Monday, May 11, 2015

How to eliminate government budget deficits with some simple efficiency-based tax reforms

I recently became awarec that each year the Commonwealth Government publishes a tax expenditures report that details the tax exemptions, deductions or offset concessional rates as well as deferrals of tax liability.  A colleague told me that state governments publish similar documents for tax expenditures associated with land tax, payroll tax and the non-taxation of non-profits. I have not yet checked these out.

A tax expenditure is a bit of tax the government could grab but it does not - it foregoes the tax. It is just like government spending in terms of its impact on the budget deficit. They increase the deficit. Actually more than a "bit" . Huge amounts of foregonee possible tax revenues arise:

  • Exemptions of capital gains-tax on family home $25b
  • Exemptions on residences previously lived in  $20.5b
  • Concessional tax on superannuation $16.3b

These alone would boost the total tax take by 12% and obliterate the deficit.   These tax expenditures have grown dramatically over the paast few years because of the property booms in our capital cities. Getting rid of housing exemptions would reduce property prices and leave our children better-off.  Over-investment in housing would give way to more productive investments in other areas.

Generally even without adding to tax income the fewer these types of exemptions therec are the smaller are the excess burdens (deadweight losses) of the taxesc that remain. Big taxes impose disproportionatetely large inefficiency costs - roughly they are proportional to the square of the tax size.

Apart from income tax deductions there are also exemptions from the GST - Australia compared to NZ which does have a broadly based GST has  40% less coverage. Some big items here:

  • Exemptions of food from GST $6.4b.
  • Exemption of education $3.9b
  • Exemption of health services $3.6b etc etc.

There are plenty of opportunities to resolve our fiscal difficulties if politicians had the guts and stamina to approve such changes. They won't in the foreseeable future.  We are timid of even modest cuts in childcare benefits! A basic principle of Australian policy (a version of the Pareto Principle) - no policy should be undertaken unless it disadvantages no-one.  There are no such policies so we will do nothing!


  1. I am in agreement with most of this BUT you cannot implement all of this because of the contractionary effect on the economy. You have a weak economy at present. you do not want to make it weaker.

    You simply implement it in stages.

  2. I'd prefer to introduce these measures, cut income taxes, eliminate company tax and raise the GST. A bold package that would create armed conflict in Australia!

  3. Harry,

    You have to be careful.
    Cutting taxes is all very well but if no cut in spending then you create a structural deficit just like Costello did and Swan continued.

    Changing the tax mix will have only a very limited effect although there would be efficiency gains.

    I would have short term stimulus via infrastructure spending but medium term budget consolidation as per above.

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