Bracket creep lives to fight another day

An Australian newspaper’s headline on the morning after the budget was SCOMO STOPS THE CREEP. The nation’s most ponderous political pundit intoned that the Treasurer would “eliminate bracket creep for the middle class”.

The man himself claimed his tax-cut plan “ran a sword through bracket creep”.

Sorry, yet another of Scott Morrison’s attempts to mislead us in a most misleading budget. He’s exploiting the public’s hazy understanding of what bracket creep is and how it works.

If you’re not paid to be treasurer, you can be forgiven for imagining that bracket creep occurs when pay rises or other increases in your income push you into a higher income tax bracket, causing you to pay more tax.

At present, the middle, 32.5¢-in-the-dollar bracket starts at incomes of $37,000 a year and runs to $87,000. Morrison plans to raise this upper bracket limit to $90,000 in July this year, then to $120,000 in July 2022, then $200,000 in July 2024.

At the moment, about 53 per cent of taxpayers have the last part of their income falling in that 32.5¢ bracket. But by the time he’s finished, he expects almost three-quarters of people to be in it.

Get it? Someone on $87,000 could see their income rise by 130 per cent before they were pushed into a higher tax bracket.

This is the basis for ScoMo’s claim to be pretty much killing off bracket creep. But it’s not as true as he wants you to believe.

Why not? Because chapter two of the The Idiot Politician’s Guide to Income Tax  explains that you can suffer from bracket creep even if you don’t get pushed into a higher bracket. If that wasn’t true, people on the top, 45¢-in-the-dollar tax rate wouldn’t suffer from bracket creep – and I assure you we do.

How can it happen? It happens because everyone’s income is taxed in slices, and the rate of tax on each slice gets progressively (note that word) higher.

At present, the tax rates start at zero for the first $18,200 of annual income, then 19 per cent for the next $18,800, 32.5 per cent for the next $50,000, 37 per cent for the next $93,000 and 45 per cent for everything over that total of $180,000.

By the time ScoMo’s three-step, seven-year plan is intended to be in place in July 2024, however, it will be zero for the first $18,200 of annual income, then 19 per cent for the next $22,800, 32.5 per cent for the next $159,000, and 45 per cent for everything over that total of $200,000.

Ignoring the complication of the low-income tax offset, at that time someone on $41,000 would pay an average rate of tax on the whole of their income of 10.6¢ in the dollar, whereas someone on $200,000 would pay an average tax rate of 28¢ in the dollar.

Guess what? As the incomes of people at the bottom of the new, huge 32.5¢ bracket rose over time, their average rate of tax would rise from 10.6¢ in the dollar towards 28¢. And that would happen without them being pushed into a higher tax bracket. As an economist would say, their marginal tax rate would be unchanged at 32.5¢.

How can this happen? People’s average tax rate rises because, as their income increases, a smaller proportion of it is taxed at less than their marginal tax rate, while a higher proportion is taxed at their (higher) marginal rate.

For someone who, in 2024, is on $41,000 a year, 44 per cent of their total income would be taxed at zero, while 56 per cent would be taxed at $19¢ in the dollar.

By the time that person’s income has increased to $200,000 a year, however, only 9 per cent of their income is tax at zero, and 11 per cent at 19¢ in the dollar, leaving the remaining 80 per cent taxed at 32.5¢ in the dollar.

So the correct way to understand what economists call “fiscal drag” and punters call “bracket creep” is that it happens because people’s average rate of tax increases as their incomes rise.

What is true, however, is that actually moving into a higher (marginal) tax bracket accelerates the rate at which your average tax rate rises.

Bracket creep is an inevitable consequence of our “progressive” income tax. The term progressive means that as your income rises, the proportion of your income paid in tax gets progressively higher.

But what does most to make an income tax scale progressive is an initial zero-rate bracket. Say some crazed treasurer of the future decided to introduce a tax scale with just a single positive tax rate of 32.5 per cent. That would be still be a progressive tax scale provided it had a zero-rate bracket (a “tax-free threshold”) to start with.

Only if the 32.5 per cent tax rate started at an annual income of $1 would such a tax be a true “flat-rate” tax. Economists would say such a tax was neither progressive nor “regressive” (where the proportion of income tax paid declines as incomes rise) but “proportional”.

When you have a progressive tax scale, as every rich country does, the only way to (largely) eliminate bracket creep is to index each of the bracket limits to some measure of price or wage inflation no less frequently than once a year.

Except for a minor change in the 2016 budget, our tax scale has been unchanged since July 2012. Consumer prices have risen by more than 12 per cent since then, and the wage price index by 14 per cent. That’s a fair bit of bracket creep.

So what are Morrison’s plans for raising the bracket limits? The zero bracket would be unchanged, the 19¢ in the dollar limit would rise by 11 per cent, the 32.5¢ limit would rise first by 3 per cent, then a cumulative 38 per cent and then 130 per cent. The top, 45¢ bracket would rise by 11 per cent.

Whatever ScoMo’s objectives are, fixing bracket creep isn’t one of them.

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Tax cuts: lies, damn lies and bracket creep

If Malcolm Turnbull's promised tax cuts ever eventuate, we can be sure they'll be justified in the name of redressing terrible "bracket creep". But there are few aspects of taxation that involve more deception.

Treasury has been overselling the bracket creep story since the arrival of the Abbott government, while the Turnbull government has been exaggerating how much of it there's likely to be, so as to prop up its claim it's still on track to return the budget to surplus in 2020-21.

Every politician with their head screwed on loves bracket creep. When pressed, however, all profess to think it a bad thing. The punters think they disapprove of it, but their "revealed preference", as economists say (what they do rather than what they say), tells us they prefer it to the alternative.

It's only commentators like me who are free to say openly that, in this imperfect world, bracket creep's a jolly good thing and there ought always to be a fair bit of it.

Bracket creep occurs when a taxpayer's income increases by any amount for any reason. That's because we have a progressive income tax scale – one where successive slices of income are taxed at higher rates in the dollar – that's fixed in nominal terms.

Sometimes the creep happens because the increase in income lifts the last part of someone's income into a higher tax bracket, but it occurs even if this isn't the case. That's because the higher proportion of their income that's taxed at their highest ("marginal") tax rate increases the average rate of tax they're paying on the whole of their income.

If politicians really disapproved of bracket creep they could eliminate it by indexing the tax scale's bracket limits on July 1 each year in line with the rate of inflation in the previous financial year.

If you wanted to allow only for the effect of inflation, you'd index the brackets to the consumer price index. If you were a true believer in Smaller Government, who thought it a crime for a person's rising real income to raise their average rate of tax, you'd index it to average weekly earnings.

That no government has indexed the tax scale in this way since Malcolm Fraser's abortive experiment with it in the late 1970s is all the proof you need that, whatever they say, politicians of both colours quite like bracket creep. Same goes for Treasury.

The pollies' preference is to let it rip, but then make big guys of themselves by giving some of it back about once every three years, just before or just after an election. Only during the first half of the resources boom, when their coffers were (temporarily) overflowing, did John Howard and Peter Costello depart from this approach.

I believe in bracket creep because it's always played a vital role in helping to balance the budget. It's part of the implicit contract between governors and the governed, who want ever-growing government spending, but don't like explicit tax increases, particularly new taxes.

Their unspoken message to governments is: you find a way to pay for the spending we want, just don't wave it in front of our faces. Bracket creep is the tried and true way of squaring this circle, with limited objection from taxpayers.

What few people seem to realise at present, however, is that we've had precious little bracket creep for the past four years because inflation has been unusually low, and wages have barely kept up with it.

Limited bracket creep is the greatest single reason the Coalition government has had so little success in returning the budget to surplus. The government's persistent over-estimation of the bracket creep that will come its way is the main reason it has kept failing to reduce the deficit as forecast.

Yet throughout this government's term, official estimates of the huge extent of future bracket creep have been published, seemingly making the case for big tax cuts. The latest, issued last month by the Parliamentary Budget Office, were reported as though they were established (and scandalous) fact.

In truth, they were mere projections, based on this year's budget projections that wage growth will accelerate to 3.75 per cent a year over the next three years – projections that have been pilloried as wildly optimistic.

I'll let you into a secret unknown to the innumerate end of the media: if your big economic problem is exceptionally weak wage growth, one problem you don't need to worry about is excessive bracket creep. Nor is there any urgent case for tax cuts.

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Tax cuts would have cons and pros

Yippee! It's almost Christmas and Malcolm Turnbull has dropped a big hint that tax cuts are coming. Good old rich Uncle Mal has been to see his bank manager, got the overdraft extended, and is determined we'll all have a great Chrissie, no matter what.

Actually, it's all a bit vague at this stage. We don't yet know whether the cuts will even be announced before Christmas, let alone when they'll be delivered. Nor do we have any idea whether they'll be large, small or indifferent.

Wouldn't surprise me if they were on the small side, nor if we got them only as a reward for voting Turnbull back into office at the next election, to be held late next year or in the middle of 2019.

All we actually know is what Turnbull dropped into a speech to the Business Council after affirming his intention to press on with the hugely expensive company tax cuts for big business.

"In the personal income tax space, I am actively working with the Treasurer and my cabinet colleagues to ease the burden on middle-income Australians, while also meeting our commitment to return the budget to surplus," he said.

It wouldn't surprise me if even Turnbull doesn't yet have a clear idea about the size and timing of the cuts. That will depend partly on Treasury's grudging willingness to make it seem they can be afforded "while also meeting our commitment to return the budget to surplus", but just as much on the calculations of his spin doctors.

Will they decide to announce the cuts soon, using them as an attempt to break the circuit of negative media discussion of some problem the government's having, or keep them under wraps until much closer to the time when voters are asked to show their gratitude at the polls?

That Turnbull has dropped the big hint this early in the piece is a sign they're more likely to be chewed up in a desperate but futile attempt to give the government some "clear air", than carefully preserved as part of a grand re-election strategy.

But though uncertainty abounds, there are three iron laws of tax cuts.

The first is that a government's motive in making them is always mainly political. It either fears that if it doesn't cut it will lose votes – because voters are starting to resent how much tax they're paying on any pay rises or overtime – or it hopes if it does cut this will win votes in thanks for its magnanimity.

The second law is that, despite their political motivation, tax cuts always come colourfully wrapped in wonderful economic justifications. By taking this political gift, we're assured, we'll be creating jobs, reducing unemployment and making the economy grow.

It's almost our economic duty to accept the offer of the bloke selling tax cuts for votes.

The third law, however, is that voters' gratitude for being given a little of their own money back is faint to non-existent. A tax cut announced is soon forgotten; a tax cut delivered before an election has next to no influence on the outcome.

But can the budget afford tax cuts? Not if you accept the government's preferred way of measuring the deficit. It says we're still a long way from returning the budget to balance.

The government's prediction we'll be back to budget surplus by 2021 rests heavily on its forecast that wages will soon start growing strongly, much faster than inflation. Maybe.

If Treasury finds a way to maintain that trajectory while paying for tax cuts, it will be by stepping up its over-optimistic forecasts of wage growth. With circular logic, the "bracket creep" such forecasts imply would then be used to justify the tax cuts themselves.

For years we've been told a government that needs to borrow each month to keep itself afloat can't possibly afford to give aid to poor people overseas. But borrowing to cover tax cuts to big business isn't a problem nor, apparently, is borrowing to give voters a tax cut.

The sad truth is that this Abbott-Turnbull government has got neither the conviction nor the honesty to stick to a consistent line on debt and deficits.

In opposition they told us the debt was a frightening crisis, but easily fixed by them. In government they had one go at fixing it at the expense of everyone but their own supporters, but lost public support from that moment, and since then have abandoned any serious attempt at budget repair, merely waiting like Mr Micawber for something (bracket creep) to turn up.

Now it's decided it can't wait even for that, but must give some of it back on the assumption it will turn up – eventually.

But whatever their political motivation, tax cuts do have effects on the economy, so what would they be?

At a time like this, tax cuts would have a similar effect to a decent pay rise, making it a little easier for households to keep spending, giving consumer spending a modest boost and, indeed, creating a few more jobs.

And if you defy federal Treasury and measure the budget balance more sensibly, stripping out investment in infrastructure, you find the recurrent deficit has already been largely eliminated. A small tax cut wouldn't set it too far off course.

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Hard-working Aussies help pay for company tax cut

I often think Scott Morrison does a remarkably good Joe Hockey impression, but in this budget he's performed a Wayne Swan sleight-of-hand that's better than Swanny ever did.

Consider this. Big business has been desperate for a higher goods and services tax. Why? Because this was the only way the government could afford to grant them their longed for cut in company tax.

So when Malcolm Turnbull balked at increasing the GST, it seemed he wouldn't be cutting company tax either.

When the budget was unveiled, however, we still saw the government committing itself to cutting the company tax rate from 30 to 25 per cent over 10 years, and making an immediate start by cutting the rate to 27.5 per cent for all companies with turnover of less than $10 million a year, from July 1.

For good measure, Turnbull and Morrison threw in a small personal tax cut for the top quarter of earners. How on earth did they afford this without a higher GST?

Over the four years of the forward estimates, the company tax phase-down will cost $5.3 billion. Add $4 billion for the personal tax cut and we have $9.3 billion to account for.

The measures in the "tax integrity package" – which include the Google tax – should raise a net $3.3 billion.

The reforms to superannuation tax concessions will save a net $3.2 billion over the period, and the further hikes in the tobacco excise should raise $5.2 billion, meaning the three big revenue-saving measures will raise a combined $11.7 billion.

This leaves the government – the one so committed to lowering taxation – $2.4 billion ahead on the deal.

Satisfied all is in order? I'm not. Once fooled by Swanny, twice shy.

This government has done nothing but complain about how Labor committed itself to two expensive new spending programs – the national disability insurance scheme and the Gonski school funding – which proved to be "uncosted and unfunded".

What Swan did was stagger the introduction of the two schemes so that they didn't cost all that much in the first four years (the ones shown in the forward estimates) but got a lot more expensive in the following years (which we couldn't see).

Get it? This is the same trick Turnbull is using to hide the unaffordability of his vastly more expensive plan to cut the company tax rate over the next 10 years.

Little wonder he was so reluctant to reveal that the cumulative cost of the company tax "glidepath" was a paltry $48.2 billion.

So we've been told how the first $5.3 billion will be funded, but not the remaining $42.9 billion.

A key figure we haven't been told is the annual cost of the tax cut once it's fully introduced. But Deloitte Access Economics' Chris Richardson's estimate is about $16 billion a year.

Clearly, this is far more than the budget's tobacco excise increase, super reforms and company tax "integrity package" are likely to be able to cover.

In the last year of the forward estimates, 2019-20, those three measures are expected to raise only about $5.1 billion.

So if Morrison can now claim that the 10-year company tax cut phase-in has been costed, can he also claim it's been funded?

He's making the same claim Swan used to make by producing the "medium-term projection" of the budget showing it returning to surplus (in 2020-21, no change from the mid-year update) and staying in surplus until 2026-27.

Trouble is, whereas in last year's budget the government's "budget repair strategy" required it to deliver surpluses "building to at least 1 per cent of gross domestic product by 2023-24", this year's projection shows the surplus plateauing at 0.2 per cent for the last six years to 2026-27.

Why? Because progress in increasing the surplus (so as to pay back more debt) has been sacrificed to covering the ever-growing cost of the cut in company tax.

The cut really becomes expensive in the last three years, when big businesses join the phase-in. You can bet this "glidepath" has been carefully structured to stop the medium-term budget projection looking too sick.

Note too that the medium-term projection assumes tax collections are capped at 23.9 per cent of GDP after 2021-22, with the possibility that any excess is used to fund bracket-creep-returning tax cuts for Morrison's "hard-working Australians".

So the projections purporting to show that the company tax cut can be funded by our settling for seven years of a budget surplus no higher than $3.5 billion in today's dollars, also rely on the assumption of no further personal tax cuts for another six years.

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Budget more about politics than jobs and growth

You get the feeling this budget was pulled together with the use of a checklist. "We've got to have something on super, bracket creep, women, company tax, cities, multinationals, infrastructure . . ."

It involves a lot of imminent-election tidying up of loose ends from projects the government has supposedly been working on for three years, plus much squaring away of key interest groups.

What it's not is any kind of carefully considered "plan" for the economy, whatever Scott Morrison's claims.

It is, of course, a plan to get Malcolm Turnbull re-elected. Its measures are much more easily explained in political terms than justified as doing wonders for "jobs and growth".

Coming from the man in whom we held so much hope, it's uninspired and uninspiring. It's neither agile nor innovative, with not a spark of greatness.

That doesn't make it a bad budget, however. It's competent. It will play its part in ensuring the economy keeps chugging on for another year.

It contains all the Coalition biases you'd expect in a Coalition budget.

It's a cautious budget, with little to which many people will take great exception. Most voters' pockets won't be greatly affected one way or the other - certainly not in the near future - which, of course, is the reason for the caution.

If you believe the government should be pressing on with reducing debt and deficit - as it repeatedly promised it would - the budget is a great disappointment.

Turnbull and Morrison have achieved little more than their Coalition predecessors did. They inherited from Labor an expected budget deficit for 2013-14 of $30 billion (or 1.9 per cent as a proportion of gross domestic product).

Now Turnbull and Morrison are expecting a deficit of $40 billion (or 2.4 per cent of GDP) in the present financial year, falling only to $37 billion (2.2 per cent) in the coming year.

They expect government spending to grow by 4.7 per cent and tax revenue by 5 per cent.

Morrison boasts that the budget "outlines a path back to surplus", but that's true of every previous budget, back to the one Julia Gillard took to the 2010 election. The path first supposed to end in 2012-13, now stretches to 2020-21 - if you can believe it.

Up to now, the slow progress is explained partly by continuing falls in export prices. Much of what progress the Coalition has made is explained by it keeping the proceeds of bracket creep.

The truth is Turnbull and Morrison have abandoned any attempt to cut the deficit. Their best effort is to avoid doing anything that adds to it, while they wait for nature - "growth" - to take its course.

But while this lack of enthusiasm for the axe will disappoint those who've been convinced our debt is perilously high, I'm not among them. Morrison is right to say the "transitioning" economy is still too "fragile" to cope with public sector slashing and burning.

To that extent the budget wins high points for its steady contribution to the management of the macro economy.

It doesn't win many points for fairness, however. We now know what more than three years' big talk about tax reform adds up to: not a lot.

Low to middle income-earners have been saved from an increase in the goods and services tax, but gain nothing.

For years we've been told bracket creep is a terrible thing, hitting people on low taxable incomes harder than those on high incomes.

So what's the remedy? A tiny tax cut which, because it starts with people on more than $80,000 a year, will benefit only about the top quarter of taxpayers.

Thus the government gets to keep all the bracket creep to date and most of the bracket creep to come. But remember, only Labor stands for higher taxes.

What else do high earners get? No reneging on ending the 2 per cent temporary deficit levy. No change to negative gearing schemes, to the 50 per cent discount on capital gains tax, to family trusts or to deductions for professional development courses in Hawaii.

Big business missed out on its longed for increase in the GST and on a cut in the top rate of income tax but, even so, did get the promise of a company tax rate falling by 5 percentage points to 25 per cent, starting in the early 2020s and continuing until 2026-27 - if you can believe it will happen.

The big exception to this, however, are the changes to superannuation tax concessions, which will be less generous to high earners and less mean to women and low earners.

In other key areas of reform - particularly improved effectiveness in healthcare, education and infrastructure - after three years the government has hardly scratched the surface, with little further progress in the budget.

"Jobs and growth" is a slogan, not a plan. Its purpose is to create the illusion of a busy, striving government and divert attention from the lack of progress in achieving the much-promised return to budget surplus.

Name the budget - or the government - that hasn't claimed to have jobs and growth as its overriding goal.

To claim that a tiny tax cut and a "glidepath" cut in company tax will have any significant effect on jobs and growth is an exercise in over-optimism and exaggeration.

The tax cuts for small business, and their extension to a relative handful of medium businesses, is more about politics than jobs and growth. Small businesses have votes; big business has most of the jobs.

This is not the budget we were entitled to expect when Turnbull ousted Tony Abbott last September.

It's probably better than Abbott and Joe Hockey would have delivered, but only by a bit.

This is the last of three budgets from a government seeking re-election on the basis that only the Coalition is any good at managing budgets and running the economy.

That was a lot easier to believe at the last election than it is today.

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Don’t-worry budget plan is built on bracket creep

I hope events prove me wrong, but I have a feeling that, whatever its other virtues, the Turnbull government won't be the one to get the budget back to surplus.

And that does matter. One of the reasons we escaped the Great Recession was that, unlike other countries, we went into it with little public debt. This allowed us to stimulate private sector activity and restore confidence with vigour and without hesitation.

It's looking likely we won't be so well placed next time. We used to have exemplary fiscal discipline – an example to the world – but now that distinction is slipping from our grasp.

It's become a twice yearly ritual for the treasurer to produce 10-year budget projections invariably showing the budget balance heading steadily back to ever-rising surplus.

The first such exercise, produced by Wayne Swan in his last budget in 2013, showed us returning to surplus by this financial year, 2015-16. Just a few months later, Labor's last statement pushed it back to 2016-17.

Joe Hockey's first budget pushed the date back to 2018-19 and his second to 2019-20. Now Scott Morrison's mid-year update has shifted the return to surplus back to 2020-21.

This ought to be enough to convince you these ever-confident predictions are not to be trusted. They're mere projections, based on assumptions that soon prove overly optimistic.

Any treasurer who endlessly repeats the ideologically blinkered but patently absurd line that the budget doesn't have a revenue problem, it has a spending problem, can have no credibility as a budget repairer.

The 2014 budget was the ultimate demonstration that, while repairing the budget almost solely on the spending side may be theoretically possible, it's not practically possible. Such plans can't be made to stick because they're too unpopular and too aimed at requiring the least able to bear the heaviest burden.

It seems Morrison's stopped repeating this mantra, but his replacement rhetoric is no better: "Our plan is straightforward – responsibly restrain expenditure while supporting economic growth to lift revenues."

Translation: we're prepared to do no more than match our inevitable new spending programs with offsetting savings – as we did last week – while we wait for the economy to return to trend growth and so allow the budget to fix itself.

This tells you Malcolm Turnbull isn't willing to increase taxes overtly but, by the same token, isn't willing to make major cuts in government spending that might cost him votes when he gets his ascension endorsed by the electorate next year.

If Turnbull goes to the election without mentioning a plan for slashing spending in his next term, what are the chances he'll do it anyway? Not great.

It's possible Morrison has stopped claiming the budget doesn't have a revenue problem because the plan is to cut back superannuation tax concessions as part of the tax reform package.

It's also possible the tax package will involve net savings to the budget, if not immediately then a few years down the track as the revenue saving measures grow faster than the cost of the tax cuts.

It's possible, but I won't be holding my breath. It's more likely the political frictions in the tax package will require it to be "budget negative", so that – whatever the happy claims about it encouraging people to "work, save and invest" – it sets back the budget's return to surplus.

Last week's mid-year update reveals Morrison to be presiding over a structural budget deficit equivalent to about 2 per cent of gross domestic product, even while he peddles the line that economic growth will get us back to surplus.

Don't believe it. By definition, the structural deficit is the deficit you still have after the economy has returned to trend growth. Only if the economy were to be in an inflationary boom might the cyclical surplus be big enough to hide the underlying structural deficit.

No, only explicit decisions to cut spending or increase taxes will reduce the structural deficit – with one key exception: bracket creep. Not deciding to index the income tax scales for inflation does help reduce the structural deficit.

Buried deep in the update's fine print (bottom of page 19) you find a sentence which, after you've reread it a few times, tells you that to help achieve the appearance of an ever-improving budget balance, the government has quietly pushed the assumed tax-to-GDP cap of 23.9 per cent out by another year to 2021-22.

Translation: Morrison latest "don't worry, we'll get back to surplus eventually" projection is built on the assumption of another six years of bracket creep. But would this government ever increase taxes? Never.

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How to fix everything: cut my tax

If I was on a mission to make big progress in increasing productivity and participation in the workforce, I wouldn't start with tax reform.

That the people who profess to be so concerned about productivity and participation have started with tax reform does make you wonder about their motivations. Especially when you realise that the primary beneficiaries of the particular reforms the urgers are seeking would be their good selves.

The motives of the Business Council and other business lobby groups are transparent: their high income-earners want to pay less tax, so are happy to see other people pay more.

To them, this is the attraction of using an increase in the goods and services tax to pay for cuts in income taxes.

The better-off (such as me) benefit because their higher rate of saving limits how much more GST they pay. They benefit even further if the cut in income tax is shaped in a way that favours high income earners.

Powerful people pursuing their self-interest is hardly surprising. Nor is seeing them seek to disguise their self-interest with happy chat about improving incentives to "work, save and invest" and professing to be terribly concerned that Oz will miss out on foreign investment or that all our top executives will be lured away by American corporations.

But if, as a would-be reformer, I did get down the to-do list as far as taxation, what "reforms" would I make?

First, I'd remember that all the bracket-creep we've subjected ourselves to in recent years is the standard way governments achieve a recovery in tax collections after they find they've earlier gone overboard with tax cuts and tax breaks - as we did in the first stage of the resources boom.

I'd remember that Treasury has overstated the extent of bracket creep because its projections assumed a much higher rate of wage growth than has transpired. It's true, however, that bracket creep is regressive, hitting people on the lower tax rates proportionately harder than people whose incomes have reached the top tax rate.

So if I felt it was time to ease up on bracket creep, I'd do it simply by lifting all bracket limits bar the top one by the same percentage, determined by the rate of price (not wage) inflation over the period. This would yield a quite noticeable weekly saving to workers.

That is, I'd belatedly do what in an ideal world I should have been doing once a year: indexing the tax scales to price inflation.

What I wouldn't do is con the punters by using the regressiveness​ of bracket creep as cover for a tax cut biased in favour of high income-earners (particularly when the earlier tax cuts and tax breaks the punters have been paying for were themselves biased in favour of high income-earners).

Second, to cover the cost of this tax cut - and possibly also to increase our tax-raising capacity to cover the future growth in health and education spending Treasury is always agonising over in its intergenerational reports - I'd increase not GST but a uniformly applied land tax (which could apply to the same tax base as local government rates).

Why? Partly because GST is a regressive tax, whereas land tax is progressive, hitting higher-income households proportionately harder than lower-income households.

Do that and the need to "compensate" low income-earners disappears - though it would be necessary to institute reverse-mortgage arrangements for asset-rich/income-poor oldies.

It would also remove the government's temptation to short-change the punters by double-counting the return of bracket-creep as compensation.

Increasing land tax would mean the reform package made the tax system fairer rather than less fair - surely an important goal of honest tax reform.

As well, universally applied land tax is more efficient than GST in that, as every economist is supposed to remember, it would do less to distort people's decisions about whether to "work, save and invest".

The argument that income from capital and, for high earners, income from labour, need to be taxed more lightly because globalisation has made financial capital and executive labour more mobile between countries, is widely used - especially by Treasury - to justify taxing consumption more heavily.

But how can these guys be fair dinkum in this argument when they're overlooking the ultimate immobile tax base, land?

Finally, though excessively generous superannuation tax concessions and capital gains tax concessions are overdue for reform, I'd use the proceeds to reduce the structural budget deficit, not throw them into the tax reform pot to help justify tax cuts for high income-earners.

It's arguable that budget repair is more important than tax reform.

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Try a little compromise to fix the budget

It was easy to miss, but a proposal with much practical potential arose from this week's meeting of the great and good at the National Reform Summit. It was an idea that could break the budget impasse.

Australia is seen to have so many economic problems at present that the participants at the summit from business, union and community peak bodies got to four of them before later remembering one I would have had at the top of my list. As someone thought to write into the final statement, "unconstrained climate change would have serious environmental, economic and social impacts on Australia".

Oh yes, that probably could be a bother, couldn't it? Glad we remembered to pop it in.

The problems that got more considered attention were: lifting productivity growth and workforce participation, tax reform, sustainable retirement incomes policy and, of course, "fiscal policy for a growing economy".

On fiscal policy – the budget – the participants began by acknowledging that "governments have a key role to play in providing or funding public services, a social security safety net and economic and social infrastructure essential for economic growth".

Here's an important point of agreement: "All expenditure programs, including direct expenditures and tax concessions, should be subject to rigorous evaluation to ensure efficiency and effectiveness over time."

To date, the Abbott government has insisted on excluding tax concessions.

Government income-support payments should be appropriately targeted to those who most need them, we're told, but also this: "Gaps in the basic social safety net should be closed, such as improving the adequacy of income support for unemployed people and affordable housing for people on the lowest incomes, and services to people with a disability."

Plus this: "People on low incomes or who are otherwise vulnerable should be protected from the impacts of fiscal reform."

See how much more reasonable business people become when you bring them face-to-face with the unions and welfare organisations?

The participants' list of things governments should do says they should "rigorously monitor the effectiveness of all expenditure programs, including tax and direct concessions, and make findings public".

You might think that, no matter how bad our budgetary system is, it couldn't be as bad as the Americans'. That's probably true, but in one respect they beat us hollow: Congress is diligent in monitoring the effectiveness of spending programs and making the results public.

Our taxpayers would save a lot of money if only ministers and their department heads were more willing to check how well their programs were achieving their stated objectives and then let us in on the secret.

So far, the summiteers' statement of principles is all very sensible, but what about Tony Abbott's "budget emergency" – do we have one or don't we?

We don't, but we will if we're not careful.

"While we currently have low public debt levels by international standards, expenditure in a number of key areas is rising rapidly, owing largely to population ageing in areas like pensions and age care, and rising health costs for all," the final statement says.

"Weaknesses are emerging in our public revenue base. These have been papered over temporarily by income tax bracket creep at the Commonwealth level and a surge in housing stamp-duty revenues in some states, but neither is a sustainable source of public revenue . . .

"If current policy settings persist, federal and state governments are likely to post substantial deficits for many years to come."

Just so. Which brings us to our present impasse on the budget. In 2014 the government allowed us to see the harsh recommendations of its commission of audit only a week or so before its first budget, which implemented a version of them.

The public reacted in amazed horror, partly because they involved breaking a lot of election promises, but mainly because they were seen as unfair to low and middle income earners. Not surprisingly, the Senate declined to pass many of the worst measures.

Abbott's standing in the opinion polls has never recovered from the unpopularity of that first budget, even though he used his second to backtrack on many of his stalled measures and to buy a bit of approval from couples needing childcare and from small business.

Joe Hockey used some dodgy assumptions to claim the budget was still on track to return to surplus in 2020, but few at the summit believed him. With 2016's a pre-election budget, it's hard to foresee a renewed effort to get things heading in the right direction.

But this is where the summiteers' good idea comes in. Partly in response to comments at the summit by Dr Martin Parkinson, the former Treasury secretary, Peter Harris, of the Productivity Commission, and Professor Peter Whiteford, of the Australian National University, the peak bodies got together and came up with a plan to return the budget to "structural balance" within 10 years.

The idea is to separate significant structural reform of the budget from the annual budgeting process conducted by Treasury and Finance. A new assemblage of peak bodies would be given two years to develop a plan to get the budget back to balance over the following eight years.

On the spending side, the new outfit would focus on the biggest and fastest-growing programs, such as health, where inefficiencies were identified and removed while protecting their adequacy and fairness. (Any medico will tell you there's plenty of wasteful spending in health.)

On the revenue side, reforms would focus on tax concessions that were no longer "fit for purpose".

Such a process would be more public, would produce more "buy in" by key interest groups, would impose greater pressure on vested interests to make concessions for the greater good and, if done well, would do more to help voters see the need for reform and the measures proposed.

Well worth a try.

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Don't believe all you're told about bracket creep

Beware of treasurers promising to protect you from the ravages of bracket creep. They're like Mafia bosses promising to protect you from robbers and thieves. Maybe they're offering something nice, or maybe they're working some kind of con.

Joe Hockey's speech about tax reform on Monday was more an advert than a policy announcement. He said the government would have to do something about the evil of bracket creep, but didn't say what or when, nor how it would be paid for.

The firmest we got was a hint that the Abbott government would go to the election next year promising a tax reform package involving a cut in income tax.

Hockey explained that "bracket creep occurs when people are pushed into higher tax brackets as a result of inflation and rising wages". Not quite right, but near enough.

Hockey warned that the average income earner on about $77,000 a year is just below the second highest tax bracket of 37¢ in the dollar, which kicks in above $80,000.

He estimates that, if nothing is done in the next two years, about 300,000 people will move into that bracket. And if nothing were done in the next 10 years, more than 40 per cent of taxpayers would be in the top two tax brackets. (Remember that the rate you pay on the last part of your income is much higher than the average rate you pay on all your income. Those on just over $80,000 pay an average rate of 22¢ in the dollar.)

The truth is, all treasurers have form when it comes to bracket creep. It can be prevented easily by increasing the four bracket limits once a year in line with the inflation rate. Malcolm Fraser and John Howard tried this in the late 1970s, but soon gave up.

Why? Because it delivered annual tax cuts that were too small and too mechanical for voters to notice and be grateful for. Much better to let bracket creep rip for three years or so, then have a bigger tax cut just before or after an election.

Every year that bracket limits aren't raised, the treasurer is knowingly letting brackets creep up, unless he (or one day, she) grants discretionary tax cuts. With help from Wayne Swan, Peter Costello delivered eight such tax cuts in a row between 2003 and 2010.

Those discretionary cuts cut a lot deeper and cost a lot more than eight years of "tax indexation" as we called it. They were part of the excesses of the resources boom and turned out to be far more generous than we could afford – as we realised after falling coal and iron ore prices started slashing company tax collections.

This is why, since 2010, successive governments have let bracket creep rip. They're trying to increase income tax collections so they play their part in getting the budget back into surplus. We've had our fun, now we're suffering the hangover.

This means the man who now professes to be so concerned to end bracket creep is the same man who used projections of years of further creep in this year's budget to prove he was getting on top of the deficit.

If you think that sounds a bit sus, try this. The low and middle-income earners suffering most from bracket creep at present, weren't the taxpayers who gained most from the eight tax cuts – those were the high income-earners (such as yours truly).

If alleviating bracket creep was Hockey's true motivation for wanting tax cuts, his response would be simple: leave the rates of income tax unchanged, just raise the bracket limits by as much as you could afford.

But in his next breath Hockey was arguing that the top tax rate – 45¢ in the dollar – which cuts in when incomes hit $180,000 a year, was far too high and needed cutting.

See the scope for trickery? Justify tax cuts by telling the majority of voters on low and middle incomes how tough they're doing it, then give most relief to high-income earners again. Lawyers call it "bait and switch".

Hockey is right in arguing that (thanks mainly to the bias in the eight tax cuts), bracket creep hits low and middle-income earners proportionately harder that it hits high-income earners, thus making bracket creep "regressive".

But this raises an obvious question: how would the tax cuts be paid for? Could we be sure the cure wasn't worse than the disease? Assuming Hockey wouldn't have the effrontery to allow them simply to add to the budget deficit, one way would be for their cost to be covered by (massive) cuts in government spending.

We know from his first budget that this would rebound on the very low and middle-income earners he was purporting to help.

But it's a reasonable bet Hockey is hoping for a deal in which the cost of the cuts in income tax is covered by an increase in the rate of the goods and services tax.

Trouble is, the GST is also regressive. And a recent paper by Professor Patricia Apps, of the University of Sydney, demonstrates that an increase in the GST would be more regressive than the bracket creep it corrected. Why? Because it would hit all those people whose incomes were below the income tax threshold.

Beware of treasurers promising to protect you from bracket creep.

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Everyone wants a slice of a higher GST

Norman Lindsay called it the Magic Pudding. Economists call it opportunity cost. In the untiring campaign by some for an increase in the goods and services tax, a new magic pudding has been created. The trouble is, opportunity cost is real, but magic puddings aren't.

Put at its simplest, the concept of opportunity cost says that if you've got a dollar, you can only spend it once. This truth might be glaringly apparent, but it's surprising how often grown men (and, less commonly, grown women) forget it.

By contrast, the original magic pudding allowed its owners to "cut and come again". No matter how many times they cut themselves a slice, the pudding would magically grow back.

Just the most recent proposal for a higher GST – of 15 per cent – comes from the Premier of NSW, Mike Baird. He wants it to help the state governments raise more taxation to help them pay for the ever-growing cost of their public hospitals and still balance their budgets.

But Baird and some of his fellow premiers aren't the only people with designs on the extra revenue a higher GST would bring. He's been spurred by the knowledge that, so far, Prime Minister Tony Abbott is sticking with the plan announced in last year's budget to move to a less generous way of indexing federal grants to the states for their public hospitals and schools from 2017, which would cause those grants to grow by $80 billion less than they would have, over the following decade.

There are people cynical enough to believe this cut was aimed at softening the premiers up and obliging them to agree to an increase in the GST as the only solution to their future funding problems.

But do you see what this means? It means a big slug of the extra revenue raised by a higher GST would go towards solving the feds' budget problems, not the states'. Suddenly, the pot of gold isn't looking so big.

But that's not all. There are a lot of economists and business people urging that the proceeds from the higher GST first be used to abolish various state taxes regarded as "inefficient" – that is, ones that have the effect of seriously distorting the choices people make.

Top of the list of inefficient state taxes is stamp duty on the transfer of commercial and domestic properties, and the tax on insurance policies. But some business people have their eye on using the GST to replace payroll tax. And a lot of landlords would like to get rid of land tax.

But why stop at eliminating state taxes? Why not use it to reduce a few federal taxes you don't like?

Big business is very anxious to "reform" the tax system by using a higher GST to cut the rate of company tax. And many high income-earners believe it vitally important to cut the top personal tax rate, lest all our top people migrate to countries where taxes are lower (Malaysia, say).

It's clear Treasurer Joe Hockey would very much like to cut company tax and the top tax rate for individuals, if only the boss could summon the courage (and Hockey's powers as a salesman were magically transformed).

But Hockey has another problem he'd no doubt like the GST's help with. He knows that the main thing he's using to allow him to project slowly declining budget deficits in coming years is ever-rising collections of income tax, caused mainly by "bracket creep" – inflation pushing people into higher tax brackets.

The trouble is, after a while, people notice the higher tax rate they're paying on any overtime or pay rise. When they do, they tend to get pretty stirred up and look for a politician to blame.

So Hockey knows that, before long, he'll need to have a tax cut that gets people on tax rates below the top one back into lower brackets. It would be nice if he could make up some of this lost revenue by increasing the GST.

See the magic pudding? There's a host of different groups pushing for higher GST, but they all want to use the proceeds to pay for something different. Between them they have plans to spend each extra GST dollar many times over.

That's true even if, as well as simply increasing the rate to, say, 15 per cent, we also extended it to cover food, education, health and financial services.

And don't forget this: because the GST is universally acknowledged to be a "regressive" tax – it takes a higher proportion of low incomes than of high incomes – it would have to come with a lot of "compensation" for low- to middle-income earners, in the form of increases in pensions and the family allowance and cuts in income tax at the bottom.

All this compensation would have a cost. In other words, the net proceeds from raising the GST would be a lot lower than the gross.

If you get the feeling the debate about increasing the GST has entered the realm of fantasy, you're not wrong. Once the more fanciful ways of using the proceeds had been eliminated, the number of people pushing for it would be greatly reduced.

If you get the feeling this means the GST won't be going up any time soon, you're not wrong, either. I won't be losing any sleep over it.

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Don’t believe Abbott stands for lower taxes

Tony Abbott did so well at the last election with his scare campaigns against the carbon tax and the mining tax it seems he thinks his best chance of re-election is another scare campaign on tax.

An obvious conclusion from voters' overwhelming rejection of last year's budget as unfair was that the attempt to fix the deficit almost exclusively by cutting government spending - without touching any of the "tax expenditures" on the revenue side of the budget - was crazy.

So it wasn't surprising to see, a few weeks back, Joe Hockey edging towards the idea that repair of the budget would have to involve reform of the hugely generous superannuation tax concessions to the well-off.

With Labor making similar noises, Hockey might even eventually have edged as far as promising to do something about the "negative gearing" loophole, had Abbott not stepped in and stopped him in his tracks.

Why? Because Abbott thought he saw a brilliant opportunity to wedge Labor. If Labor was promising to fix super tax concessions and negative gearing, why not promise the Coalition wouldn't touch 'em?

That way, Labor could be portrayed as the party of high taxers, whereas the Liberals could portray themselves as the party committed to lowering taxes, implacably opposed to all tax increases. If you want to pay much higher taxes, vote Labor; if you don't, vote for us.

Not bad, eh? Abbott has telegraphed his game plan so clearly it will be interesting to see if Labor keeps its nerve and offers voters a genuine alternative.

But Abbott's claim to be opposed to all tax increases is not one to be believed. As the former top econocrat Dr Michael Keating has pointed out, this year's budget shows increased taxation is expected to be the main way the government is planning to get the budget deficit down.

In the Labor government's last year, 2013-14, total federal government revenue (including more than just tax collections) was equivalent to 22.8 per cent of gross domestic product. In the coming financial year it's expected to have risen to 24 per cent. And by 2018-19 it's supposed to be 25.2 per cent.

So the government is projecting that revenue will rise by 2.4 percentage points of GDP over the five years. At the same time, the budget deficit is projected to fall by 2.7 percentage points.

"Clearly," Keating writes on John Menadue's blogsite, "these figures show that revenues are doing almost all the work to reduce the budget deficit". Government spending is expected fall by only 0.3 or 0.4 percentage points of GDP over the five years.

So what's the story? Where will Abbott be getting all this extra revenue from? Does he have some new tax hidden up his sleeve? Is he counting on a big increase in the GST?

Well, some part of it will come from the changed accounting treatment of the annual earnings on the Future Fund. But, for the most part, it will come from what, in an earlier chapter of the Libs' professed campaign for lower taxes, Malcolm Fraser and John Howard used to call "the secret tax of inflation".

These days it's more commonly called "bracket creep" - as your income rises over time to (you hope) at least keep pace with the higher prices you're paying, a higher proportion of it is taxed at higher rates. This happens even if you aren't literally pushed into a higher tax bracket, but it happens with a vengeance if you are.

Keating says receipts from personal income tax are projected to increase from 10.4 per cent of GDP in 2013-14 to 12.1 per cent in 2018-19, and this increase of 1.7 percentage points is a rough measure of the contribution of bracket creep to the budget bottom line.

According to his figuring, bracket creep will account for 63 per cent of the projected improvement in the budget deficit over the five years to 2018-19.

But how politically realistic is such a projection? Already it implies that someone on average weekly earnings can expect to move into the second-highest tax bracket in the coming financial year. They'd be paying 39c in the dollar on the last part of their income and on any pay rise.

Keating says that, according to the budget projections, someone on average earnings would see their average tax rate (the rate paid on every dollar) rising from 21.7 per cent to 27.4 per cent over the next decade.

Don't worry, it's unlikely any politician would allow that to happen. But it does warn you not to believe Abbott's claim to be a low taxer.

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Budget shows Abbott's true priorities and values

Tony Abbott has turned out to be a chameleon. Before the election, he took the guise of a populist, opposed to all things nasty and in favour of all things nice. Since the election, he's revealed himself to be a hard-line ideologue, intent on reshaping government to suit the interests of big business and high-income earners.

Before the election, he was the consummate vote-seeking politician. Since the election, he has transformed into an inflexible "conviction politician" who doesn't seem much worried about whom he offends.

Dr Mike Keating, former top econocrat, says the budget is always the clearest guide to a government's priorities and values. That's certainly true this time.

This budget scores high marks for its efforts to get the budget back on track. As almost every economist will tell you, there is no "budget emergency". But there would be problems if we allowed the budget to stay in deficit for another 10 years, which was a prospect had Abbott failed to take tough measures (all of which were in marked contrast to his sweetness and light before the election and many of which were in direct contradiction to his promises).

The budget's great strength is its approach of announcing savings while delaying their major effect until 2017-18, by which time it's hoped the economy will be strong enough to cope with the reduced spending. That, plus Treasurer Joe Hockey's efforts to increase spending on infrastructure in the interim.

But the budget goes further than is needed to fix the budget. It's our first genuine attempt to achieve (as opposed to talk about) "smaller government". So as to minimise the need for future tax increases, it puts government spending on a diet.

It does so partly by increasing user charges (for GP visits and tests, pharmaceuticals and university tuition), but mainly by changing the indexation of pensions and government grants to the states for public schools and hospitals, from indexes linked to the growth in wages to the main index linked to consumer prices.

That's a saving of at least another 1 per cent a year, cumulating every year forever (or at least until it's reversed as politically and economically untenable).

By restricting his savings to cuts in government spending and studiously avoiding all the lurks hidden in the tax system, Abbott ensured the burden of his savings is carried overwhelmingly by low and middle-income earners, leaving high-income earners largely unscathed, save for a small temporary tax levy. He also ignored almost all the government spending constituting welfare for businesses.

You would have to be terribly trusting to believe all this happened by accident rather than design.

The public's wholehearted disapproval of the budget makes it likely a lot of its measures won't make it through the Senate. Abbott's opponents will have a field day acting as our saviours.

No doubt much of this disapproval arises from simple, short-sighted self-interest. After all, Abbott spent the past four years fostering our selfish incomprehension. People got it into their heads that their cost of living was rising rapidly, causing their standard of living to slip. It wasn't true, but Abbott reinforced rather than corrected the misperception. (To be fair, the Labor government was no better.)

But I'd like to believe there's more to our disapproval than simple selfishness. John Howard says the public will accept a tough budget provided people are satisfied it's reasonably fair and in the nation's interests.

Trouble is, this budget is neither fair nor in the nation's interest - unless you share the Business Council's certainty that the world would be a much better place if only big business was allowed to do whatever it pleased and executives paid minimal tax.

What surprises me is how Abbott could change from being such a supremely pragmatic, vote-obsessed pollie in opposition to being so willing to alienate so many interest groups while in government.

I never imagined I'd see the day when any government decided to take on perhaps the most powerful voting bloc of them all, Grey Power. The fury of the old will be even greater when they fully comprehend how the planned change in pension indexation will lower their relative incomes.

Nor did I ever expect to see any government declare war on virtually the whole of the younger generation. The plan to deny education leavers the dole for six months involves high social costs with little budgetary or economic merit, but is the reappearance of one of Abbott's personal bonnet-bees.

The plan to let universities charge what they please for their courses and impose a real interest rate on students' HECS debt will saddle our brightest and best with big debts, lingering for many years. I've heard of worse injustices, but it seems a strange way to endear yourself to those who represent the future Liberal heartland.

Abbott is no doubt counting on there being a long time for voters to forgive and forget before the next election in 2016. But despite its goal of avoiding future tax rises, the budget's incorporation of a further two years of bracket creep means it will push up the tax rates faced by a lot of low to middle-income earners.

If I were Abbott, I wouldn't be counting on too much voter gratitude for fixing the budget.

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Why Hockey's budget is unsustainable

Coalition governments have been banging on about the need for "smaller government" since Malcolm Fraser started echoing Maggie Thatcher and Ronald Reagan. They've talked without doing anything. Until now.

Few have noticed, but the goal of this budget is to reduce government spending by 1.1 per cent of gross domestic product (GDP), from 25.3 per cent this financial year to 24.2 per cent in 2024-25.

If that doesn't impress you, this may: Joe Hockey's plan is to cut government spending to 0.7 percentage points below its 30-year average of 24.9 per cent.

That makes this the most ideologically driven budget we've seen - not that Hockey or Tony Abbott will admit it. They claim the budget's harsh measures are needed simply to get the budget back to surplus and start paying down the public debt.

They don't admit it was their choice to do this in a way that achieved savings more by cutting spending than by cutting tax expenditures. They cut the real growth in pensions, but left high-income-earners' absurdly generous superannuation tax concessions untouched.

They tightened up the family allowance and cut young people's access to the dole, but didn't tackle the concessional taxation of capital gains, negative gearing or company cars, while ignoring the miners' diesel fuel rebate and other business welfare. They imposed a co-payment on GP visits, but didn't abolish the private health insurance rebate.

The intended effect of this bias against spending and in favour of tax breaks is to make the budget significantly less redistributive. That's because, particularly with our tightly means-tested welfare system, government spending tends to benefit the less well-off, whereas tax expenditures go disproportionately to people at the top.

So it's the "end of entitlement" for people in the bottom half, but no change to the entitlements of the well-off, save for a small three-year tax levy.

It's true the government's 10-year "medium-term budget projection" sees tax collections rising as a proportion of GDP from 21.6 per cent this year to 23.9 per cent in 2019-20, at which point it would be prevented from rising further. (This cap is based on the average tax ratio to GDP between 2000-01 and 2007-08.)

This seems to indicate Hockey is relying more on higher taxes than lower government spending to get the budget back to a surplus of 1.5 per cent of GDP. But this impression is misleading.

At 25.3 per cent of GDP, government spending at present is only a little above its long-term average of 24.9 per cent, whereas at their present 21.6 per cent, tax collections are well below Hockey's benchmark of 23.9 per cent.

It's no secret why tax collections are unusually weak at present: because the fall in mineral export prices is causing real national income to grow more slowly than real GDP and because of the continuing revenue loss from the eight income-tax cuts in a row we enjoyed when the Howard government assumed the resources boom (and its inflated company-tax collections) would run forever.

To get tax collections back to a more normal proportion of GDP, the government is relying mainly on allowing another six years of bracket creep. The 23.9 per cent cap after 2019-20 is supposed to allow the resumption of regular tax cuts (though who will benefit most from those cuts is another matter).

What we do know is that, whereas the eight successive tax cuts weren't particularly "progressive" in their effect on the income-tax scale, its particular shape at present means the following eight years of bracket creep will be highly "regressive", causing average tax rates towards the bottom to rise a lot further than those at the top.

So even the recovery in tax collections will come mainly at the expense of the less well-off.

It's clear the government will have much trouble getting many of its more controversial measures through the Senate. What the 10-year projection will end up looking like is anyone's guess.

But even if the budget passes intact, it contains the seeds of its own destruction.

Pensions heading inexorably below the poverty line? Pressure throughout the public sector for wages - including for nurses, teachers, childcare and age-care workers - to rise no faster than inflation, while private sector wages continue rising in real terms with productivity growth?

The vice-chancellor herd given total control over how high uni fees (and graduate debts) rise, including whether they make training for jobs as nurses, teachers and even government lawyers financially untenable?

This budget is unsustainable because the wider implications of its measures haven't been thought through. By knocking back its worst features, the Senate will be doing the Coalition (and the nation) a favour.

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Sleights of hand in Hockey's budget

You have to look hard, but there are two logical sleights of hand in Joe Hockey's fiscal policy, as dutifully expounded by his Treasury secretary, Dr Martin Parkinson, in his speech this week.

Parkinson makes three important points that have tended to be lost in all the furore over Hockey's choice of victims in his efforts to get the budget back on track. I'll take issue with the last two.

The first is the "measured pace of fiscal consolidation". ("Fiscal" is a fancy word for the budget and "fiscal consolidation" is a euphemism for the spending cuts and tax increases needed to get the budget back into surplus.)

Parko's point is that, though Hockey has announced a host of decisions to improve the budget balance, many of them don't start for a year or three and the rest don't have much effect for a few years.

Relative to the estimates we were given in the mid-year budget review just before Christmas, the effect of the measures announced in the budget, plus any revisions to the economic forecasts, is expected to reduce the deficit for next financial year by just $4 billion (relative to nominal gross domestic product of $1630 billion).

The expected improvement in the second year, 2015-16, is just $7 billion, with the same improvement the year after. Not until the fourth year, 2017-18, is a big improvement of $26 billion expected to bring the budget back almost to balance.

See how gentle it is? Why so "measured"? Because the economy is still relatively weak - "below trend", in the jargon - and is expected to stay relatively weak for another year or two as spending on the construction of new mines and gas facilities falls much further.

So Hockey delayed the effect of most of his measures until he was confident the economy could absorb the shock without falling in a heap. This is exactly what the Brits and others didn't do - which is why it's both wrong and ignorant to refer to Hockey's measures as a policy of "austerity".

Parko's second point is that the budget measures involve a "compositional switch" in government spending. Hockey's cuts are aimed at "transfer payments" (transfers of money) that flow into consumer spending.

At the same time, however, he's actually increasing investment spending on new infrastructure by almost $12 billion over five or six years. Five billion of that is his "asset recycling initiative", which offers the state governments a 15 per cent incentive to sell off some of their existing businesses and use the proceeds to build new infrastructure.

So the incentive should lead to a lot more infrastructure spending than would otherwise have occurred. And, on top of that, we know investment spending has a higher "Keynesian multiplier" than consumption spending.

This change in the mix of government spending is happening by design, intended to help fill the vacuum left in the engineering construction sector by the sharp fall in mining construction. More proof Hockey is no economic wrecker.

But this year's budget papers include a new section giving the split-up of total government spending between "recurrent" spending (cost of keeping the show going for another year) and spending on investment, something forced on Hockey as part of a deal with the Greens to remove Labor's (silly) cap on total government borrowing.

What past governments haven't wanted to tell us is that about 9 per cent of their annual spending is capital, not recurrent. For the coming financial year this is $36 billion. More than half of this is capital grants to the states, 20 per cent is defence equipment and 14 per cent is building the national broadband network, leaving 11 per cent on the feds' own capital purchases.

The budget papers confirm the new government's commitment to the "medium-term fiscal strategy" first set down by the Howard government to "achieve budget surpluses, on average over the course of the economic cycle".

This is a good formulation, with one, now-more-salient weakness: its failure to distinguish between recurrent and capital spending. Hockey and his boss keep saying the budget has to be returned to surplus because we're "living beyond our means" and leaving the bill for our children.

That's true only to the extent we continue borrowing to cover recurrent deficits. To the extent we borrow to help cover the cost of infrastructure - which will deliver a flow of services extending over 30, 40 even 50 years - we're not living beyond our means (any more than a family that borrows to buy its home is) and not treating the next generation unfairly.

So setting yourself the goal of paying for all your infrastructure investment and having the government end the cycle with an ever-rising bank balance is fiscal conservatism gone crazy.

The second of the government's fiscal sleights of hand comes with Parkinson's third point: Hockey's plan involves creating "headroom for tax cuts".

In projecting government spending and revenue over the coming decade, the government has resolved to impose a cap on the growth in tax collections at 23.9 per cent of GDP. And government spending has been cut hard enough to accommodate that cap while still producing ever-growing surpluses.

Why? Because, we're told, "fiscal drag" (bracket creep) can't be allowed to run on forever. It would push low- and middle-income-earners into much higher tax brackets ("marginal tax rates") which would be both economically damaging and politically infeasible.

Fine. We've had to rely on years of bracket creep to correct the irresponsibility of Peter Costello's eight tax cuts in a row, but this can't go on for ever.

Did you see the sleight of hand? You don't need to cap tax collections just to counter bracket creep in income tax. Hockey is making room for much bigger tax cuts than that. And there's zero guarantee the chief beneficiaries of those cuts will be the low- and middle-income-earners who suffered most under the creep.

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Bracket creep has become highly regressive

If you think you're having trouble coping with the rising cost of living now, just wait until you see what the politicians have in store for you over the next three years. In all likelihood, you'll be losing a significantly higher proportion of your pay in income tax, though people on low incomes will be hit a lot harder than those on high incomes.

This will happen because an increase in the overall tax we pay is inevitable, but it suits both sides of politics to avoid the obvious, up-front increase that would come from raising the rate of the goods and services tax (or from extending the tax to spending on fresh food, education and healthcare) and rely on what Malcolm Fraser called "the hidden tax of inflation" - otherwise known as bracket creep.

The pollies know voters much prefer any increase in taxation to be hidden from their view. Trouble is, the increase in "marginal" tax rates (the tax on the last part of your income, such as on a pay rise or some overtime) many workers face will be so big, you'd have to be pretty thick not to notice.

Treasurer Joe Hockey has been softening us up for the tough budget he's preparing for next month. Fine by me. But he's studiously avoiding admitting there's no way his spending cuts will get the budget back into lasting balance. He's pretending all the problem is on the spending side (and all caused by Labor), when he knows the problem on the budget's revenue side is just as big, if not worse.

Consider the facts. Collections from company tax - which account for about a fifth of total tax collections - aren't likely to grow any faster than the economy (gross domestic product). And collections from indirect taxes - which include the goods and services tax and excises on alcohol, tobacco and petrol - are likely to grow a lot more slowly than GDP.

Collections from excises are declining relative to the rest of the economy, partly because John Howard abolished the indexation of the petrol excise, but also because consumers' spending on alcohol and tobacco accounts for an ever-declining share of their total spending.

Collections from the GST are also in relative decline, because consumer spending has stopped growing faster than the overall economy (as it did when households were borrowing heavily) and because consumers' spending on items subject to the GST is growing more slowly than overall consumer spending. Putting it another way, private spending on untaxed education and healthcare is growing faster than our spending on taxed items.

That leaves collections from income tax, which account for about half the federal government's total collections. Assuming regular tax cuts, income tax collections will grow in line with GDP. Only if further tax cuts are avoided will continuous bracket creep mean income tax collections grow strongly enough to make up for the revenue-raising deficiencies of the GST and other indirect taxes.

Guess what? All the budget projections Hockey is using to justify big cuts in government spending assume no further income tax cuts. Without that assumption the underlying weakness on the tax side would be apparent.

His first reason for ignoring the budget's revenue-raising weakness is his need not to expose as wishful thinking the line Tony Abbott ran from the moment he became Liberal leader, that the Libs stood for low taxation, opposed all "great big new taxes on everything" (except the GST, of course) and should be voted for by anyone who didn't like the sound of the carbon tax or the mining tax.

Hockey's second reason is that any hint of increasing the GST (or any other tax) would allow Labor to do to Abbott what Abbott did to Labor. The party of higher government spending opposes the other side's new taxes for reasons of blatant political advantage.

But Labor also professes to oppose the GST because it's "regressive" - taking a higher percentage of low incomes than of high incomes. It must face the unpalatable truth that the past eight tax cuts have left us with a rate-scale that now makes bracket creep highly regressive.

Consider this. The average full-time wage next financial year, 2014-15, will be about $76,000. On the basis of reasonable assumptions about the growth in wages over the three years to 2017-18, you can calculate that someone on half the average wage would see the proportion of their wage that they lose in tax increase by 3.5 cents in the dollar.

For someone on the average wage the increase would be 2 cents in the dollar. On twice the average wage it's 1.1 cents. And on six times the average wage it's 0.8 cents.

Now that's regressive. Does Labor really think a rise in the GST would be much worse?

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