Date created:27/8/04
Last modified:27/8/04
Maintained by: John Quiggin
John Quiggin

Latham's next great leap

Australian Financial Review

15 July 2004.

With the government having, as usual, sought to eliminate any surplus before the election, there has been considerable speculation over whether Labor can manage a credible policy delivering both significant new spending initiatives and a tax cut proposal to compete with that of the government.

The first question confronting Labor is how much money is available to spend. A reasonable goal for Labor's first term would be to maintain the ratio of public expenditure to GDP. The 200405 Budget projects expenditure to decline from 22.6 per cent of GDP in 200304 to 21.9 per cent in 200708. Aiming to hold the expenditure/GDP ratio constant would allow Labor to spend an additional $20 billion over a three-year term.

The initiatives Labor has committed to so far amount to about $5 billion over the three-year term, so there is certainly room to move. But finding the resources for new policies is not easy.

An Opposition can always promise to finance at least some of its promises through cuts in duplication and waste. The Liberals made vaguely specified claims like this before the 1996 election and Labor can do the same. But there's only so far you can go with this. It will be necessary to identify real targets. Labor could reasonably aim to find $1.5 billion per year by cutting government advertising, over-reliance on consultants and pork barrel grant programs.

The health insurance rebate is big, expensive, and, despite some recent claims to the contrary, not very effective in reducing the use of public hospitals. The annual direct costs are now $2.5 billion. In addition, the incentive for claimants to seek treatment in higher-cost private hospitals costs about $0.5 billion in extra Medicare payments. Labor could tighten up the rebate and redirect proceeds towards the preservation of bulk-billing.

The biggest tax policy mistake of the present government was the cut in capital gains tax. To his credit, Mark Latham was the only member of Labor's caucus to speak against the disgraceful deal Labor made to go along with this cut. The combination of unrestricted deductibility of interest costs and concessional treatment of capital gains has proved to be a recipe for real estate speculation on an unparalleled scale.

There are two main ways of addressing this. Logically, the most satisfactory way is to reverse the tax cut in on capital gains. But an alternative might be to follow the American practice of 'quarantining' losses on investment housing so that tax deductions can be claimed only against profits from the same activity and not from general taxable income. The potential revenue gain here would be large. The Australian Tax Office pays out about $700 million more in deductions on housing investment than it takes in tax revenue. Because these investments are supposed to make a profit, and at least some investors do pay tax, quarantining losses would save at least $1 billion per year.

Latham has promised wider tax cuts than those contained in the government's 20045 budget package in. If this means Labor would give all government's tax cuts and their own on top, this would be clearly unaffordable. But it's hard to see Labor cancelling tax cuts that have already been given out.

The most reasonable basis for proceeding, then, is that Labor should scrap the second round of the government's proposed tax cuts and use the proceeds to finance an alternative. Then, an obvious option for Labor is to make no further changes to the top threshold, instead raising the income thresholds for the 30 percent and 42 percent marginal rates. This would provide revenue of around $2.5 billion per year as the basis for an alternative tax cut.

The deal that lured the Opposition into supporting the capital gains tax cut was also supposed to oblige the government to combat tax avoidance schemes exploiting personal service companies and family trusts. The same measures had previously been promised to the Democrats in return for support on the GST. But then the government caved in to pressure from business, withdrawing most of these measures. The government's own estimates at the time suggested measures to combat tax avoidance could raise $1.5 billion a year. Labor should aim for $2 billion.

The options are there, but none of them are easy. The temptation is always to revert to the small target strategy, adopted successfully by the Liberals in 1996, and unsuccessfully by Kim Beazley in 1998 and 2001. It will be interesting to see which way Labor jumps.

John Quiggin is an Australian Research Council Federation Fellow in Economics and Political Science at the University of Queensland.

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