6
May
2018

Budget 2018 is about deciding between two very worthy objectives

by Danielle Wood


Published in the Australian Financial Review, Sunday 6 May

There is one central question at the heart of tomorrow’s budget: will the Turnbull government give priority to tax cuts for today’s workers who are bearing the strain of low wages growth and a growing tax burden; or will the government finally start paying down the debt we will hand to future generations?

Given it’s an election year, and only one of these groups can vote, it’s no surprise Scott Morrison has foreshadowed income tax cuts. But are these cuts justified, and what will they do to the state of Australia’s finances?

Australian workers have a case for a tax cut. They are being asked to bear disproportionately the cost of repairing the budget. Last year’s budget projected personal income tax collections would rise to 11 per cent of GDP in 2021, their highest level since 2006. This was party because of the increase in the Medicare levy to fund the NDIS (now scrapped) and partly because of bracket creep: growth in income taxes as a share of wages if tax brackets aren’t adjusted over time. Other than a big increase in the tax free threshold in 2012 and the modest increase in the threshold for the second-top bracket in 2016, there haven’t been any permanent changes to the tax brackets since 2008.

Middle-income earners are particularly hurt by bracket creep. Based on the wages growth projected in the 2017-18 budget, the Parliamentary Budget Office estimates average tax rates for people in middle-income groups will increase by between 2.3 and 3.2 percentage points by 2022.

And wage growth has stagnated. Real wages grew just 0.1 per year over the past five years. Considerably below the 0.8 per cent a year of the previous 10 years.

A cut to income taxes – particularly if targeted towards low and middle-income earners – would stimulate the economy. This group are more likely to spend the additional money in their pockets. Lower taxes would also increase workforce participation: tax rates have the biggest impact on workforce incentives for middle-income women with children in childcare.

But the case to stop mortgaging our children’s future is even more compelling. The Australian government has been running sizeable deficits for the past nine years. And three more years of deficit are forecast. On a best-case scenario, net debt is forecast to reach more than $365 billion and peak next year as a share of the economy at just over 19 per cent.

The Treasurer is promising a return to surplus in 2021. But we’ve heard that before. While the numbers on company taxes and income tax receipts have recently surprised on the upside, the promised return to surplus relies on strong wages growth and superhuman spending restraint in the lead up-to an election. And of course even modest income tax cuts will quickly eat away at any surplus.

Even if things go well and the 2021 target is reached, the government’s 10-year projections suggest that future surpluses would be modest – peaking at 0.5 per cent of GDP in 2026-27. This is because of the government’s commitment to cap tax collections at 23.9 per cent of the economy: the average level across John’s Howard’s second and third terms.

But it seems to stretch to breaking point another of the government’s fiscal objectives: to achieve “surpluses on average over the course of the economic cycle”. Twelve years of deficits averaging 2 per cent of GDP would take many, many more years of these modest surpluses to come out ahead on average: a very long cycle indeed.

And there are sizeable longer-term structural pressures on the budget: an ageing population will reduce the share of net contributors versus net drawers on the budget; large infrastructure projects that have been put off budget still need to be paid for if they don’t make the promised commercial return; and demands for more and better health services – leading to health spending growing as a share of GDP – are not going away. And debt takes longer to whittle away when economic growth is in the doldrums.

Without more effort to pay down the debt, Australia has limited room to respond to any future economic shock. And continuing deficits would mean continuing to transfer the cost of today’s spending to tomorrow’s taxpayers.

Of course there are other ways to repair the budget and still deliver income tax cuts: better targeting the increasingly expensive R&D tax incentive, winding back the capital gains tax discount and negative gearing, not proceeding with the planned increase in the Super Guarantee, and better targeting of tax breaks for older Australians are just a few. The government probably won’t have the stomach for many of these in a pre-election budget. But I’m sure future generations of Australians would thank them for it if they did.