WHEN Kevin Rudd and Wayne Swan released the Henry tax review last Sunday they said that the Howard government had missed the opportunity to spend a lot more money on hospitals and schools by failing to collect more revenue from mining. True. In contrast, they intend to hit miners with a super profits tax that they estimate will raise around $9 billion a year after it starts to bite on 1 July 2013. But they won’t spend a cent on hospitals or schools. They have different priorities.
The two most important ways Rudd and Swan can think of to spend the $9 billion are to cut the corporate tax rate from 30 per cent to 28 per cent and to subsidise retirees, including multimillionaires, so they can consume more in their old age. They are expected to announce a third priority – subsidising bank deposits – before the election. Apart from a small increase in funding for infrastructure announced last Sunday, that’s it. Nothing will be left for education, health or any number of other things that could improve the wellbeing of the population.
Over time, the biggest chunk of the $9 billion will be taken by the cost to revenue of government’s decision to boost retirement incomes by increasing compulsory superannuation contributions to 12 per cent of salaries. This was not one of Henry’s recommendations – he reported that the existing level of 9 per cent is enough to provide a comfortable retirement once the system is mature. Indeed, Treasury modelling shows that the 9 per cent, supplemented by the age pension, will give low-income earners a higher disposable income in retirement than they get while working.
The government also decided to reject a number of other recommendations from Henry – many good, some bad. One of the worst decisions was to rule out changing the tax treatment of investment properties, which the Reserve Bank sees as helping push up house prices and adding to the pressure to raise interest rates.
Many commentators say the government is on a winner by taking an extra $9 billion a year from mining because it is one of the least popular industries in Australia. Perhaps, but it would be surprising if most people believe the nation gains more from the finance sector than from the tremendous lift that mining gives to exports. Yet the finance sector’s profits will be boosted by how the government has decided to allocate the proceeds of the new tax.
The funds management industry, largely owned by the banks, had essentially given up lobbying for an increase in compulsory super contributions to boost its coffers. Rudd had assured employers before winning the 2007 election there would be no increase in the 9 per cent rate they must pay into employees’ super accounts. Then Rudd and other ministers said in recent months that they would rejig the concessions on the existing rate to give lower-income earners a bigger share at the expense of high-income earners. The structure of the existing concessions provides a tax cut of over $15,000 for someone on the top marginal rate who contributes $50,000 to super, but nothing to those on the lowest marginal tax rate. Because of the way the low-income tax offset works, some at the bottom can even end up paying extra tax. The new system leaves this structure in place but tries to offset the disadvantage at the bottom with a direct subsidy for low-income earners.
Once the government saw the revenue bonanza it would enjoy from the super profits tax on miners, it rejected Henry’s recommendation – also advocated by some industry super funds – for contributions to come from after-tax income, supplemented with a uniform rebate to improve equity. Instead, it decided to let high-income earners keep their extraordinarily generous tax concessions and give a new subsidy to low-income earners at an estimated cost of $830 million in 2013–14. It also decided to reverse an earlier decision to limit annual contributions from before-tax salaries to $25,000 a year for people aged over fifty, instead of $50,000. This backdown is estimated to cost $785 million a year – all of which goes to those who can afford to put more than $25,000 into super each year.
But the big cost comes from the gradual increase in the contribution rate, beginning on 1 July 2013 and reaching 12 per cent by 2019–20. According to a senior government source, the combined cost of the super changes will be around $8 billion in 2019–20. This figure will grow as the cost of the concessions applies to an increased level of fund earnings over time. The Treasury does not publish projections after 2012–13, when it says the overall cost of super tax concessions will be $32 billion, not far off the $36 billion the age pension is projected to cost in that year.
For many decades government basically funded only one form of retirement income, the age pension. Now, it has turned the principle behind means testing on its head and it is funding a second stream, super, where the biggest benefits go to those with higher incomes. The combined cost of the budgetary support for the twin retirement income streams will be $68 billion in 2012–13. Projected spending on higher education will be $8.75 billion.
Although the extra money going into super from the higher contributions rate should lead to less reliance on the age pension in future decades, the great majority of people will still be paid a part pension. The ageing of the population also means that age pension costs will continue to rise as a share of GDP.
The super tax concessions are often said to be necessary to give people an incentive to save for their retirement. But no incentive will be needed for people to put 12 per cent of their salaries into their super – it will be compulsory. The concessions will continue to give an incentive to “sacrifice” extra money into super from pre-taxed salaries, something only higher-income earners can afford to do to any significant extent. The government’s repetition on Sunday of its promise never to tax payouts – or the earnings on retirement balances – creates a strong motive to cut tax by salary sacrificing.
Another aspect of compulsion is often overlooked. Ultimately, every dollar the government forces people to put into super is a dollar that is not available for spending on what many people might regard as higher priorities when trying to bring up a family, pay for their own or their children’s education, pay off a home mortgage, gain from overseas travel and so on. Nor are the contributions really a gift from employers. Instead, the government says that almost all employers will pass the cost of the compulsory contributions onto their employees via lower wage increases than would otherwise occur.
Many free marketeers in the finance sector are normally quick to condemn government interference in what people choose to do with their money. But they rarely complain about the way compulsory contributions force everyone to hand part of their salary over to fund managers. Every other business would love to be the beneficiary of a similar government decree. Although compulsion will not be involved, the banks, credit unions and building societies are also about to get a handy unearned bonus from the super profits tax on miners.
Sometime before the election, the government will announce special tax breaks for interest on deposits in savings accounts. No details are yet available, but the budgetary cost is unlikely to be low. Apart from this new concession, the company tax changes announced last Sunday will cost over $3 billion in 2013–14. The government puts particular stress on how small business will gain from its cut of two percentage points in the corporate tax rate and more generous depreciation provisions. But the majority of small businesses operating as companies don’t pay any tax, so the cuts won’t mean anything to them – let alone induce them to become more productive. The corporate rate cuts are also irrelevant to the two million small businesses run by trusts, sole traders and partnerships.
Although the government said modelling by KPMG Econtech showed that its cut in company tax would increase GDP by 0.4 per cent, it did not give any estimate for the gain, if any, from spending an extra $8 billion a year on subsidies to super. But this year’s pre-budget submission from the nation’s vice-chancellors included modelling results from KPMG showing that a relatively modest increase in spending on universities would increase GDP by 6.1 per cent. Modelling should always be treated with caution, but this outcome suggests the government has got its priorities badly wrong in deciding how to carve up the proceeds from the super-profits tax on mining.
Moreover, there is a risk that Rudd will soften the tax so it no longer delivers the full $9 billion a year he expects, on average, over the next decade. There is also a distinct possibility that the mining boom will fade earlier than anticipated. If so, the government will be locked into spending $9 billion a year that it doesn’t have, so a new squeeze is likely to hit outlays in areas such as education, urban transport and research and development.
APART from the dubious value of boosting superannuation, there are good reasons to question the wisdom of the government’s announcement last Sunday that it will reject nineteen of the Henry review’s recommendations and several alternative suggestions for reform. One of the most disappointing decisions is the refusal to touch the treatment of capital gains and negative gearing for investment housing and shares. Compared to other options, the minimal changes Henry recommended don’t go far enough, especially when he offset them with a proposed 40 per cent discount on tax paid on rental income. But the government wouldn’t go even that far.
In a speech last September the Reserve Bank’s head of economic analysis, Tony Richards, explained why declining housing affordability is important. Although this point is widely overlooked, Richards said, “As a nation, we are not really any richer when the price of housing rises, but the more vulnerable tend to be hurt.” He went on: “Lower-income households are less likely to own housing, either their own home or an investment property, than higher-income ones. So when the price of housing rises, higher-income households tend to benefit at the expense of lower-income households.”
When the Howard government halved capital gains tax during the wild “dot com” boom, the rationale was that it would induce US pension funds to provide venture capital to fledgling Australian firms. Instead, money borrowed by local punters flooded into the investment housing market, especially for existing residences. Cutting the capital gains tax in half added to the tax attractions of “negative gearing,” which allows loan interest and other costs to be written off against overall income if there is insufficient rent income to cover all the deductions. Similar incentives applied to borrowing to buy shares after the cuts to capital gains tax.
In the case of existing properties, a number of tax reformers (unlike Henry) want to quarantine the deductions for negatively geared properties to rental income. Because the deductions could not be used until net rent was positive, this would reduce the attraction of using negative gearing to buy existing residences. These reformers also propose quarantining income from gearing into shares. They argue that the tax treatment of capital gains from any asset should be restored to the Hawke–Keating system in which the gains were fully taxed after allowing for inflation.
If these changes only applied to new purchases of rental properties and other assets, the Rudd government would suffer little political pain. For the prime minister, however, any pain is usually too much. But he has the chance to prove otherwise by not succumbing to pressure to soften his super profits tax on miners. •