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Whither tax?

By Nicholas Gruen - posted Friday, 30 July 2010


Iris Murdoch and her very literary husband John Bayley had a term for going to Literary Festivals and talking on panels with names like “whither the novel”. They called it “whithering”. The Sydney Morning Herald asked for 1,500 words of whithering on the tax system, which I structured around what I liked and what I didn’t about the Henry Review. Unfortunately, it turns out they didn’t, in the end, want 1,500 words. Of the 1,000-odd words on Fairfax websites, even fewer made it into the paper and, as is the way with such things, some things got garbled.

But that’s the game with papers, so there you go. At least I get to post it here. So here it is in its full 1,500-word glory.

It seems first term governments can’t help themselves. Hawke, Howard and now Rudd made big tax reform announcements in their first term. This cruelled Hawke and Rudd’s honeymoon popularity and nearly lost Howard what should have been a “honeymoon” election.

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Rudd’s dance with death was a study in fecklessness. We’re forever being seduced by the idea of approaching the tax system afresh and, thus emboldened and enlightened, sweeping away its maddening perversities. If only! Wresting over 25 cents in every dollar people earn is no picnic. Volumes of legislation go into preventing people from wriggling out of the net. And when taxpayers aren’t individually wriggling, they’re kicking and screaming to prevent the community getting hold of their money. Ask the miners.

Against that background what chance is there of even giving a comprehensive review a clean sheet of paper? It took about five minutes for the Government to go tree doctor. The “root and branch” review of taxation ended up with progressively more roots ripped and branches lopped. And whoever suggested giving the panel 18 months so their report could suppurate in the government’s in-tray in the run-up to the next election has surely already received the Godwin Gretch medal for services to the Opposition in some secret hideout somewhere.

Still, Henry provides excellent broad benchmarks for reform which are of sufficient ambition that the review itself contemplates their influence over years rather than in a single package. There are also ideas the panel liked, but which it thought the government wouldn’t like. These ideas surface, but often “between the lines” - as we’ll see. Then there are some places where I think Henry gets it wrong, which I raise below in conclusion.

The economics of taxation revolves around raising sufficient revenue to fund modern governments’ myriad functions while doing as little economic damage as possible. Taxes harm an economy when people change their behaviour, either deliberately to avoid tax or in response to the way taxes change their incentives. If someone can earn $1,000 per week working but it costs them $250 to drive their car to and from work, the tax on their income and their transport consumption might make the difference between them wanting a job or sitting at home on welfare.

The panel spent lots of time trying to better integrate our tax and family payments system to minimise this kind of thing, leading for instance to proposals to increase the tax free threshold from $6,000 to $25,000.

Business taxes also change behaviour. The capital that businesses invest is more mobile than labour. So taxing it is more costly. International studies show a strong negative correlation between company tax rates and economic growth. Quoting this, Henry wanted our company tax rate cut from 30 to 25 per cent. But he left a way of being much more ambitious sitting there between the lines - to which we’ll return.

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The review also made a big play for expanding taxes where they didn’t change behaviour or, better still, where they could actually change behaviour for the better. Taxing resources falls into the first category. The resources can’t move. So, we can tax our little heads off so long as we leave miners with sufficient remaining returns to get that dirt out of the ground and to minimise the cost of doing so.

Henry’s proposed resource rent tax met those requirements admirably as does its replacement (though less so roughly in proportion to the revenue disgorged in securing political peace in our time with Big Mining). Henry also wants to switch taxation towards annual taxes on land and away from stamp duty on property transactions. (Land isn’t going anywhere, but hefty stamp duty charges obstruct people changing their home to suit changing circumstances.)

And if we tax resource and land rents without distorting behaviour, there are some ways to raise revenue while actually changing behaviour for the better. Henry’s proposal to restructure registration as road user charges fits this bill, as road charges help push people towards more efficient and environmentally friendly use of our transport infrastructure, for instance, by greater use of car-pooling and public transport.

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An edited version of this was first published in the Sydney Morning Herald on July 28, 2010 and in the blog Club Troppo.



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About the Author

Dr Nicholas Gruen is CEO of Lateral Economics and Chairman of Peach Refund Mortgage Broker. He is working on a book entitled Reimagining Economic Reform.

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