Tax and Government in the 21st Century
Parliament House, Canberra
Thursday, 6 October 2022
One of Florence’s great city-states is the walled city of Sienna. Home to the famous Palio di Siena, an annual spectacle described as ‘the world’s most insane horse race’, its city building shows on the wall a painting known as ‘The Allegory of Good and Bad Government’. Painted by Ambrogio Lorenzetti in 1338 and 1339, it shows a well-governed society – happy people, productive enterprises, strong communities; and a badly-governed one – crime, garbage and dysfunction.
Miranda Stewart has chosen for her cover image of Tax and Government in the 21st Century a segment of Lorenzetti’s fresco depicting good government. It underpins her central message – and one that the rulers of Siena knew in medieval times – that taxation is an integral part of a good society.
Tax and Government in the 21st Century takes a broad sweep, both in time and space. It begins with the origins of modern tax systems, and the way that taxation was expanded to cover public goods. As the Bismarckian welfare state grew, so too did a need to fund unemployment insurance, health insurance and pensions. Stewart’s history is impressive, but I couldn’t help feeling that she perhaps gave too little attention to the role of war in expanding tax systems. For example, Australia’s federal income tax was introduced in 1915 (to pay for World War I) and massively increased in 1942 (to pay for World War II).
Budgeting, Miranda Stewart notes, is fundamentally an ethical exercise. She discusses the growing emphasis in government budgets on analysing the impact of taxation and spending policies on gender and inequality, and discusses the rise of green budgeting. Fittingly, as Treasurer Jim Chalmers has noted, a major focus of the October 2022 budget will be on wellbeing, and measuring what matters.
Another trend that Stewart notes is the rise of fiscal rules. In 1990, she notes, less than ten countries had fiscal rules. In 2021, more than one hundred countries had fiscal rules. But rule-following is imperfect, to say the least. Stewart concludes that fiscal rules are ‘frequently honoured in the breach’, such as when the 2008-2009 global recession causes many countries to breach rigid budget rules. Troublingly, she suggests that a result of this episode was less budget transparency, as some countries engaged in ‘creative accounting’ to conceal the breach.
How should we judge tax policy? A common answer is ‘equity, efficiency and simplicity’. Stewart takes us back a little further, to Adam Smith’s maxims of ‘equity, certainty, convenience and efficiency’. The focus on certainty and convenience may reflect the fact that Smith was writing in the era of the window tax, a tax that led homeowners to brick up their windows or build homes with fewer windows. As Miranda Stewart notes, the result was darker, danker homes, and sicker residents. Bad tax policy led to bad buildings.
Miranda Stewart does a terrific job in drawing out the devilishly difficult details that flow from the simple maxims of tax. A proper analysis of equity should consider not only taxes, but transfers too. And it ought to account for income dynamics over the lifecycle, not just equity at a single point in time. Australia’s HECS-HELP system, for example, was built on the principle that attending university raises lifetime incomes, and so students should pay a portion of their tuition costs. But I am not aware of any comprehensive analysis of tax burdens over the lifecycle. Nearly thirty years ago, Dianne Rogers and Don Fullerton did their analysis on the US, published in a 1993 Brookings Institution book titled Who Bears the Lifetime Tax Burden?. It might be useful for a researcher to conduct a similar analysis for contemporary Australia.
The issue of efficiency, as Stewart notes, was a central focus of Jim Mirrlees’ 2010 review of the UK tax system. There are certainly efficiency gains to be had in tax reform – such as by switching from stamp duties to land taxes. But efficiency as the sole goal of policy can be disastrous. In 1990, hundreds of thousands of Britons marched into Trafalgar Square to protest against Margaret Thatcher’s poll tax, a highly efficient tax that required every UK resident to pay a fixed sum. Challenged on the tax, one member of Thatcher’s cabinet asked ‘Why should a Duke pay more than a dustman?’. By the end of the year, Thatcher was no longer Prime Minister. A few years later, the poll tax was gone.
Improving efficiency is important, but it needs to be kept in perspective. Because the deadweight loss increases with the square of the tax rate, it’s the biggest taxes that cause the most damage. Moreover, tax inefficiency pales beside the human damage that a recession can do. As Jim Tobin once put it, ‘It takes a heap of Harberger Triangles to fill an Okun Gap.’
Another limitation of the equity-efficiency-simplicity mantra is that it leaves aside the role of Pigouvian taxes – which aim to correct an undesirable market activity, such as internalising an externality. Perhaps the most successful Pigouvian tax has been the tax on cigarettes, which has played a central role in reducing smoking rates – and therefore deaths from smoking. In other areas, Pigouvian taxes have proved politically challenging – such as when dealing with the externalities from congestion and carbon pollution.
What’s next for taxation? Miranda Stewart highlights the growing role of negative income taxes, which transfer money to poor families by subsidising low-wage work. In the United States, the Earned Income Tax Credit is one of the country’s largest and most successful antipoverty programs. Its central philosophy is the opposite of a universal basic income: transfer resources to the neediest, while encouraging labour force participation. Coming back to the theme of wellbeing, there is good evidence that having a job has a huge positive impact on life satisfaction – so it is likely that negative income taxes do more to boost wellbeing than a universal basic income.
Miranda Stewart also analyses tax expenditures (known to their critics as tax loopholes), noting the measurement challenges that are inherent in estimating them. Her careful discussion reminds me of a point that one of my public finance professors, Martin Feldstein, used to make. Feldstein was passionate about getting rid of tax concessions such as the US mortgage interest deduction. Scrapping inefficient tax loopholes, he argued, was a more efficient form of revenue-raising than increasing tax rates. But because the benefits of tax expenditures tended to be skewed towards higher income earners, it was also a more equitable reform than cutting government expenditure.
Better data has also been crucial for improving the quality of policymaking. When I worked on public finance as an economics professor at the Australian National University, it was not possible for a professor to access tax microdata. Today, confidentialised data are routinely analysed by researchers. Work done at the ANU’s Tax and Transfer Policy Institute – formerly headed by Miranda Stewart, and now by Robert Breunig – is providing more precise estimates of key elasticities and distributional impacts.
In the realm of multinational taxation, Tax and Government in the 21st Century takes a deep dive into the challenges posed by tax havens and so-called ‘stateless income’. ‘The globalisation and digitalisation of the economy’, Stewart notes, ‘presents a fundamental challenge to the authority, structure and resilience of the tax state in the twenty-first century.’ It is a particular pleasure to see (on page 309) a careful diagram showing how the infamous Double Irish-Dutch Sandwich tax planning structure used to operate. At the 2022 election, Labor pledged to close down two multinational tax loopholes: debt dumping and the abuse of royalty payments. We also promised to implement transparency measures, such as country-by-country reporting for large multinationals and tax disclosure by significant government tenderers. Stewart’s discussion is a reminder of the scale of the challenge in ensuring that company taxes are fit for purpose in an increasingly weightless economy.
Four hundred pages about tax may not be everyone’s idea of a page-turner, but I thoroughly enjoyed Miranda Stewart’s expansive and lively analysis. This book will be welcomed by students, tax practitioners and academics for its international focus and engaging examples. It strikes the right balance between law, economics and politics in explaining the central issues in tax and government.
What would I have added if I had been writing this book? One topic is the time cost of tax compliance. A 1995 estimate suggested that the average Australian taxpayer spent 8½ hours a year keeping records and filling out his or her individual income tax return. Unless that figure has fallen markedly (and I’m not aware of a more recent analysis), it suggests that taking people out of the filing system would be the equivalent of providing another public holiday. I have always done my taxes personally, because I believe it’s important to understand the system. But even for a tax tragic like me, it isn’t my favourite activity.
Another area that the book might have explored further is the potential for policy experiments to improve the tax system. As in many other areas of policy, randomised trials have been critical to understanding many aspects of public finance. In the United States, random audit studies (through the Taxpayer Compliance Measurement Program) provided insights into the extent of tax underreporting by income. Randomly varying the language of tax warnings has helped revenue authorities test messages from behavioural economics, such as pro-social messaging (‘did you know that most people pay their taxes?’). Building a better feedback loop is essential to creating a better tax system.
Ultimately, one of the best aspects of Tax and Government in the 21st Century is that it recognises the link between taxes and decency. Miranda Stewart quotes one of Australia’s great novelists, Peter Carey, from his 1991 book The Tax Inspector: ‘It was Alistair who said, on national television, that being a Tax Officer was the most pleasant work imaginable, like turning on a tap to bring water to parched country. It felt wonderful to bring money flowing out of multinational reservoirs into child-care centres and hospitals and social services… He sold taxation as a public good.’