It’s more tax from both sides

Voters have Hobson’s choice when it comes to tax. Both major parties are proposing to increase income tax, the Coalition only a little less quickly than Labor.

So shallow and ignorant has the political debate become that the Turnbull government’s plan to increase taxes is being couched as a cut and, even more farcically, as an excessive one by the Labor ­opposition.

This is not only my view. “The proposed changes to the personal income tax system are not excessive and are not even a true tax cut,” write Robert Carling and Matthew O’Donnell, two former Treasury economists, in an analysis to be released today.

In 1998 the major parties debated the merits of a GST: consumption versus income tax. In 2018 they debate the rate of change of an increase in income tax, absent any structural reform of the tax system.

Writing for the Centre for Independent Studies, the two authors assess the government’s so-called $144bn seven-year tax plan, announced in last month’s budget, against timeless tax criteria: equity, efficiency and simplicity. It gets two out of 10 on all three, its only saving grace being it is better than Labor’s.

Carling and O’Donnell make what should be an obvious point: that taxes will rise regardless of whether the Coalition or Labor wins the next election.

The four income tax thresholds in 2008 were $6000, $34,000, $80,000 and $180,000.

Had they kept pace with prices they would now be $7376, $41,795, $98,341 and $221,266. Yet they have barely changed. Had they kept up with wages, which tend to rise faster than prices, the top two rates would be $104,974 and $236,192.

The big-ticket change, the one Labor considers might be too generous — lifting the top income tax threshold to $200,000 in 2024 from $180,000 — is a small reduction in the planned tax increase the government has pencilled in.

That’s not the end of the analysis, though. Between now and 2024, wages and prices are likely to go up by another 13 per cent, assuming sluggish rates of growth continue, making the drama around the increase in the proposed thresholds look even sillier.

Indeed, the fine print of the government’s tax costings shows the share of people in the top tax bracket will rise from 4 per cent to 6 per cent, as the share of tax paid by the top fifth of taxpayers ­increases.

The problem with the tax plan doesn’t stop with its extraordinary timidity, by any logical or historical comparison. “Leaving aside the questionable accuracy of the $144bn figure, the 10-year aggregate is being used as a rhetorical device to dramatise a relatively modest policy proposal,” the CIS authors say.

Let’s examine that figure. In a shocking admission this week, the Treasury confirmed to The Australian that its tax “costings” — an unfortunate term for what are estimates for reductions in revenue, not costs in any reasonable sense — make no allowance for responses to tax changes.

That is, the $144bn “official” figure bandied about by the government and opposition, that forms a backdrop to the tax cut debate, is wildly and obviously wrong, an exaggeration so large, one must believe it is deliberate — to create the impression of a big cut.

Logic and statistics always show that lower tax rates reduce the incentive to avoid or evade tax and, for most people, hone the incentive to work more hours. That means the “cost” of the tax cut is partly offset by the additional revenue it generates.

University of Queensland economist John Humphreys, who specialises in dynamic tax analysis, put the 10-year cost at about $78bn — half the Treasury’s estimate. That was using a conservative assumption that a 1 percentage point reduction in tax would increase taxable income by 0.4 per cent overall.

Recent developments in Britain are instructive. In 2010, the government of Gordon Brown lifted the top marginal tax rate from 40 per cent to 50 per cent. It was quickly reversed, and it is easy to see why.

According to a HM Treasury inquiry, total income tax collections for those paying the top rate, which were routinely higher than £100bn every year from 2006 to 2009, plunged to £87bn the year the higher rate was introduced.

High-income earners are particularly responsive to higher tax rates, not in terms of how much they actually work or produce but in how much effort they put into avoidance. Studies consistently show that top marginal rates above about 40 per cent are highly ineffective.

Why hasn’t there been a similar inquiry here on how much the 2 percentage point deficit levy raised? The 2014 budget estimated $1.2bn a year. If our Treasury assumed no behavioural impact, that figure must be wide of the mark.

Ultimately, the problem is spending.

For all the talk of prudence, real spending growth under the Coalition has been increasing every year. In 2014-15 it was minus 0.3 per cent — a rare shrinking, owing to the first Abbott government. That was the first full year of Coalition government. The next year it was 1.3 per cent, then 2 per cent in 2016-17 and then 2.7 for 2017-18. Next year, 2018-19, real growth in spending will be 3.1 per cent, among the fastest in recent years.

Where does all this restraint come from? That’s in the future, of course. Real spending growth is meant to crash to 0.2 per cent in 2019-20 and remain about 1.1 per cent for the following two years of the budget estimates.

In any case, it’s deceitful to leave tax brackets unindexed. The additional revenue only fuels public spending by creating the illusion of increased tax revenue.

“While in the short run the redistribution from the high income earners benefits the majority of voters, over the long run, extractive democratic regimes lead to reductions in growth … highly mobile in-demand workers will respond (by leaving),” the CIS authors say. France’s top marginal tax rate, by the way, is not only lower, at 45 per cent, but cuts in at an income of €153,000 ($237,027).