The Case for Increased Taxation
By Michael Keating

Occasional Paper 1/2004 , Policy Paper #1

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A civilised society depends upon taxation. At present, Australian policy is confined by a taxation ceiling which is essentially arbitrary. This Occasional Paper, the first in a series of policy papers commissioned by the Academy of the Social Sciences in Australia, discusses the need for a more balanced appreciation of the future needs for taxation in our society.

Many other developed countries have higher levels of taxation than Australia, and international empirical evidence does not suggest any direct connection between present levels of taxation and economic growth. Nor does the empirical evidence suggest that taxation is greatly affecting the supply of labour or capital. Ironically, the combination of taxation and the withdrawal of means tested family payments results in low-income families facing the highest marginal tax rates. However, any attempt to rationalise means tests would increase the overall level of government outlays and taxation. The experience within the United States and Europe also suggests that the mobility of labour and capital in response to different levels of taxation is still not very significant. Equally important is how the revenue raised is spent.

This paper suggests that any future taxation target should focus on the predictable future expenditure needs of our society. Although there have always been claims of unmet need, the key pressures for additional public expenditure may well be of a different order over the next few decades. For instance, the Treasurer has drawn our attention to the possible implications of an ageing population for government outlays over the next forty years. In fact health will be the main source of upward pressure on age-related expenditures. But spending more money on improvements in medical technology that improve the quality of life, may well represent a rational decision by a society with rising per capita incomes.

The other principal source of expenditure pressure discussed is the need for increased expenditure on education and training in response to the changing composition of the labour market in favour of skilled jobs. This changing composition of jobs is the main reason why earnings have become more unequal. In addition, employment participation by men aged 45 to 64 has fallen by twenty percentage points. Retraining these men is not only vital to maintaining an egalitarian society, it could largely pay for itself in the long run by fostering faster economic growth.

Overall, when combined with other sources of spending pressure on the natural environment, public infrastructure and national security, total government outlays (Commonwealth and State) could increase by as much as 10 percentage points as a share of GDP. Nobody has suggested how to make offsetting savings of this order of magnitude. Moreover, most of the easy savings options have been taken up already, and policy decisions by the Commonwealth Government since 1990-91 have resulted in a net addition to government outlays.

A critical issue examined by the paper is peoples’ willingness to pay higher taxes to finance these expenditure demands. The paper argues that there are several ways of improving the connection between taxes and the services that are financed, including:

• public spending must be tightly controlled and any return to a ‘tax and spend’ approach will meet with continued taxpayer resistance;
• earmarking taxes to finance specific expenditures can make it easier to raise those taxes;
• environmental and ‘sin’ taxes may be easier to raise;
• devolution so that the public has more say in how the money is spent.

The main alternative to increasing taxation to pay for the projected demand for public services would be privatisation of more services and an increase in user pays. Charging the beneficiaries of a service has a long history in Australia and is often considered to be fair. But a substantial change along these lines would imply a narrower concept of citizenship than has traditionally applied, and it would tend to change the nature of our society.

There is little doubt that if the present size of government was considered to be about right twenty years ago, it should not altogether be a surprise that taxation might rise in the future, given the nature of the challenges that our society is facing. For the last two decades, economic growth has been founded on the rapid adoption of new technologies and the opening up of our markets to competition. Fiscal intervention by the government is equally necessary to help those adversely affected by economic change to adapt and maintain their participation in a fair society that protects the quality of life for all Australians.

The problem with treating the present limit to taxation and spending as sacrosanct, without any serious consideration of what that implies, is that we are more likely to distort our abilities to manage our future priorities. Unfortunately the resulting tensions, including from ‘broken promises’, may in due course then lead to increasing disillusionment with our system of democracy, and that is something no society can afford..

Dr Michael Keating AC, Visiting Fellow, Economics Program, Research School of the Social Sciences, Australian National University. Dr Keating is also an Adjunct Professor in the Department of Politics and Public Policy at Griffith University and former Secretary of the Departments of Employment and Industrial Relations, Finance and Prime Minister and Cabinet. His principal research interests are the integration of social and economic policy, factors which are affecting our governance, and the changing relations between the citizen and the state