Slash tax to secure prosperity

The Australian economy has performed extraordinarily well in the past decade. But the biggest impediment to continued global economic success is our tax system. To make it globally competitive, the top marginal rate of income tax should be substantially cut to 30 per cent and cut in at a much higher income level (with equivalent changes throughout the tax schedule).

Such a tax policy change would complement the economic reform agenda in recent years that has helped make the Australian economy the envy of the world. From floating the dollar, deregulating the financial system and cutting tariffs in the mid 1980s to the gradual freeing of labour markets, and the introduction of the GST more recently – free-market reforms have helped Australia record the fastest productivity growth in the world and keep inflation low and unemployment falling.

But if we want continued prosperity, we must continue the process of economic reform – especially when it comes to fixing up our tax system.

The biggest problem with that system is the relatively high marginal rates of personal income tax and the relatively low income levels at which the various tax rates cut in.

When the top marginal rate was 60 per cent, the reward for evading tax was greater than that from earning more money. Even at 47 per cent, the reward for evasion is almost as great as the return from earning more.

Substantially cutting the top marginal rate of income tax to 30 per cent would equate the top personal rate with the company tax rate and allow substantial simplification of administrative arrangements. It also would make Australia highly competitive in the race for internationally mobile capital and skilled labour.

This approach to tax policy – which became known as the Laffer Curve in the US during the Reagan years – is privately endorsed by many politicians and most economists. But there are two supposedly fatal flaws: it would drive the budget into deficit and it would help the rich more than the poor.

The strong objection to budget deficits by virtually every public commentator in the land is a natural response to the damage done by profligate governments that, in the past, spent taxpayer's money in a totally irresponsible manner. A temporary budget deficit resulting from big cuts to rates of income tax would be a serious investment in the competitiveness of the Australian economy, so it would be welcomed by the international investing community.

The negative effect on the budget would be only temporary. And the strong positive effects on savings, investment and entrepreneurial effort would mean, within a few years, the budget would be stronger, not weaker.

These assertions are controversial. We need a thorough analysis of the issues. Only Treasury can do this with authority. An immediate move to a 30 per cent top rate would probably create too large a deficit, so Treasury should answer the following question: What would be the five-year economic effect of cutting the scale of personal income tax so that the top rate was 40 per cent and cut in at $200,000? Examine and explain your assumptions carefully. Please provide a range of outcomes depending on the size of the assumed responses of saving, investment and additional personal exertion. Also advise on the likely response of international investors if Australia implemented such a policy.

As to the distributional effects, it may be that such a policy would have as its immediate effect the further stretching of relativities of income and wealth.

Two points must be made about this. The first is that there are strong global forces making for a less equal distribution of wealth and incomes in capitalist societies and fighting these forces with tax policy is probably futile and will certainly make Australia less competitive.