Do dire warnings of falling living standards add up to need for tax reform?

Warnings of a drop in Australia’s real GDP per capita - a measure of living standards - still provide a stark contrast to Greece, where the real GDP per capita is likely to be 25% lower in 2013 than in 2008. AAP

Last week, the Organisation for Economic Cooperation and Development (OECD) in a preliminary version of its 2012 Economic Outlook lowered its growth forecasts for Australia from 3.7% to 3.0% in 2013.

This is a considerably more optimistic forecast for Australia than for many other countries – Greece is forecast to contract by a further 4.5% in 2013, with Spain, Italy and Portugal also shrinking. Overall, the OECD warned that the risk of a major new contraction in the world economy cannot be ruled out.

In what the Australian Financial Review described as a “sharply worded warning”, the OECD advised Australia that “sustaining a robust rise in the standard of living will entail bolstering productivity by pursuing reforms in taxation, infrastructure and innovation.”

In its related publication, Going for Growth, the OECD spelled out that tax reform in Australia should involve further lowering corporate and personal income taxes and raising the goods and services tax, and simplifying and rationalising the States’ tax systems, especially on housing.

As is well known, the Australian economy has done better than most other developed countries since the Global Financial Crisis (GFC). Since 2008 and up to 2011, real GDP per capita in Australia has increased by about 2%, exceeded slightly by Germany and Sweden, and more substantially by a number of lower-income OECD countries such as Korea, Poland, Israel and Turkey.

But for 23 out of the 33 OECD countries, real GDP per capita in 2011 remained below its 2008 levels – by 15% in Greece, 6% in Ireland, nearly 4% in the United Kingdom, and 1.4% in the USA. In the case of Greece, this does not include a further fall of 6% in 2012 and its forecast fall in 2013.

While GDP per capita is often taken as a measure of wellbeing, GDP itself is only a measure of goods and services produced. If we want to look at how individuals and families have fared in terms of living standards then it is better to look at studies of household incomes. These tend to show a much more sombre picture than you get from GDP figures.

For example, a recent US study by Jeffrey Thompson and Tim Smeeding found that the Great Recession has been the most dramatic economic downturn the US has experienced in more than six decades.

Tumbling stock and housing markets erased nearly 10% of real total national financial assets, with house prices having dropped 30% since their 2005 peak. Overall, the global recession has resulted in over $7,300 in foregone consumption per person or about $175 per person per month by 2011.

But the effects of such a downturn do not affect everyone equally. Between July 2008 and 2009 total non-farm employment fell by 5%, more than any time since World War II. The employment to population ratio fell to its lowest level since 1990, 58.2%, even though older workers actually increased their employment. A full 20% of 25-54 prime age male workers were not in work in April 2011, the lowest fraction since 1948 and five points below the trough of any previous recession.

Moreover, Edward Wolff found that median wealth in the US nearly halved between 2007 and 2010, and by 2010 was at its lowest level since 1969, at only $57,000. Moreover most of the income growth that has occurred since the end of the recession has disproportionately benefited the rich.

If this is what you get for the USA when GDP per capita is about 1.4% lower than in 2008, then the impact in Greece where real GDP per capita is likely to be 25% lower in 2013 than in 2008 doesn’t bear much thinking about.

The contrast between Australia’s experience and that of most other rich countries is made even starker if we recall that up to 2007, Australia enjoyed one of the largest increases in real median incomes of any OECD country. From 1995 up to 2007-08, median Australian households experienced an increase in real income of 53%, second only to Ireland, and from a much higher base – and Ireland of course has subsequently gone backwards.

The contrast in terms of wealth is even starker. According to the 2012 Credit Suisse Global Wealth Report the median net worth of Australian households – even though it has also fallen since 2008 - at US$194,000 (AU$186,000) remains the highest in the world.

Hopefully, any slowing of growth in Australia is unlikely to have the sorts of effects experienced in the USA and Europe, but our solid performance to date is no cause for complacency. Slower growth would mean that future living standards will be lower than they might otherwise have been, and if other countries benefit from more rapid increases in productivity then Australia might start to fall down the international rankings, as it has done in the past.

There are certainly efficiency grounds for arguing for tax reform. The Henry Review found that increasing royalties, the crude oil excise, state insurance taxes and existing payroll taxes involve much larger welfare losses than income tax, which in itself is much less efficient than the GST.

However, the stronger case for tax reform is one deriving from equity concerns. In this context, OECD figures show that total Australian tax revenue in 2010 at 25.6% of GDP was lower than in any year of the Howard government and in fact was lower than in any year since 1976.

But according to the 2010 Intergenerational Report total spending is expected to grow to around 27% of GDP by 2049-50, around 4.75 percentage points of GDP higher than its low-point in 2015-16.

And this is based on hopefully unrealistic assumptions, like continuing to index Newstart only to prices, which if continued would result in the deep impoverishment of the unemployed.

And this does not include the need to pay for the costs of desirable new reforms such as the NDIS, dental care reforms, aged care reforms and reforms to education arising from the Gonski review.

So tax reform does need to be on the policy agenda not only to maintain and improve living standards but to ensure that the benefits of growth are more equally shared.