We need to talk about tax. At the moment it remains firmly in the shadows of the election’s economic debates. But ignoring the elephant in the room doesn’t make it disappear. Whoever wins the election will face two significant challenges: raising enough revenue to pay for higher spending, and raising it in a way that doesn’t drag too much on economic activity.
To the first. The Coalition might trot out the claim of being the party of small government, but it just made government permanently larger. The budget anticipates that spending will stabilise at 26.3 per cent of GDP by the end of the decade. This compares to an average of 25 per cent in the decade before the COVID-19 crisis. It is even more extraordinary when compared to the projections before the 2019 election, which suggested government spending would shrink to 23.6 per cent of GDP by 2030.
The elephant-sized $50 billion in annual additional spending by the end of the decade reflects higher baked-in spending on aged care, defence and the NDIS, as well as earlier misplaced optimism on expenditure restraint.
Most Australians would support much of that higher spending, but how is it that we can have such a sizeable structural increase in government activity without so much as a discussion about how we pay for it?
Yes, we will need to make savings, but the idea that you massively expand spending while maintaining the same cap on tax as a share of the economy is magical thinking.
So how do we collect more revenue in a way that doesn’t drag too much on economic activity?
Reform personal tax
Personal income tax is the workhorse of the federal budget – it currently accounts for just over 50 per cent of total tax receipts. But it is also an increasingly leaky base. A labyrinth of concessions, deductions and deferral options are available to the well advised.
Investment income is concessionally taxed compared to income for working. And while there are some valid policy reasons – particularly compensating for the effects of inflation on returns for longer held-assets – concessions have been overly generous, putting pressure on the revenue base. Remember: one person’s tax concession is someone else’s higher marginal rate.
The capital gains tax discount and superannuation tax concessions are substantial tax expenditures – together costing the budget more than $50 billion a year – that are hard to justify in their current form.
The 50 per cent CGT discount has been more generous than needed to compensate for inflation. And, when combined with the almost uniquely Australian tax advantage of negative gearing, it encourages investors to load up on debt and pushes up house prices. Reducing the CGT discount to 25 per cent would reduce some of these distortions, without substantially reducing the rate of new home developments.
Super tax is poorly targeted
Similarly, super tax concessions have gone further than necessary to deliver their stated purposes of helping people replace or supplement the age pension. They are poorly targeted: half the tax benefits flow to the wealthiest 20 per cent of households, who already have enough resources to fund their own retirement. The cost of these concessions vastly outweigh the corresponding age pension savings.
Tighter limits on annual pre-tax contributions and lifetime post-tax contributions would reduce the use of super as a tax planning tool. And taxing super earnings in retirement – currently untaxed for people with superannuation balances below $1.7 million – would ask comfortably off older Australians to make some contribution to the costs of government services.
Together these changes would raise at least $10 billion a year. Are they politically impossible? Not necessarily. Governments have a history of greasing the path of tax reform by throwing in some sweeteners. The introduction of the GST in 2000 and the carbon pollution reduction scheme in 2007 both cost the budget money because they came with generous compensation packages.
But where will the money to buy reform come from? Both sides have committed to sizeable personal income tax cuts in 2024-25. The Stage 3 tax cuts will reduce tax revenues by more than $15 billion a year. These were calibrated and legislated in 2019, back when wages growth was expected to be healthy and the government was projecting surpluses as far as the eye could see.
These tax cuts are much more generous than current economic or fiscal circumstances dictate. But if we are committed, why not use them as the down-payment on real reform? Bundling up the tax cuts with the changes to the capital gains tax discount and super tax concessions that I propose would be a classic base-broadening, rate-cutting tax reform.
Most people would still be better off. And, importantly, the proposed changes would substantially reduce the upfront budget hit of the tax cuts and shore up revenues over time.
Will we hear about it in the election campaign? Absolutely not. But something will need to happen afterwards. Josh Frydenberg and Jim Chalmers might tell you that we can continue to tax like its 2019, but the numbers say otherwise.
While you’re here…
Grattan Institute is an independent not-for-profit think tank. We don’t take money from political parties or vested interests. Yet we believe in free access to information. All our research is available online, so that more people can benefit from our work.
Which is why we rely on donations from readers like you, so that we can continue our nation-changing research without fear or favour. Your support enables Grattan to improve the lives of all Australians.
Danielle Wood – CEO