Heavy tax burdens drag down economic performance

Bookmark and Share Economics & Deregulation | Julie Novak
The Drum 4th March, 2013

In his Drum Opinion column, Joff Lelliott calls for a better understanding of the relationship between the amount of tax collected by governments and what they can provide.

This does not seem an unreasonable ask at first glance.

However it remains incumbent upon all participants in the debate about the appropriate size and scope of government, including political aspirants in the forthcoming federal election, to state their positions in ways which help fully illuminate the key issues at stake.

Drawing upon OECD statistics as presented in the Federal Treasury's Pocket Guide to the Australian Tax System Lelliott states that Australia has a relatively small government collecting taxation revenues equivalent to 25.6 per cent of GDP, grouping it in a so-called 'super-low tax league' alongside the US, Chile, Mexico, Turkey and Korea.

Even taking the OECD data at face value, it should be noted the OECD comprises only a very limited basket of countries among the nearly 200 countries in the world, and several competitor regions in the Asia-Pacific, including Hong Kong and Singapore, impose lower taxation burdens on individuals and businesses compared with Australia.

There have been a long line of Australian classical liberals over the years publicly expressing their support for this country to move toward the lower-taxing environments of these two Asian powerhouses, and consequently toward relatively greater non-government infrastructure and services provision.

For good measure there are even institutional and policy attributes of our low tax league 'super-friends' that Australia should emulate, for example robust American competitive federalism or Chilean for-profit schooling.

It seems for Lelliott the amount of Australian GDP absorbed in taxation by Commonwealth, state and local governments is insufficient, and he accordingly provides a rough calculation of the additional amount of taxation revenue to be raised if Australia taxed at the OECD average of 33.8 per cent of GDP.

The magic (or should that be magic pudding?) additional tax revenue figure Lelliott estimates is 'well over $100 billion extra for governments to play with,' which could be used to finance proposals such as the NDIS and Gonski and an undefined 'more.'

Intriguingly, Lelliott suggests that Australia's overall taxation burden could be increased by 'far less' than the OECD average to cover NDIS, Gonski and 'more,' but does not provide further detail, presumably preferring that the political class have themselves a bigger economic muck-up day with more taxpayers' money to burn.

If readers suspect that something is amiss with Lelliott's analysis, in particular that higher taxing European nation-states haven't been necessarily travelling well in the economic growth stakes for a fair while, they are onto something.

That is because a larger size of government often reflected in empirical studies through the taxation-to-GDP ratio, or even the ratio of government spending to GDP which has to be financed through taxes anyhow, will harm economic performance even in relatively small-government countries.

An overwhelming number of cross-country studies over the past decade that accommodate econometric innovations and richer data sets, and which often include Australia in the empirical coverage, have found that a larger public sector is associated with slower economic growth rates.

For example, Andreas Bergh and Martin Karlsson in 2010 undertook a study of 29 OECD countries showing a negative correlation between government size and growth, controlling for economic freedom and globalisation.

In the same year two European Central Bank researchers, Antonio Afonso and Davide Furceri, took samples of OECD and EU countries to find, in their own words, that 'total revenue and total expenditure seem to impinge negatively on the real growth of per capita GDP.'

There are countless other peer-reviewed studies which demonstrate that relatively larger public sectors tend to economically bite the hand they feed from.

A related consideration ignored by Lelliott is that implied increases in existing tax rates, or the introduction of new tax technologies, to lift the Australian tax-to-GDP ratio toward the OECD average will have strong disincentive effects.

Politicians of all persuasions, and it seems Treasurer Wayne Swan is among them, often forget that increasing tax rates after a certain threshold will provide less revenue to the government due to Laffer curve effects, and are thus routinely frustrated when their grand taxing schemes do not come to expected revenue collection fruition.

More generally, the heavier the taxation burden the greater the economic distortions imposed upon the economy, as market participants seek alternative, sometimes lower value added, activities to escape the tax burden.

A debate about the nature, size and scope of government is most welcome, in the interests of encouraging an informed choice for voters in choosing between lower taxes and smaller government, or higher taxes and larger government.

However, it is difficult to share Lelliott's enthusiasm in believing that taxes can be increased with economic impunity.

Australians should think carefully about the electoral policy choices on offer and very carefully scrutinise big-spending ticket items, such as the NDIS and Gonski, which risk rendering citizens poorer in the long run.