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A budget for citizens — but where is the tax reform vision?

Budget night has come and gone again. For those sad folks (I count myself among them) who follow tax and fiscal policy obsessively, it’s the most glamorous night of the year. But the budget does matter…

This year’s federal budget failed to provide any hint of meaningful tax reform for businesses and individuals. Image from www.shutterstock.com

Budget night has come and gone again. For those sad folks (I count myself among them) who follow tax and fiscal policy obsessively, it’s the most glamorous night of the year.

But the budget does matter — for all of us. Decisions passed by Parliament each year define how Australians will be educated, access health care, support the needy, provide overseas aid and fund rail and public technology – and how we will raise the taxes to do it.

What happens on budget night?

On budget night, the Appropriations Bills for the coming year’s spending are introduced into the Parliament, to be debated and passed or government stops altogether, as it did for Whitlam in 1976.

Only 20% of annual expenditure is up for decision in the budget bills, as 80% of expenditure is authorised by special legislation – for example, to cover age pensions (see this for more detail). Still, this is about $80 billion a year, which can make or break new policy or infrastructure decisions.

We also get to see the government’s five-year plan. Australia’s three-year electoral cycle fosters short-sighted governing. The Medium-Term Expenditure Framework requires estimation of revenues and expenditures for five years from 2012-13 to 2016-17. Introduced in 1987 by the Hawke-Keating government, it is a strength of the budget process and keeps our budget on a more even keel than that of many other countries.

In this budget, the Gillard-Swan government tries to take an even longer view, projecting funding for the next seven years for the major education and DisabilityCare programs. It’s an interesting attempt to take the focus long term, as called for by our intergenerational reports.

Don’t worry about the deficit

All the reports are saying this not a typical election year budget. What they mean is that it’s short on handouts that we usually see every election year. That’s a good thing.

That headline figure of the deficit — $18 billion — does focus our attention, as citizens, on the cost of government. Politically, the deficit or surplus has become a symbol of bad or good government. Balanced budgets are important: we need to raise adequate taxes to fund public goods, infrastructure and the welfare state. Ongoing deficits are ultimately funded by increased government debt or future taxes.

But the deficit in any particular year does not tell us whether the government’s policies are smart or sustainable. Australia’s deficits are small relative to the size of the budget, and Australia’s government debt is among the lowest in the world.

If the government is spending that $18 billion on education, health and infrastructure, that is probably a better investment than cutting spending.

So what about taxes?

The budget papers include some good tax increases – and a few needed tax fixes. But we are missing a real vision in tax reform that could build a consensus for the future.

It was the right decision for the government to enact an additional 0.5% tax as a top up of the Medicare Levy to help fund DisabilityCare.

This levy will receive general public support. It also has the advantage that it increases the top marginal rate to 47%. Lowering top tax rates has been a major cause of rising income inequality in Australia and other countries since the 1980s. It’s time to reverse that trend. At the bottom end, the Medicare threshold will be lifted, at least for low-income families.

But this government has failed - again - to build on the broad and far-reaching Henry Tax Review recommendations about our core income tax base in Australia.

Why cap education expenses – but leave rental property losses standing?

One example of incoherent tax policy is the government’s proposal to cap individual self-education expenses at $2,000 each year. We should review work-related deductions across the board, along with an examination of how we treat investment income, gains and other expenses in the personal income tax. This proposal does not do that.

The self-education expense cap will hurt Australian students and universities. (I must acknowledge my own interest here.) The target is luxury travel and gold-plated professional conferences. But an individual working for a community organisation who wants to do a Masters in social work part-time and coughs up the dollars to do it is also going to be directly hit. That seems short-sighted.

And if we are capping tax deductions, why is this government not brave enough to cap rental losses being used to reduce tax on salary income? ATO taxation statistics show that rental deductions consistently exceed rental income. In 2010-11, 67% of rental investors made tax-deductible rental losses of $7.8 billion. It’s bad tax policy and bad housing policy.

Business tax fixes but no big picture

The budget proposes some corporate tax fixes, to prevent undermining the Australian tax base mostly by tax planning involving debt.

The business community and profession has been aware of these issues for years, and has even told the government about them. The ATO has recently lost some cases, such as RCFand Mills, in which courts have applied the law and found it does not work as the government expected.

Last year’s Treasury Working Group on Business Tax failed to agree on tax reform without substantial cost to revenue. Australia, and other countries in the G20, are struggling to come to grips with global profit-shifting and international tax co-operation.

It’s good that the government has decided to reform thin capitalisation rules, reducing the basic debt ratio from 3:1 to 1.5:1 to ensure that businesses cannot deduct high ratios of interest on debt against Australian taxable income, while effectively shifting profits offshore.

The government will also fix a flaw in our capital gains tax, to make sure that mining companies cannot avoid tax on sales of Australian mining rights by allocating more of the price to the mining information than to the mining rights. It will examine the offshore banking unit regime that enables low taxation of some Australian bank profits. And it will undertake a review on the cross-border arbitrage that can happen when Australia taxes corporate debt or equity differently from other countries.

These tax fixes will plug some leaks. But the bigger challenge is to build a vision and political consensus to enact long-term reform of our business and personal tax system.

Does Australia’s budget process need fixing?

Business Council of Australia CEO Jennifer Westacott has called for “a comprehensive audit of the scope, size and efficiency of government”.

We certainly should audit government accounts. It might also be possible to have an independent review of revenue forecasts or policy costings. And perhaps we could do a stocktake of government functions — for example, whether there is overlap in what federal and State government agencies are doing – and aim to eliminate that overlap.

But what does it mean to “audit” the scope, size and efficiency of government? Who would do it? Budgeting is a political process and the size and scope of government comes down to us: the citizens.

Australia is not in a fiscal crisis. But our decision-making processes for taxing and spending are under stress from short-term pressures (such as the global financial crisis) and long-term structural changes including globalisation, an ageing population and climate change.

Budget reform should focus on improving processes to build a political consensus among diverse interests - Australian individuals, businesses, the social sector, labour representatives. Only this can achieve sustainable tax reform.