Labor and Coalition sharpen axes for tax-cut election

Canberra is rolling in revenue but voters should expect only modest cuts.

Illustration: Eric Lobbecke

For the first time in a decade the economy gods are raining cash on Canberra’s coffers, and for the first time in a generation voters are facing a federal election that will be fought on tax. They shouldn’t ­expect the sort of change John Howard and Peter Costello accomplished when in the 1998 election they scraped back in while promising a new goods and ser­vices tax alongside slashing cuts in income tax.

But the unexpected surge in revenues, chronic bracket creep and the Labor Party’s determination to load the tax burden further on to high-income earners has guaranteed an increasingly discredited tax system is set for a revamp.

The federal budget balance is $7.2 billion better in the nine months to March than the government expected at Christmas, according to new figures out yesterday, a taste of the fiscal booty economists are now expecting.

By amassing a $200 billion-plus war chest of potential tax increases that could be used for swingeing tax cuts, Bill Shorten’s Labor has shifted the reform agenda from cutting company tax to 25 per cent — where the government’s signature reform has floundered — to personal income tax. But it’s the government that will set the parameters of this debate. The budget on Tuesday week will lock in the spending and revenue estimates around which the election will be fought.

The inevitable “black holes” that emerge will be judged against the figures Treasury’s economic boffins are putting the finishing touches to now — however inevitably wrong they turn out to be.

The Turnbull government fired its first salvo in the emerging political war over personal income tax, ditching its plan, not yet a year old, to lift the Medicare levy to 2.5 per cent from next year to help pay for Julia Gillard’s chief legacy, the disability behemoth, the National Disability Insurance Scheme. An unexpected surge in company tax revenue thanks to high iron-ore and coal prices, an increasingly buoyant international economy and strong jobs growth meant the increase, announced in last year’s budget to help fund the NDIS, was no longer needed, Treasurer Scott Morrison said.

Not everyone is convinced. “The NDIS is a very large spending program that needed to be funded and it still hasn’t been,” says Australian National University economics professor Warwick McKibbin. “To rely on excess revenue to fund a permanent and growing expenditure is problematic. Revenue streams are highly uncertain but the spending streams are highly certain,” adds the former Reserve Bank board member. Indeed, the cost of the NDIS to state and federal governments is expected to triple to $30bn over the next decade — ­assuming everything goes to plan and the scheme isn’t rorted.

Morrison’s decision to give up more than $4.4bn a year in extra levy revenue reflects a political reality, too. The increase would have practically wiped out whatever personal tax relief the government could have offered — which was bound to be constrained by the fiscal imperative of returning the budget to surplus, as promised, by 2021. And bracket creep has become a chronic problem.

All but the bottom quintile of earners are set to endure increases in their average tax rates of between 2 percentage points (the top fifth of taxpayers) to 3.5 percentage points (for middle earners) over four years to 2021, according to a recent analysis by the Parliamentary Budget Office.

“Their main message was that every quintile except the bottom will be paying a higher average tax rate by 2021 than they were in 2001,” says Saul Eslake, an independent economist.

Whatever tax cuts the government promises Tuesday week — and they are unlikely to exceed $10 a week for an ordinary household — Shorten will have the opportunity to offer more.

Despite the improving fiscal outlook, Labor has refused to discard its own “budget repair levy”, an increase of the top marginal tax rate to 47 per cent (or 49 per cent including the Medicare levy). So whatever tax relief it offers, the 4 per cent of earners with taxable incomes at $180,000 (who pay 30 per cent of income tax) won’t be getting much.

That tax is among a shopping list of other tax increases Labor has promised, including ending cash refunds for franking credits, ending “negative gearing” for property investors, halving the capital gains tax discount to 25 per cent, and cracking down on trusts.

Moreover, dumping the levy increase has had the unintended consequence of strengthening Labor’s hand. It quickly dropped its own copycat levy increase, but having promised to exempt taxpayers earning less than $87,000, it gave up less revenue.

All this, however, assumes opposition Treasury spokesman Chris Bowen can resist the collective salivating throughout Labor and the union movement, which will be baying for a slice of any higher tax take. Giving money back to ordinary workers via tax cuts wasn’t a theme of the Rudd-Gillard government.

The government might be rolling in it — relatively speaking — but ordinary taxpayers are unlikely to be feeling as lucky. Wage growth is still stuck below the rate of consumer price inflation and few economists expect the first reading for 2018, due out soon after the budget, to rise above 2 per cent. The May budget, which assumes a fanciful surge in wages, will have to face reality.

While politics will dictate tax cuts for workers earning less than $87,000, it’s arguably the higher earners who deserve them more. The closely watched Australian Taxation Office tax statistics, released yesterday for the financial year 2016, showed the share paid by the top 1 per cent of taxpayers was 17 per cent. Workers earning between $80,000 and $180,000 contributed 40 per cent of the tax take, despite representing less than a quarter of taxpayers.

OECD data out this week shows families are shouldering a greater burden too. For a family with two children — where one partner earns the average wage and the other is part-time — the average tax rate has soared from 13 per cent in 2011 to 20 per cent. It was 15.1 per cent when the Coalition won office in 2013.

Experts remain at odds over the relative merits of cutting company and personal taxes. Fiscal policy guru Chris Richardson of Deloitte Access Economics this week said he still backed the government’s company tax cut plans, despite the increasingly poisonous backdrop of a royal commission in Melbourne providing a drip feed of misdemeanours by large financial institutions.

“It’s always a bit uncomfortable being opposed to Chris Richardson, but I think there’s a much stronger case for personal income tax cuts than corporate income tax cuts,” Eslake says. “I think it would be better if they bowed to the same political reality that applied to their Medicare levy increase: it won’t be going through the Senate, it’s unpopular, so why waste capital doing it?

“Disposable income growth is weak because wage growth is so weak and government can’t do anything about that,” he notes, pointing out the share of tax in disposable income has risen to the highest level since 2005.

“That’s why I say it would do more for the economy than company tax cuts, especially if they were directed to the second, third and fourth quintiles, who would spend it,” he adds. Overall, households are paying almost 20 per cent of their taxable incomes in direct taxes, Eslake says.

The case for having tax cuts at all is far from universally accepted. “The big issue here is what can we really afford given that the commonwealth debt position is a lot less good than it used to be,” says Grattan Institute director John Daley. The government’s net debt to gross domestic product is equivalent to almost 20 per cent of GDP, up from zero in 2008. Gross debt, including the state governments, is the equivalent of more than 41 per cent of GDP, according to the International Monetary Fund’s’s latest Fiscal Monitor.

“We’ve been through the largest mining boom in history and ran deficits. We shouldn’t be funding ‘rounding error’ surpluses in what must surely be the top half of the economic cycle,” Daley says.

The government has dropped hints its intended cuts will be slow-burn, ratcheting up over a decade. A senior government source says the changes will reflect a coherent attempt to improve the structure of the tax system, not just a politically motivated attempt to ameliorate bracket creep.

“I’d really be focusing more on the role of government, looking at areas of waste, and using any excess revenue to pay for tax reform,” says McKibbin, bemoaning the lack of proper tax reform since the Henry tax review in 2009. “Every budget cycle we see no long-term strategy,” he says.

There’s certainly plenty the government could do to improve the efficiency of the economy and cut personal tax. Closing off some or all of our byzantine system of tax deductions and using all the revenue to cut marginal tax rates would be a win for everyone except the legal and accounting professions. Tax Commissioner Chris Jordan has noted taxpayers claimed more than $22bn of work-related deductions in 2015, almost 12 per cent higher than in 2013. Incredibly, 6.3 million people made clothing expense claims totalling almost $1.8bn. More than 72 per cent of taxpayers filed with an agent in 2016, reflecting the complexity of the system or, less charitably, the scope for rorting it with the right advice.

Indexing the income tax thresholds to wage growth or the CPI would treat taxpayers with respect and provide small annual tax cuts for everyone. It would also be made much less fiscally costly in an era of ultra-low inflation and wage growth.

For all the talk about the Medicare levy this week, few pointed out its own shortfall — namely being an obfuscating fraud, without any link to the funding of any sort of health or disability care.

All taxes go into the same pot; none are hypothecated. The Medicare levy raised $15.8bn in taxes this financial year, while the combined cost of the pharmaceutical and Medicare benefits schemes was $34bn. Total health costs were $75.3bn. “By fostering the myth that Medicare costs taxpayers only a small percentage of their incomes, the levy creates the false impression that Medicare is a low-cost and affordable government program,” says Jeremy Sammut, a research fellow at the Centre for Independent Studies. A government that respected voters would ditch it altogether, folding it into the ordinary schedule.