Taxes will surely grow as savings prove politically hard to achieve

THE only thing certain about the government’s Intergenerational Report is that none of it will become fact. As one wit once put it, prediction is difficult, especially when it’s about the future. Forty-year economic forecasts in 1890, 1920 or even in 2000 would not have been especially useful, naturally failing to incorporate the significant geopolitical, technological, scientific and demographic changes that would variously batter and bolster the finances of nations, businesses and households.

Australia’s first IGR in 2002 didn’t even mention our terms of trade, which were about to explode within a matter of years. The global financial crisis of 2008 rendered the 2007 IGR obsolete almost immediately. And Labor’s 2010 effort projected the budget would roar back into strong and rising surplus this year — enough said.

But all three did have one thing in common: the outcomes were worse than predicted.

IN DEPTH: Full coverage of the Intergenerational Report

The latest IGR shows federal budget deficits, based on current legislation, rising steadily to from 2.5 per cent to almost 6 per cent of gross domestic product by 2055 while net debt soars from 15 per cent to almost to 60 per cent of GDP. But in the unlikely event the government manages to convince the Senate to pass its remaining savings, the budget will whirr into a felicitous 35 years of surpluses while net debt falls to zero.

If you think this sounds fanciful, consider the economic assumptions underpinning both projections. For a start, the unemployment rate is assumed to fall from 6.4 per cent (and rising) to 5 per cent and stay there until 2055. And the terms of trade — the ratio of Australia’s export to import prices — are expected to remain around 50 per cent above their long-run average.

Economists are increasingly concerned that rich economies will struggle to keep the mass of people in meaningful, well-paid work as robots become smarter and cheaper. And Australia’s export prices appear to be tumbling back to long-run levels as China’s growth model begins to fracture.

But two other assumptions are likely to be more problematic. Despite the unprecedented ageing of the population, the level of government spending (excluding interest) as a share of the economy rises from 25 per cent to 25.1 per cent of GDP.

That spending rises by only 0.1 percentage points of GDP over forty years (the previous IGR assumed spending would rise 4.5 percentage points to 27.1 per cent) seems incredible. It assumes the political class is able to resist the temptation to introduce new spending programs or expand existing ones, something recent history comprehensively refutes.

Meanwhile, Australians will enjoy average real per person economic growth of 1.5 per cent a year on average for the next 40 years, only slightly slower than the 1.7 per cent of the past 40. This will be underpinned entirely by growth in labour productivity. The other candidates — number of hours worked a week, participation and unemployment rates — are not expected to change. But productivity growth is continuing to slow, along with the political will to foster more competitive labour and product markets, and curb inefficient taxes and red tape.

As the IGR notes: “Strong income growth, low unemployment and high rates of profitability through the 2000s may have lowered the pressure on governments to undertake the necessary productivity enhancing reforms and reduced the incentive for business to become more competitive”.

Arguably, introduction of the GST 15 years ago was the last major, lasting structural reform. Despite a bulging pipeline of reports and reviews on tax, Federation and industrial relations, the Senate’ attitude suggests pros­pects for reforms that do not entail more public spending are slim.

But Australia’s productivity growth is mainly dependent on what happens in other countries, where US professor Robert Gordon reckons it is headed back to its long-run average level, which before 1750 was essentially zero. He argues the rise in living standards during the 20th century stemmed mainly from the practical application of earlier discoveries such as electricity, and growth-boosting phenomena that can occur only once, such as air travel.

He argues computers haven’t lived up to the hype — productivity growth has waned since the 1970s — while more recent innovations have “centred on entertainment and community devices that provide new opportunities for consumption … rather than a continuation of the historical tradition of replacing human labour with machines”.

Besides, rich economies are mired in debt and bureaucracies that will require punishing taxation to sustain or repay. And demographic change that once paid a dividend in entrepreneurial activity is becoming a tax, as the share of young people shrivels.

All this is controversial. Others are waiting for productivity growth’s second wind, powered by the speed with which knowledge can now be shared online. Besides, the sheer number of humans living comfortably under the rule of law has grown substantially, increasing the probability of major scientific discoveries.

While the IGR can’t predict fiscal or economic outcomes accurately, it is correct to foreshadow increases in taxation. Bracket creep is pencilled in until 2021, by when the tax share of the economy will have risen from 22 to 23.9 per cent of GDP — the average level between 2001 and 2008. Income tax thresholds were last adjusted to help offset inflation in 2008.

Workers on an average full-time income (projected to be a little less than $80,000 by 2017) will be paying the second top income tax bracket of 39 per cent within two years, the IGR shows. The average income tax rate for someone on the equivalent of $75,000 will rise from 22.7 per cent to 27.4 per cent by 2023. For someone on $150,000 it will rise from 30.5 per cent to 34.3 per cent.

Governments can change policy in ways that improve the fiscal outlook. The IGR estimates that the Howard-Rudd-Gillard governments left a policy legacy that collectively would have seen the federal budget blow out to Greece-style deficits and net debt of more than 120 per cent of GDP by 2055. Foreign investors would have stopped lending to Australia long before that happened, and the commonwealth would have faced a choice: lift taxes or cut spending.

Already the Abbott government has made enough savings since September 2013 to improve the budget trajectory significantly. But most of the “savings” have in fact been tax increases, such as the temporary budget repair levy on incomes above $180,000 a year and re-indexation of fuel excise.

It is almost certain this habit will continue unless the government can curb spending on its biggest and fastest growing expense: the age pension, whose annual cost is projected to grow from $43 billion to $165bn by 2055 (or 3.6 per cent of GDP, which would be more than double the defence budget and triple total education spending). Proposed changes to the pension blocked in the Senate explain by far the biggest difference between the two main IGR scenarios.

Withdrawing subsidies from retirees with significant housing and superannuation assets appears to be the most logical way of doing so. The IGR estimates about 67 per cent of retirees will still be receiving at least a part-pension by 2055, by when Australia will have had more than 60 years of compulsory superannuation.