In other areas such as health, education and infrastructure,however, the demands on governments are only going to increase. Structural change has led to an increase in the proportion of national income needed for social and physical infrastructure.

At the same time, the financial sector, which seemed to offer painless ways of providing such infrastructure without drawing on the public purse, has turned out to be part of the problem, not part of the solution. Even after the costs of the current crisis have been met, the requirement for the state to guarantee financial stability will represent a huge contingent liability.

The only solution is an increase in revenue. For most governments, the simplest way to raise a lot of revenue is to increase the rate of value-added taxes such as the GST.

Income taxes present a bigger problem. Although both the US and UK have increased the top marginal rate of taxation, this is still in the ‘too hard’ basket for most governments. Instead the main focus so far has been on broadening the base, particularly by attacking tax avoidance and evasion. After decades of delay, the OECD has finally taken action to shut down the international tax haven industry. Individual governments have gone further, going in to the market for bank employees willing to sell lists of tax-dodging clients.

Finally, there are some new options. One is revenue from a carbon tax or emissions trading scheme. This has been overstated by some proponents, and even more by detractors, as in Tony Abbott’s Great Big New Tax on Everything. The revenue from pricing carbon is unlikely to amount to much more than 1 per cent of GDP, a fair bit of which will be need to compensate vulnerable households and to fund adaptation and mitigation measures.

Then there is the appealing prospect of making the financial sector pay for the government guarantees that allow it to keep on making outsize profits. The current betting is on President Obama’s proposal for a levy, but the long run solution must surely be a tax on financial transactions, as proposed decades ago by Nobel Prize winner, James Tobin.

Compared to the rest of the world, Australia’s position is relatively strong. Our debt levels are comparatively low, the hard decisions on the retirement age have been taken, and top marginal tax rates were never cut to unsustainably low levels. Our biggest constraint is the virtually impossibility of raising the GST rate. The Henry Review will make interesting reading.

Regardless of how we do it, taxes must rise to meet the demands of a modern society. Tony Abbott gave an eloquent demonstration of that point recently when he proposed his own Great Big New Tax to finance paid maternity leave.

John Quiggin is an ARC Federation Fellow in Economics and Political Science at the University of Queensland.

87 thoughts on “Futile to resist rise in tax

  1. Peter T :
    BTW, pensions were invented when it was obvious that previous community systems (parish relief as a backstop, but the obligation on landowners and families to provide) had irretrievably broken down. Old age is not new.

    Actually, there’s a fair bit of evidence that the “previous community systems” were those provided by Church institutions, and that they didn’t break down but were forcibly removed by the Dissolution of the Monasteries etc. That is, replacement systems never quite grew enough to take up the slack, and ad hoc stuff like noblesse oblige, family support and poor relief only partly met the need (particularly since private resources were also being removed from the poorer groups all along, what with enclosures etc.). Certainly Disraeli traced the damage back to the Tudor period, in asides in his 19th century novel Sybil.

  2. jquiggin :
    Alice, please remember, one comment/thread/day
    Everyone, please discuss the substantive issue and avoid attacking each other

    I’d like to remind people that I suggested incremental and gradual increases in pension age a while back, here (see also this, for broader tax reform suggestions). However, I also proposed that there should be an actuarially matched, incremental and gradual lowering of an age-related income tax break, to allow people the chance to increase their private and personal provision for retirement (otherwise, people coming up to a receding entitlement age would face greater burdens than those of earlier and later generations).

    The object of the exercise was not to force increases in retirement age but to phase out state provision of retirement needs, turning the state element into a long stop and allowing constructive use of the funds instead (letting people invest them to generate real support for later needs). Neither I nor others contemplate just making life harder for at least some, but rearranging the load so it can be managed better – which includes making investments to support the needs. Yes, under present circumstances simply cutting benefits would be harmful, but that’s because of an “other things being equal” problem. The idea is to change those other things too, using an incremental approach that allows that to be done. Engineering out a need is both morally and practically different from just ceasing to cater to it, and in fact it is both morally and practically better than continuing to cater to it – even though just ceasing to cater to it is far worse than continuing to cater to it. But it is not that last false dilemma that is at issue here.

  3. PM Lawrence

    The monasteries went in England in the 1550s. The Poor Law/Parish Relief arrangements were under obvious strain from the early 1800s. There is a gap of 250 years. You also need to consider France, Holland and western Germany. It wasn’t just the church – there were also lots of informal but effective social arrangements.

    The issue with universal or near-universal private arrangements is the temptation – never for long resisted – for those managing the money to divert increasing proportions their way – in fees, investment in their own and their friends activities, and various sleights of hand. This in turn requires detailed and effective supervision, which breeds more elaborate gaming together with diversion of effort into undermining regulation and so on. Familiar story? Leaving private support to the well-off and concentrating public support on most people seems a more stable long-run policy. This does not preclude encouraged or enforced saving in publicly-managed funds (as with the public sector schemes or the industry funds).

  4. It’s simply a matter of who is best placed to manage the risk. The government can and does allow most people to manage their own risk quite effectively and with all sorts of tax breaks. However, life is too uncertain and there are too many vagaries, so having a modest but not degrading income support system at the end of your life for those who’ve failed to manage the risk adequately is the least society can offer.

  5. Peter T :
    The monasteries went in England in the 1550s. The Poor Law/Parish Relief arrangements were under obvious strain from the early 1800s. There is a gap of 250 years. You also need to consider France, Holland and western Germany. It wasn’t just the church – there were also lots of informal but effective social arrangements.

    I haven’t got my point over. There wasn’t a gap of 250 years in shortfalls of informal and formal systems. Rather, adequacy of those arrangements ended with their main support, church systems, in the early Tudor period. They were replaced in part a generation or so later, by the Elizabethan Poor Law. That held up reasonably in practice until the Civil War, but with hindsight it wasn’t strong enough to carry loads it might face, loads which started to build up in the late 17th century and which left widespread poverty for small but increasing numbers from the early 18th century. It was just that it wasn’t until the 19th century that it was seen to have failed. Likewise, informal support didn’t take up the load, possibly because it was a period of change with yet further loads being added faster than adaptation could occur.

    So the point I was making was that the last time there had been an adequate system was the early Tudor period, and the gap wasn’t one in which other things did that job, it was a gap in which ad hoc arrangements were tried but failed progressively until they were completely overloaded and unworkable – even though failure was incipient and small rather than actual and large for most of the gap, there was still no adequate system.

  6. However, life is too uncertain and there are too many vagaries, so having a modest but not degrading income support system at the end of your life for those who’ve failed to manage the risk adequately is the least society can offer

    I think we ought to have a modest income support system for all people irrespective of age. And that is the package we (the LDP) took to the last election when we argued for a phased end to the aged pension. We proposed a negative income tax but you could achieve a similar thing with a universal social wage.

  7. TerjeP, Wilful, space does not permit me to show the workings, but my own research has indicated that a negative income tax/universal social wage is only workable when it is set at a level far enough below survival levels that, over the whole of life, people still have to work to make ends meet but high enough that they can all price themselves into work and still survive. (In a Malthusian catastrophe the floor comes up to meet the ceiling and this cannot be done.) This means that a workable system along those lines cannot be a direct replacement for current benefits which are enough to survive on, and in particular it cannot be simply a pension by another name for the old. Under such a system, the old would have to have other resources built up when they were younger, which in turn means that it would need a slow transition to allow that to come about. A long stop arrangement would be needed too, to stop isolated anomalies letting some people fall through the cracks.

    That’s a large part of why my own suggestions (referred to above) were for a support system that would act more quickly than a negative income tax/universal social wage, i.e. a negative payroll tax, and a transitional method that would be age related to avoid confronting any age groups with insurmountable hurdles.

  8. PM Lawrence

    Think you need to look more closely at the history. Poverty and associated lawlessness were a major social concern in Elizabethan times, much less so by the early 18th century (effectively as a result of demographic and economic changes which raised labourer’s wages and reduced pressure on land), then started to rise again after c 1750.

    My point about 250 years is that policy lifetimes don’t change that much – this is too long a span to be considered an interim.

    Your point about the monasteries is valid, but the linchpin of arrangements in the 18th century was the squire, who coordinated and supported the arrangements of the village community- and was expected to put in both direct support and rent relief, and use his connections to arrange county or central government support. If you read the inquiries into the Irish famine, for instance, you find English governbments asking “where are the landlords and why are they not doing their job?” – not realising (or wanting to realise) that rack-renting Irish absentee landlords were not tied into the same social and political arrangements as English ones.

    My larger point is that complex social arrangements like support for the aged have to start from where you are socially and economically, and will have many different elements. Schemes that seem to assume a blank slate are not, to my mind, likely to do very well.

  9. Hadn’t checked this thread before: worth it just for more the malignant nonsenses from the likes of Terje and Reynolds; stock-standard Murdoch-ese.

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