Tax burden would shrink with smaller government

The tax reform process needs to be carefully managed to avoid the larger government that Australia can ill-afford for a prosperous future.

With much fanfare the Abbott government this week released its long awaited discussion paper on tax reform, which it envisages will represent a start of a process in which it will take reform to the next election.

Much like the early stages of the Henry tax review under the previous Rudd-Gillard government, this discussion paper canvasses a well-worn narrative that makes the case for changing our taxation regime.

The paper especially refers to Australia's reliance on a centralised, direct taxation regime, with high and complex corporate and personal income taxes compromising economic growth by sapping incentives for greater labour supply, entrepreneurship and innovation.

So, according to the discussion paper as devised by federal Treasury, we need to alter the composition of our taxation arrangements away from direct taxes and toward indirect taxes, including the GST, to capture more revenue for government.

Market-led reforms to business structures and technologies, particularly low cost computing and online communications, have economically emancipated ordinary Australians from being forced to buy expensive and low-quality products from domestic bricks-and-mortar retailers.

The rest of us see the freight containers of imported cheap books, clothing, computers, and the like, as a massive saving of disposable income, and a friend in the fight against price inflation.

On the other hand, the Australian Taxation Office and Treasury see freight containers filled with imports as a tax grab going begging and want to put an end to it.

The tax discussion paper also makes the preposterous case that the imposition of state land taxes and council rates already represents an efficiency gain to the economy, and so what seem to us as residences and factories appear to the taxman as revenue-raising goldmines.

The authors of the tax discussion paper assert that Australia can readily bear a heavier tax load, especially on goods and services, and on land, with little economic consequence, because we supposedly are a low taxing country.

If only this were true.

As former Treasury deputy secretary Greg Smith noted in a paper written in 2007, common international tax comparison statistics provide a misleadingly low impression of the Australian tax burden.

This is because taxation laws have been imposed that effectively force people to spend their money in particular ways, such as employers compulsorily contributing to superannuation and workers' compensation schemes, or using the tax system to encourage people to purchase health insurance policies.

From an economic perspective these measures effectively act as taxes and should be incorporated into Australian estimates of taxation burden in internationally comparative perspective.

Contrary to the tax discussion paper assertion that "Australia has a relatively low tax burden compared to other countries", including compulsory superannuation, workers' compensation and health insurance mandates raises official estimates of our tax-to-GDP ratio.

In 2012 it is estimated by the OECD that our aggregate tax burden stood at 27.3 per cent, but inclusion of these obligatory payments raises the Australian tax-to-GDP ratio to 34.3 per cent (compared with the OECD average of 33.7 per cent).

And spare a thought for the much lower overall tax burdens imposed by East Asian nations, which are increasingly competing against us for increasingly mobile and specialised capital and labour.

In the final analysis, what this tax reform process does is attempt to soften Australians up for a ratcheting up of the overall tax burden, off an already high base, to validate the excessive government spending undertaken over the last few years.

By no means do we have a "revenue problem", since the ABS shows commonwealth taxation revenues rising from $286 billion in 2007-08 to $338 billion in 2012-13, and the mid-year fiscal outlook estimates a further tax increase to $354 billion this financial year.

The states and local governments have also been experiencing overall growth in taxation revenue since the global financial crisis.

It may be true that altering the bias of the taxation structure from direct toward indirect taxes would yield some marginal improvements in economic efficiency, but the deadweight loss estimates shown in the discussion paper illustrate there will still be efficiency costs substituting income taxes for the GST.

But the great problem with this tax discussion paper, as with most other tax reviews of the past, is that it looks upon tax reform issues in isolation, and without due consideration of expenditure efficiency matters.

As Australian economist Geoffrey Brennan reminded us nearly 30 years ago, tax reform in its conventional guise would only make it easier for governments to confiscate revenue from taxpayers, for subsequent spending on initiatives which rank poorly on efficiency grounds.

If a tax mix switch still imposes efficiency costs upon the economy, since every tax distorts economic behaviour in certain ways, and if government spending yields fewer benefits than that obtained if taxpayers were able to otherwise retain their proceeds, it is difficult to see how people get ahead through tax reform.

To put this in another way, we wake up, post-reform, with heavier GST and land tax burdens, a somewhat lower income tax burden that is still internationally uncompetitive, and still inefficient public sector spending with a built-in impetus for further expansion.

There is no question that there are certain deficiencies with our taxation system which require specific remediation efforts.

These include a personal income tax regime with steep gradated rates and a lack of indexation forcing average wage earners onto higher tax rates, a company tax system with a headline 30 per cent rate which is too unattractive to foreign investors, a lack of taxing powers for lower levels of government, and far too much tax complexity.

But the tax reform debate today, as it has been in the past, is informed by a central underlying question:  is the present size of government too big, or too small?

Much of the tax policy orthodoxy seems informed by an underlying presumption that taxpayers must pay for whatever expenditure commitments have been previously committed politically, even if they are intrinsically unaffordable in a small, open economy such as ours.

But if we think that the present size of government is too large, that sets the policy stage for reforms focused upon reducing the burden of public sector spending which, consequently, provides room for substantial tax cuts across the board.

Let there be no doubt:  the final menu of tax reform options presented by the Abbott government will, for better or worse, unambiguously inform the Australian electorate which direction it thinks the tax load, and ultimately public sector size, should go.

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