Date created: 28 November 1996
Last modified: 18 November 1997
Maintained by: John Quiggin
John Quiggin

Taxation: the reforms a strong prime minister would impose

The Australian

Dec 27, 1994

The last couple of months have seen what may be a fundamental change in the Australian economic debate. Since Mr. Hawke's Trilogy commitment ten years ago, Australian politics has been characterised by a bipartisan consensus on the need to cut taxes. Hints that higher taxes might be necessary, put forward in the Fitzgerald Report on National Savings and in the Green Paper on Employment Policy, fell on deaf ears. Even two months ago, when Labor MP John Langmore took the courageous step of advocating higher taxes to fund employment growth and improved services he was ignored or ridiculed by the policy establishment.

In a short space of time, the terms of the debate have changed radically. The Prime Minister and Treasurer have recently hinted at the need for higher taxes. They must have been gratified by the generally favorable response from economic commentators. Only the Opposition has continued with its usual ritual denunciation of any proposal to increase revenue.

The development of chronic nationwide crises in health care, education, law and order and other community services has made it clear that expenditure cannot be squeezed much further. A recent survey by the Economic Planning Advisory Council (EPAC), which has made a signficant contribution in changing the terms of the debate, found that most Australians would be willing to pay higher taxes in order to improve community services. (The one area of public consumption most were willing to cut was military expenditure. Unfortunately, the military appears likely to remain exempt from genuine economic scrutiny as long as the debate is dominated by Cabinet heavyweights with a penchant for expensive toys).

Although the underlying need for a change of direction reflects these fundamental facts, the suddenness of the change is due to the campaign for an accelerated return to Budget surplus. Many commentators have criticised the government's medium-term strategy, but it was not until the Reserve Bank weighed into the debate with interest rate increases that their arguments became politically persuasive.

These developments have combined to make the case for increased revenue unanswerable In terms of countercyclical fiscal policy, we need faster reduction in the deficit now if there is to be any scope for stimulus in the next downturn. In the longer term, concern with public savings can only be met by increasing revenue. Alternatives such as asset sales are merely smoke and mirrors, allowing the government to announce a lower deficit, but actually dissipating public sector net wealth. Most importantly, any response to our central long-term economic problems of mass unemployment and inadequate community services requires an increase in revenue.

But, in the words of the old conservative catch-cry, where's the money coming from ? Middle-income earners will eventually have to accept the need for some increases in income taxes in order to fund improved services. As the EPAC survey indicates, with the right political leadership, the political support for such a change could be mobilised. But in the short term, the government is faced with the need to raise revenue in a pre-election environment and devote at least some of it to the unglamorous task of cutting the deficit. Two potential revenue sources could be tapped to meet this demand.

The first option is to wind down one of the failed policy experiments of the late eighties when Australia adopted the most generous system of dividend imputation in the world, effectively abolishing company tax as it applied to franked dividends. This resulted in the average rate of income tax paid by those with incomes over $1m a year falling to around 20 cents in the dollar, far less than that of most ordinary workers. The loss in revenue is difficult to estimate but is at least $2 billion a year. According to the theorists who pushed for this plan, the old system was a disincentive to investment. But dividend imputation, has ahd no obvous impact on investment, which has been generally weak over the current economic cycle. If anything, by encouraging dividend distribution at the expense of retained earnings, it has acted to reduce investment. A move to half dividend imputation, still generous by world standards, would yield at least $1 billion a year.

The second option is to cut back the massive and regressive tax subsidies to superannuation. With superannuation now compulsory, there is little need for these subsidies. The real problems in superannuation are in assuring a decent return for the low-income workers who have been pushed into a system geared to high and regular contributions. Existing concessions, costing $5 billion a year, do nothing to address these problems. It should be possible to save as much as $1 billion a year and still improve the performance of the system.

When combined with the dividend from faster-than-expected growth, these measures would permit the government to achieve its deficit target of 1 per cent of GDP at least a year ahead of schedule. This would be enough to satisfy the financial markets and take the pressure off monetary policy. With interest rates easing, Labor would be virtually assured of re-election.

Mr. Keating would then be faced with task of burying the orthodoxies of the past ten years, and replacing them with a renewed commitment to an equitable and progressive taxation system yielding sufficient revenue to meet the needs of the community. This, far more than the republic, or even reconciliation with Aboriginal Australians, will be a true test of his leadership.

John Quiggin is Professor of Economics at James Cook University and author of Great Expectations: Microeconomic reform and Australia, published by Allen & Unwin.

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