Economics
We’re undertaxed and underserviced
Two experts put a compelling economic case for higher taxes: there are three ways higher taxes can be politically palatable.
A nation that already taxes its citizens lightly cannot go on delivering labour-intensive public services for an ageing population, increase defence spending, sustain spending on infrastructure, and maintain reasonably tight control on public finances, without collecting more public revenue.
That’s basic fiscal arithmetic. It’s also a simple explanation of the contradiction in the Liberal Party’s (implicit) promise to do all those things, and to deliver tax cuts into the bargain. We might call it “Taylor’s impossibility theorem” out of respect for its learned author.
This impossibility is explained in a Saturday Paper article – Liberals’ tax delusion – by Stephen Bell of the University of Queensland, and Mike Keating, former head of the Department of Prime Minister and Cabinet and the Department of Employment and Industrial Relations.
Bell and Keating expose the humbug about the Liberals’ claim to be responsible fiscal managers when they are in office. (In fact in a gross conflation between fiscal and economic management they even claim to be sound economic managers.)
Their most important message is about the need for a public sector capable of providing services that the private sector cannot provide, or cannot provide so well as the public sector:
… lower taxes and smaller government are not good for our society, economy, nor even our democracy. Taxation is how we pay for needed services and infrastructure that typically do more for our wellbeing and productivity than a lot of private expenditures.
For a longer version of this basic principle you can turn to a textbook on public finance, or to Miriam Lyons’ and my 2015 book, Governomics: Can we afford small government? In that book we point out, as Bell and Keating do, that there is no economic virtue in “small government”. There are countries with small governments and poor economic performance: some are on their way to becoming failed states. And there are countries in Northern Europe with large governments and very successful economies. The idea that there is some intrinsic economic virtue in “small government” is Liberal Party bunkum.
Although Australia is one of the lowest taxed countries of all prosperous “developed” countries, there has been a small increase in our taxes over the last few years. This has mainly been through bracket creep in personal income tax scales, driven by inflation.
There’s nothing new about that: it’s a long tradition practised by governments that don’t want to increase specific taxes or even talk about raising taxes from more visible sources, such as the GST, or introducing new taxes, such as a carbon tax or a tax on wealth, including the sacred “family home”. Unsurprisingly, therefore, our present tax mix, because of the relative growth of income taxes, has contributed to significant inequities, including (but not limited to) intergenerational inequity.
The politics of taxation – three ways to raise public revenue
The case Bell and Keating put forward for higher taxes is convincing. That is, it would pass as an essay in public finance, or as a prescription written by an outside observer such as an IMF economist. But is it possible politically to raise public revenue?
Academics and public servants have turned their attention to that question for decades. Their research leads them to three situations where higher taxes may be politically acceptable.
The first acceptable situation is in response to some catastrophe or urgency. It is not surprising that Commonwealth income tax was introduced during the 1914-18 War and strengthened during the Pacific War when the Commonwealth completely took over income tax from the states. If there are new taxes in the coming budget the opportunity presented by the Trump-Netanyahu war will have influenced the government’s timing.
Second is the popularity of taxes levied on someone else. Taxing multinationals and firms believed to be earning excess profits goes down well with the public. No one should be surprised by the upswell of support for levying a higher tax on gas companies.
The idea that the government should “tax the rich” has appeal, but it fades once people think it through. Because most people tend to associate with people with the same means, even the very-well off tend to consider themselves as middle income earners. They’re comfortable with the idea of taxing oligarchs but doing so won’t raise much revenue. When well-off people realize that taxing the rich means increasing taxes on the top quintile of income earners or wealth holders, and not just on a few oligarchs, their enthusiasm wanes.
A more appealing variant, however, is “tax the privileged” – not necessarily the most well-off, but those who have been enjoying tax breaks not available to lesser mortals. The principle is fairness, rather than some utopian quest for equality. (The two principles are easily and misleadingly confused.)
A full list of tax breaks is in Treasury’s annual Tax Expenditure and Insights Statement. Some can be justified in line with taxation principles, but many of the biggest breaks don’t pass such scrutiny. These include zero or lightly-taxed incomes from large accumulations of superannuation, income tax avoidance in family trusts, and the taxation of financial wealth that favours speculation, particularly so-called “investment” housing. Once people are made aware of the extent of these privileges, proposals for reform become more politically attractive.
Because many of these breaks are enjoyed by older people, who tend to be loyal to parties on the right, the political risk of withdrawing them is low. Peter Hartcher has a whimsical but serious article, The PM’s about to offer selfish boomers like me a chance at redemption, referring to pre-budget speculation that many of the tax breaks enjoyed by older people (the “ransack generation” in his terms) will be wound back.
The third and most enduring way to gain public acceptance of taxes lies in ensuring that they are linked to clear benefits. When people are asked questions such as “for what things would higher taxes be justified?” health and education always come out on the top. Support for roads, environmental protection and policing, tends to vary with the perceived standard of those services. Support for “defence” follows geopolitical trends and the stridency of scare campaigns. When it comes to transfers to individuals much depends on framing: “age pensions” are popular in a way that “social security” isn’t. At the bottom of preferences generally comes “public administration”.
Some of these benefits, such as age pensions, are clearly redistributive. Some, such as roads, defence, and weather forecasting are provided to all: they fit the economists’ definition of “pure public goods”. Between these lie a group of services such as health care and education which have redistributive consequences but which are publicly-funded for other economic reasons. For these benefits there is a conflict between means-testing and universality.
Means-testing allows for targeting of benefits, which means there can be progressivity in service availability while government expenditure is contained. Bell and Keating point out that Australia already stands out from most other countries because we rely heavily on means testing.
Proponents of universality point out that means and needs are devilishly hard to determine. Think NDIS, care for the aged, Robodebt.)
Means-testing can lead to “two tier” services – one standard for the well-off and one for the “indigent” to use the American term, with the result that the rich no longer have a stake in the publicly-provided service, and their privately-provided-privately-funded services tend to suck resources out of the publicly-provided services. In fact this is happening in hospital care and school education.
So we’re back to Taylor’s impossibility theorem, or as Bell and Keating put it:
In short, Australia needs to rethink its taxing and spending policies, and it seems clear that the Liberal Party does not have the answers.
What have we got from the commodities boom?
An overvalued exchanged rate, unrealistic short-term expectations, and a low-tech manufacturing sector are our dividends from a misnaged commodity boom.
The Senate inquiry into taxation of gas resources (linked in last week’s roundup) has given former Treasury Secretary Ken Henry a forum to remind us of three related aspects of our “hollowed out” economic structure. Gareth Hutchens summarises Henry’s message in his post Former Treasury boss says Australians left with little to show from commodities boom.
One aspect is our heavy dependence on the export of basic commodities. Just three minimally transformed commodities – iron ore, coal and gas – account for 55 percent of our exports. Another 9 percent of our export income comprises gold exports, a short-term benefit of higher gold prices in times of global economic uncertainty.
There’s nothing new about our commodity dependence. Up to the 1970s that dependence was in the form of rural commodities: Australia was the country that rode on the sheep’s back. By this century mineral commodities had taken over that dominant role. Donald Horne reminded us in his 1964 book The Lucky Country that successive cycles of luck have allowed us to enjoy a first world living standard with a third world economic base, as one economist put it.
What would surprise Horne, however, is that sixty years later we have still not diversified our economy. The mining boom early this century gave us an extraordinary opportunity to collect public revenue to invest in diversifying our economy, but we squandered the opportunity. We enjoyed the short-term benefits of higher wages and speculative profits, and are now feeling let down because that pattern was unsustainable. Without naming names Henry reminds us of the destructive politics of the mining boom that saw our opportunities wasted.
How we wasted the mining boom
Some of the blame is attributed to the disruption of the Global Financial Crisis, and some to the hesitancy of the Rudd government, but the most destructive factor was the behaviour of the Coalition, in government and in opposition. There was the indolence of the Howard government, and the bastardry of the Abbott opposition and government, who with the backing of the mining industry and the Murdoch media sacrificed the country’s economic future in order to dislodge the Rudd government.
That lack of diversification is Henry’s second main point. Drawing on the Kennedy School Growth Lab’s studies of countries’ economic complexity, he points out that Australia is ranked 74th out of 145 countries for economic complexity, nestled between Uruguay ranked #73 and Jordan ranked #75. He could have rubbed the point in a little harder by pointing out that our poor performance on economic complexity places us at rank 122 on projections for growth over the next ten years.
We lie far behind almost all “developed” countries. Size is no excuse: countries much smaller than Australia, including the Netherlands, Belgium and Sweden, are among the top twenty countries. The only redeeming interpretation of the figures is that the complexity index is based on the composition of exports. A country with a large volume of commodity exports and an advanced domestic economy could still show up poorly on this index – as does Norway at #39, but that’s still well ahead of Australia.
Furthermore our ranking has been falling over the last twelve years, and this leads to the third point that runs through Henry’s warning. The long-term future for our commodity exports is not promising. The present crisis may deliver some super-profits for our gas industry, and even for our thermal coal industry: that’s why it’s important to grab the opportunity for getting a public revenue return from firms’ windfall profits.
But the long-term prospects for most of our commodities are not promising. The Gulf crisis is surely accelerating countries’ transition away from fossil fuels, away from thermal coal in the short to medium term, and away from gas and metallurgical coal in the longer term.
It appears that we have tended to see these industries, particularly the export gas industry, in terms of the short-term benefits of project investment, rather than in terms of our long-term economic structure. In fact the Petroleum Resource Rent Tax is specifically designed to encourage excess investment while it delays long-term returns. Our policymakers, particularly (but not only) those in the Coalition parties, have a cargo-cult mentality to investment, seeing it only in terms of its immediate economic stimulus.
Here is where our energy transition and the Future Made in Australia program are so important because they represent a more mature way of thinking. And it’s why the Coalition parties, with their explicit proposals to discourage renewable investments, and to stop all development of a hydrogen economy, are so short-sighted and irresponsible. We can only hope that their plans include a multi-billion dollar fund to remediate the sites of rusting oil refineries, decaying gas terminals, crumbling coal-fired power stations, and other stranded fuel assets.
Is that inflation – or is it just a temporary price rise?
Most journalists interpret the 4.6 percent rise in the March quarter CPI as a harbinger of higher interest rates. They should look more closely at the data.
Headline inflation surges to 4.6 percent in March as higher fuel prices bite is the headline in Gareth Hutchens’ account of the CPI, released by the ABS on Wednesday. That figure, up from the headline rate of 3.7 percent last month, has prompted expectations of a rise in interest rates when the Reserve Bank meets next week, because it lies even further outside the Reserve Bank’s 2.0 to 3.0 percent comfort zone.
That’s all a bit hasty. As the headline in Hutchens’ article points out, fuel prices are responsible for much of that rise. The ABS “trimmed mean” CPI rise was only 3.3 percent, the same as last month. This is a series that clips off some of the most volatile items – an indicator that should protect the RBA from chasing a volatile headline figure up and down. This suggests that the most prudent path for monetary policy for the RBA is to hold interest rates at the 4.10 percent they set at their March meeting, to wait to see how its effects work through the economy. Michael Janda suggests that the RBA may take such a cautious approach in his article Inflation details may give RBA pause for thought on interest rates – an article that goes into the detail of price rises revealed in the March data.
Notably the big rise this month has been in “tradeable” items. That is, items whose prices tend to be set in markets outside Australia, a category into which liquid fuels easily fit. The graph below shows the different CPI movements in tradeable and non-tradeable items.
There is not much monetary policy can do about prices set in international markets. The main concern of monetary authorities is about the price of non-tradeable goods and services. That is stuff made in Australia, potentially subject to the positive feedback cycle of higher prices driving higher wages, driving higher prices …
Among the non-tradeable group electricity retail prices have had an extraordinary influence on the CPI, having risen by 24 percent between March last year and March this year. We can be sure that the Coalition will be squawking about this, blaming the government for its woke renewable energy policy. But that figure comes about because of the withdrawal of public subsidies: it’s an artefact resulting from the way the CPI is constructed. As economists keep reminding us, and as politicians and journalists don’t understand, the CPI is not a measure of inflation: it’s an indicator of household costs. Because of the increasing amount of low-cost renewable energy in our electricity, the trajectory of electricity prices is downward – see the next post.
The sudden rise in fuel prices, and the distorted figures for electricity, confirm that categorical statements asserting that “inflation is X percent”, whatever the apparent authority of that figure X, are meaningless. As has often been pointed out in these roundups, even the present-tense verb “is” is a misnomer, because the figures are historical. The figure below, constructed from basic ABS index numbers, shows how the headline CPI is presented. It’s the percentage change between two points, shown in green – the index number 102.44 in March this year compared with the index number 97.96 in March last year. All interveningdata is ignored. That rise is 4.6 percent, as reported. QED. It says little about how the CPI is now moving and nothing about how it has been moving in recent months.
There are too many conceptual and calculation problems in getting an estimate of current inflation, let alone a reliable forecast. The RBA has a go at this in its statement of monetary policy: its February statement estimated that the ABS headline CPI would be 4.2 percent by the middle of this year, but that was before any hint of coming troubles in the Gulf region.
There are other unforeseen developments that should influence CPI inflation over the next couple of months. While gasoline was probably as expensive in March as it was going to get, steep rises in diesel and kerosene prices are still working through the economy, as will fertilizer and plastic prices. And the worsening El Niño conditions are likely to cause a medium-term rise in food prices. Offsetting these rises is a rising Australian dollar which should make some imports cheaper. And there is the possibility that Trump may be able to call upon divine power to open the Strait of Hormuz.
Good news on electricity prices
Renewables and batteries are doing their bit to reduce electricity prices, in a way that electricity distributors and retailers aren’t.
Electricity prices are falling. In the first quarter of this year wholesale electricity prices in the National Electricity Market (basically the eastern states including Tasmania and South Australia) were 12 percent down on prices in the same quarter last year. This price rise is associated with a rise in the renewable share of electricity generation, even while demand was higher than in the previous year.
You can read full details in the Australian Energy Market Operator’s Quarterly Energy Dynamics Q1 2026 (a fairly dense publication), the Energy Minister’s press release (key facts and numbers with a dose of political spin), or in Giles Parkinson’s post on Renew Economy, Batteries both big and small have reshaped the grid and forced wholesale prices down, AEMO says (a detailed explanation, emphasizing the contribution of batteries to lowering prices).
Where your money goes
These reports are all about wholesale prices. The AEMO report shows that wholesale prices in the NEM fell from 7.3 cents per kWh to 6.9 cents per kWh. This is not easy to relate to the prices appearing on electricity bills, that are usually in the range of 25 to 35 cents per kWh. That’s because between the generators and your electricity meters there is a chain of price gougers. There are the monopoly owners of poles and wires, a largely privatized industry enjoying a generous return on investment from a deliberately weakened regulator. And there are the “retailers”, often subsidiaries of the generators, who take a large share for doing very little apart from buying electricity wholesale and selling it to you, enriching the advertising industry in the process.
The final determination of maximum prices, the “default market offer” to be set by the Australian Energy Regulator later this month, will take these wholesale price reductions into account. The final price at your meter to appear after June will probably be a reduction, but you will still be paying more than you would have if right-wing politicians and zealous economists had not unwisely privatized the electricity distribution system.