Australian Economy

Australia must switch to the right tax mix

Now the major political parties ask to be elected on ludicrous claims that their inadequate policy offering will reverse Australia’s productivity slowdown.

In a great failure of the political system, both refuse to endorse The Australian Financial Review’s calls for an expedited review of the tax system.

Bleedingly obvious problem

That leaves a creaking tax system that imposes even more of a drag on Australia’s economy, says Ken Henry, the Treasury head who Wayne Swan, the mentor of Labor shadow treasurer Jim Chalmers, chose to head Labor’s ill-fated tax review.

The International Monetary Fund and the Organisation for Economic Co-operation and Development, now headed by the Coalition’s former finance minister, Mathias Cormann, agree. This is the tax agenda that Scott Morrison dismisses as retro.

Back in 2015, Joe Hockey’s Re:Think tax discussion paper tried to prepare the ground for the tax-mix switch that should be the “no brainer” of Australia’s structural tax modernisation agenda.

The bleedingly obvious problem is that too much of Australia’s tax burden now falls in the wrong places – on income rather than on consumption.

Too heavy reliance on taxing productive workers and business earnings blunts incentives to work, save and invest. Too little indirect taxation of spending on goods, and increasingly on services, prevents spreading the burden and doing less economic damage as revenue is raised.

The 50 per cent of government revenue raised in Australia from personal and company tax is the second-highest among developed countries.

To its credit, the full implementation of the Morrison government’s three-stage personal income tax cuts will flatten the tax scales, eliminate the 37 per cent tax bracket and leave most wage and salary earners paying a marginal tax rate of 30 per cent.

Yet Australia’s 45 per cent top tax bracket remains high by international standards, and kicks in at relatively low levels of income.

The $18,200 tax-free threshold also pushes up tax rates at higher income levels and creates tax penalty work disincentives that partly explain New Zealand’s approximately 5 per cent higher rate of workforce participation than Australia.

At least the LMITO – low and middle-income tax offset – cash handout, thrice rolled over amid the pandemic, is slated for abolition in 2023.

But capital-importing Australia still has the Coalition’s populist two-tier corporate tax regime that taxes the profits of big companies at an internationally uncompetitive 30 per cent rate. And a populist levy on the banks because “no one likes you”.

Relying on distorting taxes

Labor’s tax populism closes off its tax reform options.

Mr Keating weaponised the GST in the Coalition’s Fightback manifesto to destroy John Hewson’s prime ministerial pretensions at the 1993 election. Labor opposed the introduction of the GST that Howard successfully staked his political future on at the 1998 election.

The belief that consumption taxes punish the poor is now part of Labor’s political theology.

Yet in an increasingly service-based economy, the narrow and eroding base of the exemption-riddled GST means that far from becoming the growth tax needed to fund essential health, education and other services, state governments are forced to increasingly rely on distorting taxes such as stamp duty on property transactions that increase the upfront purchase price of homes.

Australia’s complex and distorting tax system is a mess because it lacks a first tax principles approach to raising revenue as simply and efficiently as possible, and at least cost to the economy.

The failure to commit to budget repair, and promises to keep on spending by both sides of politics, point to higher taxes after the election.

Fiscal populism colliding with an unreformed tax system would impose an even greater drag on the economic growth that both the Coalition and Labor are counting on to stabilise Australia’s $1.2 trillion debt burden as a share of national income.

The Coalition says it will abide by the 23.9 per cent tax-to-GDP ratio. After the debacle of Bill Shorten’s big taxing agenda at the 2019 election, Anthony Albanese says there will be no tax rises under a Labor government.

But whoever wins on Saturday needs to run with a tax review. It doesn’t need to be a royal commission-sized affair because the tax system modernisation needed to sharpen Australia’s growth potential is the mainstream policy thinking about the right tax mix.

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