Review of the Economics Society of Australia’s Budget Night

Budget analyses in the media consist of a scramble to tell  readers whether or not the government has kept or broken promises and above all else,  to tell us who has won and lost out of the budget, as well as who would have won and lost had the opposition been in power.

What never fails to escape the focus of the media hurricane is the extent to which this budget addresses the deeper issues facing the country as a whole and what measures are being taken now to combat the medium to long term pressures that the country faces. However at the Economics Society of Australia’s annual Budget Night, Professors Neville Norman and John Freebairn provided their members (along with a strong showing of ESSA members) with precisely that kind of analysis.

Associate Professor Neville Norman, University of Melbourne
Professor John Freebairn, University of Melbourne

 

 

 

 

 

 

 

 

Budgets : Where to Begin?

Both speakers stressed that the starting point for analysing the budget is to take a step back and define what the goals of a government are, and how these should translate through the budget. Professor Freebairn neatly summed these goals up as being a responsibility to ensure property rights and low transaction costs to enable the smooth running of the market economy, and to address the issue of equity through the provision of grants, services, health, and a progressive income taxation system.

Professor Freebairn then pointed out that rather than having low transaction costs, Australia suffers from overregulation and an oversized bureaucracy, and that equity aims have long been hampered by a highly inefficient taxation system. He gave a glaringly clear example of the tax efficiency costs that exist in Australia by comparing royalty and stamp duty revenue raising, that cost approximately 80 cents to administer for every dollar raised, with GST revenue that costs only around 10 cents to administer for every dollar raised. Unfortunately the Henry Tax Review of 2010 which recommended that inefficient taxes be scrapped in favour of simpler, fairer, and more efficient taxes, was and remains  largely ignored.

Risk that the Budget will not meet expectations

Professor Norman made the excellent observation that the budget, just like any other business modelling, is risk sensitive and therefore budget forecasts should display alternate figures for differing scenarios so as to “never hang your hat on one version of the future”. The point was made that it only takes one natural disaster or a downturn in the world economy for all the numbers in the Budget to become irrelevant.  The risk of either event occurring is far from negligible.

Furthermore the forecast surplus that Professor Norman referred to as “wafer-thin and extremely brittle”, could easily become a deficit if growth doesn’t meet expectations (Professor Norman predicted growth of 1.5% instead of the 3.25% government forecast).  A deficit could also eventuate from relatively minor shifts in revenue and/or expenditure. For example if the mining tax doesn’t raise as much as expected (many predict that it won’t), or as Professor Freebairn pointed out, if the National Broadband Network (NBN) ends up running at a loss leaving the tax payer to foot the bill.

Obviously governments are not keen to provide alternative scenarios for the budget, preferring instead to present them in the best possible light  or as best fits their strategic aims.  For example,  Treasurer  Peter Costello’s Budgets during the Howard years (1996-2007) frequently had an upside  ‘surprise’ which  allowed strategic cash handouts, to shore up electoral support, particularly in election years.

Talking Tax

In the 2012/13 Budget, much was made of raising the tax-free threshold from $6,000 to $18,200, thereby removing the need for up to one million low income earners to file tax returns.  However both Professors made the point that the actual marginal benefit to income earners, including low income earners, is much lower than these figures might suggest.

The low income tax offset (LITO) currently provides a tax rebate of $1,500 to workers earning under $30,000 dollars (the $1500 then reduces at a rate of 4% for each dollar earned over $30,000 and phases out completely for incomes above $37,500), making their effective tax-free threshold $16,000 rather than $6,000. After the government raises the tax-free threshold the LITO will be reduced to only $450 but won’t start phasing out until $37,000 at a rate of 1.5% on income earned thereafter (phases out completely at $67,000).  This means a worker on an income of $37,000 or less will have a tax-free threshold of $20,543 rather than $18,000. Therefore the change in a low income earners tax threshold is only $4,542 (20542-16000) rather than $12,200 (18200-6000).

Marginal tax rates have also increased.  Incomes between $18,201 and $37,000 (between $20,543 and $37,000 for people earning $37,000 or less) will now be taxed at 19% instead of 15%, and incomes between $37,001 and $80,001 will be charged at 32.5% instead of 30%.

Together this means that the overall benefit to wage earners is much lower than is suggested by the government’s raising of the tax threshold:

Income Earned Tax Saving Income Earned Tax Saving
$20,000 $600 $55,000 (Median income) $303
$25,000 $503 $60,000 $303
$30,000 $303 $65,000 $303
$35,000 $303 $70,000 $253
$40,000 $303 $75,000 $128
$45,000 $303 $80,000+ $3
$50,000 $303

The problem that this does not solve, except temporarily in the case of low income earners, is that whilst incomes continuously increase over time with inflation, the tax thresholds remain fixed, meaning that all workers pay more tax each year as the bulk of their incomes slowly move into higher brackets.  This is known a tax creep, or to use Professor Norman’s more theatrical description, “the strangler!”.

Addressing the Long Term Challenges Facing Australia

The Australian economy faces a host of structural challenges into the future, described by Professor Freebairn as “severe”.  Some of his examples included:

  • Massive infrastructure requirements to meet the needs of a growing Australian population; the Australian Bureau of Statistics population projections are between 30.9-42.5 million people by 2056 (currently approx. 22.9 million).
  • The aging population is increasing demand for government expenditure, particularly in the areas of health and old-age pensions, and is simultaneously diminishing the proportion of Australians generating tax revenue.
  • Australia has seen poor productivity growth in recent years, with little sign of improvement on the horizon. Currently masked by the mining boom, if not improved, low productivity could see Australia’s economic prospects rapidly deteriorate when the boom ends (if not before).
  • Potential cost blowouts and poor performance of existing infrastructure projects such as the NBN.

One strategy, raised by Professor Freebairn, to counteract these issues is to increase the efficiency with which government revenue is collected and spent, and thereby reduce individual and business compliance costs in meeting tax and regulatory obligations, as well as massively reduce the need for bureaucracy.  Examples of how to achieve this included condensing all the different individual and family benefits, all of which need to be separately administered, into one means tested payment; as well as abolishing alternate tax treatments on income, such as the discount on superannuation contributions, recommending that all income be taxed at the same rate, albeit preferably a lower one. Revisiting his point about how different taxes cost different amounts to administer, Professor Freebairn also advocated increasing the Goods and Services Tax (GST), broadening the mining tax (include more than just iron ore and coal), replacing stamp duty with an annual land tax, and implementing all of the other recommendations of the Henry Tax Review.

Controversial Claim of the Evening

Professor Norman took the prize for the most controversial claim of the evening!  He accused the RBA of creating more instability than it solves.  Stating that because the bank’s decisions are based on time-lagged economic data, it reacts too late to changes in the economy, and consequently often makes things worse. The controversy did not stop there.  He went on to announce that the interest rate should be pegged, and furthermore that the government should “not just put the rate on hold. Put the bank on hold!” Any attempt at a quick analysis of this can of worms in this article would not be giving Professor Norman the respect that he has so clearly earned over his long and illustrious career and therefore my next article will be dedicated to exploring his ideas on the RBA further.

Wrap Up

Economically, Australia finds itself in a state of political short-termism, reinforced by the media, which has resulted in people viewing the budget only in terms of what they will gain or lose in the following year. Therefore to paraphrase the ESA Victorian Branch President Dr Mathew Butlin, good tax reform can only be implemented by a powerful government with votes to lose, as tax reforms are always unpopular even with people who, through economic ignorance, fail to realise that it benefits them.  This statement holds true for any major economic reform.  It is therefore up to economists to explain good economic policy to politicians, and for politicians to actually prioritise the implementation of expert policy research such as the Henry Tax Review by being prepared to spend the time and energy to explain important reforms to the people. This is no small task in the face of a reluctant media, and opposition parties who are all too willing to build up fear campaigns to gain popular support.  This is what happened with Labor’s opposition to the GST, and in the current Opposition’s campaign against the mining tax, which together with mining lobby support, has led to a tax that is very far from the efficient broad based tax intended by the Henry Tax Review.  What’s worse is that these politically motivated fear campaigns generally come with an Opposition promise to rescind the contested policy if elected into office, although this rarely happens as evidenced by the Liberal Party not rescinding medicare and similarly Labor not rescinding the GST. The threat of rescission creates an environment of uncertainty, making businesses hesitant to invest, to the detriment of the overall economy. Politics is a dangerous game for more than just the participants.

 

Follow me on twitter @david_haines85