Inter-Generational Tax Inequity

Tax Day New York. April 17, 2012

Written by Leith van Onselen and cross posted from Macrobusiness.

Business Spectator’s Rob Burgess wrote a great article over the weekend arguing how the current structure of Australia’s Budget risks generating a generation of tax slaves, as younger generations are forced to pay more tax (and consume less) in order to pay for the generous entitlements and health care provided to the old. Accordingly, widespread reform of the tax and expenditure system is required, in order to both return the Budget to a more sustainable footing and to restore inter-generational equity:

…The NDIS, pension increases and general health spending will disproportionately benefit retirees – when you get older, sickness and disability increase. The paradox is that there are major holes in the current tax base that older Australians enjoy.

The main one is the tax concession older Australians make the most use of close to retirement – so called ‘super tax concessions’…

On the other side of the coin, the same retirees love the super tax concessions they got in their last few years of work. They love that their primary residence (the house they’ll leave to the kids) is not part of the pension asset test, and that by spending superannuation dollars on it they’re channeling low-tax dollars to their children’s inheritance and hastening the day they’ll get a chunk of pension income.

That impossible tension cannot last – voters loving both their tax concessions and the benefits the missing tax dollars would have helped pay for…older Australians will have to be convinced that the argument of “it’s my money, so hands off!” must be followed by the corollary “so please tax my children more!”

Burgess’ arguments are broadly in line with views expressed by me on this blog (for example, see here).

According to the Grattan Institute, without corrective action, the Federal Budget deficit could hit $60 billion per year by 2023, or up to 4% of GDP, due mostly to rising health and welfare costs. Current welfare policies also overwhelmingly favour the elderly at the expense of the young – an unsustainable situation in light of Australia’s rapidly ageing population, which will see the ratio of working-aged Australians supporting dependents (mostly the aged) trend lower, slashing the tax base at the same time as age-related outlays expands.

Two of the biggest and fastest growing areas of Budget expenditure – the aged pension and superannuation concessions – are at the heart of the problem. Both are incompatible with Australia’s rapidly ageing population. More importantly, they are both poorly targeted, providing too much assistance to those on high incomes and/or with substantial assets (see here).

As such, reforms are desperately required to improve the integrity, fairness and sustainability of the retirement system, including:

  • Increasing the eligibility age for the Aged Pension to 70 years (from 65 currently and 67 from 2023);
  • Increasing the access age to superannuation (from 60 years currently) so that it more closely matches the pension access age;
  • Reducing the ability to draw superannuation as a lump-sum;
  • Providing everyone with the same superannuation concession (e.g. 15%); and
  • Including one’s owner-occupied home (or part thereof) in the assets test for the Aged Pension and/or reducing the eligibility thresholds for income and financial assets, so that welfare flows only to those in genuine need.

That said, even with bold reform in the above areas, the Budget is still likely to remain in structural deficit given the shrinking tax base and rising health expenditures, requiring increased taxes. In fact, according to The Australian today, Australia’s ratio of tax-to-GDP of 28% is 9% below the OECD average and are also 3% below where they were in 2007. With the proportion of workers across the economy trending lower as the baby boomers retire, along with falling tax revenues as the terms-of-trade declines, the tax take is likely to fall further without reform.

Raising the rate of GST and/or broadening its base is an obvious solution. The Henry Tax Review showed that GST is relatively efficient. It has a relatively low “marginal excess burden” (i.e. a small loss in consumer welfare relative to the net gain in government revenue), because it is broadly applied, is difficult to avoid, and does not significantly distort behaviour (see next chart).

ScreenHunter_97-Sep.-26-08.53

Another option is to tax rents on land and natural resources via a combination of land taxes and resource rent taxes. According to Prosper Australia, economic rents comprise 23.6% of GDP. When these economic rents are not taxed they are privatised and constitute a free lunch for some that underlies increasing inequality. A classic example, as highlighted today by Ross Gittins, is the mining sector which, because it is 80% foreign owned and employs few workers in the production phase, sees Australians benefit little from the exploitation of our fixed resource endowment.

Taxes on rents are also highly efficient. As shown above, the Petroleum Resource Rent Tax (PRRT) creates zero distortions, since it is applied to a tax base that is completely immobile. While not shown above, a broad-based land tax would have similar efficiency to the PRRT and municipal rates, again because land is completely immobile.

Any discussion about tax reform, therefore, needs to also include implementing taxes on rents, along with increasing the rate and broadening the base of GST.

2 Comments

  1. THEO20-03-2014

    I would rather have hoped this report would emphasise more the introduction of a land tax and incentives for us to work more and longer by reducing direct taxation and the getting rid of so many tax laws and loopholes like negative gearing and allowing superannuation to be used for investments etc. rather than equally emphasizing on making the majority of Australians being forced to make more sacrifices again.

  2. Karl Fitzgerald
    Karl Fitzgerald20-03-2014

    Yes Theo – I dare say you are talking about the Grattan report on tightening super access for retirees. They have mentioned the need for land taxes in other reports, though it would be nice to see in every report!

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