Picture: Aaron Francis. Source: The Australian
The government wants to prepare Australians for major changes to the taxation system and there is a strong consensus towards raising the goods and services tax and cutting personal income tax.
As per the current status quo, Australians' standard of living is threatened by weak productivity growth, falling commodity prices and an ageing population. Without significant changes in the May 13 budget, the government would still be in deficit by 2023-24 and almost $25 billion in today's terms short of the government's surplus target of 1 per cent of gross domestic product. That doesn't include the Coalition's aspiration to increase defence spending by $32 billion.
By 2023-24 spending on health will have risen 79 per cent to $116 billion a year; pension payments will cost an additional $39 billion a year and the National Disability Insurance Scheme another $11.3 billion.
The government's challenge is to cut income tax - to encourage people to keep working as they enter high tax brackets - and to close the gap between expensive policies and weak tax revenue.
To do this, it has been argued that Australia should rely more on indirect taxes like other developed nations do. Australia's mix of tax collection hasn't changed much since the 1950's. Research consistently says that reduced reliance on income taxes and increased reliance on other, more efficient sources of revenue, including indirect taxes, can support higher growth and high living standards.
Without making these vital changes, we may as a nation become increasingly vulnerable to the next global crisis.
Furthermore, the Treasury has advised the government that the budget is in dire shape and big policy changes are needed if living standards are to improve much.
However, it has also been argued that the budget isn’t in crisis and the government is simply creating angst over spending to justify ideologically motivated spending cuts.
For the budget to be repaired through growth alone, the economy would need to expand by a massive 5.25 per cent a year to return to surplus within five years. Such a staggeringly high rate of growth would be around 40 per cent quicker than average and the biggest increase since the 1960's. It is also likely to generate a massive inflation break-out after only a year and send official interest rates sky-rocketing.
Even current projections for no surplus within 10 years assume Australia will have 33 years of uninterrupted growth. Excluding Japan, the nearest among developed nations was the Netherlands, which grew for 26.5 years from 1981 to 2008 on North Sea oil exports.
The second assumption was that personal income tax receipts would be allowed to surge through fiscal drag, where wage inflation pushes workers into higher tax brackets. This implies there would be no personal income tax cuts for another decade, something that wouldn’t be politically feasible and would hurt the economy by driving more people out of the workforce as their marginal and average tax rates surged.
Undermining the budget outlook is the reality that commodity prices will continue to fall in the coming years, just as a wave of baby boomers hit retirement, pushing the ratio of workers to retirees to 2.7 in 2050 from 5 in 2010 and 7.5 in 1970.
Labour productivity is also unlikely to offset the falling terms of trade or ageing population, crunching income growth to about a third of the rate Australians have become accustomed to. These threats will inevitably widen the gap between community expectations and what governments could realistically do, as well as the cost of those services.