Michael Brennan, the CEO of the e61 Institute, recently laid out the arithmetic on the fiscal trainwreck that Australia is ever-so-slowly heading towards. Basically, the tax to GDP ratio has to rise to pay for all the spending commitments our governments have made. But the big fish (high-income earners) are essentially tapped out, and low income earners will face higher effective marginal tax rates due to benefit phase-outs, which disincentivises them from working and limits the revenue that can be raised from them.
As Brennan concludes:
“At some point, policymakers will face the stark choice: either find a second workhorse, or lighten the load.”
Michael Brennan is no fool. Notice the two choices he offers here: raise taxes other than on incomes – for example, by raising the GST (a more efficient consumption tax) – or cut spending.
But the longer I’ve thought about that choice set, the more inclined I’ve become to reject it entirely.
Let’s just think about the tax mix change for a moment. In theory, we – Australia – could easily reduce the deadweight losses that taxes impose on us, enabling the government to pay for its various commitments without raising society’s overall tax burden.
That sounds great, right? And it’s almost certainly what the economists at Treasury, and perhaps the e61 Institute, are suggesting the government does.
What economist doesn’t like a bit of tax reform?! I’ve personally argued for it on these very pages (along with the need for fiscal rules!).
But the longer I’ve pondered the issue, the more fond I’ve become of the existing, inefficient income tax bracket creep model on which many successive governments have relied to pay for their various promises—the very model that is going to eventually lead to the fiscal trainwreck about which Brennan cautioned.
Why? Because without also doing institutional reform – that is, imposing some kind of binding constraints on future spending – what’s to stop the next round of politicians from simply cranking up the amount they tax until the tax burden equals what it is under the existing model?
To be clear: I’m not arguing that deadweight losses don’t matter. Moving from income taxes to consumption taxes would, without question, make the economy more efficient. That is, we would have more investment, workers would face better working incentives, and we’d all be materially better off. Any economist worth their salt would tell you the same.
What I’m arguing is that the political economy benefits of the income tax’s visible pain outweigh the static efficiency gains from tax reform, unless it’s also paired with institutional reform to restrict total spending. An inefficient tax system that forces politicians to confront spending constraints is better than an efficient one that lets them kick the can down the road until we become no better than your average basket case European nation. We need the crisis that bracket creep creates, precisely because it’s a crisis that can’t be ignored.
Now, Michael Brennan is probably all-too aware of such political economy issues; after all, his old man, Geoffrey Brennan, “collaborated extensively with Nobel Prize winner James M. Buchanan and became the first non-American president of the Public Choice Society in 2002”.
Perhaps that’s why he abstained from making any actual concrete recommendations; Brennan must know that tax reform alone is futile at stopping Leviathan. Indeed, tax reform without fiscal rules is like giving an alcoholic a better-tasting drink: it might be more pleasant, but it does nothing to address the underlying addiction.
So, until I see a genuine commitment to binding fiscal rules, I’ll take a tax system that is visible, painful, and prone to the trainwrecks about which Brennan cautions over the alternatives, no matter how efficient they may be at raising revenue.