Election 2004: Labor’s economic policy options in the coming election

John Quiggin, University of Queensland

ECONOMICS AND ELECTIONS

Economic policy has many components, notably including macroeconomic management and microeconomic policies of regulation, deregulation and reregulation. In general, however, the economic policies that decide elections are those relating to taxation and public expenditure. (Interest rates are also important, but, under a system where monetary policy is determined by an independent Reserve Bank, are largely outside the control of governments.)

It’s usual to compare the policies of government and opposition, but this can be a complicated and confusing exercise. As I noted in my contribution to Robert Manne’s collection, The Howard Years:

Economic policy under the Howard government presents a contradictory picture. Sometimes the government appears as a continuation of those of Hawke and Keating, implementing the reforms those governments were unwilling or unable to introduce. At other times, as in its ‘nation-building’ infrastructure exercises, it seems like a throwback to the developmentalist ideas of the 1950s and 1960s. Still more of the time, it appears content to drift, happily taking the credit for a long period of relative economic prosperity and putting forward economic reforms on a purely opportunistic basis, as and when the political climate demands an appearance of action rather than stability (2004, p. 169).

These contradictions show up in tax and expenditure policy too. After campaigning on the promise of a ‘relaxed and comfortable’ Australia, and specifically ruling out spending cuts, the first Howard government manufactured a budget crisis and made severe cuts in the 1996–97 Budget. At the same time, it appointed a Commission of Audit to build the case for rolling back the public sector.

The first Howard government manufactured a budget crisis and cut the 1996–97 Budget severely.

In more pragmatic moments, however, the government has responded to public resistance to cuts in services and demands for improvements. And these demands are hard to resist. As income rises, the demand for services like health and education tends to rise—both absolutely and as a share of total expenditure. In the absence of radical privatisation, this trend inevitably means an increase in the ratio of public expenditure to national income. Despite its ideological desire to roll back the public sector, the Howard government has been forced to respond to political and social realities. However, it has done so grudgingly and incoherently.

These contradictory actions have meant that, under the Howard government, the level of national government expenditure and revenue—relative to national income—has remained about the same. Admittedly, measuring this is more complicated now, because the GST has replaced a mix of national and state taxes and GST revenue has replaced some grants to the states as well.

The Labor opposition has responded to the contradictions of the government’s approach by adopting equally contradictory lines of attack. Labor points to many areas of unmet need while assailing ‘the highest-taxing government in Australia’s history’. Without going into the tangled debate about Labor’s claim, we might observe that this broadly correct description ought to be seen more as a compliment than as a condemnation.

Having it both ways works well enough in opposition, but it’s not satisfactory for an alternative government. There’s a natural tendency to put off making firm commitments until the election is imminent. Labor has yet to announce the tax policy foreshadowed as a response to the 2004–5 Budget. However, as Kim Beazley’s ‘small target strategy’ in 2001 demonstrated, this approach can be disastrous. Labor needs to announce a coherent tax and expenditure policy as soon as possible. Although Labor did announce substantial health and education measures some time ago, these are insufficient for what promises to be a closely fought election campaign.

LABOR’S BIG CHALLENGE: FINDING THE MONEY

The first question confronting Labor is how much money is available to spend. A reasonable goal for Labor’s first term would be to maintain the ratio of public expenditure to GDP. The 2004–05 Budget projects expenditure to decline from 22.6 per cent of GDP in 2003–04 to 21.9 per cent in 2007–08. Aiming to hold the expenditure/GDP ratio constant would allow Labor to spend an additional $20 billion over a three-year term. Allowing for $10 billion over three years from reallocation of existing priorities would permit Labor to announce expenditure programs amounting to $30 billion.

The first question confronting Labor is how much money is available to spend.

The initiatives Labor has committed to so far amount to about $5 billion over the three-year term, so there is certainly room to move. But creating the resources for new policies is not easy. Here are some concrete suggestions for Labor that will answer ‘Where’s the money coming from?’ question and help fund up to $10 billion in tax cuts and new expenditure.

Duplication and waste

The Opposition has some advantages of its own. In particular, it can promise to finance at least some of its promises through cuts in vaguely specified duplication and waste. Howard and Costello made claims like this before the 1996 election and Labor can do the same. But there’s only so far you can go with this. It will be necessary to identify real targets. Labor could reasonably aim to find $1.5 billion per year by:

  • cutting government advertising. It’s currently $200 million per year, much of which is propaganda.

  • trimming consultants. It is hard to know how much the government pays consultants, but it is at least $500 million per year. The growth in spending on legal services is particularly notable.

  • stopping pork barrel grant programs. The Natural Heritage Trust, which received $300 million in the last budget, is typical and substantial savings could be made if this money was rolled into general environmental spending.

The health insurance rebate

The health insurance rebate is big, expensive, and not very effective. The annual direct costs are now $2.5 billion. In addition, the incentive for claimants to seek treatment in higher-cost private hospitals costs about $0.5 billion in extra Medicare payments (Smith 2001). There’s also an implicit $1 billion or so in tax expenditures flowing from the additional Medicare levy surcharge on those higher income earners who avoid the surcharge when privately insured. Against this, support for private health provision does reduce the use of public hospitals somewhat, which benefits the states. By reducing the rebate to 15 per cent and applying higher Medicare surcharge to the privately insured as well, Labor can make annual savings of $1 billion to $2 billion.

Negative gearing and capital gains

The costs of the health insurance rebate exceed the savings to public hospitals.

Unrestricted deductibility of interest costs and concessional treatment of capital gains only encourages housing industry speculation. To his credit, Mark Latham was the only member of Labor’s caucus to speak against the disgraceful deal Labor made in the Senate that enabled the Howard government to gut the capital gains tax. There are two basic ways of addressing this. Logically, the most satisfactory way is to reverse the tax cut in on capital gains. But an alternative might be to follow the American practice of ‘quarantining’ losses on investment housing so that tax deductions can be claimed only against profits from the same activity and not from general taxable income. The potential revenue gain here would be large. The Australian Tax Office pays out about $700 million more in deductions on housing investment than it takes in tax revenue. Because these investments are supposed to make a profit, and at least some investors do pay tax, quarantining losses would save at least $1 billion per year.

Motor vehicle Fringe Benefits Tax

Eliminating concessional treatment of company cars would save around $500 million per year and a similar amount could be gained from further restricting salary packaging for a total of $1 billion per year.

Cancelling Howard’s latest tax cuts

Latham has promised wider tax cuts than those contained in the government’s 2004–5 budget package. If this means Labor would give all government’s tax cuts and their own on top, this would be clearly unaffordable. But it’s hard to see Labor cancelling tax cuts that have already been given out. The most reasonable basis for proceeding, then, is that Labor should scrap the second round of the government’s proposed tax cuts and use the proceeds to finance an alternative. Then, an obvious option for Labor is to make no further changes to the top threshold, instead raising the income thresholds for the 30 per cent and 42 per cent marginal rates. This would provide revenue of around $2.5 billion per year as the basis for an alternative tax cut.

Tackling tax avoidance through trusts and companies

The deal that lured the Opposition into supporting the capital gains tax cut was also supposed to oblige the government to combat tax avoidance schemes like personal service companies and family trusts. The same measures had previously been promised to the Democrats in return for support on the GST. But then the government caved in to pressure from business, withdrawing most of these measures. The government’s own estimates at the time suggested measures to combat tax avoidance could raise $1.5 billion a year. Labor should aim for $2 billion.

Labor’s even bigger challenge: structural reform

Labor needs more than plans to identify savings and promises to spend more money.

Labor needs more than plans to identify savings and promises to spend more money. It needs a bigger plan to respond to structural barriers that inhibit improvements in services, the most important of which are in the health sector. As I argued when the Howard government was first elected:

We could start to resolve the problems of the health sector if the Commonwealth took complete responsibility for health. This would go a long way towards eliminating the present cost-shifting and duplication. More important, voters would be faced with a clear choice between lower Commonwealth taxes and better health services (Quiggin 1996).

The problems of cost shifting are obvious and have become steadily worse as policies like case-mix funding encourage hospitals to exploit arbitrage opportunities created by multiple sources of funding. In seeking to provide services that attract a high case-mix return, hospitals end up shifting high cost components onto Medicare.

On the other side of the cost-shifting equation, the Howard government has taken funds from the state hospital systems to finance its private health insurance rebate. Most independent analysis has shown that the costs of the rebate exceed the savings to public hospitals (Segal 2003). If the Australian government had responsibility for hospitals it would have a much greater incentive to get the balance of costs and benefits right. Shifting responsibility for hospitals to the Commonwealth would also go a long way towards fixing the problem of vertical fiscal imbalance and would enable the elimination of a large class of specific payments as well as much of the remaining general purpose grant to the states.

The most important benefit of Commonwealth responsibility for hospitals would not be administrative but political. As long as the Commonwealth raises most tax revenue and the states provide most services, Commonwealth governments will always have a political incentive to cut taxes and pass the pain on to states. The Commonwealth’s role as paymaster leads to the adoption of the view that health expenditure, as a proportion of GDP, should be kept as low as possible.

The next election will not be won by a ‘small target’ economic strategy.

Going further along this path, Labor should persuade the states to withdraw completely from the university and vocational education sectors. Although they get almost no state funding, most universities operate under state acts of parliament. As a result, state governments have both responsibilities for financial supervision which they have a limited capacity to fulfil, and powers to interfere in the running of universities with no responsibility for the consequences. Funding vocational education is an even more confused mess I won’t tackle here. Equally, the Commonwealth should completely get out of school funding. With the Commonwealth giving disproportionate assistance to private schools and the states giving disproportionate assistance to public schools, it will never be possible to achieve a coherent outcome.

Structural reform is also needed in tax policy. Labor must keep its promise to produce an alternative tax and family payments policy that includes ‘broader and fairer’ tax cuts and does not crowd out additional expenditure. I have already proposed a crucial step—scrapping the second round of tax cuts outlined in the 2004–05 Budget. The most attractive alternative to the government’s package would be an earned income tax credit that Labor proposed in 1998. This alternative would integrate the tax and welfare systems, particularly for families dependent on relatively low wage incomes: tax credits would reduce the implied marginal tax from means-testing welfare benefits.

CONCLUSION

Although the government is vulnerable, the next election will not be won by a ‘small target’ economic strategy. Labor needs to announce substantial tax and expenditure initiatives and to do so as soon as possible.

REFERENCES

Quiggin, J. 2004, ‘Economic policy’, in The Howard Years, ed. R. Manne, Black Inc., Melbourne.

Quiggin, J. 1996, ‘Commonwealth must take responsibility for services’, Australian Financial Review, 7 August.

Segal, L. 2003, ‘Why support private health insurance in Australia?’, New Doctor, no. 79, pp. 10–11. [Online], Available: http://www.drs.org.au/new_doctor/79/Segal.htm [2004, July 9].

Smith, J. 2001, ‘The Medicare levy surcharge: tax penalty or tax subsidy’, Discussion Papers, no. 38, Australia Institute, Canberra, August.

John Quiggin is a Federation Fellow with joint appointments in the departments of Economics and School of Political Science and International Relations at the University of Queensland.

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