No, Australia does not have a tax revenue problem - The Centre for Independent Studies
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No, Australia does not have a tax revenue problem

It seems plenty of commentators think Australia has a tax revenue problem and we need to increase taxes to ‘restore’ taxes to historical levels.

These views are wrong, and this becomes evident with a simple examination of official data.

The Budget forecasts Federal Government tax revenue will be 22.3% of GDP this financial year. This is:

  • Well above the 10 year average of 21.7%;
  • Just below the 20 year average (22.5%);
  • Equal to the 30 year average (22.3%); and
  • Above the 40 year (post-Whitlam) average (22.0%).

It is much better to take averages of a number of years, including booms and slumps, such as the 30- and 40-year average, than to take an average that includes the mining boom only (as some have done), or — even worse — look only at a single year, which the former Secretary to the Treasury, Dr Ken Henry, has done in saying  the current tax level is well below the levels in 2002. He does not take into account that taxes were unusually high in 2002 with the introduction of the GST, because some taxing powers were transferred to the Federal Government.

Why choose a year such as 2002, when tax revenue was abnormally high? We could equally choose 2011, when tax revenue was abnormally low in the aftermath of the Global Financial Crisis. Or 1993, in the aftermath of the ‘recession we had to have’.

This is why a comparison with averages over a longer time are better. On that basis, increases in tax cannot be justified.

In fact, the tax to GDP ratio is scheduled to increase to levels well above the historical average. Mainly due to bracket creep, the tax to GDP ratio is forecast to be 23.4% in 2018‑19, a substantial 1.4 percentage points above the 40 year average.

Therefore, to maintain the tax to GDP ratio at the historical average, by 2018-19, we would need tax cuts worth around $24 billion per year (in today’s money).

So the tax to GDP ratio argues for tax cuts, not tax increases.

Commentary on this issue tends to focus on total government revenue, which includes both tax and non-tax revenue. However, in the past non-tax revenue was much larger because the Federal Government used to receive substantial interest from the states, which it then simply passed on to its own bondholders. It would not make sense to justify tax increases on the basis of a (now ended) financial arrangement with the States. So the calculations in this article focus only on tax revenue, excluding non-tax revenue.

Regardless, all this debate about the revenue (or tax) to GDP ratio misses the key point. This ratio shouldn’t be driving decisions about tax.

It would be nonsensical to increase taxes in a slowing economy. But this is what a slavish focus on the tax-to-GDP ratio means. It would mean pro-cyclical tax policy that would (particularly) exacerbate recessions. It is hard to see why this is a reasonable approach to setting taxes.

A focus on tax to GDP would also mean tax cuts in booms, which I agree with, but other economists have concerns with.

Similarly, even if we accepted the erroneous case that the current tax ratio is below the historical average, economic growth is sluggish and the last thing we need now it an additional ‘foot on the brake’ from tax increases.

Instead of a one-eyed focus on the overall level of tax, commentators and policy makers should look at the impact of individual taxes (and spending programs) on the economy.

Modelling by the Treasury and KPMG indicates that some taxes, particularly company tax, have substantially adverse effects on the economy. These taxes harm productivity, employment, investment and innovation, and these serious effects could be worsening over time.

As a result, keeping tax at the same proportion of the economy, let alone increasing tax, will have a more and more detrimental impact as time goes on.

And finally, trying to maintain tax levels ignores the substantial options to keep government spending in check (and hence allow taxes to be reduced). There are substantial options for wealthier Australians to provide for themselves rather than relying on government support. With the expected return to national income growth, more and more opportunities will be presented for limiting government spending to those in greater need.

Regardless of these points, commentators and policy makers can — and will — argue for higher rates of tax. However, they should acknowledge the costs of tax increases, and not hide behind the incorrect argument that taxes must be increased to ‘restore’ taxes to historical levels.

Michael Potter is Research Fellow at the Centre for Independent Studies.