Tax levels are at a historic high, so where’s all the money gone?
TREASURER Wayne Swan ought to consider himself lucky as he starts the traditional pre-budget grumbling about the need for parsimony this year.
Despite the GFC’s impact on the economy during the past financial year or two, Mr Swan presides over the Treasury at a time of historically high taxation across the nation.
Compared to the reign of almost any other treasurer except perhaps his predecessor, Peter Costello, the rivers of gold have never flowed so fast.
The graph accompanying this column shows the historic highs that tax levels are now at, with the only comparable period being immediately after WWII, when the nation was trying to rebuild and the welfare state was emerging.
It is worth noting that this graph reviews tax as a percentage of GDP, so the major acceleration of the tax take around the 1940s would also reflect the need for government to fund relatively unproductive services such as the defence of Australia during the war.
In the same vein, Australia’s economy has grown at an extraordinary rate during the past decade (even avoiding technical recession during the GFC), which means that, even as the percentage of GDP has grown comparatively moderately (from 20 per cent to 30 per cent over about four decades), the quantum growth of the tax take has still been extraordinary.
In historic terms, our treasurer has never had it so good.
In fact, perhaps he ought to look at this graph and extrapolate what might come next (see ‘Trend or bubble?’).
The graph has been taken from a Centre for Independent Studies report entitled ‘Why does government grow’, a review of many of the theories that abound in this area.
One perplexing notion raised by the CIS study is that those who argue for smaller government and more efficient taxation methods (often one and the same) may have been checked by the surprising fact that tax reform has led to bigger government.
Nowhere is that more evident than in Australia, where dramatic tax reform has coincided with government growth for decades. This is an apparent win-win, or having your cake and eating it. As the nation has developed we have simultaneously become better off collectively and government services have grown. Whether this is sustainable or just a short-term development is hard to know.
Certainly, Australia was at or around the richest nation per capita in the world at the turn of the 20th century, when its tax take was much lower. But would we trade the advances in health and education, much of it delivered by government, to be back at the head of the pack? In a democracy that is clearly very difficult.
But what if we could argue our per capita wealth would be greater if the tax take was lower? What if economic growth had been greater in a lower tax environment, such that the quantum of actual tax take was the same or higher than it is today, even if tax as a percentage of GDP was lower? In other words, could we have those services and be richer?
Have those tax reforms provided rising revenues to allow government to simply expand and consume those funds, paying ever more for things that might seem laudable but which we could do without, or pay for ourselves?
Would we not have been better off with a lower tax rate that constrained government spending?
The GST is a good example where the sales tax net was spread more widely and was therefore seen as more efficient.
The fact that it has occurred at a time of staggering economic growth means we don’t know if it has been a drag on the economy. In fact, it was introduced at an economic low point so how do we know if it stunted growth afterwards?
Furthermore, many in business might argue that the GST didn’t just raise more money for the state, it also shifted the burden of tax collection to business, therefore taking it off government books and placing it with the private sector. If the cost of GST collection and administration to business was added to the size of government it could well change this graph dramatically.
In my view, whether or not reforms that were more efficient and less distorting also helped the government raise more money is not important. It doesn’t shy away from the point that federal coffers are taking relatively more than they ever have in historical terms.
That suggests Mr Swan has plenty of money to spend, he just doesn’t know how to stop spending more of it.
Trend or bubble?
THE word ‘trendy’ used to be a popular term to describe something that was suddenly fashionable.
These days we’d call it a fad.
Trendy was a horrible bastardisation of the word trend because the short-term nature of the fashion shifts it sought to describe seemed to go against the definition of the root word from which it was derived.
Trend meant a general direction in which something was developing or changing. The word itself, it appears, was first used by economists in the late 19th century as they started to develop their field.
I learned a bit about this listening to leading econometrician from Yale University, Peter Phillips, who delivered a lecture entitled ‘Exploring the Mystery of Trends and Bubbles’ at the University of Western Australia.
While many of the theories touched on by Professor Phillips (in his still noticeable New Zealand accent) went over my head, he did bring much of his thinking back to simple terms by using an approach popularised by Steven Levitt and Stephen Dubner in their book Freakonomics.
For instance, using the data taken from prehistoric sources such as the Vostok ice cores, he showed how time periods matter when it comes to discovering trends in global temperature. He also showed how hard it is to model such things.
Bubbles are even harder to model, but Professor Phillips has been working on econometric modelling that might at least flag when a bubble is under way and when it has officially ended.
He suggested there was a human need to bring order into chaos by drawing a line through it – something we all do automatically when we look at a graph or a scatter diagram.
I was intrigued about how he would view the graph used to illustrate this column.
It shows the tax take as percentage of GDP. Interestingly, there is one particular point after WWII when it rose sharply, hit a peak and then dived.
Could this be a bubble? A period when government exuberance for tax collection ran out of control until other forces in the market arrested it – like an election perhaps?
While growth in the percentage rise has steadied since the period starting in the late 1930s and ending around 1950, the upward trend is still steeper after that period than it was beforehand.
Are we seeing another bubble ending? Or does tax representing 30 per cent of GDP represent some sort of barrier that government can’t get past?