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OECD’s tax reform proposal for Australia is hard to disagree with

So it was with the recent economic survey of Australia issued by the Paris-based OECD (Organisation for Economic Cooperation and Development), now led by Australia’s former long-serving finance minister Mathias Cormann.

It is not that the OECD was saying anything very different from what it has said in the past, or different from what our own economists and tax reviews have said.

But whether it is a manifestation of the Australian cultural cringe or something else, when an international organisation gives its seal of approval or disapproval, the same advice gets more attention here.

The OECD’s core proposition on tax is that we rely too heavily on direct taxation (mainly personal income tax) and not enough on indirect tax (mainly the GST).

Income tax should be cut more than the Morrison government is cutting it and the GST should be increased and/or broadened in its coverage. The thinking is this would make the tax system more economic growth-friendly and less subject to revenue decay through population ageing.

Stated in these terms, the proposition is hard to disagree with. Every Australian tax review going back to the Asprey review of the early 1970s has said the same thing. And this OECD survey is merely repeating what previous surveys have said.

But that doesn’t make it any easier to pull off in practice. And it hasn’t happened.

Even when the GST was first introduced by the Howard government in 2000, it was a replacement for other indirect taxes rather than a switch from direct to indirect taxation – although income tax was cut at the same time. How can something be so obvious, totally within the Australian government’s control, and technically feasible, yet impossible to deliver? It is partly because both sides of politics have dug themselves into positions of never ever touching the GST.

But it is also because the public senses a trade-off between more GST and less income tax would just lead to a higher overall tax take.

Indeed, most other OECD countries that we keep being told have much higher GSTs than ours also happen to have higher overall tax burdens. It is not difficult to see how this would come about in Australia.

The income tax system is perfectly designed to achieve this result through bracket creep-whereby with unchanged tax brackets, a person’s average tax rate goes up over time as an increasing share of income falls into higher marginal rate brackets.

This is how it can be that personal income tax as a share of GDP will be about the same in 2031 (as projected in a Parliamentary Budget Office report released last week) as it was in 1999, despite several major income tax cuts in the intervening 32 years.

The tax cuts have done little more than hand back the proceeds of bracket creep and they have been partly offset by a Medicare levy that keeps ratcheting up.

Bracket creep could be neutralised by a proper system of indexing the brackets to inflation, but no government has shown any interest in this since the Fraser government tried it and abandoned it in the 1970s.

The OECD is right to highlight the tax mix issue, but in practice what they are suggesting would likely lead to a rise in the overall tax burden over time – as has happened in many other OECD countries. And the OECD is not suggesting indexation.

Perhaps Australia is destined to have a higher overall tax burden.

The OECD report provides valuable information on the increasing long-term fiscal cost of population ageing, reinforcing what the Treasury’s intergenerational reports have been saying. There is also the rising cost of the NDIS and defence.

But before accepting more taxation as inevitable, our governments should at least try to spend more efficiently and effectively.

The OECD’s other tax reform proposals are to increase tax on super fund earnings, cut the capital gains tax discount and replace stamp duty with land tax. These also are politically fraught and unlikely to make much headway. Nor do they all have merit.

Fortunately, there are other nuggets of economic policy wisdom in the OECD’s survey.

The most valuable part of the report is in what it has to say about Australia’s sluggish economic performance before the pandemic and what can be done to strengthen that performance after the pandemic.

They focus on the importance of new business creation to job growth, the decline in business formation and job-switching rates and productivity-enhancing labour reallocation and the weakness in business investment – all of which have contributed to lower productivity growth and real wage stagnation.

Here it offers many clever ideas that governments should act upon.