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.