Only two tax cuts count – a cut in the top marginal rate or a cut indexed against average weekly earnings.
All other tax “cuts” are temporary respites until inflation and increases in average weekly earnings restore the Government’s grab. They are lollipop tax cuts – colourful and sweet-tasting at first, but quickly eroded to nothing.
The talk this week – after the announcement of a bigger surplus than expected — was for a tax cut for only some of those on the top marginal rate. There was no mention in a permanent cut in the top marginal rate itself. The spending side is also interesting, but more of that anon.
When the Howard Government came to office the top marginal rate cut in at about 1.5 per cent of average weekly earnings now it cuts in at 1.3 per cent. So Prime Minister Howard is talking about moving the threshold at which it cuts in from $62,000 to $75,000.
Lollipop cuts. If average weekly earnings rise by 5 per cent a year, it will take just four years for its effect to be gone. If they rise by 4 per cent it will take just five years.
But politicians like to hand out lollipops. Only Paul Keating a Treasurer had the ticker to cut the top marginal rate – from 66 per cent to 48.5 per cent. It is one of the reasons that Australia is doing well economically.
The company tax story shows why the top marginal rate should be cut across the board – not just for those under $75,000.
Treasurer Peter Costello only has the extra surplus because company-tax revenue was high. Companies are paying more in total since the rate was lowered from 36 per cent to 30 per cent. Sounds odd, but true.
It would be the same with income tax. The 48.5 bracket could be cut out leaving the top marginal rate at 43.5 per cent. That would notionally cost $3 billion. But incentives to earn more and reduced incentives to avoid would probably result in an increased overall take.
It would put Australia in better international company. High-taxing European economies are in the doldrums.
Raising the tax rate does necessarily not produce more revenue. Up to a point, lowering it produces more economic activity and more revenue.
But it won’t work politically. Axing the top rate would result in a 5 per cent tax cut for everyone earning over $62,000. The simplistic argument that someone on $1 million a year would get a tax cut of $50,000 is political dynamite. But people on $1 million a year do not behave like PAYE wage slaves. They can move money and income about. A top marginal rate of 43.5 per cent would make Australia a more attractive place to declare income.
The GST is another reason to cut the top marginal rate. This week’s figures showed that sole traders and partnerships are contributing more income tax. Many of these people are also the hardest hit by the GST. Big manufacturing companies have large GST inputs so get back a large portion of the GST they pay. But those who use labour and brains to deliver services do not have large inputs so they shoulder most of the GST burden themselves. The GST is in effect a 10 per cent tax on their income – less only a tiny bit of credit for GST paid on inputs. When these people tender for a job, the tenderees look at the total package and do not isolate the GST. In effect, these sole traders have a marginal tax rate of up to 58 per cent. It is a bit like the difficulty at the other end of the scale where people on welfare who try to get back in the workforce face an effective marginal rate of 60 per cent as they incur tax and lose benefits.
On the spending side, this week’s budget outcomes reveal some surprises.
You might think that the Howard Government has screwed welfare, health and education and squandered money on defence. Not so.
Over the period of the Howard Government, the percentage of outlays spent on defence has hardly budged – from 7.1 per cent in 1995-96 when Bomber Beazley was Defence Minister to 7.2 per cent now.
But the Howard Government has substantially increased welfare spending – both in real terms and as a percentage of outlays. Welfare has gone up from 34.7 per cent of government outlays in 1996 to 41 per cent now. Overall outlays have gone down slightly as a percentage of GDP – a couple of percentage points, but GDP as a whole has gone up by a much greater percentage, so overall spending has gone up. Health has gone up from 13.7 per cent of outlays to 16.6 per cent. So it is a myth that the Coalition has squeezed health and welfare at the expense of defence. Education has only gone down a little as a percentage of outlays – from 7.8 per cent to 7.1 per cent.
I use the percentage-of-outlays measure because it reflects government priorities. Billions of dollars become meaningless after a while.
So how has the Howard Government increased health and welfare? Fiscal responsibility, that’s how. In Labor’s final year, its outlays were 27.2 per cent of GDP, but revenue was just 25 per cent. For years Labor was on the wrong side of Micawber’s equation. And ended in misery.
In Labor’s final year, it was forced to waste 6.9 per cent of outlays on interest payments.
In 1996, the Coalition hacked the outlays back to just over 24 per cent of GDP and paid back the debt. We all squealed. But now, instead of interest payments swallowing 6.9 per cent of outlays, it goes – surprisingly – to welfare.
The irony is that the more Labor sought to spend on welfare, the more it ran up debt and interest and the less it had to spend on health and welfare. Further, if Telstra had been privatised the Government could have wiped its debt completely. The new shareholders would have copped losses and welfare, health and education consumers reaped the benefits. But that sound argument, alas, is no match for dogmatic ideology.
This week’s figures show the benefits of governments resisting the temptation to go into the red and the benefits of getting economic fundamentals right so a buoyant economy can deliver good revenue.
Pity that the side of politics that manages the economy so well can be so heartless and visionless with the 3R policies which cost nothing (refugees, republic and reconciliation).