Don't cook the goose on tax reform, Huffington Post, 4 September
What does an efficient tax system look like? Economists will tell you that its one where we minimise the unwanted distortions on behaviour. Most taxes change what people do: if you tax chocolate bars at a higher rate than apples, people will be more likely to pack a Granny Smith with their lunch.
But some taxes lead to far bigger distortions than others. Insurance taxes discourage people buying insurance, which means they’re more vulnerable to risk. Stamp duty discourages mobility, which means we have too many empty-nesters rattling around in homes that would be better used by growing families. The result of inefficient taxes like these is underinsurance and higher house prices.
Efficiency isn’t the only thing that matters, but it has to be part of the debate. As 17th century French politician Jean-Baptiste Colbert put it, ‘The art of taxation consists in plucking the goose so as to get the most feathers with the least hissing’.
What politicians call ‘hissing’, economists call ‘excess burden’. In effect, this measures how much economic activity gets destroyed by revenue-raising.
The government’s Re:think tax discussion paper included a useful table detailing the excess burden of a range of different state and federal taxes.
One big thing that jumps out from the Re:think paper is the fact that income taxes and the GST are almost exactly as efficient as each other. This isn’t my analysis – the words are there in black and white on page 25 of the government’s own discussion paper. If you raise $5 via income tax, you destroy $1 of economic activity. Raise $5 via the GST, and you destroy $1 of economic activity.
It has become fashionable recently to suggest that cutting income taxes and raising the GST would create a more efficient tax system. The Treasurer was at it again just this week when he rather deliberately mentioned tax cuts and adding the GST to healthcare in the same breath. (As an aside, isn’t it interesting that he refers obliquely to ‘healthcare’, rather than making the case for taxing dentists, paediatricians and wheelchairs?)
Using a GST increase solely to fund income tax cuts just doesn’t make economic sense. Since we know that these taxes have the same impact on people’s behaviour, raising one and lowering the other leaves you exactly back where you started with the efficiency of the tax system overall. Same amount of feathers – same amount of hissing.
But while income taxes and the GST may be equally efficient, they definitely do not hit all Australians equally. Income taxes are highly progressive, because the marginal tax rates increase as someone’s pay rises. By contrast, the GST is highly regressive, because the poorest Australians spend every cent, while those up the income scale save about one-quarter of their income.
So cutting income taxes and raising the GST won’t make our tax system more efficient, but it will certainly make it less equitable. That’s not what I’d call a good tax reform.
If the GST were raised to 15 per cent, and the exemptions kept the same, Australian families in the lowest income quintile would end up spending 11 per cent of their income on this tax. That compares with only 8 per cent for those in the top quintile. Similarly, we know that the poorest households spend more than twice as much of their income on health costs as the richest households do. So broadening the base of the GST to cover this would also hit those who can least afford it.
If we really want to make the tax system more efficient, we should start by looking at the loopholes that corporations and high-income earners use to shrink their tax bills. Every tax deduction and write-off creates distortions in how capital is invested, whether money is spent or saved, and where productive assets end up.
You only need to listen to the evidence from the Senate’s recent corporate tax inquiry to realise that loopholes and deductions play a big role in guiding how companies structure themselves, both here and overseas. A hard look at how deductions interact with each other and the wider tax system would no doubt find plenty of scope for increasing efficiency. We want companies and individuals making decisions that are based on economic fundamentals, not on where they can get the biggest tax perk.
Labor is all for creating a more efficient tax system. In the 1980s, the Hawke-Keating Government cut personal income tax rates by widening the tax net to include capital gains and fringe benefits. This textbook reform – widening the base in order to lower the rate – was fiercely opposed by the Liberal-National opposition of the day.
Jacking up the GST and cutting income taxes won’t improve efficiency. But it would make our tax system less equitable at a time when inequality is already at a 75-year high. If the government believes its own tax discussion paper, it should start proposing reforms that are efficient or equitable – and preferably both.