First published in the Australian Financial Review on 11 November 2013.
By Alan Mitchell.
IT’S not just productivity that Joe Hockey needs.
Remember the Treasury’s three Ps: productivity, participation and population?
The Grattan Institute’s 2012 review of Australia’s reform options identified only three reforms that could be relied on to make a substantial difference to Australia’s economic output in a decade.
They were reform of the tax mix (basically increasing the GST to cut personal income and company tax rates), and lifting the labour force participation rates of women and older males.
There are lots of other important reforms, including in education, health, power generation, industry policy (cars, etcetera), building infrastructure and cutting road congestion. And governments should be working on all of them.
But, according to the Grattan Institute’s John Daley, only changing the tax mix and raising participation rates will make a big difference to the economy – and, by extension, to tax revenues and the budget – within the life expectancy of the Abbott government.
Each of these big three reforms potentially could increase the level of gross domestic product by more than 1 per cent by 2022.
Changing the tax mix would lift productivity. Cutting company tax would increase the profitability of business investment. That would lift labour productivity through the introduction of new technologies embodied in new capital equipment, through increased investment in research and development, and by making production more capital intensive. Increasing the revenue-raising role of the GST also would encourage saving, so that more of the returns on investment would flow to Australians rather than foreigners.
RE-ENGINEERING THE TAX MIX
The Organisation for Economic Co-operation and Development estimates that shifting 1 per cent of tax revenue from income and corporate taxes to consumption taxes could increase GDP in the long run by 0.74 per cent.
However, if re-engineering the tax mix is among the most rewarding reforms, it is also among the most politically difficult. And, from the way Tony Abbott retreated from the initial suggestion of a GST review, it also looks increasingly unlikely.
That makes the second P – participation – all the more important.
The Grattan paper shows that increasing the labour force participation of working-age females and older (mainly male) workers together could raise the level of GDP by $50 billion in 2022.
Yet that, too, involves major political challenges. Increasing the female participation rate almost certainly requires expensive tax reform and increased government spending on childcare. Raising the participation rates of older workers requires further increases in the pension and superannuation preservation age.
Australia’s female participation rate is above the OECD average, but well below that of Canada. If Australian women did as much paid work as women in Canada, the institute estimates, Australia’s GDP would be about $25 billion higher in a decade.
The increase in GDP would come primarily from the increase in the size of the paid workforce, but there also would be a productivity gain as educated women spent more time in paid work and less time providing childcare, and employers reaped the benefits of a wider and more competitive talent pool.
Canada’s experience is important because of the cultural and economic similarities with Australia.
Female labour force participation rates increased strongly in Canada when marginal tax rates and the costs of childcare were reduced.
Workforce participation of women aged between 25 and 54 rose from 53 per cent in 1976 to 82 per cent in 2012. This compares with just over 75 per cent in Australia. Moreover, in excess of 80 per cent of Canadian female workers in this age group are employed full-time.
CUTTING MARGINAL TAX RATES COSTLY
But gains of that magnitude do not come cheaply or easily. The cost of cutting effective marginal tax rates for second-income earners is large, as shown by the $8 billion four-year cost of the Gillard government’s decision to treble the tax-free threshold. Quebec also supplies childcare at $5 a day.
The Henry tax review proposed a much larger increase in the tax-free threshold, but that was part of a blueprint for comprehensive tax reform that neither the Gillard government nor the Abbott-led opposition was prepared to embrace.
The Abbott government will have a Productivity Commission review of childcare, which is an important first step towards expanding the supply of that sector.
But the government still faces unpopular and expensive decisions if it wants to imitate Canada’s success in increasing the female workforce.
Similarly, the gains from increased participation by older workers may not come easily. The Grattan Institute believes they will require a pension and preservation age of 70. There also would have to be more spending on training.
So, here is the government’s problem. On politically realistic estimates, it faces the prospect of an expanding fiscal gap in the latter part of the decade.
Hockey recognises that the only politically viable answer to this challenge is faster economic growth that will generate the revenues needed to produce budget surpluses.
But Tony Abbott has no mandate for the tax reform needed to generate that needed revenue, and he has promised a first-term government of no surprises. He has all but denied himself the opportunity to push through unpopular decisions in the first half of his first term – an opportunity used by the Hawke government to establish the foundations for more than a decade of Labor rule.
This leaves Hockey to harvest his productivity gains across a wide but relatively stony landscape.
That raises the stakes in the car industry debate. It also increases the importance of the spending reforms identified by Abbott’s commission of audit.
The Abbott government has to cut spending programs, not just to get the budget back into surplus in the medium term, but to create space to fund the programs that it will need to raise participation rates through the decade.
