Government must live within its means

The Latin phrase quis custodiet ipsos custodes used to be the most important idea in our democracy.

Regrettably those days are long gone.  These days it is merda taurorum animas conturbit.  Nowhere is this principle more apt than in the area of taxation.

Government in a modern democracy is quite large.  By that I mean government spends a substantial amount of the income of working Australians.  Where it can't or won't spend government regulates — forcing people to spend their own money on government preferences.

This financial year the Government plans to spend $370 thousand-million.  Of that amount it expects to raise $336 thousand-million, the rest will have to borrowed and paid back out of future tax receipts.

Somebody, somewhere, at some time, has had to work to earn each and every single one of those dollars.  They then give up those dollars to the Government.  It is generally the case that every dollar anyone receives from the Government has been earned by somebody else, and taken from that person.  Of course, with churning it is the case that often that ''someone else'' is a former, or future, version of themself.

So the first point to understand about taxation is that the Government has taken money away from somebody.

Now there might be good reason why taxation is a good idea.  After all, civilisation doesn't come cheap — nor should it.  Somebody has to pay the salaries of the soldiers who defend our borders and the police who protect our lives and limbs.  The prisons that house criminals are a legitimate government expense too.

All reasonable people would agree that some government expenditure is legitimate and should be financed by taxation.

At this point, however, public debate degenerates.  Government very often expands well beyond prudent levels.  It often engages in expenditure best left to individuals and voluntary associations.

One way government expands is by masking the true costs of government.  For example, we might hear that Australia is a low-tax economy.  On average that might even be true — but Australia operates a highly progressive tax system.  A hypothetical average doesn't capture the actual tax burden that taxpayers endure.

So government engages in an activity known as fiscal illusion — where the costs of taxation are obscured and the benefits of government spending over-sold.  All this allows the Government to expand beyond its optimal size and raise more taxation than is actually necessary.

One particularly seductive mechanism is the perversion of language.  The Government describes an increase in taxation as a ''saving''.  Tax cuts are described as ''spending''.  Failure to introduce a tax is described as ''tax cuts''.  Not introducing a tax might also be described as a ''subsidy''.  Here we have the case of merda taurorum animas conturbit.

This terminology is very misleading and is, basically, dishonest.  Yet there are very few individuals who will call out those politicians who engage in this behaviour.

I'm not actually having a go at Wayne Swan — he'll keep for later.  I'm having a go at Malcolm Turnbull.  In a piece published in the Business Spectator this week he made the argument for a sovereign wealth fund.  He set up the hypothetical situation of a future government confronted by a budget surplus.  What to do with the money?  (Answer:  Cut taxes).

Turnbull suggests, quite correctly, that the Government would likely fritter the money away.  His solution is to establish a sovereign wealth fund providing ministers with a savings objective.  I have argued against this idea before;  quite frankly if Turnbull and his fellow ministers don't trust themselves to deal with a budget surplus why do they trust a future government (presumably of the other party) to be any better?  This is the classic quis custodiet ipsos custodes problem.

So far, so good.  But Turnbull went beyond arguing for a sovereign wealth fund.  He suggested that tax cuts were government spending and without a fund ''the arguments for 'giving us our money back' are pretty compelling in a political sense''.

The argument for ''giving us our money back'' must always be pretty compelling.

The counter-argument, however, is that some tax cuts are ''unsustainable''.  This means that government is not raising enough money to pay for required government spending.  That is a theoretical proposition.  It also begs the question of ''required government spending''.  But it has a good pedigree.  Peter Costello used that logic in 2007.

''Our tax system exists to fund the decent services in health, education, aged care, and other services that Australians legitimately expect and are entitled to receive.  If after we provide for those services, invest for the future, and balance our budget, we can reduce the tax burden, we should do so.''

In other words cutting taxes was a fourth-order objective after the Howard government had run out of ideas and things to spend money on.  It wasn't good enough then, and it's not good enough now.

What happens in the presence of a soft budget constraint is that government finds ways of increasing expenditure.  To be fair there are always good causes that tug at our heart strings.  As Malcolm Turnbull indicates there are bad causes too.  On that we are entirely in agreement.

Cutting taxes, cutting spending, reducing regulation;  frankly getting out of the way and letting the private sector generate wealth and opportunity must be a first order objective of any government.  Government must live within its means.  That implies that it should tailor expenditure to revenues and not vice versa.  There cannot be unsustainable tax cuts, only unsustainable spending.

A government that lives with that philosophy is likely to spend our money wisely.

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