Tax reform a priority, but only if it is done right - The Centre for Independent Studies
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Tax reform a priority, but only if it is done right

 

tax money monopolyTreasury modelling of tax reform proposals confirms the analysis of the Centre for Independent Studies that tax reform is a priority, but only if it is done right.

First, the Treasury modelling confirms the importance of fixing bracket creep, which is caused by personal tax thresholds not being indexed to inflation or wages growth. If nothing is done to remove this hidden tax impost, it is reported that growth will be cut by 0.35%.

However, this understates the impact of bracket creep. The modelling assumes that the higher government spending funded by bracket creep will increase economic growth by 0.2%. This is unrealistically optimistic, given the pervasive inefficiencies in existing spending programs highlighted in the government’s own National Commission of Audit. If this offset doesn’t happen, then the harmful growth effect of bracket creep blows out to 0.55%.

The adverse impact of bracket creep is consistent with the report released by CIS in December, Exposing the Stealth Tax: the Bracket Creep rip-off. Our report estimated the large tax hike that is facing everyday taxpayers if nothing is done (see an interactive graph of our estimates here); the Treasury modelling in addition indicates that this tax hike will have large costs to economic growth.

Second, the modelling reported today is that a large boost to economic growth will come from cutting the company tax rate. This aligns with earlier arguments by the CIS in Business Spectator that company tax reform is a high priority. It also aligns with many other reports including an OECD report finding that taxes on companies were the most harmful to growth out of any tax studied, and a major review of taxes in the United Kingdom, the Mirlees review.

Finally, the modelling also finds that personal tax cuts funded by a GST increase will have limited if any benefit to economic growth, if most of the higher GST revenue has to go on higher welfare payments. It is also reported that if compensation is increased, then the benefits to growth will approach zero or may even become negative.

This is in alignment with the scepticism raised by CIS researchers over the proposals for a so-called GST tax-mix switch. Not only were we sceptical about the benefits of a tradeoff, we also noted that personal tax cuts funded by a GST increase could be eroded over time, but the GST would remain at a higher level forever. So a tax mix switch could just, in the longer term, result in higher taxes. This would not be tax reform.

The modelling reported today is a valuable contribution to the tax reform debate. It should be welcomed by all participants. We trust that the government will release details of the modelling so that the public can be fully informed about these issues.

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