Whilst tax as a price for civilised society is well understood, less appreciated is the second part of his observation – that tax provides a chance to insure against a crisis.
As nations emerge from the COVID-19 crisis with policies unthinkable just six months ago, and associated debts previously unimaginable, it is becoming clear that while some were well insured and able to respond rapidly, most were underinsured, exposing their civilisations to previously unthinkable risks.
In many ways Australia is an exemplar in its use of taxation to provide the “chance to insure”. It funds Medicare; the Pharmaceuticals Benefit Scheme; the Higher Education Loan Program; the Superannuation Guarantee Charge and contingency-based welfare payments.
COVID has exposed the weakness in our system
COVID-19 has exposed how underinsured Australia is in other ways. It will have to borrow heavily to protect the economy, but for many years won’t be able to impose the extra taxes that will be needed to pay down the debt.
Introducing new taxes or increasing existing tax rates would threaten what will be a fragile recovery.
The only realistic option is to review what Australia gives away, such as tax concessions, and what it fails to collect, as measured by the so-called tax gap.
The tax gap is the difference between the amount the Tax Office collects and what we would have collected if every taxpayer was fully compliant with tax law.
In 2016-17, the Commonwealth raised A$389 billion in taxes, intentionally gave away an estimated $166 billion and unintentionally failed to collect a further $30-35 billion that the Tax Office knows of.
Mapping out a pathway to winding back government debt and funding programs to better insure our civilised society has to begin with ensuring those who are not currently carrying their fair share of the legislated tax burden do so through reforms to reduce non-compliance.
Many of us aren’t paying the tax we should
The Tax Office conservatively estimates that non-compliance for the taxes it has so far examined is equivalent to more than 8% of the tax revenue it collected in 2015-16.
The Treasury also estimates that tax concessions in 2017-18 were equivalent to 41% of Commonwealth government revenue, or more than 9% of GDP (although it cautions against adding estimates together as reducing one concession can affect the use of others).
Given the scale of the Commonwealth response to COVID-19, the government will need additional tax revenues of around 2.5% of GDP (about $50 billion) for some years.
This should not prove insurmountable. In comparison with other advanced economies, Australia is a relative low taxer with a total tax burden of 28.6% of GDP in 2017-18, well below the OECD average of about 34.5%.
There’s revenue going begging
The tax gap estimates show billions can be raised from integrity measures such as addressing overclaimed work-related expenses ($3 billion), unreported cash wages ($1 billion) unreported rental property net income ($2 billion) and unreported business income ($2-3 billion).
There’s much more available from reducing tax concessions, removing the personal tax-free threshold, winding back retirement savings concessions, and broadening the goods and service tax (especially from fully taxing the food that is already partially taxed).
Lower income groups affected by the changes should be compensated by improved targeting of expenditure programs.
Right now we’ve a near-universal welfare system and a targeted tax system.
The way out of our present problems is to make the tax system more universal and the welfare system more targeted.
New taxes and higher rates should be resisted, especially if made more palatable by more concessions.
What we are proposing would not only result in a tax system that was simpler and harder to escape – but one that was capable of funding the insurance we will need to preserve our society into the future
There’s no reason to think there won’t be another pandemic exposing the weaknesses in our tax system that remain.
Paying the debt will likely take decades. The burden will fall mostly on younger generations, through higher taxes or reduced public services such as health care and education.
Younger workers are also bearing the brunt of the immediate economic effects. Industries with the biggest proportion of young workers have been hit hard. In arts and recreation services, a quarter of workers are under the age of 25. In retail it’s about a third. In accommodation and food services it’s almost half.
But the peculiar dynamics of this crisis open the opportunity to introduce a temporary levy now. This would enable those with secure incomes to share the pain and reduce the double impost on the younger generation.
A temporary income tax levy is not unprecedented.
In 2014 the federal government implemented the “temporary budget repair levy” to reduce the budget deficit (then A$37 billion). Gross national debt was about $320 billion. The levy increased the marginal tax rate on the top income bracket (more than $180,000 a year) from 45% to 47%. It collected about A$3 billion over three years.
Given the magnitude of the deficit we now face, a similar levy makes sense.
An example levy is illustrated in the table below (based on income tax data from 2016). A 1% levy is applied to annual income between A$18,200 and A$37,000, a 2% levy to income between A$37,000 and A$90,000, a 3% levy up to A$180,000, and a 4% levy to income of more than A$180,000.
For someone on a median full-time income of A$1,463 a week, this would mean paying an extra A$17 a week in income tax.
Over a six-month period such a levy would raise about A$6.5 billion.
The main argument against raising income taxes is that it reduces incentives to work and lowers consumers’ disposable income, which dampens economic activity (and ultimately government revenue).
This, and the politics of tax, means governments usually wouldn’t dream of raising taxes during an economic crisis, because that would further reduce consumer spending and compound the downturn.
But the COVID-19 economic crisis is unique. It is suppressing spending by those with secure incomes because people are staying home.
Analysis published by The Sydney Morning Herald and The Age shows consumer spending fell to 13% below normal in late March. One-off government stimulus payments totalling A$5 billion reversed the downward trend in the first week of April. However, the effect of the one-off stimulus payments is likely to be temporary as higher-income earners, who didn’t receive a stimulus payment, continued to reduce their spending.
If people are spending less because there are fewer opportunities to spend, this novel aspect of the crisis reduces the likelihood a temporary increase in the income tax levy would have any negative economic effect.
Right now the costs of the COVID-19 crisis are being disproportionately borne by a small proportion of the population – the 700,000 Australians who have lost their jobs and about the same number relying on the JobKeeper wage subsidy.
Many of those who have lost their jobs were already in low-paid and insecure jobs.
As previous research on the longer-term effects of natural disasters has found, these types of economic shocks widen inequalities, with most people never making up the income they lose. A levy would reduce this inequity.
It doesn’t have much choice. The Parliamentary Budget Office is required to take the government’s surplus and deficit projections for the next four years as given, and to take its economic forecasts and tax and spending announcments for the next ten years as given, whether realistic or not.
What it is allowed to do, and does once a year in a publication entitled medium-term fiscal projections, is to set out the implications of those projections.
Those implications, spelled out on Thursday, show the projected budget surplus to be so fragile as to be unrealistic, except the parts that rely on much higher personal income tax collections.
That’s right: much higher income tax collections per person, even after taking into account the coming decade of legislated tax cuts.
Middle earners hit hardest
But it won’t be higher for all of us.
The middle fifth of earners will pay far more of their income in tax in ten years’ time under the government’s projections, according to the PBO’s calculations. Instead of paying 14.9% of their income in tax, by 2028-29 they will pay 18.8%.
That’s after taking into account the long-term tax cuts the government pushed through parliament in May and went to the election on.
Without those legislated tax cuts, they would have been paying an extra 6.3% of their income in tax. With the legislated cuts (and others pencilled in by the PBO to keep the government’s tax take within its promised ceiling) they will be paying an extra 3.9%.
Put another way, the government’s tax cuts will undo some of the damage caused by bracket creep as more of each pay packet climbs into higher brackets, but not most of it.
It’s the same for pattern for the second-lowest fifth of earners. They will move from paying 5.3% of their income in tax to 9.9%, a near doubling, which is taken is taken into account in the surplus projections.
The second-highest fifth will move from paying 22% of their income in tax to 23.4%, even after the tax cuts. The bottom fifth, who don’t pay much tax, will move from paying 0.6% to 1.2%.
Highest earners escape
But workers in the top fifth, which at the moment is workers earning above A$90,000, won’t pay a cent more, at least not on average.
The government’s projections, as spelled out by the PBO, have them paying less of their income ten years from today than they do today.
Put another way, they are the only fifth of the population that won’t be expected to wear pain to keep the budget surplus.
There are other contributors to the budget surplus. One is a pretty hefty assumed decline in growth in government spending over the next decade, amounting to 1% of GDP, taking government spending from around 24.9% of GDP to around 23.9%.
Much of it is projected to come from tighter eligibility criteria for payments, and measures to constrain their growth, something the PBO believes might be difficult to maintain:
The spending restraint seen over the past few years may be increasingly difficult to maintain over coming years given the length of time over which restraint has been applied, the pressures emerging in some spending areas, and the potential need for fiscal stimulus, noting that the projected improvement in the budget balance is mildly contractionary.
And it is saying the government might need to spend in ways it hasn’t accounted for, including on measures to support the economy in the event of a downturn.
Budget conventions to the rescue
The projections assume the opposite of a downturn.
No blame should attach to this government for them, but our rather odd budget conventions dictate that the worse the economy is, the better the budget’s projections for economic growth. That’s right: the weaker our current economic growth, the stronger the budget’s projections for future economic growth.
The thinking is that over the long term, the economy should grow at roughly its long-term average growth rate. To get there when the economy is weak, as it is now, the budget assumes several years of stronger than normal economic growth to catch up.
In this case it’s five years of stronger than normal economic growth.
The PBO contents itself with the observation that economic growth that was merely normal (or worse, remained weaker than normal) for some of those years would have a “significant and compounding effect on the budget position over time.”
The surplus is far from assured, and it shouldn’t be. The government might well find that it can’t and shouldn’t restrain spending on payments as much as is projected in the decade ahead, and it might find it needs to spend to support the economy.
It will almost certainly find that lifting the tax take on middle Australians from 14.9% of income to 18.8% is intolerable.
In an enormous week for economic news at the start of the month, parliament passed the government’s three-stage personal income tax plan, and the Reserve Bank cut official interest rates to an unprecedented low of 1%.
It happened against the backdrop of a flagging economy in dire need of stimulus.
As the bank cut rates to a record low, its governor Philip Lowe again warned about the waning power of rates (monetary policy) to lift the economy.
Monetary policy does have a significant role to play and our decisions are helping support the Australian economy. But, we should not rely on monetary policy alone. We will achieve better outcomes for society as a whole if the various arms of public policy are all pointing in the same direction.
Lowe and many others – including yours truly – have repeatedly pointed out that spending on physical and social infrastructure can do what lower rates can’t do well – boost the economy while lifting its productivity. So, too would other productivity-enhancing reforms, particularly in the labour market.
And, of course, the government’s tax cuts will also stimulate the economy when they come into effect.
With tax cuts, timing’s the thing…
The obvious problem is that much of stimulus from those tax cuts will happen years from now, rather than today.
What the government should have done was insist on enacting all three stages of their tax plan immediately. Not staggered over several years, not in 2024-25. Now.
That would have, of course, pushed the budget into deficit in the short run, and that would would have run counter to the government’s narrative about being responsible economic managers.
But how responsible is it to prioritise one’s own political brand over the economic health of the nation?
Let’s not forget where the timing of the government’s tax plan came from. 2024-25 is outside the budget’s so-called “forward estimate” period and thus the impact on the deficit or surplus projections is not apparent.
It was the same rationale that underpinned the glacial, decade-long pace at which the government’s “enterprise tax plan” was to move to a 25% company tax rate. And it is the same set of dodgy accounting tricks that Wayne Swan was a master of for everything from health to education spending commitments.
…and the timing could be immediate
Productive infrastructure spending is hard to enact quickly. Spending on social infrastructure like education and training has a long lead time.
And structural reform of the industrial relations system might is probably the hardest and longest of all to put in place.
They are real constraints.
The Reserve Bank faces another, the so-called “zero lower bound” of conventional monetary policy and the complexities and uncertainties of unconventional policies such as quantitative easing.
But a government which won a mandate for its tax policies, and who frankly has the Labor opposition in a tailspin, could have insisted on all three stages of the tax cuts immediately.
The only thing standing between the economy and the aggressive fiscal stimulus it needs is the government’s obsession with balancing the budget regardless of the circumstances.
We’re not in the best of times
Don’t get me wrong, I think debt and deficits most certainly do matter. The government deserves credit for chipping away at the structural budget deficit, and we shouldn’t be running deficits in good economic times.
But we’re not in good economic times. We’re standing on the precipice of the first recession in nearly three decades. We’re looking at highly uncertain global conditions, domestic economic growth that has slowed to a trickle, sluggish wages growth, persistently high underemployment, and even the possibility of Japanese-style deflation.
The irony is that if, with the failure to enact sufficiently bold stimulus, we do tip into a recession, the red ink will flow all through the budget. Unemployment benefits and welfare payments will rise, personal and corporate income receipts will fall, GST revenue will drop. And young people who enter the labour market during a recession will suffer for years to come.
The downsides of not enacting sufficient fiscal stimulus far outweigh whatever benefits there are of a glide to path to budget balance while avoiding a recession.
It’s certainly not the time for hand-wringing
Coming back to Lowe’s admonition that we need the “various arms of public policy…pointing in the same direction”, here’s where we currently stand: The bank has acted, but far too late. For years it told us that 5% unemployment was as good as it could get long-term, to be patient and to wait for higher wage growth and inflation.
It’s been a mere five weeks since Lowe stopped impersonating Charles Dickens’ character Wilkins Micawber, who was fond of saying “something will turn up”.
Now the treasurer Josh Frydenberg is giving us his version of the same routine. On one hand he says personal income tax cuts are crucial to boosting employment and spending. On the other hand, he says we’d better wait.
The Australian economy can’t afford to wait for aggressive stimulus. The government has shown more concern for its political brand than for our economic health.
Build-to-rent won’t be a silver bullet solution for Australia’s housing affordability stress, but it does have potential to tick the box on several important public policy objectives. These include widened housing diversity, enhanced build standards, and a better-managed, more secure form of private rental housing.
But for this to happen, Australia’s tax settings need adjustment.
What is ‘build-to-rent’?
This refers to apartment blocks built specifically to be rented, usually at market rates, and held in single ownership as long-term income-generating assets.
The enduring owner might be, for instance, an insurance company, an Australian super fund, a foreign sovereign wealth fund, a private equity firm, or the building’s developer.
A scattering of build-to-rent schemes are already underway or completed, mainly in inner Sydney and Melbourne. And they may prove to be the forerunners of a new Australian residential property sector – but that is far from guaranteed.
In Australia, our private rental market is almost entirely owned by small-scale mum-and-dad investors, so this kind of housing would be a largely new departure from typical Australian real estate.
The build-to-rent development model, involving a long-term owner commissioning an entire building, creates an incentive for higher, more enduring quality than the standard “build-to-sell” apartment development approach.
Importantly, build-to-rent is a long-run investment that caters for rental demand, which tends to grow steadily.
This means the model is largely immune to the fickle changes in housing demand resulting from typically short time horizons and primarily speculative instincts of individual buyers traditionally dominant in our market.
So at its full potential, this new housing product could introduce a valuable counter-cyclical component into the notoriously volatile residential construction industry, helping to offset damaging booms and busts. In other words, build-to-rent can create stability in the Australian property market.
How build-to-rent can incorporate affordable housing
Optimistically, some have claimed build-to-rent could also provide an “affordable housing” fix for many earners who are doing it tough in our existing private rental market.
But this could be possible only with the aid of major government funding or planning concessions.
Ideally, housing at rents affordable to low or moderate income earners would be included in predominantly market-rate build-to-rent schemes. Indeed, one major construction industry player recently advocated this as a standard expectation.
So how should affordable housing be provided in this case?
To find out, our analysis compares the cost of developing affordable housing by a for-profit company with development under a not-for-profit community housing provider.
Thanks to that non-profit format, and the tax advantages that go along with it, community housing providers can, in fact, construct affordable rental housing at significantly lower cost than their for-profit counterparts. Less subsidy is therefore needed.
Nonetheless, government help in some form will be essential to enable an affordable housing element. The most painless way for this to happen, from the government perspective, is through allocating sections of federal or state-owned redevelopment sites to community housing providers at discounted rates.
Encouragingly, this strategy was recently advocated by newly designated federal housing minister Michael Sukkar.
Such designation of government-owned sites could, for instance, be factored into large-scale urban renewal projects like Sydney’s Central-to-Eveleigh and Rozelle Bays. When complete, it could fulfil the widely voiced demand that 30% of these developments should be affordable housing.
Levelling the playing field
Our modelling shows that under current conditions, even market-rate build-to-rent projects are barely viable – at least in Sydney.
The inflated price of developable land in Australia’s urban housing markets is an important contributing constraint. But our research also identifies a range of government tax settings that disadvantage build-to-rent, compared with both mum-and-dad-investors and traditional build to sell developers.
Removing less favourable land tax and GST treatment could markedly improve build-to-rent feasibility.
From a housing policy perspective, there’s also a case for the federal government to reconsider its recent “withholding tax” decision that treats overseas-based institutional investment in rental property less favourably than investment in commercial property.
Since such global funds would likely lead the establishment of a new Australian build-to-rent asset class, revisiting the withholding tax changes could be a significant step in making build-to-rent a reality in Australia.
In any case, build-to-rent is no simple solution for Australia’s affordable housing shortage.
But even as a market-rate product, it could fulfil several important public policy objectives. How far it might do so in practice is something that governments rightly need to weigh up when considering industry-proposed tax and regulatory reforms.
Hal Pawson, Associate Director – City Futures – Urban Policy and Strategy, City Futures Research Centre, Housing Policy and Practice, UNSW
The first stage of the tax relief – in the form of an offset for low- and middle-income earners when people submit their returns – will be available as soon as the Tax Office makes the necessary arrangements over the next few days. Getting the legislation through this week means there is only minimal slippage from the July 1 start date that was promised in the budget.
The numbers fell into place with Tasmanian crossbench senator Jacqui Lambie declaring she would vote for the package. She had negotiated with the government on her demand that it forgive the $157 million social housing debt her state owes the Commonwealth. This would save Tasmania $15 million a year, which Lambie wants used to deal with issues of homelessness and social housing.
Lambie said: “The good will is there and they know that we’ve got housing problems down there.”
While Finance Minister Mathias Cormann, who had said there would be no horse-trading over the package, was publicly coy about the deal, Lambie is confident it will be delivered.
She said some details still had to be sorted out.
What I don’t want to be doing is rushing out saying here’s the money and that’s it. We want to make sure that that money is targeted […] we’re still dealing on good faith. And I look very forward to that over the next four to six weeks.
Cormann told Sky News: “Senator Lambie has been a very forceful advocate.
She has raised issues with us. We are very happy to work through these issues with her. When we are in a position to make further announcements down the track we will.
The other crossbench votes needed for the package come from independent Cory Bernardi and the two Centre Alliance senators.
Centre Alliance extracted a deal over action on gas prices.
It said in a Thursday statement that it had “worked with the government on both short- and long-term reforms to deal with gas market concerns.”
The government would announce the full package in coming weeks, it said.
It would include
changes to the Australian Domestic Gas Security Mechanism (ADGSM) to deal with current pricing, market transparency measures, measures to deal with the monopoly nature of East Coast gas pipelines and longer term measures to ensure future gas projects deliver surplus supply to the Australian market.
The gas agreement, canvassed publicly in recent days, has caused some blow-back from the industry.
Faced with the inevitability of the tax package passing, Labor said it would continue to pursue its attempt to split the package and then consider its options.
Eyes are now on Lambie’s position on the government’s bid to repeal the medevac act. Home Affairs minister Peter Dutton on Thursday introduced legislation for the repeal. Lambie said she was still making up her mind on how she will vote when the legislation arrives in the Senate. She is set to be the crucial vote.
As hissy fits go, it was a beauty. Pauline Hanson was very cross indeed. Senate leader Mathias Cormann hadn’t called her, even though he was reportedly negotiating on the government’s $158 billion package of income tax cuts.
Venting on Sky on Wednesday night, Hanson said: “I don’t think he’s got the guts to pick up the phone and actually talk to me. And to turn around and say that he’s negotiating with crossbenchers is not the truth, because he’s not negotiating with me”.
She went on to rail about the Liberals preferencing One Nation below Labor, doing “grubby deals” with Clive Palmer and trying to destroy her.
The three-stage 10-year package, which promises an extra tax offset for low and middle income earners, is the big game in town for the first days of the new parliament, which opens the week after next, and it’s causing some grief.
Despite the government’s confident words during the election campaign, the Tax Office has declined to pay the offset of up to $540 until the legislation is passed. This means the July 1 deadline from when the offset was supposed to be available will be missed. (Although people will get from July 1 the tax cut in the pipeline from last year’s budget.)
If the tax legislation is passed quickly, a few weeks’ delay for the offset is no big deal, especially as many people won’t be putting in their tax returns for a while. But the pressure on the government to deliver the first stage of its plan ASAP – not least because the economy needs the stimulus – reduces its ability to hold out indefinitely on its insistence it won’t split the package to accommodate objections to the later cuts.
Labor is in even more of a bind. It is happy to tick off the first stage – worth $15 billion – but has yet to decide its position on stages two (costing $48 billion and starting 2022-23) and three (costing $95 billion and commencing 2024-25).
Its objections are particularly to the last stage, which delivers cuts for higher income earners. Both the later stages come after the next election, due early 2022.
Those urging Labor should try to block at least stage three argue, apart from the equity issue, that mounting economic uncertainty makes it irresponsible to lock in such big tax cuts out in the “never never”.
On the other hand, a strong case can be made on grounds of principle and practicality for Labor to wave the whole package through.
The question of when a party or politician has a “mandate” is vexed.
On one view an opposition can claim it possesses a mandate to stay faithful to positions it advanced before an election even after it has lost that election.
But when the Morrison government went to the polls with the tax package as its prime policy, it does seem to have a strong case to say the parliament should pass it.
The same point would have applied if Bill Shorten had won. He would have had a mandate for his proposed changes to franking credits and negative gearing – both opposed by the Coalition.
It doesn’t help maintain faith in the political system, or in election promises, for parties to try to govern from opposition, despite the Senate’s voting system sometimes facilitating this. Voters should be able to expect that major election policies of the winning side are implemented (perhaps with some alterations at the edges by parliament).
It is another matter when, as happened with the Abbott government’s 2014 budget, big new controversial initiatives are brought in soon after the election campaign, during which they were not flagged.
The practical reason against Labor going to the barricades on the tax package is that as it regroups, there is little to be gained by taking on this particular battle, especially when it is trying to reposition itself as appealing better to “aspirational” voters and leaving behind language attacking the “top end of town”.
Labor might be right that the proposed long term tax cuts could look irresponsible later, but if so, that is a fight to be had at the next election, when the ALP could highlight doubts it had previously registered.
There are divisions in Labor about what to do. Victorian MP Peter Khalil this week said if the government won’t split the package, Labor should vote for it all. Anne Aly, a backbencher from Western Australia, expressed concern about the package’s implications against a darkening economic outlook. The ALP has asked the government for more information. Anthony Albanese is consulting within the party before shadow cabinet decides the position it takes to caucus.
While the government is focusing the rhetorical pressure on Labor, it has an eye to the alternative route – to get the package through via the crossbench.
For Cormann, the new Senate is easier than the last, partly because the non-Green crossbench has been slashed at the election.
To pass legislation opposed by Labor and the Greens the government needs four of the six non-Green crossbenchers. These include two from Pauline Hanson’s One Nation, two from Centre Alliance, South Australia’s Cory Bernardi, and Tasmania’s Jacqui Lambie.
Bernardi will vote with the Coalition. He has said he wants to help the Morrison government as much as possible, and on Thursday he announced he is winding up his Australian Conservatives party. It’s not clear whether he’ll seek to rejoin the Liberals, from whom he defected in 2017, or even stay in the parliament.
Cormann has been in discussion with Centre Alliance about their push for lower gas prices, and an agreement on some action appears likely. While this deal is formally separate from the tax package, he and they both have that front of mind.
This would leave one vote to be collected.
Lambie refuses to comment on her position. Hanson said earlier this month she was “not sold” on the current package and “therefore not likely to support the measures” – and proposed some of the funds be used for a coal-fired power station and a water security scheme.
After Wednesday’s outburst, Cormann was (of course) on the phone to her at crack of dawn Thursday. On her account, he said: “I’m not negotiating with crossbenchers with this at all. We have our three stages. We’re going to pass that no matter what”.
The government aims to keep the heat on Albanese. By the same token, if the crossbench has to come into play, Cormann won’t want a repeat of last term, when he couldn’t muster the numbers to deliver tax relief to big companies.
The government’s tax relief package is shaping up as the first test of incoming opposition leader Anthony Albanese, with Treasurer Josh Frydenberg declaring on Friday it must be supported “in its entirety” when put to the new parliament.
But Albanese has only guaranteed support for the first tranche. As for the later cuts for higher income earners, “we will consider that,” he said on Friday.
But let me tell you, it is a triumph of hope over experience and reality that the government knows […] what the economic circumstances are in 2025 or 2023, in the middle of the next decade.
Appearing with Albanese on the Nine Network, Trade Minister Simon Birmingham said:
Albo, it would be remarkable if your first act as leader of the opposition was […] to oppose a long term package of tax relief – that would show a real tin ear for the Australian people”.
In an interview with The Conversation, Frydenberg refused to be drawn on what the government would do if unable to get the whole bill through.
It would, however, be hard for it to avoid splitting the bill – to hold out would deny the immediate relief pledged in the April budget.
All or nothing
Nor could Frydenberg say when parliament will meet to consider the legislation, although the government has effectively conceded it will not be in time for the promised July 1 start of the additional tax offset promised in the budget. (A smaller offset from last year’s budget will be paid from then.)
But Albanese said the tax cuts could be passed in time for July 1, because it would only need a couple of hours of sitting. “We’ll do a deal. I can do that. One speaker a side, and Bob’s your uncle.”
Frydenberg said Reserve Bank Governor Philip Lowe had highlighted the positive impact the tax cuts would have on household incomes.
“Let’s too not forget that $7.5 billion will flow to households in the coming financial year, as a result of these tax cuts,” Frydenberg said.
Tax cuts as good as rate cuts
“This benefit to households and the economy is equivalent to two 25 basis point interest rate cuts and is one reason why growth and household consumption is projected to pick up,” he said.
“The tax reforms we are putting to parliament are not just providing immediate relief, but leading to long term structural change. This will tackle bracket creep and reward aspiration.
“Earning more is nothing to be ashamed of and should be encouraged not punished. Rewarding aspiration is in the Coalition’s DNA and will be a fundamental driver of our policies in government.”
In his assessment of the economic outlook, Frydenberg had two messages.
He said in his discussions with some of Australia’s biggest employers, “I’ve been buoyed by their confidence and their desire to work with the government, to support continued economic growth and job creation”.
But the economy “faces significant headwinds. Trade tensions between the United States and China have increased, with the potential to negatively impact global growth.
“Were there to be another round of US tariff increases, the potential for which has been flagged publicly, the proportion of global trade covered by recent trade actions would double from 2% to 4%.”
Also, flood, drought and fires had taken a toll and the housing market slowdown was hitting dwelling investment and having an impact on consumption.
The challenges made the government’s agenda for growth, including tax relief, so important and time critical.
Asked whether the “headwinds” faced by the Australian economy were stronger than at budget time, when he also spoke of headwinds, Frydenberg said: “I think the tensions between China and the US have increased”.
Frydenberg spoke with the US Treasury Secretary Steve Mnuchin this week and the two will meet in Japan at the G20 finance ministers meeting in a few weeks. Frydenberg stressed in the conversation the importance of free trade to Australia and its wish to see disputes resolved as amicably as possible.
Asked whether, if the economy deteriorated further, the government would be willing to live with a smaller surplus next financial year than the $7.1 billion projected in the budget, Frydenberg said, “that’s the amount that we’re committed to”.
He would not be drawn on the signal this week from Lowe that an interest rate cut was coming.
The Treasurer said the current unemployment rate of 5.2% reflected “strong labour market performance”.
While there are no plans for an overhaul of federal-state relations by the re-elected government, Frydenberg said he would work closely with the states on infrastructure and managing population.
As I mentioned a few days ago, Treasurer Josh Frydenberg and Prime Minister Scott Morrison recycled three pretty big tax ideas in the 2019 budget, each one originally from the 2018 budget but supercharged, and in one case doubled.
The ideas were:
eventually eliminating the 37% bracket to make the tax system flatter;
upsizing the Low and Middle Income Tax Offset to A$1080; and
increasing the value of business investments that may be written off.
Today I’ll deal with the second: the Low and Middle Income Tax Offset, also known as the LMITO or lamington.
In last year’s budget it was to be worth up to $530 per person, but this year the government intends to more than double that to $1,080. And they’d do so retrospectively, so that by the time people put in their 2019 tax returns, many will get a tax cut more than twice as big as originally expected.
(As it happens, the operative word is “intends”. In budget week Morrison said the Tax Office would be able to make the changes “administratively” without the need for legislation. He didn’t have time to introduce the leglislation and Labor would broadly support it. Last week in its official pre-election overview of the government’s finances, the public service said no. It would need “the relevant legislation to be passed before the increase to the Low and Middle Income Tax Offset can be provided for the 2018-19 financial year”.)
The idea of the lamington
But let’s examine the idea of the lamington anyway because it does have bipartisan support and will become law and part of the tax scales. On one hand, it will deliver a welcome boost to taxpayers on middle and low (but not the lowest) incomes. On the other hand, it will push up a key marginal tax rate and kill incentives in a way the Treasurer hasn’t yet acknowledged.
The offset is a gift of $530 (soon to be $1080) slipped into the tax returns of everyone who earns between $48,000 and $90,000.
People earning more than $90,000 will get less of the offset as their income climbs, up to an income of $125,000 when it the offset will vanish. Low earners will get $200 (soon to be $255), climbing to the maximum of $530 ($1080) as their income climbs from $37,000 to $48,000. People with an income too low to pay tax won’t have any tax to offset, and so will get nothing.
Described in dollar terms as I just have, it’s easy to understand. You can work out the tax cut you’ll get, and the Coaltion has helpfully prepared tables to let you see.
But it is possible to describe the changes in another way, not in dollar terms, but as a new set of marginal rates. And this is where they get interesting, and unattractive.
As a longer-term goal, the Coalition says it wants most taxpayers to pay the same unchanging marginal rate of 30% for all incomes between $45,000 and $200,000. It believes that high marginal rates and frequently changing marginal rates sap incentive.
By 2024 it wants the tax scale to look like this:
Frydenberg says the lower, flatter scale would incentivise “people to stay in work, to work longer, to work more”.
So you would think he wouldn’t want to make it bumpy, or lift the marginal rate, which is exactly what his LMITO does.
What the lamington does to those rates
You won’t find the following chart anywhere in the budget papers, but it is what the offsets in this budget and in the last one will do to the tax scale for the next four years before they are replaced by the flatter scale.
First, here’s what we are told the rates look like today:
Now, here’s what they will actually be when you take account of the existing Low Income Tax Offset (or LITO) and the promised supersized Low and Middle Income Tax Offset (LMITO) in the budget.
The graph is lumpy in part because the LMITO is clawed back at the impressive rate of 3 cents for each extra dollar earned between $90,000 and $125,000.
This means it adds 3 cents to the marginal tax rate in that range, pushing it up from 37 cents to a high 40 cents, before at higher incomes it falls back to 37 for taxpayers earning more than $125,000.
Bizarrely, it means the party that has pledged to abolish the 37% rate because it saps incentive has decided to first boost it to 40% over a substantial range of incomes.
The graph is lumpy further down the income scale for another reason: as the LMITO climbs between $37,000 and $48,000, the separate LITO is is clawed back.
Below are the “including offsets” and “excluding offsets” scales together, to enable you to see the differences. The tax rates people will face are those including offsets.
The graph clarifies the trade-off at the heart of the lamington: it targets tax relief at low and middle earners at the necessary cost of higher rates further up the income scale.
How much of a problem is it? Well, that depends.
It’s a classic example of what economists call the equity-efficiency trade-off.
Arthur Okun, an adviser to US President Lyndon Johnson, described it thusly: redistributing income is like transporting water from one place to another in a leaky bucket – you can do it, but you’d better be prepared to lose some water as you ae doing it.
In much the same way, you can restrict tax cuts to low earners, but that means high earners have to face higher marginal rates which to some degree will shrink economic activity.
The critical question is how much it will shrink economic activity, how leaky is the bucket?
It worsens incentives for the roughly 700,000 Australians earning between $90,000 and $125,000. For every additional dollar each of them earns, the government will take away an extra 3 cents. That might not sound like much, but the evidence suggests it will have an effect.
How? Well, the tax rate increase lowers the benefit of generating additional taxable income. And there are a range of ways to avoid generating additional taxable income. The most obvious is working fewer hours, for example by not working overtime or by working fewer days per week. Secondary earners (often women returning to work after maternity leave) are particularly prone to that kind of response.
But it also could mean not going for promotions or pay rises where they take effort, for example by not gaining extra skills or not putting in additional work effort. And, as I found in a recent study, it could involve claiming more deductions to put a brake on your taxable income.
What will the lamington cost us?
Relying on data for the Australian tax system, I find that a 3 percentage point increase in the marginal tax rate results in an average reduction in taxable incomes of around 0.6%. For someone earning $125,000 per year, that amounts to a reduction in taxable income of $750 per year, by any of the means described above or others.
If we assume the average affected person earns in the middle of the relevant range, that implies an aggregate reduction in taxable income of almost half a billion dollars a year from the 3 percentage point tax increase. That means around $300 million less in consumption and saving and around $200 million less in income tax revenue, all because of LMITO.
That half a billion per year is the real, measurable, and unavoidable cost of targeting the Coalition’s tax break. When economists talk about “distortions” or “deadweight losses” created by tax increases, that’s what they mean. It is the cost of fairness. Whether that cost is worth paying is an open question. The government has evidently decided that it is. And now we can decide at the ballot box, ideally armed with proper information.
But it is of concern that the presentation of the policy – while politically attractive – obscures the genuine increases in marginal tax rates the Coalition’s changes will bring about, and thereby their real economic costs.
Eliminating most offsets and concessions, as recommended by the Henry Tax Review in 2010, would do the tax system good. And it do all of us good by making it easier to see what we are being asked to vote for come election time.
A lot of the plan doesn’t take effect until 2024-25, so it’s easy to dismiss as tax cuts on the never-never. But given it’s a central plank of the government’s campaign for re-election, it deserves closer scrutiny.
The plan comes in three stages.
The major part of stage 1 is the Low and Middle Income Tax Offset – giving everyone earning less than $126,000 a cheque in the mail come July and then for the following three years. Stage 2 (2022-23) would lift the top threshold of the 19% and the 32.5% brackets. The biggest cuts would come in stage 3 (2024-25) when the government removed the 37% bracket and cut the 32.5% rate to 30%.
Everyone earning between $45,000 and $200,000 would face the same 30% marginal tax rate.
Unsurprisingly, in absolute terms the biggest beneficiaries would be high-income earners. More than half the benefit would go to the top 20% of earners, those with taxable income over $87,500 a year.
But to better understand what the plan would do to the progressivity of the system, we need to consider what would happen to rates without the plan.
Without change, the average tax rate would increase across the income distribution, as wage growth pushed people into higher tax brackets.
The plan would prevent some of that bracket creep by lowering future tax rates.
Most taxpayers would be better-off than without a change – but high-income earners would benefit the most.
It goes part-way to addressing bracket creep for low and middle income earners. Someone in the middle of the income distribution would pay 3.6% more tax in 2029-30 than today, instead of 6.1% more without the plan.
But Australia’s highest earners – the top 15% of taxpayers – would escape bracket creep entirely, paying the same average tax rate or less in 2029-30 than today.
This result would be a shift in the proportion of tax paid at different points in the income distribution.
Middle earners, those earning between the third to top and the third to bottom ten percents of the income distribution, would pay a larger share of tax in 2029-30 than they do today: 23% compared to 20%.
But high-income earners, those in the top fifth of the income distribution, would pay a smaller share of tax: 65% in 2029-30 compared to 68% today.
It’s more a tax cut than tax reform
The government has been keen to sell the tax package as a “huge reform” because it removes an entire tax bracket.
It says flattening the tax scale would create a greater incentive for higher-income earners to work. But unlike earlier tax reform packages, there has been little in the way of clear articulation or modelling to demonstrate that this would be the case. And there are reasons to doubt that it would be the case.
The people who would benefit most from the tax reform would be in the top 6% of the income distribution in 2024-25. Barring major changes to gender work patterns in the next five years, they would be disproportionately men, working full time. But as the Henry Tax Review pointed out, the people who are the most responsive to changes in effective tax rates are second-earners (mainly women) working part-time.
Proper reform of the income tax system would lower the economic barriers to second-earners working more: the increase in tax, the cuts in family and childcare benefits and higher childcare costs that accompany working more.
And it might not be affordable
The budget numbers point to a decade of surpluses, exceeding 1% of GDP by 2026-27, even with the tax cuts. But the surpluses rely on payments as a share of gross domestic product falling steadily over the decade, from 24.9% of GDP today to 23.6% by 2029-30.
Achieving such a reduction would require significant cuts in spending growth across almost every major spending area, during a period when we know that an ageing population will increase spending pressures, particularly on health and welfare. The Parliamentary Budget Office says ageing will add 0.3% of GDP a year to spending by 2028-29.
The approach marks a change since the 2016-17 budget, when the government forecast that payments would grow as a share of GDP over the decade because of the ageing population. There have not been enough significant savings measures in the past three budgets to explain the turnaround. It appears to be more driven by assumption than by reality.
If we were to make the still-conservative assumption that spending remained merely constant as a share of GDP at 24.9%, the third stage of the tax cuts would push the budget back into deficit in 2024-25.
The bottom line
The pre-election tax package finally does something about bracket creep – but solves it only for the highest of earners.
It passes up the opportunity for more comprehensive reform. And most disconcertingly, it punches a sizeable hole in government revenue just at the time an ageing population will start to demand that more money be spent.