Many politicians and public servants have described to me his rare magic in combining academic rigour with clear communication and a talent for finding a cut‑through line. His retirement this year is a good excuse, if one were needed, to talk about tax reform, the subject of his major academic and policy contributions. Indeed, his research and writing read like a tax reform to‑do list.

Pick up the Financial Review on any given day and you’ll find opinion pieces grounded in John’s decades-long efforts to unpick the efficiency and equity impacts of different tax reform options. He has also made the case for these reforms directly to government as a consultant to the Henry tax review, on the review panel of the NSW Federal Financial Relations Review and in other forums.

And while he has done the hard work of tilling the ground, and has no doubt been pleased with some of the progress made on tax reform, much of the broad agenda he has articulated remains on the shelf.

The question is: why? Why, after so many decades of discussion and so many points of broad economic consensus, does tax reform remain so challenging? Is progress possible or is tax reform simply an impossible dream?

To answer this question, we need to first understand why someone with John’s rare talents decided to use them to make the case for tax reform. The bottom line is that tax matters. It matters to all of us: how much we collect and how it’s collected have implications for economic activity, governments’ capacity to deliver services, and levels of inequality.

One challenge we face when we talk about tax reform is that different people start with very different objectives. So let’s unpack some of those.

The first is economic efficiency. Economists rightly focus on the fact that how we collect tax — that is, what we tax and how much — affects the “economic drag” created by the tax system. Almost all taxes come with some loss of welfare, but some drag on growth more than others.

In a static sense, this can be measured by the “marginal excess burden” — how much economic activity is lost for every dollar collected. As Treasury and others have reminded us, this varies significantly between taxes.

But while there can be big differences in the estimates different modellers come up with, they broadly agree that a tax-mix switch from higher-burden to lower-burden taxes would deliver an economic dividend.

The most clear-cut example is a move from stamp duties to taxes on land. Stamp duties are among the most inefficient of taxes. Treasury estimates suggest that every dollar collected can reduce economic activity by up to 72 cents. Stamp duties discourage people from moving to housing that better suits their needs, and sometimes discourage people from moving to better jobs. Overall, they distort choices and gum up the economy.

Another reason we might advocate for tax reform is to make government budgets sustainable and future‑proof our tax system. At a time when the treasurer has just delivered the first budget surplus in fifteen years and we are seeing apparently endless revenue “upgrades,” it may seem strange to be having this conversation right now.

But government spending overall is projected to average 26.4 per cent of GDP over this period — compared with less than 25 per cent over the three decades before Covid — and revenues have not kept up. The federal government’s latest Intergenerational Report reminds us that the ageing population and the fallout from climate change will only see this fiscal challenge grow over the next forty years. The same is true of state budgets.

The implications of not taking policy action are clear: we are asking future generations to bear the costs of today’s inaction.

Governments have three levers they can pull to tackle long-term budget challenges: they can make economic reforms to “grow the pie,” they can increase taxes and they can reduce spending.

Pursuing policies to boost growth is critical. Much of Grattan Institute’s work has focused on this first lever. And I look forward to pursuing this in a big way when I join the Productivity Commission in a couple of weeks’ time. But, as Grattan highlighted in our Back in Black? report earlier this year, we can’t rely on higher growth alone to close the budget gap.

Given the scale of the challenge, governments will also need to find ways to reduce spending and/or boost revenue. After a decade of looking at this challenge I have come to the view that we will need to do both. The scale of the challenge, and the greater buy‑in that can come when the costs are spread across the population are arguments for looking to both sides of the budget for answers.

If we do accept that some additional revenue is needed to respond to the structural challenge outlined, then we want to make sure that additional revenues are collected with the lowest possible economic costs. In fact, this can also help us grow the pie: more efficient, less distorting taxes are one of the Productivity Commission’s “enduring policy priorit[ies]” for productivity growth.

On the other hand, if we do nothing, we may end up on the path of least resistance: collecting ever-more revenue through ever‑creeping taxes on wage and salary earners. Bracket creep may be the most politically painless way to raise revenues, but it is far from the best.

Tax reform for budget sustainability should aim to broaden the base of income taxes — looking at loopholes and overly generous concessions as well as orientating our collections towards more efficient bases such as consumption, wealth, externalities or resource rents. In other words, we need to revisit the John Freebairn back catalogue.

The atrophying of tax reform in recent decades might make us pine for a golden era. In truth, though, tax reform has never been easy. So let’s take a short history lesson — five decades of tax reform in five minutes — and see what we can learn.

Let’s start in 1975. Many elements of our tax system today can be traced back to the 1975 Asprey tax review. This comprehensive, independent review was commissioned by the McMahon government in response to concerns about bracket creep and tax evasion. (Sound familiar?)

The review outlined the basic principles of efficiency, fairness and simplicity that remain our lodestars and made the case for many aspects of the system we have today, including fringe benefits tax, capital gains tax and a broad-based consumption tax.

But the report initially had little impact. Landing in the final, tumultuous year of the Whitlam government, it was written off in the media as a “tax flop,” and its main recommendations not adopted.

It took another decade for momentum to build. In 1985, fresh off the Prices and Incomes Accord and the floating of the dollar, prime minister Bob Hawke and treasurer Paul Keating turned their attention to tax reform. They released a draft white paper on reform options and hosted a tax summit with unions, business and community groups.

These processes resulted in the adoption of some of Asprey’s recommendations, including a capital gains tax, negative gearing reform, fringe benefits tax, dividend imputation and taxation of foreign source income.

But it was a case of “two steps forward, one step back.” A broad-based consumption tax was central to Keating’s original vision but failed to win support and was dropped. And the pioneering negative gearing reforms were repealed two years later.

So the Asprey blueprint was partly implemented. Another long reform slumber followed. The next big push was John Hewson’s Fightback! platform for the 1993 election, which proposed, among other things, a broad-based consumption tax. Fightback! proved to be a false start — Hewson lost the “unlosable” election — but consumption taxes were back on the agenda.

Another six years had to pass for the reform dream to become reality. Prime minister John Howard took a proposal called A New Tax System, which included the GST, income tax cuts and the abolition of a host of inefficient state taxes, to the 1998 election. He narrowly won and the legislation ultimately passed in 1999, twenty-four years after the release of the Asprey report.

We’ve seen precious little in the way of significant, lasting tax reform since then. The landmark Henry review is close to celebrating its fourteenth birthday with most of its meaty recommendations untouched. State and territory tax reform has also, mostly, been a non-starter, despite a succession of reviews converging on similar recommendations.

So what should we take from this history? What can we learn from those rare moments when we managed to overcome the many barriers I outlined before? I see four key steps for would-be reformers.

Step 1: Put reform on the agenda

History shows that an external push is often needed to put tax reform on the agenda. In 1985, fears about Australia’s economic decline and resentment about tax avoidance pushed the discussion forward. In 1997, the High Court’s decision to strike down a key state tax left a significant hole in the states’ budgets and opened the reform window for the GST.

The optimist in me can’t help but draw parallels with last month’s High Court decision to strike down Victoria’s electric vehicle levy. Perhaps we might have another golden opportunity for a grand intergovernmental tax reform bargain on our hands?

Tax reform was hardly on the radar for the Howard government until civil society groups — representing both social services and business — started championing the cause. The Australian Council of Social Service and the Australian Chamber of Commerce and Industry, in particular, pushed in a coordinated way, culminating in the National Tax Reform Summit in 1996. The strong and united messaging put the GST and tax reform firmly back on the political agenda.

Today many groups feel similarly. Federal independent MP Allegra Spender has been spearheading a push to unite academic, business and civil society leaders to build some consensus on the need for tax reform and the way forward.

Step 2: Build a coherent package

While rewriting thousands of pages of the tax code at once would be a recipe for chaos, relying on incremental changes is probably not going to get the job done either.

History shows that reform packages can work well. In 1985, reforms that broadened the income tax base were bundled with income tax rate cuts and tax avoidance measures — a coherent story to sell to the public. In 1999, removing narrow and inefficient, but lucrative, state taxes and widely variable wholesale sales taxes made sense in the context of the broader GST deal shoring up state budgets.

Packages provide the opportunity to dull the sting of reform by sharing the costs more broadly and perhaps offering some compensation to the losers.

The major tax reforms of the past two decades have come at an upfront cost. The GST package overcompensated households by about $12 billion a year, through personal income tax changes and increases to pensions and family payments. This was a key part of its sales pitch. Former Treasury secretary Ken Henry recalled that:

the distributional tables outlining the impact of the GST were the most “thumbed” part of the documentation, certainly by those Treasury officers answering phone queries. Of course, it helped that every individual and family represented across all income levels appeared better off.

Compensation packages are particularly important where there are equity implications for lower-income households. Australians tend to reject reforms that seem unfair. But, crucially, potentially regressive reforms, such as broadening the base of the GST, can form part of larger, fairer reform packages. For example, the carbon tax package involved substantial assistance for households, particularly lower-income households, to address concerns that poorer households would be particularly affected by higher energy and food prices.

Given the long‑term budget challenges, high‑cost packages of the type needed to ensure there are “no losers” from tax changes are difficult to justify. But it is certainly possible to design packages with much lower upfront costs that still compensate vulnerable households. For example, Grattan’s previous work on the GST proposed a revenue-positive package, with a 15 per cent GST, cuts to income taxes, and an increase in welfare payments, that would leave the lowest 40 per cent of income earners better off on average.

Packages might also help address some of the other political economy challenges of reform. Ironically, opening up more fronts in the tax debate may quiet some of the more over-the-top reactions. As Ken Henry has argued, “if you give a lot of well-armed people only one target to shoot, it will take a pounding. Incrementalism sets up a single target on a battlefield occupied by well-resourced attack forces.”

And while my goal here is not to opine on the “what” of tax reform, let me give a sense of some of the types of packages that a government could put forward.

• On income tax reform, we could return to the logic of 1985: broadening the income tax base by winding back loopholes and overly generous concessions, to support a cut in rates. This could include targeting discretionary trusts and super tax concessions, or reforming capital gains tax — either by reducing the capital gains tax discount or returning to the indexation of gains.

• Another package could tackle the inconsistent tax treatment of different savings options, to reduce the distortion in savers’ choices and simplify the system. This would mean lower taxes on interest from bank accounts and bonds, and somewhat higher taxes on other savings vehicles such as superannuation (which is very lightly taxed even after accounting for the long holding periods). An even “bigger bang ” version would be a dual income tax where income from savings is taxed at a consistent low rate, regardless of source.

• On the corporate tax front, we could better tax resource rents to fund a company tax cut. We could also consider more wholesale reforms such as an allowance for corporate equity or a cash flow tax.

• For states, inefficient stamp duties could be swapped for land taxes over time, along the lines of the ACT government’s gradual phase-in or Victoria’s switch for commercial and industrial property.

• In transport, distance-based congestion charges that vary by location and time of day would be a more efficient replacement for the declining fuel tax base.

• Finally, to aid the climate transition, the government could substantially expand and strengthen the safeguard mechanism, while eliminating many higher-cost interventions to reduce emissions, such as the fringe benefits tax exemption for electric vehicles. The package would deliver both faster and lower-cost emissions reduction.

But while packages make a lot of sense, would‑be tax reformers can’t be too purist. Incremental changes in the right direction are still an improvement on the status quo, and in some cases these more incremental steps can ultimately take us towards more comprehensive packages.

Step 3: Embrace the “vomit principle”

The next step is making a compelling case for change. Complicated reforms that can’t be explained are unlikely to win support, and are more vulnerable to scare campaigns. We saw this in 2019 with the confusion about franking credits — irredeemably branded a “retirement tax” — and in 1993, when John Hewson’s tortured explanation of the effect of a GST on the price of a birthday cake helped turn the tide of popular opinion against the new tax.

Convincing the public of both the necessity of change and the proposed solution takes time and political capital. Howard and Costello spent two years and a lot of political energy highlighting the structural problems with Australia’s tax base prior to releasing their reform package in 1998.

While no one likes to pay extra tax for the fun of it, many are more inclined to agree when higher taxes are linked to better services. The proportion of Australians favouring “less tax ” has declined since the late 1980s, according to the Australian Election Study, and the proportion preferring “more spending on social services” has risen. At the time of the 2022 election, 39 per cent indicated they would prefer less tax, 31 per cent more social spending and the remainder said “it depends” — presumably on the nature of both the tax and the spending increases.

My reading is that when our political leaders do the work of tilling the ground and explaining changes and why they are needed, then hearts and minds can shift.

A more recent example, albeit one contrary to received wisdom, was the then‑Labor opposition’s 2016 policy to wind back negative gearing and reduce the capital gains tax discount. We have already discussed some of the public challenges that reform faced, but it is also worth remembering that negative gearing had formerly been viewed as a “political untouchable.”

Indeed, since the Hawke government lost its nerve and reversed its decision to wind back negative gearing in 1987, it has been considered the “sacred cow” of Australian politics. When Labor announced it would introduce these changes to improve housing affordability and contribute to the budget bottom line in 2016, just over a third of Australians supported removing or limiting negative gearing.

But, over time, as shadow treasurer Chris Bowen and others made the case, support gradually increased. Support for limits on negative gearing climbed almost 10 percentage points, from 34 per cent in March 2016 to 43 per cent in December 2018. By the time of the 2019 election, the Australian Election Study estimated that 57 per cent of Australians supported limiting negative gearing.

To me this is a textbook example of what some political strategists call the “vomit principle ” — repeat something until you feel like you are going to vomit. Only then are you cutting through.

Labor has since dropped the policy, of course, and many reading the media commentary would have gained the impression that the tax reform agenda was deeply unpopular and “to blame” for Labor’s surprise election loss in 2019. The reality was far more complex.

In any case, it’s not just down to politicians to argue for reform. Successful tax reforms need a diverse cheer squad. Historically, academics, premiers, public policy institutions, and community groups have all been important advocates for tax reform. Providing incentives for academics and non-profit organisations to participate in public debate would be a useful step to building these coalitions today.

Step 4: Make it stick

Somewhat dispiritingly, even after these hurdles have been overcome and tax reform has been passed, the job isn’t done. Tax issues tend to linger on the agenda, often for entire parliamentary terms, and reforms sometimes don’t stick. As we’ve just seen, negative gearing reforms were undone after just two years in 1987. The carbon tax and mining tax were repealed. The Perrottet government’s hesitant steps towards stamp duty reform were wound back by the new NSW Labor government.

But in other cases the controversy does die down after reform is enacted. Sometimes social norms change quickly — for example, in Stockholm, congestion charging was much more popular after it had been implemented than before, and many people did not even remember that they once opposed the idea.

In Australia, plenty of tax changes that were controversial at the time — the GST, fringe benefits tax, capital gains tax — are now so entrenched that there is no constituency or any visible public appetite for their removal.

Reforms are more likely to stick if they create positive feedback loops — for example, if they result in institutional shifts, if reform winners can be used as advocates, or if businesses make big investments under the new regime. Taking the GST as an example, the Australian Taxation Office and businesses made significant investments in the infrastructure for administering the new scheme; and the changes to federal financial relations created a key constituency — state governments — who had a strong interest in its continuation.

What are the prospects for tax reform? I, for one, remain optimistic.

First and foremost, I don’t think we have much choice. The slow‑burning platform is still on fire, and over the coming decade the gap between our spending needs and our tax system’s capacity to meet them without ever higher taxes on employment income will be stretched to breaking point.

More and more questions are being raised about the sustainability and intergenerational fairness of our current tax mix. Without action, expect them to get louder and louder over the coming decade. Tax must also come into the conversation if we are going to deliver our policy objectives in other areas, including the green transition.

Second, I am confident that our leaders can make a positive case. While I have focused on the challenges, I am also heartened by the leadership we are seeing on difficult reforms in other areas.

Over the past three months the Commonwealth and state governments have made strong commitments to boost the supply of housing through politically challenging reforms to planning laws. If they can pull it off, this would be a huge economic and social reform, and one that has been in the too-hard basket for many decades.

As a reform proposition, making the case for greater housing density is probably of the same order of difficulty as making the case for major tax changes, and yet we are seeing both levels of government go after it in a big way.

Third, I think there is appetite across a broad swathe of interested parties to shift the dial. Allegra Spender’s tax reform round tables suggest at least a consensus among business, academia and civil society that something needs to change, even if there is not yet broad agreement on the reform priorities. A process to harness this agreement, ideally led and shaped by government, could help move the conversation forward.

Finally, I have confidence in the Australian people to see through the noise. Scare campaigns and a shouty media are one thing, but if state and federal governments can hold their nerve in the rule in/rule out game long enough to make a positive case for change, and keep making it, history shows that people can be brought along.

Tax reform is hard, but it’s not impossible. It’s time we woke up from our slumber and became a little less afraid and a little more Freebairn. •

This is an edited version of this year’s Freebairn Lecture, delivered at the University of Melbourne last week. The full lecture, with charts and footnotes, is here.

The post Tax reform is hard, but not impossible appeared first on Inside Story.

That’s why it is especially noteworthy when an unsung backroom researcher steps into the limelight — not from the Parliamentary Library in this case, but from Britain’s equivalent. The person in question is Georgina Sturge, the House of Commons Library’s senior statistician, and she has just released a book about data — or, more specifically, about bad data and how it misleads.

Sturge’s book, Bad Data, has particular resonance for anyone (like me) who has spent many years peering into the sausage-meat vats of public data collection and use. Almost every example of “bad data” advanced by Sturge has an Australian parallel.

I certainly let out a knowing chuckle or two reading Sturge’s discussion of “zombie statistics” — those dodgy numbers that haunt public debates. Sturge highlights how the bogus figure for Britain’s weekly contribution to the European Union, £350 million, continued to be referenced by Brexit campaigners even after it was comprehensively debunked by the UK Statistics Authority.

In Australia, similarly disingenuous numbers haunt a host of debates. Some of the more egregious come from anonymously commissioned modelling in 2015 that suggested Labor’s $1.5 billion policy to wind back negative gearing would wipe $20 billion off GDP (!) and increase rents by 10 per cent (!!).

Those numbers continued to emerge from beyond the grave even several years after they were shown to be garbage, and even after they had inspired a Media Watch episode exposing the willingness of some media outlets to publish almost any number without a sense check.

Ditto Sturge’s discussion of dodgy policy costings. Despite government forecasts that outsourcing probation services could save British taxpayers £10.4 billion over seven years, the policy was considered a failure and the government paid an additional half a billion to end the private contracts early. Similar examples of cost blowouts abound in Australia — from disability services to major infrastructure and defence projects. Optimism bias and the rubbery forecasts that result are a global phenomenon.

Then there is the “algorithm unleashed” approach to policy implementation. Anyone who has been following the fallout from Australia’s scandalous robodebt scheme will shake their heads when Sturge describes similar crackdowns on tax and benefit fraud in Britain and the Netherlands.

As well as blind faith in badly designed algorithms, both schemes generated huge waves of stress among recipients of incorrect debt notices and, in the case of the Dutch government, more than €1 billion in compensation payments.

Bad Data lays bare the good (data is very helpful for informing policy decisions) and the bad (for many policy decisions the data is non-existent or poor) in the easy-to-understand style you would expect of a data expert who spends all day communicating with the less numerate.

Sturge describes eye-openingly common problems with data ­— inconsistent definitions, sample-size problems, lack of useful time series — as well as issues with modelling. She takes a deep dive into several key areas of public life — crime, poverty, migration — and points out the inherent difficulty in delivering high-quality and time-consistent data on these crucial topics.

One surprising gap in Bad Data is its failure to highlight the exciting developments in government data collections — “good data” — that are starting to overcome at least some of the problems Sturge highlights. She mentions administrative datasets, but her readers don’t get a sense of just how revolutionary it is for policymakers to be able to link datasets that cover the whole of a relevant population.

For example, linking tax data showing someone’s income with location data and health data allows us to understand how disease prevalence, access to healthcare and health outcomes vary across locations and socioeconomic and cultural groups.

Linking data can also help understand people’s pathways through government services, creating a powerful tool for identifying gaps. How many of those turning up to emergency departments, for example, have made visits to a GP that might have kept them out of hospital?

In Australia, many key public service organisations have been slow to understand the potential of these linked whole-of-population datasets and invest in the capability needed to work with them. The light coverage in this book suggests the same may be true in Britain.

The other key omission is more understandable, given Sturge is a serving civil servant. Her book contains no strong critique of the British government’s commitment — or lack of commitment — to investing in better data.

In her opening chapter, Sturge makes the powerful observation that while we can easily find how many times Harry Kane made an on-target shot at goal with his left foot in the last season of the English Premier League, Britain doesn’t have accurate data on how many people are eligible to vote, how many died from Covid-19, and whether crime is going up or down.

The difference, of course, is investment: the football analytics industry invests in paying people to catalogue, in meticulous detail, every pass, tackle and touch.

What is apparent is Sturge’s frustration that the UK census is conducted only every ten years. But she stops short of more obvious questions about funding of statistical agencies, and how much and what data should be collected to enable government to make better decisions. In an environment where the Office for National Statistics, like the Australian Bureau of Statistics, has sometimes been starved of funds while demands on its services kept growing, this is an important corollary to the story of bad data.

But we should celebrate the fact that one of Britain’s “anonymous” civil servants has been able to share her knowledge more widely. I seriously doubt that the risk-averse Australian public service would support an employee publishing such a book.

Sturge has produced a useful and engaging guide to understanding the common pitfalls of data and modelling in public life. But perhaps, for those wanting more, the next item on her to-do list should be a follow-up book about how and when governments should invest in better data, and the opportunities they have to get the most out of enhanced analytical and computing capability. •

Bad Data: How Governments, Politicians and the Rest of Us Get Misled by Numbers
By Georgina Sturge | Bridge Street Press | $32.99 | 299 pages

The post Lies, damned lies, and data appeared first on Inside Story.

Lina Khan, a Columbia Law School professor, has been nominated to join the five-member board of the Federal Trade Commission, one of the two key US agencies responsible for preventing businesses from acquiring and abusing monopoly power. Even before she finished her law degree, Khan was a high-profile critic of the antitrust enforcement machine. An article she wrote for the Yale Law Review questioning the risks of Amazon’s ever-growing reach went viral and led to a surge of interest in the strategies the big tech platforms were using to supercharge their dominance.

Tim Wu, also a professor at Columbia Law School, will join Biden’s National Economic Council as special assistant to the president for technology and competition policy. In 2019, he published an (appropriately) small but powerful book, The Curse of Bigness: Antitrust in the New Gilded Age, drawing parallels between the tech platforms and the powerful oil and steel barons of the late nineteenth century. Antitrust laws, he argued, had failed to protect American consumers and society from their dominance.

Given the hipsters’ concerns about the power of big tech, these appointments have been seen as a shot across the bows of the FAANGs — Facebook, Amazon, Apple, Netflix and Google. Biden signalled during the election campaign that he would be open to breaking up these companies, and Wu and Khan have indicated they believe the government should be more willing to use its divestment powers, last used to break up the national AT&T telephone network in the 1980s.

But carving up the tech businesses without damaging their offer to consumers isn’t straightforward. All of the FAANGs rely to some degree on “network effects,” whereby consumers derive benefits from the fact that many other consumers or businesses are on the platform offering them the products, apps or services they are looking for. The easiest option would be to require FAANGs to divest the formerly competing businesses they have acquired in recent years, such as Facebook’s WhatsApp and Instagram, and Google’s YouTube.

Breaking up the tech companies’ core businesses would be highly complex. The regulator would need to prove in court that they had breached anti-monopoly laws and the court would need to force a break-up. The slow pace of complex antitrust litigation and the inevitable appeals could stretch out this process for a decade or more.

But the government and regulators can wage the battle of big tech market power on many other fronts. They could be far more active in preventing the big guys from buying emerging competitors (a preferred strategy of Facebook and Google). They could introduce restrictions on the tech companies competing with the businesses that use their platform to sell their products (Amazon and Google). And they could restrict the companies’ use of their growing trove of consumer data.

Because the United States is the home of the tech companies, actions taken there will have implications for consumers and businesses the world over. But the appointment of Wu and Khan also has implications beyond tech. Both are ardent critics of market power in all its forms.

Their main critique of antitrust policy is that its narrow focus on prices and consumer welfare has missed many of the real dangers of market power — harm to workers and small businesses, rising inequality and, ultimately, a threat to democracy itself. As Wu writes, “The broad tenor of antitrust enforcement should be animated by a concern that too much concentrated economic power will translate into too much political power” and “thereby threaten the Constitutional structure.”

As radical as this may sound, Wu convincingly argues that preventing these problems was the original intention of antitrust law and the animating force behind government actions against powerful conglomerates in the early twentieth century.

Such an emphasis would put the United States on the more activist end of antitrust enforcement globally. Most other competition regulators, including our own Australian Competition and Consumer Commission, are still focused on the economic fallout from market power rather than broader political or social concerns.

It remains to be seen whether Biden’s appointments will lead to a fundamental reimagining of the antitrust paradigm or simply more active enforcement of existing laws. Either way, big tech, corporate America and the world are on notice that business as usual isn’t on the menu. •

The post Biden’s trustbusters appeared first on Inside Story.

Tuesday night’s budget included several broad measures to support business and jobs, including its tax write-off for business investments and wage subsidy for employing young people. These look like sensible measures, albeit ones that bet heavily on business to lead the recovery. But when it comes to targeted policies for job creation, the 2020 budget is a sea of hard hats.

The three sectors with the most targeted support are all bloke-heavy: construction (more than $10 billion so far through the crisis), energy ($4 billion) and manufacturing ($3 billion). An extra $10 billion goes to transport projects, another boost to construction jobs in the building phase.

The problem? That doesn’t fit the story of this crisis. Unlike past recessions, the worst fallout in the Covid-19 recession has been in services sectors. Hospitality, the arts and administrative services have all been hit hard. These sectors are dominated by women, which is one reason women’s employment has taken a bigger hit this year.

Yet these sectors received next to nothing in the budget. They are also less likely to benefit from economy-wide supports such as instant asset write-offs because they are the least capital-intensive sectors.

The federal government could have helped these sectors in many ways. Overseas governments, and some state and local governments, have funded vouchers and discounts to encourage people back to restaurants, cafes and regional tourist destinations. Grants or direct support to help the arts sector revive could provide a desperately needed boost to our creative recovery.

The government could also have created many more jobs by directly investing in government services. Services create more jobs than infrastructure per dollar spent, and they have especially high economic multipliers right now.

The budget initiatives in education, aged care and mental health are welcome, but very small in the scheme of new spending. Major investments in aged care and education would be a jobs boon and could have provided a more rounded vision for the recovery.

“This government recognises that women have been significantly impacted by the Covid-19 pandemic,” the federal minister for women, Marise Payne, said just before the budget, “and it is critical that we focus on rebuilding their economic security as a priority.” Yet the government has left the biggest opportunity on the table. Making childcare more affordable is the most effective way to reduce the gender gap in working life and retirement — directly supporting jobs and the economic recovery.

The Grattan Institute has recommended a $5-billion-a-year package that would make childcare significantly cheaper and improve the workforce-participation incentives for primary carers (still mainly women). Instead, women seem to have been relegated in this budget to an afterthought in the form of a $240 million “support package” that offers no meaningful economic support.

All of these omissions are even more glaring given the spending on other areas and groups with far less need for support. Sizeable measures are targeted at energy, agriculture and defence. Yet all of these sectors have increased their total work hours since March. Another $3 billion is slated for manufacturing, a sector that has shed jobs during the crisis but should bounce back more quickly than “social consumption” businesses such as hospitality, retail and personal services.

Construction spending is needed because a crunch is expected as housing construction slows. But the focus on major transport infrastructure for job creation doesn’t make so much sense. These projects are less jobs-intensive. And states such as Victoria already have a big pipeline of large projects, so have little capacity to deliver more.

The $3 billion for shovel-ready projects focusing on road safety and local roads is better targeted to create jobs. But the government has missed the opportunity to deliver a major social housing spend to provide something desperately needed that would also help mitigate the downturn in housing construction.

To achieve its stated objective of getting unemployment well below 6 per cent as quickly as possible, the government should be focusing on stimulating sectors where activity has fallen the most — especially services sectors.

But this budget overlooks the hard hit in favour of the hard hat. The government should check this blind spot quickly.

The post High-vis, narrow vision appeared first on Inside Story.

The anti-monopoly movement began in the United States when a number of young legal scholars began questioning the effectiveness of antitrust laws in regulating market power. They argued that courts have been too willing to ignore the economic and political risks of rising market concentration. Despite the pejorative “hipster” moniker, their ideas are finding receptive ears in both political and policy circles.

One of the hipsters is Tim Wu, a professor at Columbia Law School. Wu has form as a policy innovator. Dubbed the “father of net neutrality” — he coined the term and has been an effective proponent of the policy — Wu’s latest (appropriately small) book, The Curse of Bigness: Antitrust in the New Gilded Age, is a treatise on the failures of America’s antitrust laws. He argues that regulators and courts have interpreted these laws so narrowly they have rendered them virtually ineffectual.

Wu sees the rise in corporate “bigness” as not just an economic problem but also a political one. He contends that, like in the “gilded age” of the late nineteenth century, when the big trusts such as Standard Oil and US Steel flexed their political muscle, the current world in which big players wield special influence over lawmakers is fuelling inequality and public dissatisfaction with the political system. His warning is stark: failure to rein in corporate power will fuel the rise of populism and nationalism as people agitate against the status quo.

Another of the hipsters, Lina Khan, became a famous critic of the antitrust enforcement regime even before graduating from her law degree, when an article she penned in the Yale Law Review went viral. The questions she raised about the long-term risks of the growing size and reach of Amazon, and the seeming inability of antitrust laws to control it, tapped into the zeitgeist of growing unease about the power of the big tech companies.

Backing up the hipsters, at least on the diagnosis, is one of America’s leading antitrust scholars, Jonathan Baker. His book, The Antitrust Paradigm: Restoring a Competitive Economy, is the scholarly yin to Tim Wu’s engaging yang.

Baker opens with a surprising statistic: 75 per cent of US beer sales are controlled by just two companies. He chronicles the rise in market concentration across many important sectors of the economy, including airlines, pharmaceuticals, telecommunications and, of course, technology. He argues that this consolidation has resulted from the under-enforcement of antitrust laws, increased government restraints on competition, and the fact that market power, once established, has proved hard to budge in many sectors.

Baker and Wu both draw on the history of American antitrust law, highlighting how enforcement has waxed and waned, depending on the key players and economic circumstances of the day, for more than a century.

The Sherman Act, passed in 1890, was designed to quell rising discontent about the dominance of the big trusts. The many and varied motivations of its proponents included concerns about the evils of monopoly pricing and a desire to protect the interests of farmers and small producers, tackle rising inequality, and safeguard a democracy that Senator John Sherman, the act’s proponent, believed to be threatened by the “kingly prerogative” of huge businesses.

Teddy Roosevelt was the first president to activate these laws, with cases against the big trusts, including J.P. Morgan’s railroad monopoly and John D. Rockefeller’s oil dynasty, earning him the nicknames “trustbuster” and — my favourite — “octopus hunter.” Roosevelt’s motivations were as much political as economic: he feared that the private power of the trusts would come to rival the government’s power. “When aggregated wealth demands what is unfair, its immense power can only be met by the still greater power of the people as a whole,” he later wrote.

The embrace of antitrust laws to limit the political and economic power of big firms runs like a thread through the case law across the mid twentieth century. But from the late 1970s, the thread begins to fray.

In 1978, legal scholar Robert Bork released The Antitrust Paradox, a forceful distillation of the ideas long percolating among conservative Chicago School academics. In both Baker’s and Wu’s accounts, Bork’s book triggered a fundamental change in the nation’s approach to antitrust enforcement.

Aaron Director, an influential Chicago School lawyer who had taught Bork, had long advocated that antitrust laws should have only one objective: the enhancement of consumer welfare. Bork’s genius was to brazenly suggest that promoting consumer welfare was the original (and sole) intent of these laws — despite the weight of evidence to the contrary.

But perhaps Bork’s more substantive achievement was to change the way we evaluate economic harm. The Chicago School largely equated consumer harm with short-term price effects. The longer-term economic and social costs of greater concentration were left out of the equation. Bork and his allies contended that most of the conduct previously tackled by regulators and courts was actually efficient business practice that would benefit consumers by reducing prices.

In Bork’s view, only a very narrow set of practices should raise the heckles of enforcers: naked agreements between competitors to fix prices or divide markets, and mergers that create duopolies or monopolies.

Gradually these ideas took hold among the judiciary and the enforcement agencies, leading to what Baker describes as an incremental hollowing out of the previous antirust doctrines. While the authorities developed increasingly sophisticated tools to try to assess price effects, other consumer harms from bigness, such as concerns over privacy, product quality and long-term incentives for innovation, were downplayed.

Australians are pretty familiar with bigness. We can count our airlines, our banks and our supermarket chains on one hand. Internet services, liquor retail, pathology services, newspaper publishing and casinos are also highly concentrated.

The jury is out on whether the big are getting bigger. Grattan Institute analysis suggests the revenues of our biggest listed firms — whether the top twenty, fifty or one hundred — haven’t grown as a share of the economy over the past decade. But recent research by the federal industry department using firm-level data suggests that market concentration has been increasing since around 2007, most of it in sectors that were already relatively concentrated.

And Wu’s “curse”? In fact, some of what the industry department is picking up is the growing size of our export-competing businesses. These industries have become more productive, and so their size is likely to be of economic benefit rather than concern.

But not all bigness is benign. Grattan’s analysis highlights the fact that in many sectors with high market concentration, returns are above what we would expect given levels of risk. And these high returns seem to be enduring: when we track companies in the top 20 per cent by return on equity for a decade, more than a third are still in that top-performing group a decade later.

In markets with strong competitive pressure, we would expect to see high returns eroded by new entrants or expansion by existing competitors. Persistent high returns suggest that there are pockets of the economy where competition isn’t working as it should.

Australian regulators and courts were never in the thrall of the Chicago School in the same way as their counterparts in the United States. Recent Australian Competition and Consumer Commission chairs have built their personas on taking tough actions against companies breaching Australian competition laws. The interim report of the banking royal commission contrasted the ACCC’s robust enforcement approach favourably with the more timid enforcement culture of the banking regulator, ASIC. The ACCC’s leaders were hipster trustbusters before it was cool.

But it would be naive to think Australia was impervious to the influence of the Chicago School. The ACCC, like all major regulators internationally, focuses on preventing conduct that would generate economic harm to consumers. Using competition laws to protect competitors or tackle inequality or deal with the political risks of “bigness” simply isn’t on the menu.

Nor have the Australian laws always worked as they should. ACCC chair Rod Sims has been active in calling for more powers to protect consumers. He has got most of what he has asked for: a beefed-up legal test for pursuing misuse of market power, a market-studies function so the ACCC can initiate its own market reviews and make policy recommendations, and a world-first, government-commissioned review of digital platforms.

More recently Sims has been eyeing the legal test for the ACCC to knock back mergers it believes are anticompetitive. He points to the ACCC’s desultory performance in merger cases before the courts and the competition tribunal: not a single win in a contested case over the past twenty years. If the ACCC loses its bid to block the Vodafone–TPG merger currently before the courts, you can bet that these calls will only get louder.

Wu’s and Baker’s books both seek to chart a way to strengthen antitrust laws and their enforcement. But they ultimately diverge on the question of how radical the solution should be.

Wu wants revolution: a return to the pre–Chicago School world where the regulators and courts could intervene based on wide-ranging concerns about bigness. He would like to see the consumer-welfare standard jettisoned and replaced by a “protection of competition” test. Wu argues this would allow regulators more scope to capture the dynamics of competition as well as political considerations, returning the United States “to an economic vision that prizes dynamism and possibility, and ultimately attunes economic structure to a democratic society.”

Baker also makes the case “to reverse a trend toward non-enforcement,” but charts a more measured set of changes. He argues, in my view persuasively, that a return to mid-century antitrust laws that explicitly pursued political as well as economic ends is neither feasible nor desirable. The benefits of trying to reverse the march of economics in antitrust are highly unclear, and the approach is so entrenched in the major institutions that such a significant course correction is unlikely.

Baker rightly points out that there are other policy levers, such as campaign finance reform, that can help address concerns about political power. Grattan Institute has laid out an agenda for better regulating undue political influence in Australia, including tighter rules on lobbying and around money in politics, and the creation of a robust federal anti-corruption commission.

Baker proposes a series of rules and (rebuttable) presumptions to make it easier to prosecute antitrust cases. He argues, for example, that in merger cases the courts should require more evidence to rebut the inference of competitive harm from high and increasing market concentration. He also calls for stronger controls on mergers in innovation markets, to stop big tech firms such as Facebook and Google snapping up nascent competitors.

Sims and the ACCC may have been taking notes, if recent soundings about re-examining the standard of proof for merger cases and being wary of firms acquiring potential competitors in digital markets are anything to go by.

And this is where the rubber hits the road. Bork’s role in antitrust history shows that ideas hidden in drab-looking academic texts can change the way powerful people think and economic systems operate. Wu and the hipsters have energised the political mobilisation against market power in the United States. Wu’s highly readable small book about bigness is one to dip into for an appetising taste of that discussion. But Baker provides the wisdom and the deep scholarship to chart the way forward. Let’s hope his is the book that Sims and his American counterparts have on the bedside table. •

The post The hipster trustbusters appeared first on Inside Story.

But let’s think about it another way. Imagine that refundable franking credits and negative gearing didn’t exist, and instead the Coalition was promising to introduce them. How might the debate be different?

First, instead of simply pointing to people who lose from their removal, the Coalition would have to explain why these policies should exist in the first place. That’s a much harder ask.

The Coalition would no doubt rely on some standard tax policy principles. The basic principle of franking credits is that company tax is simply paid on behalf of shareholders, at each shareholder’s marginal personal income tax rate. And so any unused franking credits are in effect an overpayment of prepaid tax, and should be returned via a cheque from the government.

In addition, it would point to the unfairness of retirees in self-managed super funds being denied (non-refundable) franking credits, whereas retirees in industry and retail super funds can get the benefits because their credits can be used to offset the tax of younger members who are taxed on their contributions and fund earnings.

In arguing for negative gearing, the Coalition would presumably point to the standard principle that losses should be offset against income before it’s taxed. Tax experts would quibble that any losses would be deducted in full, while only half the capital gains are taxed.

But such arguments from principle are rarely enough to win a tax debate. Theoretical purity is all well and good, but there are plenty of other considerations that take into account how things work out in practice. And here the case would become much harder to make.

Retirees might question why the government should send cheques for $6 billion a year to the wealthiest Australians, instead of doing more to help pensioners, especially renters, at risk of poverty and financial stress in retirement.

After all, more than half the benefits of refundable franking credits for self-managed super funds go to funds with balances of $2.4 million or more. And shareholdings among over-sixty-fives outside super are also highly skewed towards the wealthy: the richest 20 per cent of households over sixty-five own 86 per cent of the shares held directly, while the poorest half of all retirees own less than 2 per cent.

Others would question whether the budget can afford such giveaways, especially when fifteen years of intergenerational reports have warned us of the long-term budgetary threat from the ageing of the population. Are refundable franking credits really appropriate when fewer than one in six retirees pay any income tax? Are they affordable if they lead to the average retired household with $100,000 in income a year paying the same amount of tax as a working household earning $50,000?

With negative gearing, we’d be debating whether it’s really a priority to spend between $1 billion and $2 billion a year of taxpayers’ money on tax breaks for housing investors, especially when most investors would simply purchase existing properties. Voters might also be worried by projections showing that negative gearing would push down home ownership as negatively geared investors outbid first homebuyers at auctions.

And how would the public weigh these policies compared with their alternatives?

The $6 billion annual savings on refundable franking credits would be enough to fund a 40 per cent increase in Commonwealth Rent Assistance for all income-support recipients ($1.2 billion) and relax the taper rate on the age pension assets test ($750 million a year), with plenty left over to shore up the budget against the long-term costs of an ageing population.

And if we’re serious about boosting housing construction, $1 billion in incentive payments to state governments to reform land-use planning rules and get more housing built in the inner and middle suburbs of our major cities would be far more effective.

Of course, the big difference between this imagined world and real life is that we wouldn’t have a cacophony of special interest groups arguing so loudly to keep refundable franking credits and negative gearing.

People prefer what they know, and like keeping what they have. These biases are powerful allies for those defending bad policies. Take them away, and the case for change becomes clearer.

The reality is that no major party would be able to defend introducing these policies today. And if you can’t make that case, we should worry less about abolishing them. •

The post If franking credits and negative gearing didn’t exist, no one would invent them appeared first on Inside Story.

Labor claims that most of those hit by the change are wealthy retirees who are not paying their fair share of tax. Scott Morrison counters that abolishing refunds of unused imputation credits will mainly hurt low-income earners. So, who’s right?

Part of the confusion stems from the fact that data on what retirees earn, what they own and what tax they pay is highly fragmented. Personal income tax returns provide only a patchy picture of the earnings and wealth of retirees. Superannuation payouts have been tax-free since 2006: they don’t even have to be declared on personal income tax returns. And drawdowns of savings other than superannuation to fund retirement — whether shares, bank deposits or investment property — are not declared as income.

Australian Bureau of Statistics surveys tell us which retirees own shares and what other assets they own, but not whether they receive imputation credits or claim other deductions, or precisely how much income tax they pay. Meanwhile, data on self-managed super funds — which will pay most of the extra tax — is not connected to members’ personal income tax returns or retirees’ other assets.

Picking up these various threads and weaving them into a coherent story about who would pay more tax under Labor’s reforms is no easy task. But here goes.

Australia’s dividend imputation system ensures that shareholders are not taxed twice on corporate profits. “Franking credits” are attached to dividends paid to shareholders, reflecting any company tax already paid, and can be used to offset any personal income tax the shareholder owes to the Tax Office.

Refunds for unused franking credits were introduced in 2001. The logic was simple: people with no or low income should receive equivalent tax treatment as others. Any unused or “excess” franking credits left after someone had reduced their tax liability to zero were returned via a cheque from the government.

Labor’s plan would restore the pre-2001 system: most taxpayers could still use imputation credits to offset other tax owing to the ATO, but those with no income tax liability — mainly retirees and their self-managed super funds — would no longer be able to claim cash refunds.

The government claims that 54 per cent of people affected by Labor’s policy — some 610,000 individuals — have taxable incomes of less than $18,200. And it says that 86 per cent of the value of all franking credits refunded are received by those with taxable incomes of less than $87,000 a year.

These claims are deeply misleading. Taxable income ignores the largest source of income for many wealthier retirees: tax-free superannuation.

Take the example of a self-funded retiree couple with a $3.2 million super balance, plus their own home, and $200,000 in Australian shares held outside super. Even drawing $130,000 a year in superannuation income, and $15,000 a year in dividend income, they would report a combined taxable income of just $15,000, and pay no income tax whatsoever.

And is the treasurer seriously suggesting that 610,000 retirees actually get by on less than $18,200 a year, or nearly 20 per cent below the poverty line? If that were anywhere close to the real story, it would signal a full-blown retirement-income crisis.

Whoever they are, Scott Morrison’s 610,000 “low-income earners” are clearly not the poorest retirees. Few, if any, are maximum-rate pensioners.

A single retiree receiving the full age pension has an income of $23,318 a year, and more if he or she earns extra income in dividends from shares. All this income would show up as taxable income if this retiree submitted a personal income tax return — as required to claim refundable imputation credits.*

Some maximum-rate couple pensioners could have a taxable income below $18,200. The maximum-rate pension for a couple is $32,000 a year, or $16,000 each. So one half of such a couple could receive dividends of up to $2200 a year (including refunded franking credits) and still receive a full pension. The maximum hit for them from Labor’s policy would be $660 a year.

But most of those affected by Labor’s policy who declare taxable incomes of less than $18,200 a year are far from being low-income earners. They are either part-pensioners, or not receiving any pension at all. And they’re drawing much of their income from tax-free superannuation.

When superannuation withdrawals are stripped out from income in ABS survey data, as is done to calculate taxable income, almost half of the wealthiest 10 per cent of over-sixty-fives report incomes of less than $18,200. On average, though, they have wealth of nearly $2 million — and that’s even before considering the value of their home or any other property assets they might own.

Of course, there will be examples of seniors with low incomes being hit hard by the change. But media reports highlighting their plight rarely tell the full story.

When we hear of part-pensioners with a taxable income of less than $18,200 a year being hit by Labor’s plan, it is worth asking why they’re only receiving a part-pension in the first place. As single retirees, they must have either an assessable income of more than $27,700 a year or assets exceeding $253,750 (excluding the family home if they’re a homeowner) or $456,750 (if they rent). To be on a part-pension, a retired couple will have an income of between $40,000 and $78,000 a year, and assets of between $380,500 and $1 million.

The full story is that many part-pensioners are relatively wealthy, especially because the home is excluded from the pension assets test. Half of all pension payments go to those with assets of more than $500,000. Almost 20 per cent of payments go to those with assets of more than $1 million. They’re clearly much better off than the bottom 40 per cent of retirees, who draw a full age pension.

Nor is it clear that incomes are the best way to judge just how well-off retirees are. People build up retirement savings during their working lives, which they then draw down to fund their retirement. Or at least that’s the idea.

One reason so many retirees report such low incomes is because they only draw down very slowly on their retirement savings, or not at all. One recent study found that at death the median pensioner still had 90 per cent of their wealth as first observed.

Many retirees who report having very low incomes in retirement have substantial retirement nest eggs. A retiree homeowner with $1 million in super, enough to make him or her ineligible for a full pension, but drawing down at the minimum required rate of 4 per cent, would declare an annual income of just $40,000 a year. And although $40,000 a year, even tax-free, may sound low relative to average full-time pre-tax earnings, retirees tend to have lower expenditure because they are no longer saving and typically are no longer paying off a mortgage. This is a well-off group; few working-age Australians have the chance to accumulate $1 million in superannuation, and pay off their own home, before they retire.

It’s also worth remembering who will pay most of the extra tax under the Labor policy. About 33 per cent will be paid by (mainly wealthy) individuals who own shares directly, 60 per cent will be paid by self-managed superannuation funds (typically held by wealthier retirees), and the remaining 7 per cent will be paid by super funds regulated by the Australian Prudential Regulation Authority.

The poorest half of all retirees own less than 2 per cent of all shares held directly. By contrast, the wealthiest 40 per cent of retirees own 97 per cent of all shares held directly, and the wealthiest 20 per cent alone own 86 per cent of all shares held directly.

Among self-managed superannuation funds (primarily held by wealthier retirees), half of the refunds are currently going to people with balances over $2.4 million.

For more than a decade, superannuation tax concessions have been absurdly generous to older people on high incomes. They are one of the major reasons older households pay less income tax in real terms today than they did twenty years ago, even though their workforce participation rates and real wages have jumped.

These age-based tax breaks help to explain why the proportion of seniors paying tax almost halved in twenty years, from 27 per cent in 1995 to 16 per cent in 2014. The rise of these “taxed-nots” coincides with the introduction of the Senior Australian Tax Offset in 2000, and tax-free super withdrawals in 2007.

Generous super and other age-based tax breaks have been funded by deficits. The accumulating debt burden will disproportionately fall on younger households.

The government’s claim that abolishing refundable imputation credits will mainly hit low-income earners is deeply misleading. Taxable income ignores the largest source of income for many wealthier retirees: tax-free superannuation.

Retirees with the lowest taxable incomes are likely to be wealthier self-funded retirees — precisely the group Bill Shorten wants to target. About 14,000 maximum-rate pensioners and 200,000 part-pensioners would be hit, but the vast bulk of the revenue would come from wealthier retirees. That’s the real story. • 

* The Pensioner Guarantee, announced by Labor soon after the original policy was released, ensures that every recipient of an Australian government pension or allowance who has direct shareholdings or shareholdings via an SMSF before the cut-off date would continue to receive cash refunds. The Parliamentary Budget Office estimates this change reduces the revenue from the policy by $300 million, or around 5 per cent, in 2021–22. In other words, most of the revenue was never coming from those with low levels of income and wealth.

Of course, even with the Pensioner Guarantee not all people adversely affected by the policy change would consider themselves wealthy. But they have generally accumulated a reasonable nest egg — especially if they also own their own home.

People over sixty-five are not eligible for the pension if they have assets of at least $564,000 apart from their home (if they are homeowners), or $771,000 for non-homeowners. A retired couple will have assets of at least $848,000 (homeowners) or $1,055,000 (non-homeowners).

• An update to this analysis, accounting for subsequent changes by Labor to exempt all pensioners from the policy, can be found in Grattan’s submission to the parliamentary inquiry into the implications of removing refundable franking credits.

The post The real story of Labor’s dividend imputation reforms appeared first on Inside Story.

For the first time in years, a federal treasurer has had some luck in the lead-up to the budget. Over almost a decade, tax revenues have repeatedly fallen short of forecasts. But this year, tax receipts have exceeded expectations.

Total receipts are up $31.5 billion over the four years to 2021–22 compared to the mid-year update in December, driven by stronger personal and company tax receipts. Australian companies appear to have finally run out of tax-deductible losses from the 2008 global financial crisis and are suddenly paying far more tax. Wages are still stagnant, but personal income tax revenues have risen anyway as employment has increased, due in part to record migration. And with the world economy the best it’s been in years, there’s also good news in commodity prices, which feeds into higher company tax revenues in Australia.

All this good luck means Treasury now expects the budget to return to surplus in 2019–20, a year earlier than previously forecast. But the projected surplus in 2019–20 — of $2.2 billion, or just 0.1 per cent of GDP — hangs in the breeze. A more solid surplus of $11 billion (0.5 per cent of GDP) is expected in 2020–21, but that too still relies on the treasurer staying lucky.

Basking in such good fortune, the treasurer plans to share it around. He will not proceed with the planned 0.5 per cent increase in the Medicare Levy to help pay for the National Disability Insurance Scheme. Most Australians will get tax cuts, starting on 1 July 2018 with the creation of a new low- and middle-income tax offset worth up to $530 a year; together with slight tweaks to the tax thresholds, this will deliver modest tax cuts of up to $665 a year to those earning between $20,200 and $125,000.

The government has also set out a radical plan to flatten Australia’s tax scales over the next eight years, including abolishing the 37 per cent tax bracket. By 2024–25 the vast majority of Australians will pay the same marginal tax rate of 32.5 per cent, for incomes starting at $41,000 all the way up to $200,000 a year. The tax cuts might favour low- and middle-income earners in the short term, but high-income earners will be the beneficiaries in the long term.

Tax cuts were inevitable after a sustained run of bracket creep. Income taxes were closing in on the peaks of the late 1980s and the 1990s. But the size of the personal tax cuts — worth $4.5 billion by 2021–22 — and the decision to abandon the planned Medicare Levy increase leaves lots of room for Bill Shorten to offer his own basket of budget goodies in the budget reply speech on Thursday night.

Like all budgets, this one also has its share of fudges. But gone are unrealistic forecasts for nominal GDP and revenues, the fudges of budgets past. Instead, projected budget surpluses, in spite of planned tax cuts, are built on herculean spending restraint.  Spending is supposed to grow by a mere 0.7 per cent in 2020–21 and 0.5 per cent in 2020–21, after adjusting for inflation.

Given recent experience, such spending restraint looks wildly optimistic. After all, real spending grew by 2.7 per cent in 2017–18 and is projected to increase by 1.9 per cent in 2018–19. Health spending is projected to grow by just 1.9 per cent a year over the next five years, well below average growth of 3.8 per cent in the past five years. Meanwhile, federal spending on courts, housing, agriculture and transport are all forecast to fall in absolute terms between 2017–18 and 2021–22.

Reclassifying federal money for new transport infrastructure projects as “off-budget” capital spending also helps. This buy now, pay later approach has allowed successive governments to commit around $50 billion in infrastructure spending over the past decade — including on the NBN, Inland Rail, Western Sydney Airport and the Snowy Hydro share buyback — without any immediate hit to the budget bottom line. But if the numbers on these projects don’t stack up, future taxpayers will be on the hook for today’s bad decisions.

The budget forecasts for wages growth, driving much of the planned increase in personal income tax collections, also remain optimistic. Like the Reserve Bank, treasurer Scott Morrison is banking on strong growth in full-time employment translating into higher wages. Wages growth is expected to accelerate from just over 2 per cent a year today to 3.5 per cent by 2020–21.

And a plan to collect tax on tobacco at the border will bring forward $3.3 billion in tax revenue, providing a one-off boost in 2019–20, without which the government wouldn’t have achieved its early surplus.

Looking further ahead, the government is set to tie itself in knots with a plan to formally adopt a tax-to-GDP limit of 23.9 per cent, writing it into this year’s budget rules. The political logic is clear: to wedge Labor, which is relying on tax increases to pay for higher spending while still balancing the books.

But the inconvenient fact is that spending has averaged more than 25 per cent of GDP for the past decade. Non-tax receipts, worth 1.7 per cent of GDP in 2018–19, help bridge the gap between spending and tax revenues. But the government’s approach still relies on a strong economy and unprecedented spending restraint to keep spending down as a share of GDP. Most recent successful budget repair has occurred through tax increases, not spending cuts. Past attempts to bring down spending, such as those in the 2014–15 budget, proved deeply unpopular. Many ended up languishing in the Senate, or were later abandoned.

More importantly, the pledge to limit taxes to below 23.9 per cent of GDP is likely to crash headlong into the growing budgetary costs of Australia’s ageing population, as successive intergenerational reports have shown.

Spending per older household on health and the age pension has grown faster than the economy: governments already spend twice as much on each sixty-year-old as they do on each thirty-year-old. The 2015 intergenerational report showed Commonwealth health spending was projected to increase from 4.2 per cent of GDP in 2014–15 to 5.5 per cent of GDP in 2054–55.

The Coalition is unlikely to cut back spending on health and education, especially with fresh memories of the “Mediscare” campaign from the last election. The planned increase in the pension eligibility age to seventy years — although worth pursuing — remains unlegislated. So the tax cap, combined with rising spending from an ageing population, is a recipe for ongoing budget deficits.

This is clearly a pre-election budget. Of course, the polls suggest the next budget is just as likely to be brought down by Labor’s Chris Bowen. Which means that Thursday night’s budget reply speech could prove just as important as last night’s announcements. And the contrast couldn’t be clearer. But the question is whether either side can make the numbers work over the longer term. •

The post Built on good fortune, relying on luck appeared first on Inside Story.