Shonky advisers have led Rudd badly astray

Kevin Rudd has his back to the wall. He's no fighter, but he has little option but to stand and fight for his bitterly resisted resource super profits tax. With luck the experience will help turn him into the more substantial figure we need to lead us.

All Rudd's instincts - and those of the Hollow Men on whose counsel he relies - must be to ditch or greatly water down a tax he now discovers has proved hugely unpopular with the miners and which an economically uncomprehending business community doesn't like the sound of.

For a man who's always searching for a soft cop - those "reforms" that are riding high in the opinion polls, such as health care and, formerly, action on climate change - this must have come as a great shock to him.

But Rudd has no choice but to stand and fight. Having instantly shredded his credibility with his cowardly decision to cut and run from his emissions trading scheme when its popularity slipped, he simply can't afford another blow to his reputation.

If that's not enough, there's this: almost all the nice things he's promising to do if he's re-elected - cut company tax, help small business, further subsidise superannuation and the rest - hang off the resource tax. No tax, no goodies.

Normally, a prime minister has room for tweaks to placate the vested interests, but this time Rudd has none. His credibility is too low.

And the precedent of weakness he set with all his cave-ins to miners and other rent-seekers over the emissions trading scheme means giving the miners something this time would be more likely to further incite their greed than calm them.

Rudd is a weak man fallen among thieves. He may be from Queensland, but his moral compass now comes courtesy of Sussex Street. I'm sure he remains convinced of his own uprightness, but clinging to office comes first.

Actually, for a bunch that puts political expediency above all, Rudd's cynical advisers have made a succession of bad calls. They imagined they could give in to the rent-seekers on emissions trading without being seen as an easy mark on every subsequent business issue.

They quailed at the thought of defending "a great big new tax" at a double-dissolution election, and deluded themselves that if they ditched the emissions scheme no one but a few greenies would care.

They commissioned the Henry tax review without thinking through the implications of having it lob just before an election. Then they imagined they could turn it into a get-out-of-jail-free card.

Introduce a big new tax on a group for which no one had much sympathy - the big, largely foreign-owned mining companies - then use it to pay for a raft of supposed reforms, carefully chosen for their vote-catching abilities, without adversely affecting the return to surplus.

And this lucrative tax came with the economic rationalists' Good Policy seal of approval, co-signed by Dr Ken Henry and Professor Ross Garnaut. Economic imprimaturs don't come from any higher authority.

One small problem: the resource tax is so pure - so carefully designed to ensure it doesn't do all the bad things it's being accused of - that it's impossible for anyone who's not a paid-up economist to understand.

Worse, its most prominent feature, the allowance rate set at the long-term bond rate, makes every ignorant Fin Review reader (and most of the business commentariat) imagine they can see the glaring flaw Henry and Garnaut missed. Yeah, sure.

We must assume that, unlike all the rest, the miners themselves have studied the complex design of the tax and disabused themselves of this beginner's error. But are they going to dispel or to exploit the business punters' illiteracy? One guess.

Did Rudd's whatever-it-takes political smarties see that one coming? I bet they didn't. Nor did they foresee the way the miners, aided by a hostile state government, would use the tax to heighten the West Australian electorate's resentful delusion that their state's propping up the rest of the economy Back East.

Did it occur to the political experts that all Tony Abbott had to do to solve the Liberals' acute lack of election funding was to oppose the tax then pass the hat round the miners? I doubt it.

Did it occur to the spin doctors that getting the business community and even the wider electorate to accept the wisdom and fairness of this tax would require an enormous effort by expert wordsmiths to formulate and feed ministers with simple ways of explaining the otherwise incomprehensible, rather than relying on their usual tricks of emotive slogans and manipulating the news cycle?

I doubt it. You can see that from the way some smarty decided to rename the Henry report's resource rent tax as the resource super profits tax. The half-baked notion was to heighten the great unwashed's resentment of foreign mining giants.

What it actually did was heighten the resentment of the miners and the sympathy of the wider business community by rubbing in the notion that this was an additional tax on company profits, levied at 40 per cent. That's a false perception, but it acted as red rag to a bull.

Had the perception managers understood the economics, they would have realised the measure was more a complex-calculated price for the use of natural resources owned by the Australian people than a tax, and renamed it something like the "reasonable royalty charge".

Rudd has been badly served by his spin doctors and advisers. They've led him astray and dropped him in it. If he's got any sense he'll switch to giving the electorate what it's shown it wants: a leader who is honest, straight-talking and principled.

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Henry's plan is for taxes based on hard evidence

What happens when you ask perhaps the foremost tax expert in the country to conduct a "root and branch" review of the tax system? He recommends things no prominent businessman or retired judge would dream of proposing.

Few if any taxes are popular, but in all the submissions to the Henry review there was little agreement on which were the really bad ones - or on why they were so bad.

A lot of the arguments we have about particular taxes - whether they're achieving their objectives, whether they're doing more harm than good - are based mainly on the vested interests, ideology or some economic theory, freefall rather than objective evidence.

Has it ever occurred to you that the decisions governments make about what taxes to levy and the rates at which to levy them ought to be a lot more scientific? Based more on hard evidence than judgment?

Though the primary purpose of taxes is to raise revenue, most have stated policy objectives behind them. If nothing more specific, they're supposedly designed to minimise the tax system's distortion of the choices we make, to spread the burden of taxation fairly, to treat people in similar circumstances similarly, and to do all this in ways that leave people certain of their rights and responsibilities and don't generate high costs to comply.

Then we have the growing tendency to use taxes to correct the spillovers that occur when people make decisions but don't take into account their impact on others.

Sometimes the tax is intended more to change behaviour than raise revenue; sometimes the revenue raised compensates the losers from the spillover. Emissions trading schemes and carbon taxes are the latest examples of this, as is the push for congestion taxes.

But let's consider taxes on tobacco and alcohol. Ideally, tax on alcohol is set at the relevant "marginal social cost" - the level that transfers to drinkers the costs their actions impose on the community, as well as compensating the community for those costs.

How do we know the right level for the tax? We don't - not without collecting a lot more empirical evidence than we have now. More generally, we need to monitor the performance of the tax system better.

Henry says that "where possible, the performance of specific taxes and transfers should be measured objectively to identify whether they are meeting their policy objectives.

"An objective evidence base can reinforce public and government support for successful economic reforms and helps to determine when existing policy settings are no longer appropriate."

The paucity of information on specific taxes or cash transfers means data designed for other purposes are often used for analytical purposes, but this can be unsatisfactory.

Unbiased and systematically collected data on the tax system, based on widely accepted methodology and appropriate for tax policy purposes, are rare and often not publicly available.

Because such information is a public good - that is, the producers of it can't stop it being used by people who haven't paid for it - and even though society would benefit through improved tax policy based on it, the incentive for individuals or businesses to produce it is weak.

In any case, the capacity of non-government players to generate such information is limited because much of the data needed for the analysis is held by government.

All this says it's primarily governments' responsibility to generate - and make public - the needed information.

Henry adds that we would benefit from a system-wide study of taxpayers' compliance costs to monitor, on a continuous basis, the costs of complexity.

"Well-designed system-wide surveys are expensive," Henry says, "but they would provide valuable information on where simplification would yield the greatest returns".

Another area where we'd benefit from more information is on the extent of non-compliance with tax laws. The Tax Office doesn't derive estimates of non-compliance for key income and deduction items, nor publish these estimates.

Where people do examine the performance of taxes they tend to consider taxes separately. But this makes it difficult to get a sense of the system's combined performance and effects, and to determine whether it's making a coherent contribution to our national objectives.

So Henry recommends that federal and state governments systematically collect data on aspects of existing taxes and cash transfers - including compliance costs - according to consistent and transparent classifications and concepts, and make this information freely available for analysis and research.

He further recommends that every five years the feds publish a "tax and transfer analysis statement" on the overall performance and impact of the system, including estimates of efficiency costs and distributional impacts.

Academics, tax practitioners and the public should be encouraged to contribute to - and contest - the analysis in the statement. All data used and a full description of methodologies should be available to the public and subject to peer review. The government should also support one or more institutions to undertake independent policy research relevant to the tax and transfer system.

Only a man as possessed by the need for good tax design as Henry is would dare recommend such an egg-headed and expensive program just to make tax policy more "evidence-based", as the medicos like to say. But that doesn't mean he's wrong.

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How much stick to give jobless

Just one of the major elements of the Henry tax review that Kevin Rudd brushed aside in his rush for a quick political fix was reform of the "transfer system". Huh?

In the jargon of economics, a transfer is a cash payment from the government to an individual, which isn't made in return for the receipt of goods and services.

So transfers include pensions, the dole and family benefits. You may think social security payments have nothing to do with taxation, but economists see the two as closely related. Taxes are cash going from us to the government; transfers are cash going from the government to us. For every dollar the federal government gets in, more than 25 goes out in transfers.

Indeed, the review's terms of reference required it to consider improvements to the "tax and transfer payments system" - note the implication: two components of a single system. Dr Ken Henry and his panel note that our transfer system is different from those in most developed countries. Its primary purpose is to provide a minimum adequate standard of living - meaning its goal is to alleviate poverty rather than help people maintain the incomes they enjoyed when they were working.

This emphasis just on avoiding poverty is the reason our system provides people with a flat rate of benefit (rather than a proportion of their former income) that's subject to a means test to ensure assistance goes only to the needy. This makes our transfer system the cheapest among the rich countries (which does much to explain why our level of taxation is lower than most of theirs). But it also means our system is the most "progressive" - it benefits the poor disproportionately to the rich.

A lot of people imagine progressivity comes from the choice of taxes you levy - lots of income tax and not much indirect tax. But you can also make the total system more progressive by biasing government spending in favour of low-income earners - which is just what we do.

Henry makes the further point that (contrary to the nonsense we keep hearing from the libertarian think tanks) means testing greatly reduces the degree of "churning" - taking money from people, then giving it back to them. Our system tends to take from the well-off and give it to the less well-off (which is what the well-off libertarians hate about it).

Now, it's clear from all the references to the "tax and transfer system" that one of the major goals of the review was to fully integrate the two systems - make them fit together better. That the two systems don't fit well can be seen from our frequent wrestling with the problem of high "effective marginal tax rates". Say a mother working full-time is considering moving to a tougher, higher-paying job. On each extra dollar she earns she would lose 31.5 in income tax. But she may also lose 30 in family benefit. If so, her marginal tax rate is, effectively, 61.5 in the dollar - well above the top tax rate of 46.5 and quite a disincentive.

It's clear the hope in getting the Henry review to look at the tax and transfer system was for it to find a comprehensive fix to the effective marginal tax problem.

But here's the scoop: it couldn't do it. After much effort it decided the two systems just couldn't be integrated. The problem is created by our love of means-testing, but is compounded because income tax is levied on the individual, whereas eligibility for transfer payments is based on the joint income of couples.

Its best suggestion was that the separate means tests for part A and part B of the family benefit be combined, with a single "withdrawal rate" of only 15 to 20 for each extra dollar of income earned.

The review turned to the range of transfer payments, saying their adequacy, structure and incentive effects could be improved. It says income-support payments should be divided into three categories reflecting society's expectations about the individual's ability to work.

Particularly with an ageing population, we want to encourage as many people to work as possible. The benefits of work are social as well as economic. It doesn't just provide you with an income, it makes you feel good to be part of the action. The first category is "pensions" - for the aged and the seriously disabled - where there's no expectation of work. Next is the "participation" category for those who are expected to work now or in the near future. This would include the unemployed and sole parents. The last category is "students", for young people undertaking full-time study.

The review notes that successive governments have allowed big gaps to emerge between the levels of benefits in the three categories with, for instance, the single-adult dole falling $108 a week below the single pension of $336 a week. "These differences produce very different outcomes for people with similar capacity to work," the review says. "They can create disincentives to work" or incentives to move on to payments (such as the disability support pension) that don't require you to look for a job.

It says these gaps should be reduced, and then each category's payment should be indexed on the same basis to prevent them widening again. But the gaps shouldn't be eliminated, with people in the participation category getting less than those on pensions, and students getting less again.

Why the differences? The dole should be lower than the pension to increase the incentive to find work and because it's assumed periods on the dole will be short. Students should get less because they can save by living at home or in groups and because they can work part-time.

Sorry, but this doesn't make sense to me. At present the single dole is only about 45 per cent of the minimum wage. People of working age face more costs than the elderly, not fewer. How much stick do the unemployed need to make them work? Hardly that much.

Maintaining a gap between the pension and the dole will continue to present a disincentive for sole parents to risk looking for work, lest all they find is a lower rate of benefit. But if you don't like what the review has proposed, don't worry.

It will be a long time before the government puts reforming the transfer system on its to-do list. It's happy to live with all the present deficiencies.

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You can trust politicians ... to do exactly what's best for them

What terrible shi ... people politicians are. Kevin Rudd decides he wants a "root and branch" review of Australia's tax system. The biggest and best review in the history of the universe. Federal, state, local, the lot. So our top econocrat, a tax expert, and four other highly qualified and busy people devote 18 months of their lives to a very thorough, thoughtful review.

What does Rudd do? Takes months to get around to looking at it then, when he does, picks the one big plum out of the pudding - a genuine, economic rationalists' licence to impose a great big new tax on an industry for which there's little voter sympathy - explicitly rejects 19 controversial recommendations and passes no comment on the remaining 120-odd.

Thanks very much, that's you off to a pigeonhole.

So let's ignore our appalling politicians and pay the Henry report the courtesy of considering what it has to say. Its key point is we need changing taxes for changing times. We're in the early part of a new century, our lives are changing, the position Australia finds itself in is changing, so how does our system of taxes need to change in response the major challenges we're likely to face over, say, the next 40 years?

Ken Henry and his fellow panel members identify three big trends we need to adjust to. The first is demographic change. The population is ageing and the higher proportion of older people will involve increased demand for spending on age pensions, aged care and healthcare, putting a lot of pressure on federal and state budgets.

You've heard that before from the pollies, but you haven't heard this: "We do not expect total tax burdens will rise in the next few years, but some increases in later times may be unavoidable." So taxes will be going up, not down as politicians like to fantasise. We need a "robust" group of taxes, the collections from which keep up with ever-increasing government spending, and the rates of which can be increased from time to time without causing distortions.

We need to ensure older people - facing choices about when to retire and whether to work part time in semi-retirement - aren't discouraged from working by rates of income tax that are too high. We also need to keep getting the bugs out of the taxation of superannuation so people are encouraged to save for their retirement income needs on top of the age pension.

The second major trend is globalisation. Australia has always needed to attract foreign capital because our opportunities for economic development far exceed our ability to save the capital needed to exploit them.

Globalisation is increasing the alacrity with which international investors (including pension funds) are willing to move money around the world in search of the highest returns. But development of the poor countries, particularly in Asia, means we're facing more competition in attracting the foreign investment we need.

When you boil it down, governments tax only four main things: land (including natural resources), capital, labour and consumption spending. The Henry panel believes the greater international mobility of capital - and the competition between small economies to attract that capital - means we can't get away with taxing it as heavily as we once did. This explains its recommendation to reduce company tax from 30 per cent to 25 per cent. It also believes globalisation is making highly skilled labour more internationally mobile and thus harder to tax at high rates.

But if mobile resources need to be taxed less, then immobile resources will have to be taxed more. Nothing's more immobile than land and natural resources. Hence the proposal for an annual land tax, at a low rate of, say, 1 per cent, on all land (but with the abolition of conveyancing duty).

And hence the proposal for a resource rent tax on natural resources. The coal and iron ore belong to all Australians, not the mining companies, and the use of this tax to effectively replace state royalties is just a way of ensuring the miners pay us a price for our resources that more accurately reflects their hugely increased value (as a result of globalisation and the economic development of China and India).

The third major trend is environmental degradation. Environmental pressures are emerging "in areas such as land degradation, species decline, water use and climate change", the panel says. Higher population and continued economic growth "will put pressure on our increasingly fragile ecosystems".

Our economic prospects are strongly linked to environmental sustainability. "The environment provides natural resources essential to Australia's productive capacity, and ecosystems that absorb and assimilate the waste generated by people and industry. Sound land and water management practices are essential to maintaining agricultural production; biodiversity enables technological progress, particularly in medical and pharmaceutical applications; and low atmospheric pollution is essential to climate stability."

People and businesses make decisions every day that affect environmental quality, but in many cases they aren't fully aware of their impact, or don't value those impacts as highly as others do, particularly future generations. "Accordingly, there is a role for government to influence decision making with a view to achieving better environmental outcomes."

The tax system can play a greater role in promoting sustainable policy outcomes by influencing the incentives that lead to environmental degradation. "An equally important consideration is to ensure that settings within the tax and transfer system do not unintentionally produce adverse environmental incentives or conflict with the broader environmental goals of ... other policy measures."

Bet you haven't heard that kind of talk about tax reform before. And what's the one big reform we need to get us moving on the right path? A carbon pollution reduction scheme.

Oh.

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In time we will get the nasties - but not just yet

If history is any guide, pretty much all the nasty changes proposed in the Henry tax review will be implemented.

We'll end up with a congestion tax on cars, much higher tax on wine, land tax on the family home, higher tax on capital gains, cutbacks in negative gearing, a tax on bequests and annual increases in petrol tax.

But it will take up to 25 years to happen. And few of the nasties will be taken up by the government that originally received the report.

That's what happened to the Asprey tax review of 1975, which recommended a host of things the Whitlam government wouldn't touch with a barge pole: a tax on capital gains, taxes on fringe benefits and entertainment expenses, something weird called dividend imputation, and a value-added tax (which John Howard delivered in 2000, exactly 25 years later).

Ken Henry's objective was to lay out another blueprint for long-term tax reform. So though Kevin Rudd has sworn not to touch most of Henry's nasties, don't imagine you've heard the last of them.

Rudd has sorted Henry's many recommendations into three boxes labelled Yes now, Maybe later and No never.

In the Yes-now box are all the nice ideas Rudd hopes will win him votes at the election this year, includ-

ing a great big new tax on mining companies and cuts in company tax, particularly for small business, and bigger superannuation concessions for low-income earners.

To these Rudd has added some good ideas of his own, such as higher super contributions by employers and a big new infrastructure fund.

In the Maybe-later box are various reforms Rudd has failed to specify but which, presumably, wouldn't worry most voters and would seriously antagonise only interest groups for whom the public doesn't have much sympathy.

If you can find anything there that you and enough others don't like, make a fuss and Rudd will quickly rule it out.

Rudd needs these reforms to justify his bid for re-election, to demonstrate all the wonderful improvements he needs to be allowed to get on with doing for us in his second term.

In the No-never box are all the nasties Rudd knows would cause him grief and cost him votes, no matter how much in the nation's interests they might be. These include all the nasties I listed at the start, plus higher tax on company cars, tougher tax rules for single-income families, anything a charity wouldn't like, ending dividend imputation and much else.

In other words, Rudd's response to Henry's recommendations has been determined by his top priority - political survival. For such a timid man, his willingness to commission such a potentially controversial review, timed to report on the eve of an election, was always a puzzle.

His dawning realisation that he'd be unveiling 1000 pages of trouble may do much to explain his decision last week to ignore "the great moral challenge of our time" and abandon his commitment to his emissions trading scheme because Tony Abbott had labelled it "a great big new tax".

Now Abbott will be trying to convince us Rudd has half a dozen big new taxes up his sleeve, waiting to be sprung on us. All the proposals Rudd says are in the No-never box are secretly in his Once-I'm-re-elected box.

But that's the bitter beauty of last week's political cowardice and failure of leadership. We needn't fear Rudd has any tax nasties up his sleeve because we now know he doesn't have the courage.

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