To get the Australian budget on track, it's time to wind those tax cuts back
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Version 0 of 1. We all got hit in the arse by a rainbow in the 2000s. That's the memorable phrase Paul Keating used to describe Peter Costello's luck in inheriting the Australian economy when he did. But the proceeds of that luck were funnelled back to most of us via the huge personal tax cuts of the mid-2000s. Those tax cuts have blown the budget. They flowed overwhelmingly to higher income households, contributing to higher inequality. And it's time to wind them back. The mining and property booms meant that rivers of gold started flowing into the federal Treasury a decade ago. This enabled Costello to maintain government spending, slash taxes, and deliver budget surpluses – all at the same time. But those surpluses masked a problem. Once the rivers of gold stopped flowing, it was clear that our tax revenue wasn’t enough to match government spending. In economists’ jargon, we’ve had a "structural" budget deficit since the mid-2000s. The main problem isn't that government spending rose, but that tax revenue fell away. The independent Parliamentary Budget Office estimates that most of this deficit is due to falling tax revenue, not rising spending, and that over two-thirds of the fall in revenue is due to the personal tax cuts between 2003 and 2008. Back in 2004, the top tax rate kicked in at an income of $70,000. If this threshold had just been increased in line with the CPI, it would now be around $90,000. Instead, the top threshold is now $180,000. That's a huge increase in the level at which the top tax rate cuts in, much larger than would have been needed to compensate for "bracket creep" from inflation. Tax rates were cut too, with the top rate falling from 47% to 45%, and the rate below that coming down from 42% to 37%. Most of the big cuts were implemented by John Howard's government, particularly in his final term of office. But Labor's promise in the 2007 election to more or less match the Coalition's tax cut pledge led to big cuts in 2008, as well. If tax rates hadn't been cut, and the thresholds had just risen in line with inflation, I estimate (using NATSEM's widely-used economic model) that the government would have raised about $32bn more in revenue last year. That's pretty close to the size of our structural deficit. The true figure would probably be a little lower, because some people might work a bit less or put more effort into tax avoidance if we had higher taxes. Nevertheless, the federal budget would be in a much better state if we hadn't had big, above-inflation tax cuts. Most of the benefit from these unsustainable tax cuts went to high income earners. The bottom 10% of families are around $1.50 per week better off than they would've been if the tax thresholds had just been indexed to the CPI and the rates hadn’t been cut. The top 10% are $192 per week better off. Our tax and welfare system does less to reduce inequality than the systems of most other developed countries. Before personal tax and cash payments, our Gini coefficient (a common measure of inequality, where a higher number means more inequality) is 0.469<strong>; </strong>afterwards, it's 0.334<strong>. </strong>That means that personal taxes and cash payments reduce inequality by 0.135 points, a modest reduction in inequality relative to most OECD countries. For example, the UK reduces inequality through taxes and transfers by 0.182 points, while Germany achieves 0.206 points worth of redistribution.The tax system is progressive – high income earners pay more than the poor – and the welfare system is highly targeted, so the poor receive the lion's share of cash payments. But Australia's overall level of taxing and spending is one of the very lowest in the developed world. That’s why we do much less redistribution than other countries. We also do less redistribution than we used to, in part because of the big, skewed tax cuts of the past decade. Over the coming weeks and months, we're going to hear a lot about the need for deep spending cuts to get the budget back in the black. But the real problem isn't on the spending side. Unsustainable tax cuts are the cause of much of our budget problems, and rolling them back should be a big part of the solution. At a minimum, inflation and time should be allowed to do their thing and erode the windfall gains of last decade. That would have the added bonus of making us less unequal, if only by a little bit. Our editors' picks for the day's top news and commentary delivered to your inbox each morning. |