Monday, December 14, 2015

Turnbull’s tax reform striptease has started

Sorry, Malcolm, but it's not adding up. Of course, it's probably not intended to add up just yet. That's what our Prime Minister's still working on. But last week we got a big hint on how we'll be let down gently.

Turnbull replaced Tony Abbott in September with three key tasks to perform: restore the government's popularity by being very different to his bellicose predecessor, make progress in delivering big business's reform agenda, and do better on returning the budget to surplus.

For good measure, he needed to cheer up our business people, whose lack of faith in the economy's future was holding back the recovery in non-mining business investment.

I have no problem with last week's package of measures to encourage innovation, even if there's no assurance most of them will prove effective. We've been promised that Tuesday's mid-year budget update will reveal how their cost of $1.1 billion over four years will be covered.

Turnbull is providing what his predecessor never could, a positive "narrative" of how he, with a few judicious policy changes, is leading us onward and upward to a brighter, more prosperous future. All the talk of innovation is part of that. Fine.

But it doesn't fit. His package of increased spending (and increased tax concessions) doesn't fit with Scott Morrison's rhetoric that increased taxation is unthinkable, so all measures to repair the budget must involve reduced spending.

Nor do his new tax concessions fit with the most basic principle of tax reform: broaden the base to cut the rate.

And even if he does find spending cuts to cover the cost of his new spending, they'll come at an opportunity cost to budget repair. Measures that could have been used to reduce the deficit have instead been used merely to stop it getting worse.

A key tactic in Turnbull's efforts to restore big business's confidence in the government was to announce that all options for tax reform were now back on the table.

Fine. But most of them were mutually exclusive. If you jump one way, that rules out jumping four other ways. In particular, we have at least three competing ways to use the proceeds from an increase in the goods and services tax.

But if Turnbull is to take a tax reform package to next year's election, its details will need to be finalised before the May budget. So we've come to the point where Turnbull must start taking options off the table.

Though it's not clear to many observers which options will go and which survive, it would be surprising if, by now, Turnbull and Morrison hadn't formed a pretty clear idea of where they want to end up.

Almost three weeks ago, my colleague Peter Martin got way ahead of the game – so far ahead it suited not the government, the opposition or the media to admit they'd read his piece – and confidently laid out the various reasons why the government had pretty much decided not to go ahead with any significant changes to the GST.

The first problem was that ownership of the GST had been bequeathed to the states. Why would the feds incur the huge political risk involved in increasing the rate or broadening the base of the GST just to make life easier for the premiers?

But how could they use the proceeds from a GST increase for other purposes without paying a sufficient bribe to the premiers? Fail to do so and the premiers have nothing to lose by opposing the increase.

The other big problem is that increasing the GST is political suicide without adequate compensation to low and middle income earners, but various changes since 2000 have made this very much harder and more expensive.

More than half the gross proceeds from a GST increase would be needed for compensation, with a much higher proportion of it going as increases in welfare spending rather cuts in income tax.

Everything that happened at last week's meetings with state treasurers and premiers was consistent with the thesis that the states have been cut out of the GST inheritance as just the first veil to be removed in the tax reform striptease.

But with a deteriorating budget position, how could the government afford to cut income tax and company tax without having the net proceeds from a GST increase to call upon?

It's obvious, though not easy: broaden the income tax and company tax bases by removing sectional concessions – superannuation, for starters – and use the proceeds to fund a revenue-neutral cut in tax rates.

Not exactly what Turnbull's big-business backers were hoping for.