Tax cuts are good for government

THE crux of Treasurer Joe Hockey’s tax reform speech this week was spot on. In his words, our tax system is holding us back from reaching our end goal of a stronger economy.

The speech has been criticised as an attempt to make a big deal out of stating the obvious. This is unfair.

For one thing, he is doing what the Abbott government has been criticised for not doing in the past — explaining what they want to do and why, and winning public opinion before making big policy announcements, such as those in last year’s Budget.

What Hockey said may have been obvious to some people but it’s not obvious to many, like the premiers of Victoria and Queensland who want a doubling (or more) of the Medicare levy. Increasing the Medicare levy is an increase in income tax by another name. It would go in the opposite ­direction to the kind of reform flagged by Hockey this week.

He spoke of the tax system but his focus was personal income tax, which is only part of the system but a big part of what is holding back the economy.

The burden of personal income tax is too high and the government relies too much on the revenue and its automatic growth, which includes a bracket creep component. Cuts in tax rates and increases in bracket thresholds need to be on the agenda.

Income tax cuts have acquired a bad reputation as election bribes but there is more economic substance to them than that. Personal income tax reform is critical to fostering the ­faster productivity growth and higher workforce participation that underpin a stronger economy and higher living standards.

This is not a case of fiscal stimulus financed by increased government debt, which the Rudd government ­delivered by the truckload during the GFC. Instead, it is what economists call boosting the economy from the supply side. Lower income tax rates encourage more people into the workforce and incentivise them to work more hours; more investment in human capital (making ourselves more ­employable at higher pay) and more business creation, risk taking and innovation. In these ways, the economy’s productive capacity will expand.

But income tax cuts come at a cost to revenue and have to be funded. Hockey hasn’t explained how he would jump that hurdle.

It would be nice to think the cuts could be self-funded by the extra ­employment, higher wages and business activity — and therefore tax revenue — they generate. This is Laffer Curve thinking from the 1980s. There is an element of truth in it, but not enough to make income tax cuts a free lunch for the Budget.

There are only two ways to make room for income tax cuts — hikes in other taxes, or cuts in government spending (or more likely, slower growth of spending). Hockey rightly favours the latter, but the track record suggests he will struggle to get his way.

Robert Carling is a former NSW and Commonwealth Treasury official and now Senior Fellow at the Centre for Independent Studies