Are higher taxes the best way to shore up the economy?

Jo Masters

Chief economist, EY Oceania

The impact of COVID-19 on economic activity was almost immediate, and the government response was swift. The debt burden we have as a result of this health crisis is debt that we had to incur, but it could realistically take decades to pay off. We do need to address this debt in time, otherwise we leave a burden for future generations.

In economic terms, there is no black-and-white solution to repaying this debt. It will require a combination of government revenue raising, containing government spending and growing our economy. Everything needs to be on the table.

The more we can do to grow our economy, the less we will need to act directly on government spending and revenue raising. Productivity enhancing reform is critical – we need to look at how we tax, how we train our workforce for the future, and how red tape and a complex industrial relations system are hampering growth and innovation.

 

"Tax reform needs to be part of the conversation, as it not only impacts government revenue directly, but also affects productivity and economic growth."

 

Tax reform needs to be part of the conversation, as it not only impacts government revenue directly, but also affects productivity and economic growth.

Australia has a complex tax system, with a reliance on personal income and corporate tax.

From an economic perspective, a change in the tax mix to rebalance that reliance more in favour of consumption taxes, which provide a more sustainable tax base with a lower cost to economic growth, could be worth putting on the table.

Whichever policy path the government chooses, the road back for the economy will not be fast or straight.

Paul Drum FCPA

Former General Manager, external affairs, Policy and Advocacy, CPA Australia

The public discourse on how governments worldwide should pay for their various COVID-19-related fiscal stimulus measures has already commenced – even before the funds have been fully spent, and before countries around the world are fully out of lockdown. 

At the same time, economic indicators, such as unemployment levels and GDP, are worsening.

There is no quick-fix recovery solution. There’s no doubt increasing taxes to fund the cost of fiscal stimulus measures is one option governments will be considering, and so they should be.

However, this needs to be carefully balanced against consideration of the impact such measures may have on recovery and, more specifically, on business investment, entrepreneurship and innovation, as well as on household consumption.

Globally, most businesses have taken a major hit financially due to various governments’ responses to COVID-19, and many will not survive the COVID-19 lockdown phase.

For those businesses that do survive, one of the last things they need is the additional burden of increased taxes.

Further, increasing taxes on consumption or personal income at this time will only dampen household spending – even though households may be desperate for some retail therapy after the lockdowns are eased and shops re-open.

 

"Governments should be aiming to grow tax revenues by increasing business profitability and jobs growth."

 

Governments should be considering what they can do to help businesses bounce back, as well as encouraging new businesses to start up and succeed. This includes providing support to encourage businesses to more effectively use digital technology and enter new markets via online sales, and helping enable trade to markets domestically and globally.

Governments should be aiming to grow tax revenues by increasing business profitability and jobs growth and, if possible, doing so without putting the heavy yoke of increasing taxes on economies and on their residents in the foreseeable future.

John Daley

CEO, Grattan Institute

Australian state and territory governments are spending 9.5 per cent of GDP to look after households and businesses through the COVID-19 shutdown. Once restrictions ease, Australia will still face a deep, globally synchronised recession, and it is not inconceivable that gross debt will hit A$1 trillion, which is about 50 per cent of GDP, and up from less than 30 per cent before the crisis.

The least painful way to deal with this higher debt is rapid GDP growth, so that the debt quickly becomes a smaller proportion of our resources. This was Australia’s budget strategy after World War II.

However, this time is different. No one is forecasting a baby boom like the one that rapidly expanded the working-age population after World War II. Ongoing quarantine restrictions are likely to constrain the contribution of net migration to population and GDP growth. Furthermore, economic productivity per person has been sluggish around the world for 15 years, and there’s no obvious reason to think it will spring back.

 

"At some stage within the next five years, we will need either lower government spending or higher taxes – and successful budget repair usually requires both."

 

Australia will have to pay for budget deficits over the next couple of years with budget surpluses in future. This means that, at some stage within the next five years, we will need either lower government spending or higher taxes – and successful budget repair usually requires both.

The taxes that would do the least economic damage are largely on investment by individuals – particularly reforms to capital gains tax, negative gearing and superannuation. Arguably, these would also be the fairest taxes to raise, as they have increasingly skewed the tax system to favour capital income, benefiting older people over time.

Meet the experts

Jo Masters
As the chief economist for EY Oceania, Jo Masters is passionate about driving discussion around the traditional and disruptive forces that shape the economy. Her involvement in the banking sector has focused on economic research and trends, and currency strategy. Masters sits on the advisory committee for the Financy Women’s Index, and teaches economics 101 to SheStarts, an accelerator program for female entrepreneurs.

Paul Drum FCPA
As CPA Australia's general manager, external affairs, Paul Drum FCPA was the voice of CPA Australia in the public debate for 22 years, before his tragic passing in May 2020. He had over 30 years of experience in public policy in Australia and internationally.

John Daley
John Daley has been CEO of the Grattan Institute since it was founded 11 years ago. He has published extensively on economic reform priorities, budget policy, tax reform, housing affordability and generational inequality. Daley has worked at the University of Oxford, the Victorian Department of Premier and Cabinet, consulting firm McKinsey & Company and ANZ Bank, in fields including law, public policy, strategy and finance.