The wider landscape for the tax-spend argument

Peter Costello has opened a window on to the bigger landscape in which economic policy will in future have to be set. He has put two businessmen to report on whether Australia is overtaxed — and tossed Asia and flat tax into their pot.

Sir Roger Douglas had a go at flat tax in 1988 but lost. In 1999 Helen Clark embedded the progressivity principle.

The context for Costello’s inquiry is his and John Howard’s promise of more personal income tax cuts this year.

Flat tax is most unlikely. Costello has been defending his 47 per cent top personal rate (8 per cent above the top rate here) on the ground that from July this year only 3 per cent of taxpayers will pay it.

By contrast, more than a tenth of taxpayers here now pay the 39 per cent rate and bracket creep is gathering momentum as a result of inflation and a tight labour market pushing incomes above the $60,000 threshold.

Michael Cullen defends his rate and threshold — and has even put his partial threshold adjustment in 2008 under threat — as necessary to meet demand by various publics for roads, hip operations, an army, a large education system and much, much else. Failing to meet that demand, he says with justification, is a ticket to the Opposition benches.

Don Brash pinpoints the deeper problem with this cake-and-eat-it argument: snappy young graduates, aspiring professionals and managers and people with just about any skill can take home higher pay across the Tasman. Lose too many of those people and the economy can’t generate the growth, and consequently tax revenue, to keep up to first-world standards the services voters demand.

Brash’s answer: give back a slab of tax, thereby increase take-home pay and narrow the Tasman gap. Fewer would be tempted west. Moreover, theory tells Brash economic growth would be faster and first-world services more affordable over time.

The 1990s stand witness: productivity growth doubled, creating the wherewithal for Cullen and Clark to expand services. Labour’s election 2005 win was partly due to their lavish spending promises — coupled with claims, believed by some voters, that National’s tax policy would create a structural fiscal deficit and force cuts in government services.

But Labour’s election auction bids and the post-election deals with Winston Peters have created for Cullen his own imperative for fiscal restraint.

He is confining state agency CEOs to 2005-06 spending baselines for the 2006-07 fiscal year — that is, roughly a 3 per cent cut in real terms — and has set in train a swag of “reviews” of agencies to root out inefficient or ineffective spending.

And his large and varied taxation work programme, which goes well beyond the “bold” business tax structural review, essentially has to be fiscally neutral, at least in the near term. (Last year’s soon-to-be-passed bill, which returns hundreds of millions of dollars to business by being more generous on depreciation, fringe benefit tax and the like, is outside this calculation.)

Fiscal neutrality requires any cut in the 33 per cent headline company tax rate to be offset with other revenue. Hence, the musing about a payroll tax, which Australian companies pay along with other imposts absent here in addition to their 30 per cent rate. All sorts of combinations are conceivable in theory on that basis, including compulsory superannuation subsidies, which Australian companies pay and which could conceivably be tacked on to KiwiSaver in future.

In 2004 the Treasury advised Cullen that allocating half of superannuation spending to a payroll tax of 5.4 per cent would allow a company tax rate of 20 per cent — 7.2 per cent and 15 per cent respectively if super fund contributions were included. That’s bold, on both fronts.

The theory is that a low headline company tax rate, even offset by indirect or payroll taxes, might encourage more foreign productive investment and so help Cullen out of the stall in productivity growth improvement. Only productivity growth can sustainably lift the real standard of living.

But squint a moment at Costello’s more distant horizon.

Cullen defends his tax take as not excessive compared with the OECD average. Fine for now, perhaps, and Cullen is approaching retirement.

But look out 10 or 20 years and factor in Asia and eastern Europe generating an expanded share of the world economy. Their populations are not used to generous state services, as western Europeans are.

Perhaps they will acquire western European appetites and tax takes to match. Conceivably, that might halt the long downward competitive pressure on average tax takes and allow us to keep our tax take level and still be competitive.

But what if instead they keep their tax takes low?

In that event, as they gained weight in the world and thus more economies matched or bettered ours, our tax take would become significantly higher than the average tax take in economies — and societies — against which we measure ourselves.

That is the world on which Costello has opened a window. Of course, he won’t do a flat tax this year. Neither will John Key propose one here. A modest tax cut will be his lot.

But 10 or 20 years on who knows where the competitive argument will lie? If we are to stay with the pack, there may be some tough strategic thinking to do. When do we start?