For both critics and supporters, the obvious starting point for analysis of the Garnaut carbon tax proposal is a comparison with the GST. Like the GST, the carbon tax is, effectively, a tax on consumption. While it will not be uniform, it will have some cost effect on most items of consumption. And, as with the GST proposal the aim is to return all or most of the revenue in such a way as to maximise economic benefits while minimising political costs.

At a rate of $26/tonne, a broad-based carbon tax could be expected to raise around $11 billion or about 20 per cent of the revenue raised by the GST. The revenue can be expected to rise roughly in line with national income, given a 4 per cent annual increase in the real price, partly offset by a gradual decline in carbon emissions. But it is never likely to go much above 1 per cent of national income, and the predicted price effect is also around 1 per cent on average.

These figures alone put Tony Abbott’s scare tactics about a Great Big New Tax on Everything into perspective. The government in which he was a minister introduced a genuinely New, Great Big Tax on Everything, with none of the disastrous effects predicted by its critics.

If Abbott looks silly, how about the rightwing denialists for whom this is a plot to destroy the Australian economy, or even Western Civilisation as a whole? If the Australian economy were so fragile as to be significantly affected by such modest changes, it would have collapsed long ago.

Nevertheless, in economic, and particularly political terms, it is important to get the use of the revenue right. The Rudd government’s CPRS proposal made a mess of this, with the incompatible desires of overcompensating most households and buying off all the rent-seekers in the business sector.

In retrospect, they would clearly have done better to follow Garnaut’s advice and focus on protecting low-income and middle income households.

Garnaut’s proposals are:

  • raising of the tax free threshold to $25,000
  • the removal of the low income tax offset and potentially the seniors’ tax offset but not at this stage proceeding with the other changes to thresholds and rates
  • Adjusting thresholds and/or rates to effectively net off the value of the cut in tax for higher income earners (above $80,000).

I haven’t done the sums in detail, but a back-of-the-envelope analysis makes it look feasible. Roughly speaking, the netting out could be achieved by scrapping the 30 cent tax bracket from $37 000 to $80 000, and merging it with the 37 cent bracket.

The higher marginal tax rate would be offset by the end of the 4 per cent clawback under the Low Income Tax Offset, while the raising of the tax free threshold would end a lot of poverty traps for low income earners.

Given a few years, and it might be possible to raise the tax-free threshold and lower the 37 cent threshold, so as to allow for a system in with only two rates, of which the higher (currently 45 cent) rate would apply only to the very well-off. While the benefits of simplicity in the tax system are often oversold, it is a beguiling prospect.

Overall, Garnaut’s proposal looks both more economically appealing and more saleable than the Byzantine complexity of the CPRS.

Perhaps its biggest advantage, as far as the government is concerned, will be the nasty puzzle it sets for Tony Abbott. Raising the tax-free threshold to $25 000 will take something like a million voters out of the income tax system. It would be a courageous Opposition leader who campaigned on a promise to push them back in.

Peter Fray

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