A hard, tough and brutal tax debate is brewing

Tax is exciting -- despite what they say.  Last year the Rudd Government set up the Henry Tax Review and, for a while, shovelled all its problems on to Ken Henry.  The final report is looming and the Rudd Government will soon be shovelling problems away from Henry.  A hard, tough and brutal tax debate is brewing.  Good.  Tax reform shouldn't be easy.  Yet it is not clear that any reform will actually flow from the Henry Review.

Too many observers have been carried away by the GST exemption.  The argument that good tax reform requires a higher GST rate or a wider base is simply lazy.  It is all too easy to gouge more money out of Australian consumers by ramping up the GST.  That is the genius of the Howard Government's implementation of the GST -- the states get all the benefit, the Commonwealth all the pain from any increase.  There is no incentive for Canberra to modify the GST and so any proposal or tax reform predicated on a GST variation is simply a waste of everyone's time.

Of course, the tax purists are up in arms.  Yet tax debates are when the expression "We live in a society, not an economy" especially has merit.

Australians have no interest in living in a theoretically purist tax system.  Rather they want to get on with their lives while ensuring that the various governments are appropriately funded.  The debate has bogged down with the tax tail wagging the dog.

The best example of this is the notion of taxing the family home.

Newspaper reports have suggested that owner-occupied housing is some sort of tax rort.  A Henry Review consultation paper suggested that the Commonwealth foregoes about $25 billion per year.  Remember not being taxed to live in your own house is a concession -- home owners should be grateful.

People who advocate taxing the family home are invoking a "tax folk theorem".  As Professor Joel Slemrod, of the University of Michigan, has explained:

"There is a folk theorem among tax policymakers that goes as follows:  all taxes have weaknesses, and the marginal social cost of the weaknesses increase with the tax system's reliance on any given tax.  Therefore, revenues should be collected from a variety of taxes rather than a small number."

This folk theorem can be seen at work when Professor John Freebairn, of Melbourne University, suggested that the tax-free status of the family home lead to an over-investment in housing, and too little saving in bank accounts.  Remarkably he didn't suggest that bank interest be tax free, rather he proposed a tax on owner-occupied housing.  The United States does have such a tax and it doesn't seem to have prevented an over-investment in housing there.

The debate to date seems to be an exercise in how bureaucrats can devise a perfect tax system to raise more money.  No bureaucrat ever saw a problem that more money wouldn't solve.  But it is not clear that our existing tax system raises too little revenue, the problem is more likely the vertical imbalances in the system.  Tax reform must be about the Commonwealth raising less money and the states raising more.

Unfortunately, all we're hearing from the Henry Review is increasing taxation and greater centralisation.

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