Every year the government forgoes more than $100 billion in tax revenue courtesy of exemptions and concessions in the tax system. By 2013-14 it’ll be up to $120 billion, the Treasury forecast in the Budget.
By way of context, this year the government will take in $314 billion in tax and spend $350 billion.
There’s tax expenditures and tax expenditures. Some are straight common sense. To include transfer payments in income for taxation purposes, in effect clawing back what is being handed out, is needlessly complicated. Under current arrangements the government taxes some payments and not others. The Henry Review recommends making them all tax-exempt. But under current arrangements, the exemption of Family Tax Benefits from income tax notionally costs $2 billion a year. The exemption of the Child Care Benefit costs half a billion dollars a year. These all go towards the $100 billion-plus figure, but no one would suggest they’re a scam.
But tax expenditures are an arm of government policy that receives less scrutiny because of their complexity and the hidden nature of their costs. We also now have a better grasp of their true size, because earlier this year Treasury published a new Tax Expenditures Statement that tackled the cost of exempting the family home from Capital Gains Tax, which it estimated costs us $30 billion in lost CGT revenue a year. During the Howard years, tax expenditures were about 10% of GDP; next year they’ll fall to 7.4% of GDP and keep falling until 2013-14. That’s no feat of Rudd fiscal discipline, merely a function of the GFC and the drop in economic growth. Superannuation-related concessions bore the brunt of the fall, dropping more than 20% on boom-era highs.
The fall took our level of taxation expenditures back to the US and Canadian level, of about 6%-7%, but well below the British level of 12%-13%. The Anglophone economies, according to one OECD study, all have much higher levels of tax expenditures than European or Asian economies. Given the likely lift in expenditures as a proportion of GDP as the economy returns to full strength, Australia is likely to return to its position as second only to the Brits for reliance on tax expenditures as an instrument of policy.
How healthy is that, given the relative lack of scrutiny? Well, in fact some of the worst tax expenditures are well-known. there are plenty of economic purists who object to the the family home CGT exemption. And then there’s Meg Lees’ legacy to Australian public life, the fresh-food GST exemption, which gouges more than $5 billion out of revenue year in, year out. Thanks a heap, Meg. The private health insurance rebate slugs taxpayers for more than $1 billion a year in lost income tax — and that’s just a part of its huge drain on the Budget.
Superannuation concessions are the biggest component after the CGT exemptions. During the boom years they formed more than a quarter of overall tax expenditures. This year they’re down to 25%, but they’ll start growing again, heading towards one-third of tax expenditures in coming years.
Super concessions are normally assumed to disproportionately favour high-income earners. Judith Sloan recently contended that they don’t if you count the aged pension — in simplistic terms, either you get a handout during your working life via a super concession, or you get it via the aged pension. The Henry Review, however, urged reforms of superannuation concessions:
“… the current taxation of superannuation favours high-income earners compared to low- and middle-income earners. For example, around 2.5 million individuals receive little or no personal income tax benefit from their superannuation contributions. In contrast, around 200,000 taxpayers (those earning more than $180,000) receive a concession on their superannuation contributions of 31.5 per cent.”
The Review recommended distributing concession more equitably across high, middle and low-income earners, with the aim of lifting retirement incomes i.e. to make the current tax expenditures more effective in policy terms, rather than slashing them.
It would be churlish to criticise the government for squibbing this recommendation given its commitment to increase the Superannuation Guarantee and to reform financial services regulation to impose a fiduciary duty and start the process of eliminating commissions — two high-quality reforms from Chris Bowen, who is starting to put substance to all those Keating comparisons. It would be — if there wasn’t a sense of the government having its cake and eating it too.
In this Budget and the 2009 Budget, the government has artfully exploited the huge size of the superannuation concessions to give itself a little fiscal assistance. It did cut the limit on concessional contributions to $50,000 last year, but it also “temporarily” reduced the level of government co-contributions for lower-income earners, saving itself $1.4 billion over four years. This week, that “temporary” measure was made permanent.
The government also “temporarily” froze the indexation of thresholds at which it phases down its superannuation contribution for low-income earners. This was a similar trick to its highly rewarding freezing of the Family Tax Benefit A and B and Baby Bonus income thresholds in last year’s Budget. The mere act of holding the level at which you withdraw payments means more people start losing access to them as wage growth takes them over the threshold. It’s about the closest thing you’ll get to politically painless savings.
But hard reform would involve working out the best way to maximise the impact of what taxpayers are losing through these tax expenditures, as the Henry Review suggested, rather than treating them as a source of Budget nips and tucks that primarily end up targeting low-income earners.