Back off Moody’s: Australia should not increase taxes

The government should not give in to claims Australia needs more tax revenue. This stance — that we need higher taxes — has gained prominence recently with ratings agency Moody’s warning that Australia needs to cut its deficit to maintain our AAA credit rating.

However, looking at Australia’s taxes in comparison with recent history provides no justification for there being a revenue problem. In fact, if there is a problem, it is that taxes are too high rather than too low.

First, the federal government’s tax to GDP ratio is currently at 22.3%. This is above its 40-year average of 22.0%, and is forecast to go well above this average. A graph of this is shown below.

Our tax levels are also at or around 10, 20 and 30 year averages.

So to make a case for tax increases, some commentators compare our current tax levels to cherry-picked years when taxes were abnormally high. For example, in a recent report CEDA used the years 2000–01 to 2007–08, when tax averaged 23.9% of GDP.

But this comparison, also used in the 2015 Intergenerational Report, is not justified. This was a completely atypical period in Australia’s history.

For everyone who has missed it, including CEDA, during much of this period Australia was experiencing an enormous mining boom. Mining companies were awash with cash and paying plenty of tax — but were investing at rates never seen before. Investment funds were flowing into Australia even with our dollar at record levels, unemployment hit historical lows, and both national income growth and wages growth were strong.

Australia is nowhere near this situation today. Non-mining investment is very weak, as is wages growth, while national income is actually falling. It is absurd to think we could just replicate the tax levels from the middle of this boom.

Comparisons to other periods during the mining boom can be dismissed for the same reason.

What about closing the deficit?  Ratings agencies have argued Australia needs to reduce its budget deficit. But should this occur through tax increases, spending reductions or a combination?

Historical comparisons again assist. Let us look at the past 40 years in the years when the budget was within 0.25% of balance — in other words, the budget balance was somewhere between a budget surplus of 0.25% of GDP and a deficit of 0.25% of GDP. This is an appropriate target: the current state of the economy (noted earlier) argues against running large surpluses; and the risks to the economy argue against running large deficits, as noted by the ratings agencies.

It turns out five years meet this standard: 1980–81, 1981–82, 1990–91, 1997–98 and 2001–02. In these years, tax averaged 22.2% of GDP, which is less than its current level, while spending was 24.1% of GDP, a full 1.8 percentage points lower than today (see the leftmost column in the graph below). Similar comparisons are made in the graph below to years when the budget was within 0.5% of balance, 0.75% of balance, and 1% of balance.

This graph shows that taxes were higher when the budget was further away from balance (rightmost column): but the argument run by Moody’s and others is that Australia should move towards a balanced budget, not away from it.

In addition, spending was much lower than today in each of the cases considered above, as shown in the graph below.

There is an issue in the tax reforms in 2000, which involved the States giving up some taxes in return for the GST. As a result, State tax revenues went down and Federal taxes went up (see details here). This complicates tax comparisons after 2000.

The best way of dealing with this is to look at the total tax burden of all levels of government.

And again on this measure, the current tax burden of 28.1% is well above its long term average of 27.4% and set to go much higher — see the graph below.

In addition to all the historical comparisons above, the argument that Australia has a tax revenue problem doesn’t take account of the costs of tax increases, as clearly shown in work by the Treasury: tax hikes are expected to cut employment, wages, household incomes, GDP and investment. The argument also doesn’t account for the fact that Australia’s company and personal tax revenue are each well above the average for the developed world.

All these points lead to the conclusion: the argument that Australia has a tax revenue problem is without foundation and should be rejected in the upcoming budget.

Michael Potter is a Research Fellow in the Economics Program at the Centre for Independent Studies