Another year, another round of tax cuts. Australian governments have made an art of announcing new income tax cuts as elections draw near. But while such cuts are always popular with the public, they should not be confused with tax reform.

Labor’s redesign of the Coalition’s Stage 3 offers larger tax cuts for low and middle earners, and smaller (but still substantial) cuts for higher earners.

The real loser will be the budget. Both the original Stage 3 and the redesign will return more than A$20 billion a year in accumulated bracket creep to taxpayers without doing anything much to boost economic growth.

The cost to the budget means these tax cuts will make it harder for this government – and for future governments – to raise the money they will need to meet demands for more spending in areas such as healthcare, aged care, disability care and defence.

While high commodity prices are boosting the budget at the moment, the deficit we would have if it weren’t for that good fortune (the so-called structural deficit) is close to 2% of GDP, which is about $50 billion a year in today’s dollars.

We can try to close that deficit by making budget cuts, but spending cuts alone are unlikely to be enough.

Economic growth would help, but it’s been sluggish for more than a decade.

So what would genuine reform look like?

Genuine tax reform requires a “tax mix switch” – moving from taxes that do a lot of economic damage to taxes that are more efficient.

Such a switch would allow the government to raise as much or more money, while delivering an economic dividend at the same time.

Part of the switch would be a move away from income taxes towards taxes that would encourage us to use resources more efficiently, including taxes on wealth, land and the exploitation of natural resources.

And income taxes should be broadened by abolishing the labyrinth of concessions, deductions and deferral options available to the well-advised.

Super tax breaks cost $45 billion

Superannuation tax breaks are the biggest hole in the income tax base.

They cost the budget $45 billion a year – about 2% of GDP – and will soon cost more than the age pension.

They are also poorly targeted: half the super tax benefits flow to the wealthiest one-fifth of households – the ones who already have enough to fund their retirement.

Tighter limits on annual pre-tax contributions and lifetime post-tax contributions, and raising the tax rate on some pre-tax contributions, would reduce the use of super as a tax-minimisation tool.

And taxing super earnings in retirement (they are currently untaxed for people with superannuation balances below $1.9 million) would get comfortably off older Australians to make the same sort of contribution to the cost of government services as the rest of us.

Those changes could save the budget more than $10 billion a year.

Capital gains tax breaks encourage speculation

Similarly, the 50% capital gains tax discount means income from capital gains is taxed at a much lower rate than income from working.

When paired with negative gearing, the 50% discount encourages speculation on property in place of other more useful uses of funds.

Halving the capital gains tax discount – as Labor promised to do in 2016 and again in 2019 – would save the federal budget about $5 billion a year.

If combined with curbs to negative gearing, it’d save a further $2 billion a year at least.

Some of these savings could be used to reduce overall income tax rates. The rest could be used to repair the budget’s structural deficit.

Other ways of funding lower income tax rates and boosting government revenue include winding back fuel tax credits ($4 billion per year), boosting the taxes paid by companies that make their profits from exploiting Australia’s natural resources (at least $4 billion per year), and setting a minimum tax on trust distributions ($2.3 billion per year).

The goods and services tax is getting weaker

A bold government would revamp the goods and services tax (GST) too, either by increasing the rate or by reducing exemptions. As each year goes by we are spending more and more of our income on exempt services, including health and education.

A 15 per cent GST could raise about $12 billion a year after accounting for the cost of cushioning the impact on the poorest 40 per cent of households.

Federal and state governments would each be $6 billion a year better off if they shared that remaining revenue 50:50.

We would not expect any government to pursue all of these major changes at once. Tax reform is a marathon rather than a sprint.

But tax cuts without reform leave less money to buy genuine tax reform, reducing the government’s room to respond to future economic shocks, and pushing the cost of today’s spending onto future generations.

Real tax reform isn’t easy, but neither is good government.

The Conversation

Kate Griffiths

Chief of Staff and Democracy Deputy Program Director
Kate Griffiths is Grattan Institute’s Chief of Staff and Deputy Program Director of the Democracy program. Kate completed her Masters in Science at the University of Oxford as a John Monash Scholar and holds an Honours degree in Science from the Australian National University.