MICHAEL KEATING. The Budget: Part 2

The Budget is the most comprehensive statement of a government’s priorities. It is the Budget that tells us specifically where the government intends to spend and how it intends to pay for that expenditure.

In this article, I will seek to compare the Government and the Oppositions policies for taxing and spending, relying principally on last week’s Budget and the Opposition’s reply.

Taxation

As I noted in yesterday’s article, despite the Government wanting to make this election about taxation, for the next three years most people (75 per cent of taxpayers) will pay the same amount of income tax whoever wins the forthcoming election. The main difference in income tax will be for the 22 per cent of taxpayers whose income is less than $37,000 who will pay less tax under Labor. While on the other hand, the 3 per cent or so of taxpayers with a taxable income of more than $200,000 will pay an extra 2 per cent income tax on their income above $200,000 under a Labor Government.

In addition, Labor will also have more revenue to play with than the Coalition because of Labor’s announced policies to raise more revenue by:

  • limiting negative gearing of property investment to new properties,
  • reduction in the capital gains discount,
  • no longer providing cash rebates for franking credits that exceed taxable income, and
  • higher taxation of superannuation and trusts.

But these changes are arguably about plugging loop-holes in the tax system and will make the tax system fairer and more efficient. For example, the changes to negative gearing and capital gains taxation will stop the subsidisation of investment in existing dwellings, which will lower their prices and divert funds to new more productive investment. They will also improve inter-generational equity.

Furthermore, these changes do not affect the vast majority of taxpayers, and really only impact on those people in the top income decile. For example, there has been much publicity about the withdrawal of franking credits where there is no taxable income and how that will hurt retirees. However, the truth is that all people with a pension income are exempt from this proposed policy change, and more than 80 per cent of retirees are pensioners or part-pensioners. The other 20 per cent or less of retirees who are self-funded in fact have quite large incomes – big enough that they are not eligible for any social security pension – and their self-funded income is typically non-taxable and that will not change.

From 1 July 2022 the Coalition plans to start changing the tax thresholds, with further changes affecting both the thresholds and number of tax brackets from 1 July 2024. These changes would result in a simpler tax system, but the worry is how far they will reduce the progressivity of the income tax system. Research by the Australia Institute shows that more than half the benefit of this proposed flattening of the tax scales will go to the top 20 per cent of taxpayers, and only 3 per cent to the bottom 20 per cent.

Labor has refused to support much of the Government’s proposed changes, partly on equity grounds but also because of the cost. Accordingly, it is presently estimated that a Labor Government would collect around $165 billion more revenue than a Coalition Government over the seven-year period from 2022-23 to 2029-30.

Of course, that means that from 2022-23, on presently announced policies, higher income people can expect to pay more income tax under a Labor Government than with a Coalition Government. But 2022-23 is two elections away, and frankly no-one can be certain this far ahead about the future capacity of the economy and how much revenue it will then be appropriate to return by way of further tax cuts. Furthermore, it is quite unnecessary to lock in tax cuts so far in advance, thus raising the question about whether it is responsible to do so.

In due course, and closer to the election in 2022, a Labor Government would still be able to make its decisions about the amount of revenue it will need beyond 2021-22. That will be when decisions should be made about the future of the income tax rate scales, and the relative needs for balancing the budget and competing expenditure claims. This would be a much more responsible course, than locking in revenue so far ahead, some of which may never eventuate, as the Coalition is presently proposing.

Expenditures

While both political parties are yet to announce all their spending plans, the size of future government spending over the next three years is becoming clear.

Over the next four years the Government expects the average real growth in its spending will be 1.9 per cent, slightly lower than the projected growth of the economy. The Budget documents claim that this growth of spending represents the ‘lowest average of any government in 50 years’ – an incredible piece of ignorance: as between 1984-85 to 1989-90, under the Hawke Government, real government expenditure actually fell.

In fairness, however, there were many more opportunities back then to improve the targeting and effectiveness of government expenditures than exist today. Nevertheless, the Coalition can be accused of not really trying to improve program effectiveness, as most often they have relied on arbitrary cuts, often directed at what they deem to be ‘undeserving clients’.

Many would also argue that the past cuts to education and health expenditures have left these most essential services under-funded, and this funding doesn’t seem to have been restored in this Budget. Instead, there are plenty of new announcements, but they seem to be highly targeted at critical electorates and particular interest groups and will not ensure the adequate provision of the normal range of standard services.

Whether future real spending growth averaging 1.9 per cent will be sufficient to meet the government’s guarantee to adequately fund all essential services is equally very debateable.

In the long-run the demand for improved public services seems to rise as living standards rise, and perhaps even faster. Accordingly, the funding of government services should probably increase at much the same rate as the economy in the long-run, and possibly even a bit more, especially in the short-run if the past underspending is to be restored.

That is not to say that there are no opportunities for future savings, but many of these savings are more likely to be realised if they were re-deployed to improve other aspects of health delivery, for example.

In fact, the stand-out area for improved spending is on infrastructure. Both political parties are making big promises for infrastructure funding, but most have never had a business case – not least because it would not stand up to scrutiny – and as readers of this blog would know, many of the projects to be funded have been demonstrated to be a waste of money.

Turning to the Labor Party’s future spending, we do not yet have a summary of their total – that will come later in the campaign – but it is possible to make some assessment of the likely magnitude. First, the ALP is very likely to spend more than the Coalition, and that is already clear from Bill Shorten’s Budget Reply speech. But what is less certain is how much more and on what?

There has been much media speculation that Labor has a much bigger ‘war chest’ to finance additional spending because of its extra measures to close tax loop-holes and not to endorse the later stages of the Government’s tax reform package.

It is important to note, however, that it is only the former measures that will give Labor more revenue than the Government over the next four years. These new measures have been estimated to raise around $131 billion over ten years, so the amount extra in the next four years would probably be a bit less than $30 billion a year.

This is a useful amount, but some of it will be spent on extra tax relief for the lowest income taxpayers. Taking account of Labor’s commitment to a Budget surplus too, that means that government expenditure under Labor will only rise a very little faster than under the Coalition. And it is still too early to detect where the main differences in how that money will be spent.

Conclusion

The constraints of fiscal responsibility, that both sides accept, means that there is less difference between the two major political parties than is often popularly believed.

Nevertheless, the forthcoming election will offer a choice between more tax relief for low income people against more relief for those at the top. The Government argues that their approach encourages enterprise and will result in faster growth. The empirical support for this proposition is, however, almost non-existent.

Instead, the main problem Australia is facing is low wage growth, resulting in low growth in demand, leading to lower investment and productivity growth. As argued in Part 1 of this series yesterday, the appropriate response to this policy problem is more and better spending on education and training, plus improvements to the income support system for those people disadvantaged by changing technology and other structural changes.

What we need is not smaller government, but better government.

Michael Keating is a former Head of the Departments of Prime Minister & Cabinet, Finance, and Employment & Industrial Relations. He is presently a Visiting Fellow at the Australian National University.

 

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2 Responses to MICHAEL KEATING. The Budget: Part 2

  1. Reg Tydell says:

    Michael, I agree with everything you’ve said, with one niggle. You state “[t]he other 20 per cent or less of retirees who are self-funded in fact have quite large incomes”. In many cases I’m sure that’s true, but you left out those retirees who fail the assets test (not income test) simply because of the balance of their superannuation accounts. Their superannuation pension in most cases would be quite modest (endeavouring to make their retirement savings last as long as possible). This is a group of retirees who continue to suffer financially from the changes made by the current government to the assets test threshold.

  2. Malcolm Crout says:

    Fiscal responsibility? What about social responsibility? Governments are elected by the population to pursue social policy to benefits the population and not to meet some arbitrary fiscal rules based on questionable macroeconomic theories.
    This idea that the Government needs to tax to “fund” spending has been discredited.
    The budget statement is a political document. It’s more than taxation and expenditure, which are simply the parameters of the plan.
    We need to call out discredited economic theories promoted by people who don’t understand how monetary systems work within a modern economy. It’s nonsense.

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