Perfect taxes exist only in Rainbow Land

In life it’s better to aim for the imperfectly possible than the perfectly impossible. So it is with tax reform. Government ministers have been promising a tax reform package that results in lower taxes at a time when the mid-year fiscal outlook is certain to confirm an ocean of red ink extending over the horizon and into the Pacific Ocean. As disciples of the discredited Laffer curve, these ministers might hope to claim a growth dividend from lower taxes to lift the overall revenue take but a credible Treasury will not count Mr Laffer’s mysticism in its revenue projections.

The Abbott government’s promise of lower taxes and a return to surplus was born in Rainbow Land. “Not so”, say the government’s hard right MPs, “Lower taxes and a return to surplus can readily be achieved by spending cuts.” How savage would such cuts need to be? Further falls in iron ore prices continue to hammer the revenue forecasts. So will the Prime Minister’s laudable termination of the Hockey budget’s pretence that the economy will magically achieve 3.25 per cent annual growth in two years’ time. As we leave Rainbow Land and return to Australia, the spending cuts needed to return the budget to surplus would make Joe Hockey’s vicious 2014 budget look like a cuddly pussycat. They wouldn’t have a hope of getting through the Senate. And they would render Malcolm Turnbull’s prime ministership terminal. It’s a good plan for disaffected Abbott supporters. Labor will be keenly hoping it is announced.

Advocates of cuts in the company tax rate and in the higher marginal rates of personal tax are urging Turnbull to finance them by hiking the GST rate to 15 per cent and removing the exemptions on fresh food, health and education. They argue that the $65 billion revenue boost would be sufficient to compensate lower income earners, fund the growth in state health and education services, cut the small business tax rate to 25 per cent and abolish state payroll tax.

This sort of big bang approach of a 15 per cent GST rate and no exemptions was Hockey’s plan. In the terminology of opposition party secretaries, it would be ‘highly campaignable.’ That is, a government that took the Hockey plan to an election would be smashed. Remember, the Howard government received 48.5 per cent of the vote in 1998 promising to introduce a 10 per cent GST. The Australian public would be deeply cynical about a 15 per cent GST with no exemptions. An electorate thoroughly disillusioned with Canberra’s political antics would greet with scorn and derision any promises of full compensation by a cash-strapped government.

Recognising that we live in neither Rainbow Land nor in the hard right’s nirvana of privatised health and education systems, these are the five defining features of a socially acceptable tax reform plan. First, in an ageing population and where we will not deny younger Australians the benefit of advanced medical technologies and medicines, any tax reform plan must be capable of generating sufficient revenue to fund the services that people reasonably expect of governments. Second, while not every component of the tax system must be progressive, overall a reformed system needs to be seen to be fair. Third, taxes that do not act as a heavy drag on economic growth should be preferred over those that do so. Fourth, compliance should be easy. Finally, there’s not much point in tax office administration that spends almost a dollar to collect a dollar in revenue.

Overarching these five these tests is the sound economic principle in tax design of widening the base to lower the rates. This guided the Hawke-Keating 1985 reforms, which repaired holes in the income tax system by introducing a capital gains tax and a fringe benefits tax to fund cuts in the higher personal rates and the company tax rate. Applying this principle, proponents of top-end tax cuts and a company tax rate reduction should support new restrictions on negative gearing and at least a reduction in the existing capital gains tax discount. Expecting the poor and working Australians to pay more GST to fund a company tax rate cut and lower taxes on the wealthy would be ‘highly campaignable.’