Only radical tax reforms can solve our fiscal drag, says former treasury head Ken Henry

Former treasury secretary Ken Henry has declared the Australian taxation system is in “a parlous state” and called for “big bang” tax reform.

Henry, who headed a major inquiry into the tax system launched by the Rudd government, says recent discussions of superannuation concessions, multinational tax avoidance, and the Stage 3 tax cuts, while important, “don’t scratch the surface” of the conversation that’s needed.

No doubt knowing Treasurer Jim Chalmers, a staffer to then treasurer Wayne Swan during the inquiry, would never contemplate another one, Henry says a fresh review isn’t needed and instead advocates “a process” for reform.

Little came of the Henry review after the Labor government faced a massive backlash when it moved to implement its recommended mining tax.

Addressing a Tax Institute event on Thursday, Henry said the Australian tax system “is not capable of raising sufficient revenue to fund the activities of government. Certainly not today. Far less at any time in the future.”

He said for those who understood the fiscal challenge Australia faced, the noise around the Albanese government’s superannuation tax change, designed to raise about $2 billion extra revenue, “sounds shrill”.

“Right now, Commonwealth tax revenue should be at least 2% of GDP higher. That’s about $50 billion a year in today’s money.

“And, given the pressures of accelerating spending on defence, health care, aged care, and disability support, among others, we are clearly going to have to raise the tax-to-GDP ratio even higher over the decades ahead.

“The state of the budget demands large-scale structural reform, on both the spending and revenue sides.”

Henry said the only tax base in the federation budgeted to produce revenue growth at a faster rate than GDP was personal income tax – and that was through fiscal drag.

The “tax mix switch” made by the Howard government when it introduced the GST had been completely undone, with the GST base eroding and fuel excise at risk with the electrification of the vehicle fleet.

“We are back to where we were in the four decades between the end of WWII and the reformist period that commenced in the mid-1980s,” Henry said.

“Those four post-war decades were characterised by ill-disciplined public spending, with a heavy reliance upon fiscal drag that punished innovation, enterprise, and effort; distorted the pattern of saving; and rewarded tax avoidance and evasion.”

He said fiscal drag would naturally be governments’ “tax raiser of choice” because it was “taxation by stealth”.

But relying on it was “much more dangerous, economically, socially, and politically, than at other times in our history.

“Whilst government spending is growing strongly, the share of government spending being directed to the non-working, low tax paying, aged is also growing.

“At the same time, and in stark contrast to the post-war period, because of population aging, a shrinking proportion of the population, made up of relatively young workers, will have to shoulder a rapidly accelerating share of the burden of financing government.

“And this generation of young workers, weighed down with HECS debt, burdened with the responsibility of repaying a mountain of public debt and dealing with the costs of climate change, is finding it increasingly difficult to buy a home,” he said.

These people had been “priced out of the market by those who have already retired or are now moving into retirement, those who are sitting on tax-free capital gains in houses that are exempt from the pension assets test, those who are receiving refundable franking credits on share portfolios and a blend of publicly funded and tax-free private pensions from assets accumulated in lightly taxed self-managed superannuation funds.

“At some point, perhaps even already, the intergenerational social compact must surely fracture.”

Henry rejected the argument for incremental tax reform, instead favouring a “big bang” approach, as was taken following the Hawke government’s 1985 tax summit and by the Howard government.

“Incrementalism sets up a single target on a battlefield occupied by well-resourced attack forces.

“More importantly, incrementalism cannot address our budget and broader economic challenges. No amount of incrementalism is going to meet our fiscal challenges, far less turn around two decades of declining average living standards.

“There is no point planting a seed in a desert when what is needed is continental scale reforestation.”

Henry urged an “inclusive, cooperative Commonwealth-State process” for reform.

It should look at trends, and risks, in spending pressures at all levels of government, considering which could be trimmed and which level of government should have responsibility for policy design and program delivery.

The process should identify “the tax bases upon which increasing reliance can be placed and those that should be avoided to boost growth prospects, and with acceptable implications for distributional equity.

“That means examining the tax, transfer, and retirement income systems in concert. And then it should determine the allocation of taxing powers,” Henry said.

“To any political leader, tackling tax reform is going to present like a mountain range covered in ice, ” Henry conceded.

“And today’s tax reformers do not enjoy the political luxury available to the Howard government, to craft a revenue-negative reform package, nor even a politically challenging revenue-neutral package, such as that constructed by Treasurer Keating in the mid-1980s.

“The package needed on this occasion must be revenue positive. So, this is going to be hard.”

Michelle Grattan is a professorial fellow at the University of Canberra.

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