The ALP's illusion of lower taxation

Paul Keating's article in the March issue, while rightly attacking the myth that Labor governments are bigger taxers and spenders than conservative governments, appears to endorse the more pernicious myth that there is a fundamental difference between means-testing and taxation.

There isn't. Your real marginal rate of income tax is the number of cents that the Government claws back from every extra dollar of income that you earn. You don't care how many of those cents are clawed back by the Tax Office and how many by Centrelink, and neither does the Government. Similarly, your real marginal rate of asset taxation is the number of cents that the Government claws back each year for every extra dollar's worth of assets that you own. Again, how the clawback is divided between the Tax Office and Centrelink makes no difference to you or to the Government (except that Centrelink quotes the rate in dollars per fortnight per thousand dollars, whereas the Tax Office would more likely quote it in percent per annum). Similar arguments apply to any other "tax" or "means test'" that you care to name.

Mr Keating claims that "Labor cut recurrent Outlays by six percentage points of GDP ... between 1985 and 1990". I accept that statement under the usual definition of "Outlays" but that definition quite arbitrarily treats a tightening of means tests as a reduction in Outlays rather than as an increase in taxation. In other words, reducing "Outlays" by tightening means tests is creative accounting. With this in mind, let us reconsider Labor's record.

The Hawke government reintroduced the assets test on pensions with effect from 1985. An assets-tested pension withdrawn at a certain rate over a certain range of asset values is equivalent, for both the pensioner and the Treasury, to a non-assets-tested pension plus a wealth tax at the same rate over the same range of asset values, payable by recipients of the pension; the only difference is that an assets test is a clawback via Centrelink while a wealth tax is a clawback via the Tax Office. So the reduction in Outlays due to the assets test could equally well have been classified as a new wealth tax.

A wealth tax of x percent per annum is equivalent to paying interest of x percent per annum on your own assets – not exactly an incentive to save. The assets test also gave special concessions to home owners, thus encouraging a diversion of savings from productive enterprises to unproductive real estate. But its most obvious effects were the compliance burden on the old and infirm and the running down of their estates prior to inheritance. It would have been far more honest and far less traumatic to reintroduce inheritance taxes!

Another new tax introduced by the Hawke government, albeit more more honestly and transparently, was the superannuation tax. Initially the tax applied only to lump sum withdrawals that accrued after 1983. This arrangement – effectively a direct expenditure tax – encouraged saving by allowing people to defer income tax on the saved part of their income. But the government couldn't wait to get its hands on the superannuation billions. So the 30 percent exit tax was replaced by an entry tax plus an earnings tax plus an exit tax, reducing the incentive to save.

In 1987 came the income test on family allowance. An income-tested allowance withdrawn at a certain rate over a certain range of earned income is equivalent, for both the recipient and the Treasury, to a non-income-tested allowance plus an income tax surcharge at the same rate over the same range of earned income, payable by recipients of the allowance. So the reduction in Outlays due to the income test could equally well have been classified as an increase in income tax. This income test/tax imposed effective marginal tax rates of around 80 percent on lower-income families, destroying the incentive for self-improvement and frustrating the efforts of employers to reward superior work with higher pay. So much for Mr Keating's claim that the top marginal income tax rate was cut to 47 percent.

When the super tax and the pension assets test had destroyed the incentive to save, and when the income test on family allowance had severely damaged the capacity to save, the Keating government decided to stop the rot by introducing the superannuation guarantee charge (SGC).

The SGC exposes another definitional flaw: it is not classified as a tax, but is effectively a Federal payroll tax at a current rate of 8 percent, soon to be increased to 9 percent. It is not yet offset by substantial savings in pension payments, and any such savings in the future will be due to means tests that are equivalent to taxes. Yet compulsory superannuation is being sold as a means of reducing taxation! It is hard to imagine a more gross deception than this, and the whole country seems to have fallen for it.

The SGC is a direct disincentive to employment, and is inflationary because it is passed on in prices of goods and services; in other words, it increases both the actual rate and the natural rate of unemployment. And the affected goods and services include exports, so that if our exports are to be competitive, the value of our dollar must be lower than it would be in the absence of the SGC. (The hated GST is more benign in this regard because exports are zero-rated.)

The Hawke and Keating governments indeed reduced taxes and outlays according to the usual meanings of those terms. But when income/assets tests and the SGC are counted as the equivalent taxes, a different picture emerges. That the Howard government has introduced a major new tax and presided over a massive increase in the other part of the tax burden – compliance costs – does not excuse the actions of the Hawke/Keating regime.

So what must be done if a Beazley Labor government is to earn the mantle of a low-tax government – or, more to the point, a high-incentive government? In the present context I shall limit myself to two suggestions.

First, replace the income test on family allowance with an assets test based on the unimproved value of land owned by the family. This limited assets test would be equivalent, not to a general wealth tax, but to a land value tax. It would make zero contribution to effective marginal rates of income tax. Unlike a broader-based assets test, it would not discourage any productive activity, because neither land nor its market value is created by any activity of the owner.

Second, include the SGC in the gross income shown on group certificates, so that the SGC is reclassified as a compulsory employee contribution, and then authorize the Reserve Bank to vary the compulsory contribution as an alternative to varying official interest rates. Higher super contributions reduce consumption and increase saving, as do higher interest rates. But, whereas higher interest rates discourage productive investment (not to be confused with saving) and have nasty redistributive effects (including a reduction in debtors' ability to save), higher levels of compulsory saving do not. Therefore, as a means of restraining inflation and excessive imports, higher super contributions are preferable to higher interest rates.