Treasury warns the nation faces its most sustained period of weak growth for at least 50 years, with falling commodity prices and weak income growth until 2020. It might be right.

Nominal GDP is the dollar value of what’s produced and earned. It’s also the measure that drives taxation revenue. Due primarily to the inexorable rise in commodity prices and the terms of trade between 2003 and 2011 (with the exception of a brief collapse during the GFC), the federal government enjoyed strong nominal GDP growth and booming tax receipts from rising personal and company taxes, not to mention increased capital gains taxes as asset markets boomed. Since then, terms of trade have begun to trend down, meaning nominal GDP growth has been weak, as have tax receipts …

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The problem for the government going forward is that the terms of trade is likely to continue to trend down towards its longer-term average, which will drag heavily on income growth and nominal GDP. As a result, personal and company tax collections will be soft relative to past experience, whereas budget outlays could increase to the extent that weaker employment leads to higher welfare payments …

Another related headwind is the decline of mining-related capital expenditures, which will detract from Australia’s GDP growth and employment, again placing pressure on government budgets via lower personal and company tax receipts and GST, as well higher welfare payments …

So will a debt levy fix the problem? It’s certainly clever politics: the Coalition can claim it hasn’t “raised taxes” — as it promised during the election campaign. But it’s poor economics. It doesn’t address the crumbling structure of Australia’s taxation system associated with Treasury’s weak forecasts.

Australia’s tax base is shrinking. Two of the three main sources of tax revenue — company taxes and indirect taxes (mainly GST and fuel excise) — are either falling or about to fall. Company taxes will fade as the once-in-a-century mining boom unwinds, which will weaken mining company profitability and reduce the corporate tax take. GST revenues are also growing more slowly than the economy (and will continue to do so) as Australians spend a higher proportion of their earnings on GST-exempted items, such as health and education. Likewise, the relative tax take from fuel excise has been shrinking for more than a decade following the Howard government’s short-sighted decision to end indexation prior to the 2001 election.

This leaves personal income tax as the only prospective source of revenue growth left for the government, despite its base also shrinking in a relative sense as the population ages. In turn, the tax burden will increasingly be pushed onto the (shrinking) working population.

The Coalition’s proposed levy would, therefore, exacerbate these pressures: increasing the burden on personal income taxes, when instead fundamental tax reform is required to spur productivity, broaden the tax base and share the tax burden.

The Henry Tax Review found personal income tax (along with company taxes) to be highly inefficient, producing a “marginal excess burden” (i.e. the loss in consumer welfare relative to the net gain in government revenue) higher than most other forms of taxation …

By comparison, raising or broadening the GST in exchange for cuts to personal income taxes (or giving back bracket creep) would result in clear efficiency gains. As tax expert Professor John Freebairn claims:

“Changing the tax mix from (income taxes to indirect taxes) brings gains of 20c to 30c in the dollar and beats anything that a major corporation could do on productivity.”

There are also compelling reasons to shift the tax system back towards resource rents, as well as broad-based land taxes, which as shown above (via the Petroleum Resource Rents Tax and Municipal Rates) have almost zero marginal excess burden, since they apply to a tax base that is completely immobile — land. Both taxes are also more equitable than either consumption taxes or income taxes.

*This article was originally published at MacroBusiness

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Peter Fray
Peter Fray
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