The case for reform
By David Hughes
First published in the MRC’s Watercooler newsletter. Sign up to our mailing list to receive Watercooler directly in your inbox.
Of the seven fastest growing areas of government spending in the budget, all but two relate to health and ageing. Our ageing population has a vast impact on our economy. Our changing demographics mean more money needs to be spent delivering the services to support older Australians. At the same time, the ratio of workers to retirees changes and the tax burden on our working age population increases.
Twenty years ago the issue of our ageing population was front and centre of the national debate. Peter Costello thrust the issue onto the national agenda with the release of the Intergenerational Report in 2002.
Twenty years on and there seems to be less focus on the issue but the challenges are as real as ever.
There was an updated Intergenerational Report released in 2021 which didn't receive the attention it deserved. It warned that in 40 years’ time, the number of people aged over 65 years will have more than doubled and the number of people over 85 years will have more than quadrupled. In contrast, the number of people under 18 will have fallen.
Obviously, those under 65 are most likely to be paying income tax. The bad news for younger Australians (and our economy in general) is that our economy is becoming more reliant on income tax as a source of revenue.
Over the next decade the share of tax revenue the government receives from income tax is set to increase. Other sources of tax revenue such as company tax and the GST look set to decline or remain static.
We don't want an economy that is too reliant on income tax to pay for our essential spending programs. That's why the GST was a necessary reform. Prior to the GST, the government relied on income tax for around half of all receipts. This reliance on income tax fell to 42% after the GST was introduced. This improvement is set to be undone with income tax set to reach 48.4% of total receipts in the next few years. And it will continue to climb in the absence of reform.
Broadening our tax base through the introduction of the GST has made our economy more resilient, and less susceptible to shocks (such as increases in unemployment).
But there is worse news still for the working age population as a recent report from the Parliamentary Budget Office (PBO) demonstrates. Our budget isn't just becoming more reliant on income tax for revenue but the tax rate experienced by workers is increasing.
The average tax rate paid by workers looks set to hit an historic high of 27% in the next decade, as the table below demonstrates.
Aggregate average personal income tax rate, 1960-61 to 2033-34
Source: ATO Taxation Statistics, 2023-24 Budget, and PBO analysis.
There are modest reductions in tax rates still to flow through with the Stage 3 tax cuts. But they look set to be eaten up by bracket creep as people earn more and get pushed onto higher tax brackets.
No one can credibly argue that the Stage 3 tax cuts are too generous. Far from it. The PBO estimates these tax cuts will actually fail to address growing bracket creep.
In 2010, income tax revenue represented around 9% of our GDP. In the 2030's, income tax will have increased to over 13% of our GDP. The Stage 3 tax cuts will only lead to a 0.5% reduction in this measure — barely a blip. At the end of the day the proportion of revenue the government gets from income tax continues to climb disproportionately when compared to other taxes such as the GST and company tax.
The PBO outlines the extent of this problem:
‘For some people, especially those on relatively low incomes, bracket creep can reduce workforce participation. At higher incomes, bracket creep can strengthen incentives for tax planning and structuring. A high reliance on personal income tax can also leave government revenues vulnerable to changes in the composition of the economy. For example, the ageing population is expected to result in a decline in net taxpayers as a share of the total population. Many retirees pay little to no personal income tax because they have lower incomes and access to age-related tax concessions.’
We have a system in need of reform. As Howard and Costello knew, the longer you ignore these structural problems the harder they are to address.
We now have a tax system where the average tax rate paid by workers is at an historic high. And the share of taxpayers is declining coupled with rising costs to support an ageing population. This creates an inequality which needs to be addressed.
We need a government with the courage to take on the two key reform challenges in tax and spending. Continuing to prop up a tax system that's becoming less fair by the day and continuing to fund (but not redesign) ballooning welfare programs not only lacks foresight, it lacks compassion.
The next generation of taxpayers deserve a fairer system. And at the other end of the spectrum, the next generation of elderly Australians deserve a program of services that’s efficient, sustainable and guaranteed.