A short-term deficit levy plug does not fill a long-term hole

The mooted “special deficit reduction levy” unveiled in last weekend’s kite-flying exercise reeks of cynical political calculation, but whatever one thinks of the politics of it, the economics are lousy.

Let’s call a duck a duck; whatever labels the spin doctors put on it, this is nothing but an income tax increase. Past levies have been given the fig leaf of a special purpose (Medicare, gun buyback, Queensland floods), but this one doesn’t even have a fig leaf to hide behind. It would raise general revenue and would contribute to deficit reduction no more than do any of the other billions the federal government will collect next year.

The political calculation is that the government must get some early deficit reduction runs on the board and that in doing so it must be seen to hit the rich. An income tax rise is fit for purpose because it can be implemented quickly and as a percentage of income it takes more dollars from higher incomes.

Spending cuts tend to be slower to implement, but still the government could, if it wanted to, make some early inroads by making spending cuts with effect from the coming financial year or the next. Its political problem is that it hemmed itself in so much last year with election pledges not to make this or that change in its first term. An income tax increase would also violate an election promise, but sadly in an advanced social democracy such as ours the politics of taxing and spending are such that across-the-board tax increases are easier to get away with than sectional spending cuts.

Liberal politicians and advisers with long memories are no doubt aware of a perfect precedent for their mooted tax hike. In 1978 the Fraser government imposed a temporary 1.5 per cent income tax surcharge for no purpose other than to hasten the shrinkage of a stubborn budget deficit. The cynicism was even more breathtaking then than now, because the surcharge came hard on the heels of the 1977 election in which Fraser had made income tax cuts a major issue. (For the record, the deficit did shrink, helped by a mini resources boom, and the surcharge was removed before the 1980 election, which Fraser won with a much-reduced majority.)

Leaving aside the politics, a temporary tax hike lacks economic merit. In a recent discussion of budget options with colleagues, I ridiculed the possibility of a temporary income tax increase; the government, I thought, could not be so daft as to suggest a time-bound solution to a fiscal problem that extends as far as the eye can see. There is a structural gap (for all intents and purposes permanent) between expenses and revenue, which calls for a structural solution.

Getting some early runs on the board is important, but mapping a credible path to a balanced budget over several years is more important.

A temporary tax increase makes no economic sense. It makes no difference to what the deficit will be after the increase is removed. The economy does not need short-term cooling. And even temporary tax increases have long-lasting disincentive effects as they detract from the predictability and stability of the tax system that is so important to private sector decision making.

If tax increases are to be part of the solution to the budget problem, they should be permanent, and it is always possible that a temporary increase will be made permanent – not that I would advocate it. The appropriate balance between spending cuts and tax increases comes down to whether the fiscal gap reflects too much spending or too little revenue. There is a strong case that excess spending is the problem; Commonwealth spending as a percentage of GDP is projected to increase to historically high levels, while revenue will be at historically normal levels.

If taxes were to be increased, income tax would be the worst place to start. Australia already depends too heavily on it, and that dependency is increasing steadily with bracket creep. All taxation comes at an economic cost, but the evidence says that for income tax, the cost is relatively high, particularly starting from the high marginal rates we already have.

Depending on how an increase is structured, together with the hike in the Medicare levy already scheduled for July 1, a further increase could easily take the effective marginal rate for an average wage earner to 37 per cent, and the higher rates to 40 per cent and 48 per cent. This would expose the Prime Minister’s statements about the value of enterprise and work effort – repeated just this week – as nothing but empty rhetoric.

It is to be hoped that in the days that remain for budget decision making, the government hears this message and abandons any thought of an income tax increase, temporary or permanent.

Robert Carling is a senior fellow at The Centre for Independent Studies.