Monday, April 29, 2013

The last thing we need is an increase in taxes

Nothing quite sharpens minds more than the realisation that Australia's fiscal problems are substantive and becoming entrenched.

After repeated claims by the Gillard Government that it would target a return to budget surplus in 2012-13, the jig was well and truly up when the Treasurer made his public confessional late last year of the unlikelihood that this undertaking would be achieved.

Since that time the Government has struggled to maintain a consistent public posture regarding its approach to minimise the size of the deficit.

Treasury and Finance portfolio ministers initially talked tough about the need for deep spending cuts, however this discourse appears to have gone the way of the dodo.

Over the past fortnight, the Gillard Government has arrived at the position that any transition back to budget surpluses in the near, or more likely distant, future must depend upon revenues growing more strongly, rather than significantly reducing expenditures.

This newly enunciated position seems to have acted as a proverbial siren call for those with a preconceived disposition favouring higher taxes, with a range of academics and organisations coming out in recent days supporting revenues being bolstered by tax increases.

Tim Soutphommasane, a University of Sydney philosopher, recently wrote that ''if future governments are to support the kind of public services and investment that Australians appear to want, taxes will need to rise.''

The Grattan Institute, a government-funded think tank, has similarly called for tax increases as part of a broader fiscal consolidation strategy by both Commonwealth and state governments.

Former federal Labor minister Graham Richardson stated that a potential Abbott Coalition government ''will have to look at the revenue side'' (pay wall) with an emphasis on increasing the GST in addition to spending cuts.

Even former Coalition finance minister Nick Minchin has come out advocating an increase in the GST rate or broadening its taxing base.

As popular as higher taxes have become among some, raising taxes, in any way, shape or form, would be the worst economic outcome that any government could pursue, in efforts to return some normality back into their budgetary settings.

The notable works of economist Alberto Alesina, who has examined the interaction between alternative fiscal consolidation strategies and economic growth in numerous countries, suggests that expenditure reductions can help achieve the desired budget recovery outcomes, with the least adverse economic effects.

Alesina indicates that expenditure-based fiscal adjustments are associated with smaller economic downturns, if at all, than tax-based adjustments, and these policies, especially when combined with deregulation, have in some circumstances supported economic growth.

In addition, a more general empirical literature exists which mostly indicates that, putting aside issues of tax structure, higher rates of total taxation imposed upon individuals and businesses are associated with slowing rates of economic growth over time.

A recent study (PDF), by Davide Furceri and Georgios Karras, for 26 OECD economies, including Australia, found that an increase in total taxes equivalent to 1 per cent of GDP will reduce long-run real GDP per capita by up to 1 per cent.

A number of other studies, for single economies such as the United States and Canada, also allude, in the main, to the growth-hampering effects of increasing taxes.

These and other studies support the longstanding understanding of economists that the imposition of higher taxes would distort economic activities, by hampering productive behaviours such as working, saving, investing, or exercising innovative or entrepreneurial conduct.

In short, it seems that the latest round of calls for higher taxation would propel Australia down the wrong economic track.

To provide greater certainty for investors and bolster consumer confidence in the present economic climate, what is actually needed in the lead up to the federal election, and beyond, are clearly enunciated political statements that increasing taxes would not be countenanced, regardless of circumstance.

Political form on this issue has not been promising so far, however.

In addition to the carbon dioxide and mining taxes, Australians have been hit by flood taxes, rising alcohol, fuel and tobacco excises, and the abolition of several income tax offsets and other forms of tax relief over the past few years.

More recently, the Government announced a new tax on superannuation earnings over $100,000.

The Coalition's promise to introduce a parental leave scheme, funded by an increase in company tax on the largest 3,200 companies, has also been met with disapproval by a number of economists.

What is needed is for the major parties to turn away from their higher taxing promises, have the party leaderships utter something similar to George H W Bush's ''read my lips, no new taxes'' line, and back this with a practical commitment, in government, to not break such a promise.

Spending reductions and privatisation should, then, perform the heavy lifting of fiscal consolidation.

All too often good politics unfortunately aligns with bad economics, and indeed the persistent federal budget deficit is a case in point.

However an explicit shift in strategy by a major party toward a 'no tax increase' commitment would represent a rare and welcome occasion upon which good politics and good economics finally meet.

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