Prosperity's deadly spiral

"Is there any other point to which you would wish to draw my attention?"

"To the curious incident of the dog in the night-time".

"The dog did nothing in the night-time".

"That was the curious incident," remarked Sherlock Holmes.

In Arthur Conan Doyle's story The Silver Blaze Sherlock Holmes investigates the disappearance of a racehorse and the murder of its trainer.  Holmes establishes that the horse, Silver Blaze, was led out of its stable while a dog was sleeping in the yard nearby.  The case rested on the fact that the dog didn't bark, meaning that whoever took the horse was someone the dog recognised.  The point being that what didn't happen was more significant than what did happen.

The current tax debate in Australia is like the tale of the dog in the night.  To properly understand the economic and political dynamics of the debate we need to consider what is missing from that debate.

It has been taken for granted that if personal income tax rates are to be lowered, any reductions will be paid for by either increasing other taxes or by eliminating existing tax concessions.  In other words, tax cuts must be revenue-neutral.  However, such "solutions" focus on only one side of the tax-and-spend equation.

As yet, no one has suggested reducing public spending to pay for tax cuts.  In today's climate such a proposal is almost unthinkable.

The idea that those tax concessions that complicate and distort the tax system, such as negative gearing, should be eliminated is a good start.  However, such "tax expenditures", as they are labelled by Treasury, represent only potential tax that is not collected.

Since the past federal election the relatively few political problems which the coalition has had have been almost entirely of its own making, and Opposition Leader Kim Beazley has not been able to make much headway against John Howard.

Given this, it is almost bizarre that the tax debate is actually being carried on in terms much more advantageous to Labor than to the government.  After all, one side of politics is meant to be in favour of more tax, and the other side in favour of less tax.  But this isn't at all how the debate is proceeding.

Both major parties seem to be saying (insofar as it is possible to unravel what is Labor's position) that tax cuts in one area are achievable only if they are balanced by tax increases in other areas.

It hasn't always been like this.

Once upon a time the Liberal Party was an unashamed advocate for lower tax and a smaller public sector.  For example, at the 1987 federal election Howard promised to "significantly reduce the role of government" and ensure "unprecedented cuts in expenditure" in order to introduce a flatter personal income tax regime with only two rates of 25 per cent and 38 per cent.  The direction of John Hewson's Fightback! was similar.

So what is it that has changed over two decades to alter the Liberal Party's position so dramatically?

The answer is, in one word, prosperity.  Australia's record rate of economic growth, the product of the Hawke and Keating reforms of the 1980s and then cemented by Howard and Peter Costello, has succeeded in removing the incentive for any further reform.  The problem for those supporting industrial relations change is exactly the same as that faced by advocates for lower taxes.

The challenge is to counter the claim made by opponents of reform, which is that further improvements are unnecessary because the country is already performing well.

Prosperity, in the form of GST and land tax revenues to the states, and business tax revenues to the commonwealth, has resulted in governments of all persuasions (Liberal and Labor) seeking to maximise the political benefits available through increased expenditure.

Prosperity has created a death spiral of higher government spending, leading to higher community expectations of government, leading to higher taxes, leading back into higher government spending again.  Whether such a situation is sustainable when world commodity prices are not booming only time will tell.

But one thing is absolutely certain.  If and when an economic downturn does occur, the solution to our problems will not be more government spending and taxing.  It will be individuals and businesses responding with creativity and enterprise that Australia will have to rely upon.  At the moment it is difficult to say that the tax system does much to foster those two attributes.

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