Pluck the goose, minimise the squealing, collect the golden eggs

The “high level” budget debate has predominantly concentrated on tax. In the past, the focus was on the appropriate balance between income and expenditure taxes, especially in the lengthy GST deliberations. More recently, income tax rates have been at the centre of debate. A flatter tax philosophy is now in the ascendency worldwide. In Australia, Malcolm Turnbull’s tax scheme has been among the more radical of a number of such proposals.

This switch of emphasis reflects a heightened prominence on restoring a greater incentive to work, attracting and holding those people capable of earning high incomes, and reducing the incentives to shirk. Other related motives are to diminish incentives for wasteful evasion measures resulting from taxpayers diverting income to areas where the taxman is less grasping. Pursuit of flatter taxes has meant a corresponding lower priority on using tax to promote greater income equality.

All this focus on tax is, however, misplaced. It disguises the fact that tax is a consequence of government spending. Tax policy is about devising the best means of plucking the goose while minimising its squealing and, above all, trying not to discourage it from laying the golden eggs.

To this end clever economists have sought to devise ways whereby marginal rates are cut to promote more equal income outcomes while not dampening the work incentives. However income tax rates that rise with income levels have produced a new phenomenon, “poverty traps” whereby moving into higher tax categories together with losses of benefits bring abrupt rises in marginal tax rates.

For these reasons flatter tax rates have considerable appeal. However they are no substitute to tackling government spending head on. Flatter taxes than Australia’s are seen for example in most European countries. These are the cannon fodder Federal Treasury uses in composing international comparisons that unjustifiably compliment Australia’s performance. Their tax regimes have not prevented Eurosclerosis except in Britain and Ireland. And Britain’s moderately good performance is set to end as tumescent spending under Blair-Brown has gradually dissipated the Thatcher legacy of fiscal discipline. Britain’s government sector is now larger than that of Germany which has been Europe’s sickest man over the past decade or so.

Overall general government spending in Australia has risen from 30 per cent of GDP at the start of the 1990s, just before Paul Keating’s recession we had to have, and remains stuck at 35 per cent.

The Howard-Costello period has avoided fiscal mismanagement. Real spending (excluding state grants) by the Federal Government since 1998-9 has increased about 3.5 per cent per annum and is set to remain at that level. Though roughly in line with the economy’s growth, this is hardly a commendable outcome. The resource boom caused by Asian economic buoyancy and the benefits of the micro-economic reforms, many of which were bequeathed by Hawke-Keating, has offered us opportunities for genuine reform. We have not taken advantage of buoyant conditions to introduce policies which reduce the expenditure levels that require the current levels of taxation.

The 2 per cent annual real per capita growth we have been experiencing is poor reward for the superb economic environment in which we find ourselves. It is even more so when we consider that overseas borrowings are running at 6 per cent of GDP per annum.

Lifting our growth requires cutting government expenditures, most of which are deadweight costs. Two thirds of Federal spending is on social security, health and general public service. Obvious areas to target include the ballooning payments for people with disabilities (over the past 20 years those claiming disabilities have moved from 13 to 20 per cent of the population) and, in the light of booming demand, unemployment payments.

Paring back spending on these and other items to return the government share of GDP to that in 1990 could easily allow 3 per cent per capita annual growth instead of the 2 per cent we are experiencing. That would mean real incomes within two decades at over 30 per cent above what they would otherwise be: it would mean Australians enjoying average living standards similar to those in the US.

The key to achieving these benefits is a reorientation away from taxation and towards lowering expenditure. There is any number of worthy causes clamouring for government funding. While the treasurer should play a greater role in whittling down the claims on the taxpayer, the finance minister is crucial as the gatekeeper.

Australia has rarely been well served in this respect. The last person for the job is an avuncular chap with an indulgent perspective on government spending. Hence, Australia had its worst expenditure gatekeeper when Labor was in power, with Kim Beazley as finance minister. Ironically, Labor also gave us the best finance minister: Peter Walsh, a man whose natural parsimony and cynicism about government expenditure provided an ideal coupling for the job.

The current budget, as with most under Howard-Costello, has avoided the worst excesses. It has not placed us into hock. But nor has it done anything to undo decades of over-spending that has sapped the potential of a country with unparalled natural wealth to enjoy a correspondingly high standard of living. The treasurer tells us that freedom from debt, “has enabled the government to redirect expenditure … to spending on health, education and national security”.

Why not embark on a genuine reform so that less taxpayer money is taken in the first place? Not only would this reduce government seizure of individuals’ earnings but it would propel Australia onto the stronger growth path its fundamental wealth warrants.