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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.

Join the conversation

21 Comments sorted by

  1. John C Smith

    Auditor

    Definitely we need to fix negative gearing, that is allowing to treat active income and losses the same as passive income and losses. Not only this affect housing and construcion it affects our small business and seed money for businesses. I am sure a strict interpretation of existing laws can fix this.
    Since the Haw-Keat, tax from high income is low while tax from low incomes are high. How-Cos made it worse with the consumption tax, same tax whether the income is high or low.
    It is time to tax a family as one tax entity.

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    1. ian cheong

      logged in via email @acm.org

      In reply to John C Smith

      That sounds sensible. More so to me if the "family" was charged the same rate as the "corporation". And perhaps all of them on a variable increasing rate.

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  2. Lee Emmett

    Guest House Manager

    It's refreshing to see an article calling a spade a spade! We've long suspected that companies and individuals are getting away with paying little or no tax. And it's sad that the Henry taxation review did not make it to the newspapers to generate reasonable public awareness and discussion.

    When Kevin Rudd tried to introduce the mining tax as recommended, the industry came down on him like a ton of bricks, and ran a hostile campaign saying it would cost jobs. No, despite the effective media tirade…

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  3. Ted Stead

    Consultant

    "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."

    This is a myth that really needs to be put to rest. Taxes do not fund Australian federal government spending. This post is relevant, and has a number of other links on the subject: http://goo.gl/eUoMc

    Once people get their heads around the monetary system, and get beyond the notion that "balanced budgets" are desirable, it will then be possible to have a real debate about how and where government spending should be targeted.

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    1. David Stewart

      Writer, civil engineer at Self-employed

      In reply to Ted Stead

      Mr Stead seems to misunderstand the difference made by Professor Stewart between a surfeit or deficit in any year and the long-run quantum of debt or surplus i.e. how much money does Australia owe, or have stashed away for the rainy days, or more pertinently the drought years.

      Professor Mitchell, referred to by Stead, understands this and his writing acknowledges that "balance" is not the holy grail but keeping the business (Australia) ticking over is, and not being beholden to a creditor is also important.

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    2. John Armour

      logged in via email @bigpond.com

      In reply to David Stewart

      David,

      Maybe I'm missing something, but I can't see where Professor Stewart makes any attempt to make a point about the difference between deficits and their stock, debt, except to say that they are "ultimately funded by increased government debt or future taxes" (which is actually quite incorrect).

      Ted Stead however has correctly identified the myth(s) that balanced budgets are important and taxes fund public goods.

      This is supported by Professor Mitchell who says there is nothing intrinsically…

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    3. ian cheong

      logged in via email @acm.org

      In reply to Ted Stead

      So it OK for the consensus to be wrong on the global economy and OK for the consensus to be right on global warming (where good science can turn any consensus on a dime with real scientific evidence).

      Where is the global economy economic simulator where these radical new theories can be properly tested in an economic experiment without risk?

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    4. John Armour

      logged in via email @bigpond.com

      In reply to ian cheong

      These theories are only "radical" to the extent that they are not widely understood.

      The dominant paradigm is actually economics' equivalent of AGW denial.

      These "theories" are actually just factual statements about the monetary arrangements of modern economies (since the 1970's).

      To the dominant paradigm however they are inconvenient truths.

      Professor Mitchell, to whom Ted Stead referred, is just one economist of about 20 I could name who has written extensively on the subject.

      And if you had been following the discussion over the last year or so in Paul Krugman's NYT opinion pieces, you would know that these insights have a large and rapidly growing audience.

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    5. John Armour

      logged in via email @bigpond.com

      In reply to ian cheong

      Meanwhile "good" science tells us that the stratosphere is cooling.

      Go figure.

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  4. David Stewart

    Writer, civil engineer at Self-employed

    The article points to need for a vision. Yes, but what are the author's views, what is her vision? Reference to the Henry Review is fine but that was several years ago and most of us have forgotten what detail we understood. Could we have a brief summary of what would be good tax policy reform now, and how the next (will it be Hockey's and Abbott's?) budget should be framed. Whoever is in Government needs all the help from good thinkers they can get next year when the world's troubles really will…

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  5. Richard Ure

    logged in via Facebook

    Negative gearing subsidies the rental return for property investors. The net return to investors at current house prices is already very low especially given the impact of land tax on residential rental properties. Should this tax be abolished if negative gearing goes?

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  6. ian cheong

    logged in via email @acm.org

    It's pretty obvious the budget process is broken. The concentration of reporting of a particular set of annual figures gives no indication of the trends in play.

    Knowing the historical and future patterns of the various sources of income, budget planning should surely try to match expenditure patterns to income patterns. Stable long-term income sources can be allocated towards stable long-term expenditure programs. Unstable income sources can be allocated to short term expenditure or savings measures…

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  7. Miranda Stewart

    Professor and Director of Tax Studies, Melbourne Law School at University of Melbourne

    Dear all, thank you very much for your comments and thoughts. Yes, D Stewart - calling for a vision without putting that vision into words may lead to some queries! However, my main point really is that it is not possible just to treat government as an accounting exercise - and these are political decisions. The Henry Tax Review put forward an overall "ideal" tax system. I don't agree with it all but I do think that it needs a proper examination politically. Unfortunately, neither the Rudd nor Gillard-Swan…

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    1. John Armour

      logged in via email @bigpond.com

      In reply to Miranda Stewart

      I do hope you find time to look at Bill Mitchell's work. But be careful to wear steel-capped boots because when the "penny" drops it couple be quite painful...

      : )

      Meanwhile, have a think about the implications of the Sectional Balances Identity, the simple equality that underpins the national accounts:

      (I-S) + (G-T) + (X-M) = 0

      This tells you that if the private/household sector is saving more than it's spending and we're running a current account deficit then, mathematically, the budget has to be in deficit.

      This is not a legal issue or a political issue, it is arithmetic.

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    2. ian cheong

      logged in via email @acm.org

      In reply to Miranda Stewart

      presumably, john's suggestion of taxing families as an entity is because of various income splitting and family trust tax avoidance strategies. i don't see as vald the argument that higher marginal rates will impact desire to work. The same argument applies to single income earners.

      to see real reform possibilities, all proposls for differet tax and transfer systems need to be worked up in detail and then compared. the current system is the result of decades of politically driven tweaks, and not a "system" designed from scratch.

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    3. John Armour

      logged in via email @bigpond.com

      In reply to John Armour

      I should've added some further explanation:

      If government spending is deliberately constrained or contracts in the foregoing example, then GDP must adjust downwards with a consequent increase in unemployment (a recession).

      The only other way this can be temporarily avoided (assuming persistent deficits on the external leg) is if the household sector spends more than it earns, a clearly dangerous and unsustainable "solution".

      Sooner or later households will want to get back to traditional patterns of saving leaving only the government to fill in the spending gap.

      It's not rocket science.

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    4. David Stewart

      Writer, civil engineer at Self-employed

      In reply to John Armour

      John,
      Picking up your leads then, and acknowledging that MItchell's work is thorough and, if accepted (and I am close to acceptance), shows how an entity's (national or state or household) economy functions. So governments, which we deem responsible for the whole economy, manage a part of it and affect the remainder (and is it the greater part?) by the influence and authority they exert over individual attitudes, corporations, households and subsidiaries such as Local Government.

      Therefore the…

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    5. John Armour

      logged in via email @bigpond.com

      In reply to David Stewart

      Hi David,

      The Federal Government certainly has control of spending (G) , less so with Tax, and even less with the other inputs. That 's why Mitchell says the budget outcome is largely exogenously determined and why aiming for a particular budget outcome is a pointless exercise.

      The current orthodoxy believes that households will increase saving (S) when government spending exceeds taxation (ie, a deficit) in anticipation of future tax increases, thus negating any stimulatory effects, but recent…

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    6. David Stewart

      Writer, civil engineer at Self-employed

      In reply to John Armour

      John,
      Thanks for your leads and persistence. I am signing out of this conversation now but am persisting with Bill Mitchell's thorough website tutorials and will follow the other leads you have provided.
      Regards to you and the original author, Prof Stewart, for triggering this conversation.
      David Stewart

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    7. John Armour

      logged in via email @bigpond.com

      In reply to David Stewart

      Your engineering background will serve you well in this endeavour David. By that I mean you will not be burdened with formal qualifications in economics, but more importantly, you will be very aware of the consequences of getting it badly wrong.

      Market economists who prostitute their insights before an audience of millions on the evening TV news slot are under no such constraints.

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