801 Balancing Budgets

November 2013
Balancing budgets
Tough choices we need
John Daley
The housing wed choose
Balancing budgets: tough choices we need
Grattan Institute Support Grattan Institute Report No. 2013-13, November 2013
This report is accompanied by Balancing budgets: tough choices we need Supporting
analysis, which can be downloaded from Grattan Institutes website.
This report was written by John Daley, Chief Executive Officer, Grattan Institute. Cassie
McGannon, Jim Savage and Amelie Hunter provided extensive research assistance and
made substantial contributions to the report. James Button assisted in its preparation.
The report draws on published and unpublished work by other Grattan Institute staff,
and we thank them for their assistance.
We would also like to thank numerous people from the public policy community, the
private sector, and the members of Grattan Institutes Public Policy Committee for their
helpful comments as this work was developed. Many of its ideas have been drawn from
their suggestions, and it has benefited much from their counsel.
The opinions in this report are those of the authors and do not necessarily represent the
views of Grattan Institutes founding members, affiliates, individual board members or
reference group members. Any remaining errors or omissions are the responsibility of
the authors.
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Daley, J., McGannon, C., Savage, J and Hunter, A., 2013, Balancing budgets: tough choices we
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Grattan Institute 2013

Overview
Australian governments must make tough choices to balance their burden of these changes would be spread across rich and poor,
budgets. They face a decade of deficits, the result of big ticket workers and retirees. While all these reforms are unlikely to occur
spending initiatives, rising health costs, pressure on welfare at once, it will be hard to close the looming budget gap without
budgets and an inevitable fall in the terms of trade. Collectively tackling any of them.
these could lead to deficits of 4 per cent of GDP, or $60 billion in
todays terms, within a decade. Structural reform of benefits and tax exemptions for older
Australians offer many of the best opportunities for budget reform.
Tough choices cannot be put off indefinitely. Deficits impose They are the least-well targeted parts of our tax and welfare
heavy costs on the next generation in terms of debt and high system, with some benefits going to people that dont need them.
interest payments. Government budgets cannot simply grow out
of trouble, and the next decade may well be economically more Substantial budget repair almost always involves tax reform.
difficult than the last. Increasing fuel excise in line with inflation would raise significant
revenue, although it hits those with low incomes particularly hard.
History shows that governments that successfully repair their Higher rates of existing taxes could raise large revenues. Raising
budgets make the public case for reform, and start early on the the GST and municipal rates would slow economic growth less
hard work of cutting expenditure and raising taxes. They design a than other tax increases.
package of measures that share the burden of reform fairly across
the community. Plausible reductions in spending on transport infrastructure,
industry support, school class sizes, higher education subsidies,
This report surveys all realistic proposals that could contribute pharmaceuticals, health services, and defence could collectively
$2 billion a year or more to government budgets. It puts a priority improve budget positions by $23 billion per year. But the
on reforms that are big enough to make a difference but do not execution risks are high there would be unacceptable economic
have unacceptable economic and social effects. and social effects unless the cuts were executed unusually well.
By contrast, the oft-cited cuts to the public service and middle
One reform package could add $37 billion a year to budgets. It class welfare can do relatively little to improve budget balances.
would broaden the GST to include fresh food and private
spending on health and education; raise the age of access to Sustainable budgets depend on governments making tough
superannuation and the Age Pension; remove the exemption for choices. None will be politically easy, but making some of them is
owner-occupied housing from the assets test for the Age Pension; vital to Australias prosperity.
and limit tax concessions on superannuation contributions. The
Grattan Institute 2013 1

Table of contents
Overview ............................................................................................ 1
1. Introduction .................................................................................. 5
2. We have a budget problem.......................................................... 7
3. Mindsets and approaches for budget repair .............................. 13
4. Framing budget choices ............................................................ 20
5. Packaging reform ...................................................................... 26
6. Superannuation and pensions ................................................... 29
7. Capital gains tax and housing .................................................... 40
8. Other tax exemptions, introductions, and increases .................. 49
9. Spending cuts ............................................................................ 65
10. Asset sales ................................................................................ 78
11. Budget maintenance .................................................................. 80
Conclusion ....................................................................................... 85
References ...................................................................................... 86

Table of figures
Figure 2.1 Commonwealth budget balance ....................................................................................................................................................... 7
Figure 2.2 Commonwealth structural expenditure ............................................................................................................................................. 8
Figure 2.3 Variation in Commonwealth major tax revenues .............................................................................................................................. 9
Figure 2.4 Potential annual deficit of Australian governments by 2023 ............................................................................................................. 9
Figure 2.5 Potential impact of signature initiatives to 2023.............................................................................................................................. 10
Figure 2.6 Change in Australian governments expenditure 2002-03 to 2012-13............................................................................................ 11
Figure 4.1 Budgetary, social and economic impacts of budget choices .......................................................................................................... 24
Figure 4.2 Cumulative budgetary impacts of choice themes ........................................................................................................................... 25
Figure 6.1 Age of eligibility for superannuation and Age Pension affects retirement decisions ....................................................................... 30
Figure 6.2 Proportion of age cohort withdrawing payment from their superannuation account ....................................................................... 32
Figure 6.3 Superannuation concessions and government benefits ................................................................................................................. 34
Figure 6.4 Superannuation concessions withdrawn by proposal ..................................................................................................................... 35
Figure 6.5 Income by source for those in their 60s .......................................................................................................................................... 36
Figure 6.6 Age pension expenditures and household wealth .......................................................................................................................... 37
Figure 6.7 Household assets and Age Pension eligibility ................................................................................................................................ 38
Figure 7.1 Proportion of taxpayers, income and total capital gains ................................................................................................................. 42
Figure 7.2 Fiscal impact of collecting CGT on owner-occupied housing ......................................................................................................... 44
Figure 7.3 House price appreciation and interest paid .................................................................................................................................... 45

Figure 7.4 Budget impact of abolishing negative gearing with losses offset against capital gains tax liability ................................................ 46
Figure 7.5 Rents and vacancy rates, largest cities .......................................................................................................................................... 47
Figure 7.6 Total rental loss by taxable income bracket after deductions ......................................................................................................... 48
Figure 8.1 Foregone tax revenue from expenditure excluded from GST ......................................................................................................... 51
Figure 8.2 Changes in consumer expenditure by GST liability ........................................................................................................................ 52
Figure 8.3 Proportion of household consumption spent on goods proposed for inclusion in the GST base ................................................... 53
Figure 8.4 Payroll tax thresholds over time...................................................................................................................................................... 57
Figure 8.5 Fuel prices with and without excise indexation ............................................................................................................................... 59
Figure 8.6 Cost curve for global iron ore mines ............................................................................................................................................... 60
Figure 8.7 Mining prices, export volumes, and potential tax revenue .............................................................................................................. 61
Figure 9.1 Engineering construction work done for the public sector .............................................................................................................. 65
Figure 9.2 Actual spend and traffic relative to forecasts for large transport projects ....................................................................................... 67
Figure 9.3 Distribution of Family Tax Benefits payments by family disposable income decile ........................................................................ 73
Figure 9.4 Redistribution of welfare payments in OECD countries .................................................................................................................. 74
Figure 10.1 Value of asset sales and net debt reduction ................................................................................................................................. 78
Figure 11.1 Real expenditure growth by government term .............................................................................................................................. 80

1. Introduction
This report examines how Australian governments should The bulk of this report examines 20 budget repair choices, and
respond to the budget pressures they face. a number of possible tax increases, that might help balance
budgets. These choices, their budgetary impact, and their side-
It follows Budget pressures on Australian governments, published effects are summarised in Table 1. They are discussed in more
by Grattan Institute in April 2013, which showed the scale of the detail in Chapters 6 to 9, drawing on the evaluation of each of
budget problem Australian governments face. Chapter 2 outlines them in the Balancing Budgets: Supporting analysis that
and updates this analysis, which shows that Australian accompanies this report. Chapter 6 covers changes to the
governments face deficits of 4 per cent of GDP, or $60 billion in pension and superannuation system. Chapter 7 discusses capital
todays terms, within a decade. gains tax and housing. Chapter 8 looks at other tax exemptions,
introductions and increases that may help to repair budgets.
Chapter 3 considers the best approach to balancing budgets. It Chapter 9 covers spending cuts.
shows how repair can only succeed if politicians and the populace
have the right mindsets and approach. Chapter 10 looks at the role of asset sales in budget repair.
Governments then need to make tough choices to either Finally, Chapter 11 discusses institutions that promote
increase taxes or reduce spending. Chapter 4 outlines a budgetary discipline in the longer term.
framework for evaluating these choices on the basis of their
budgetary impact, and social and economic side-effects.
Chapter 5 indicates how the key reforms might be packaged

together so that the burden of reform is spread fairly across the
community.

Table 1: Summary of impact of proposals over $2 billion considered in this report
Theme Proposal Value to Summary of social, Pg Theme Proposal Value to Summary of social, Pg
budget economic and budget economic and
(annual, distributional (annual, distributional
$2013) impacts $2013) impacts
Super and Age Pension and $12b Neutral 29 Tax rate Corporate tax rate $10b Very negative 62
pensions superannuation increases
access age Income tax rates $10b Very negative 62
GST rate $10b Negative 62
Super contribution $6b Moderately negative 32
tax concessions Property tax rate $10b Negative 62
Superannuation $3b Moderately negative 36 Payroll tax rate $10b Very negative 62
earnings tax
concessions Stamp duty rate $10b Very negative 62
Age Pension assets $7b Positive 36 Bracket creep $16b Very negative 63
test
Spending Transport $6b Moderately negative 65
Housing CGT discounts $5b Neutral 40 cuts infrastructure costs
and
Owner-occupied $15b Very negative 43 Industry support $5b Moderately negative 69
capital
gains housing and CGT
Private health $3b Negative 70
Negative gearing $2b Positive 45 insurance rebate
Other tax GST base $13b Negative 49 Pharmaceuticals $2b Positive 70

exemption spending
s Payroll tax threshold $6b Very negative 55
Cost effectiveness of $2b Neutral 70
Fuel tax credit $3b Negative 57
treatments
New taxes Fuel excise $3b Moderately negative 58
indexation Defence spending $2b Neutral 71
Federal royalties $3b Negative 59 School class sizes $3b Moderately negative 71
export tax Student subsidies for $3b Neutral 71
higher education

2. We have a budget problem

The Commonwealth Government has had an underlying budget similar conclusion: the Commonwealth Government has run a
problem for several years, as Grattan Institutes 2013 report, substantial structural deficit for half a decade.4
Mining boom: impacts and prospects, reveals.1 Australian
government budgets face a decade of deficits, as we showed in Figure 2.1 Commonwealth budget balance
our previous publication, Budget pressures.2 Signature initiatives, Per cent of nominal GDP
rising health expenditure, pressure on welfare budgets, and an 4
Underlying cash Cyclical
inevitable fall in the terms of trade could lead to deficits of 4 per 3
balance
cent of GDP, or $60 billion in todays terms, within a decade. Terms of trade
2
2.1 We have a structural deficit 1
0
The Commonwealth Government responsible for 60 per cent of
Australian government expenditure and 75 per cent of the -1
taxation3 has had a structural budget deficit of more than -2
Structural underlying
2 per cent of GDP for the past five years. As Figure 2.1 shows, balance
the Commonwealth spent more than its income after allowing for -3
fluctuations in prices (particularly the mining boom and the terms -4
of trade), and the business cycle (particularly the Global Financial
-5
Crisis).
-6
Calculations of the structural deficit by the International Monetary -7
Fund, the OECD, Australian Treasury, the Parliamentary Budget 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013f
Office, Deloitte Access Economics and Grattan Institute all use
slightly different methods and assumptions. But they all come to a Source: Minifie et al. (2013)
1
Minifie, et al. (2013)
2
Daley, et al. (2013)
3 4
Ibid., pp. 11, 58 Ibid., p. 28; PBO (2013a) ; IMF (2013a)

The mining boom and the Global Financial Crisis (GFC) masked Figure 2.2 Commonwealth structural expenditure
the problem. Australia failed to realise that the income from the Per cent of nominal GDP
mining boom would not last, but that spending increases started 25
during the GFC would. Including stimulus
24
2.2 Spending has gone up
23
One of the problems is that we often think about government
expenditure as a percentage of GDP. In normal times, this is a
good rule of thumb. If the massive run-up in the price of iron ore 22 If terms of trade
uplift is No
and coal were permanent, then Commonwealth Government stimulus
temporary
expenditure today is only a tick higher than in 2003. But if iron ore 21
and coal prices return to historic levels, then it would be apparent
that Commonwealth government spending rose two percentage 20
points in eight years.5 That is a structural shift, as Figure 2.2 If terms of trade
shows. uplift is permanent
19 and no stimulus
This structural shift also escaped attention because of the
stimulus package. It looked as though spending was falling in 18
2012-13. But that fall was the consequence of the stimulus 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013f
package rolling off, and payments being timed to fall in different
Source: Minifie et al. (2013)
years. Underlying spending has risen rapidly.
2.3 Revenue is going down
Revenues have also fallen with the Global Financial Crisis

reducing income and corporate tax levels. Although revenues are
expected to return to long-run averages by 2014-15 depending
on minerals prices indirect taxes have fallen steadily and remain
1 per cent of GDP below their long-term trend (Figure 2.3).6
5
If minerals prices fall, then (if CPI remains unchanged) so will nominal GDP,
which takes into account the price of Australian exports. If nominal GDP falls, but
6
government spend is constant, the ratio of government spend to GDP would rise. Daley, et al. (2013), p. 22

Figure 2.3 Variation in Commonwealth major tax revenues expectations that revenue from company tax, mining resource
Per cent of nominal GDP above/below average 2000-01 to 2009-10 rent tax and the emissions trading scheme would be less than
2 previous forecasts. Additional signature initiatives have increased
Forecasts
in cost to 1 per cent of GDP. The expected increase in health
Income tax
spending to 2023 is now only 1.5 per cent of GDP (previously it
1 was 2 per cent) as some of the increase was incorporated in
2013-14 budgets. The expectation of future hits to the budget due
Corporate to increased welfare costs and a fall in the terms of trade remains
tax
unchanged.
Average
0
2000-2010 Figure 2.4 Potential annual deficit of Australian governments by
2023
Per cent of GDP
0%
-1 0.0% 1.0%
Indirect
tax
-2% 1.5% 4.0%
0.5%
-2
1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 1.0%
-4%
Financial year ended
Source: Daley et al. (2013)

-6%
2.4 Future pressures
Future pressures on Australian government budgets could reduce -8%

budget balances by 4 per cent of GDP within a decade as Figure
Forecast Signature Health Welfare
Terms of Deficit
2.4 shows. surplus initiatives trade 2023
2016-17 2003-2013 response to potential on current
Updating the analysis of our Budget pressures report for trend inequality fall trends
e.g. Schools, NDIS,
subsequent developments alters some components but comes to Direct Action, PPL increase
the same conclusion. Governments have reduced their forecast
surpluses for 2015-16 to zero, which incorporates our Source: Daley et al. (2013); subsequent Grattan analysis

The new Coalition government has promised a number of Figure 2.5 Potential impact of signature initiatives to 2023
signature initiatives that will ultimately have a net cost to the 2013$ billion
budget of about $15 billion in todays dollars by 2023 as shown in 0
Figure 2.5.
Defence
-5 Net budget
There are the costs of abolishing the carbon and mining taxes. impact
The governments company tax cut, increase in defence -10 Schools 2022-23
spending, and paid parental leave will also drag on the bottom
line. In addition, most of the planned costs for the National -15 Disability
Disability Insurance Scheme and school funding reforms start to PPL PPL levy
bite after 2017, only reaching steady state by about 2022. Direct action Corp. tax rules
-20 Other ECs
Initiatives of a similar magnitude were likely irrespective of who Public service cuts
won the 2013 federal election.7 For these purposes, we have Abolish carbon tax Foreign aid cuts
-25 Schoolkids bonus
assumed that costs of the National Disability Insurance Scheme Cut company tax Super cuts
will be as planned: in practice, costs may be higher as political
-30 Abolish mining tax Other ECs
pressure and legal decisions tend to stretch definitions in favour of
increased spending.8 FTB car exemption
-35
Spending Tax cuts Spending Tax
The largest threat to future budgets is the sustained pressure on increases cuts increases
health expenditure. Over the last decade, health has been
Note: Other ECs is other election commitments. Impact is on all Australian budgets
responsible for most of the spending increases above GDP, for (Commonwealth, states and territories). Analysis includes all federal Coalition election
both Commonwealth and state governments (Figure 2.6).9 The commitments identified by the Parliamentary Budget Office except infrastructure, which
primary drivers were not ageing, but the provision of more and has not been included as it is not possible to determine how new commitments for a given
year related to the available funding envelope. Analysis also includes the governments
better health services per person. A 60-year old today visits the commitment to increase defence spending to 2% of GDP in 10 years, its commitment to
doctor more often, has more tests, has more operations, and implement the National Disability Insurance Scheme, and a likely increase in school
funding based on existing agreements with some states and likely pressure from others.
takes more drugs, than a 60-year old 10 years ago. Source: Grattan analysis of Treasury (2012a); Daley et al. (2013); Loughnane (2013c); b);
PBO (2013b); Treasury (2013c); a)
7
Ibid., p. 33-35
8
Burkhauser, et al. (2013), p.357. There are already indications that the National
Disability Insurance Scheme will exceed cost estimates. See Fifield (2013);
Mather (2013)
9
Daley, et al. (2013), p. 15

Figure 2.6 Change in Australian governments expenditure 2002-03 Business Council of Australia has acknowledged that Newstart
to 2012-13 payments are too low.11 As a result, there may be more pressure
Real change in expenditure, 2013$ billion to increase welfare payments for those who are least well off,
45
Real growth especially if the economy turns down.
40
Growth if expenditure We are also likely to see political pressure to keep increasing age
35
a constant % of GDP pension benefits.12 These grew faster than GDP over the last
30 decade, not because of the ageing of the population, but because
25
of deliberate policy choices to broaden eligibility and lift pensions
faster than average weekly earnings.13 The political pressure that
20 led to these changes will grow as the population ages.
15
2.5 Why does all this matter?
10
5 Of course, Australian governments owe much less than many
governments elsewhere. We are not in the emergency ward,
0 crawling from one debt reconstruction to the next, with the
Welfare Health Education Defence Infra- Ageing, Govern- Other economy shrinking and government slashing the social safety net.
structure comm & ment But surely we do not want to go there.
disability
services
The most important argument for budget reform is that
Source: Daley et al. (2013) government deficits effectively require future generations to pay
Governments are under enormous public pressure to spend more for the spending of the current generation. In recent times, the run
on health to improve lifespans and quality of life. If spending up in Queensland government deficit spending led to annual
continues to grow at the same rate as over the past decade, interest payments of more than $1.5 billion a year, substantially
health will consume an additional 1.5 per cent of government constraining the state budget.
budgets by 2023.
Welfare costs are also likely to increase. Those on workforce

payments such as Newstart face high levels of hardship.10 The 11
BCA (2013)
12
Daley, et al. (2013), p. 44
10 13
Ibid., p. 18-19 Ibid., p. 20

Relatively little of the most rapid increases in annual spending can

be justified on the basis that they will benefit future generations by
increasing future economic growth. While education, research and
infrastructure will benefit future generations, spending on
increased health and age pensions increased the most. While
health spending increases workforce participation a little, its major
effect is to help todays generation live longer and enjoy happier
retirements. While this is a good thing, it is unfair to fund this
through deficits that must be paid for by future generations.
Recurring structural deficits inevitably lead to higher levels of

debt. At high levels, these limit the ability of governments to
respond to future economic downturns.14
Given the size of current underlying and projected budget deficits,

repairing the budgets of Australian governments will be hard. The
rest of this report explains how it might be done.
14
Ibid.

3. Mindsets and approaches for budget repair

If Australian governments are serious about fixing their budgets, budgets put considerable time and deliberate effort into explaining
they need to make some tough choices. The ones we present are the need for change to all involved.17 Unless the ground is
not particularly appealing. Nobody likes paying higher taxes or prepared, it is easy for the community to run out of patience with
receiving fewer services. But we need governments to make reform.
these difficult choices rather than putting them off for future
governments. We cannot simply grow out of trouble; we need To build this public case, it helps to start from a position of political
structural reform.15 strength. For example, the Borbidge Government in Queensland
was a minority government, and a mere 18 months in power gave
Valuable lessons can be learnt from previous Australian and it insufficient time and political capital to implement reforms. The
international experiences of budget repair. These experiences, final report of the 2011 Victorian Review of State Finances has
summarised in Balancing budgets: Supporting analysis, show that not even been released, which some attribute to a combination of
to balance budgets, governments need to explain the problem, the governments narrow majority, and the reports
prioritise the large reforms, tackle both spending and taxation, and recommendations, reputed to be radical.18 In contrast, the huge
resist the temptation to delay. majorities won by Barry OFarrell in New South Wales in 2011 and
Campbell Newman in Queensland in 2012 reduced pressure from
3.1 Preparing people for pain the electorate, giving those governments greater licence for
bigger reform.
There is little chance of successful budget repair unless the
government builds public understanding of the size of the Reform is also easier if the economic and budgetary challenges
problem, and the need for action.16 are obvious from the outset. In the 1990s, the major economic
problems facing Victoria, South Australia and Western Australia
Budget reform is most likely when all those affected by it from helped to create a burning platform for reform, and made it
politicians, to senior public servants, frontline public sector staff easier for governments to adopt tough recommendations.
and the general public agree that it is necessary. That means Queensland, in better shape, showed far less enthusiasm for
creating a shared understanding of the scale of the problem, and
why major change is needed. These attitudes do not spring into
life on their own. Governments that have successfully repaired 17
See, for example, Kamener and Tan (2012) on the Kennett government
budget reforms and Sancak, et al. (2011) on Canadian reform, discussed further
15
IMF (2013b), p. 10 in Balancing budgets: Supporting analysis.
16 18
Mauro (2011), p. 258 Jones and Prasser (forthcoming); Uren (2012)

reform.19 Similarly, in 2011, the Victorian government faced less Box 3.1: Case study Budget repair in Kennetts Victoria
severe fiscal and economic problems than those of New South
Wales and Queensland, which probably contributed to the lack of In 1992, Victoria had a deficit of $2.2 billion, total government debt
enthusiasm for its audit commissions recommendations. of $31 billion, and an A1 credit rating.
Nor can a government rely on a commission of audit to build this The Kennett Government was elected in 1992 with a massive
public case for budget repair. Governments should treat any majority and a mandate for budget repair. It cut spending by more
commission of audit as a buttress rather than the lead element. than 10 per cent in real terms in four years. It increased revenues
The Kennett Government did not wait for its commission of audit and sold about $45 billion worth of assets. Between 1993 and
to report before it cut expenditure (see Box 3.1). It had come into 1997, expenditure as a percentage of revenues fell from 110 to
office with a detailed reform plan already prepared, and it brought 89 per cent. Government debt was reduced to $4 billion by 2000.
down a mini-budget within a month of being elected.20
Several factors contributed to this successful budget reform:
Commissions can be useful in exploring tough choices, while A Budget and Expenditure Review Committee set firm
being distant enough to give the government plausible deniability expenditure reduction targets from the centre of government,
while it considers options. But the risk of the commissions but gave agencies autonomy in determining how to meet them.
independence is that no-one with real power owns the There was a concerted effort to get alignment between
recommendations, and they sink without trace. Successful budget politicians, senior public servants, front-line public sector staff
reform efforts, including those in Canada, Victoria and the UK, and the public on the scale of the problem and the need for
had strong buy-in from politicians and senior public servants, and major change.
strong budget processes to accompany the repair effort. The Reforms were structured so that the pain would be shared
Commonwealth Government should already be considering how it across the state. A $100 per household debt-reduction levy
will sell change and the necessary tough reforms. raised a relatively modest amount but sent a clear message
that no-one was exempt from sacrifice.
The current Commonwealth Governments rhetoric provides some
cause for concern. Although both the Prime Minister and The reforms faced opposition. The government won the 1996
Treasurer talked in May 2013 of a budget emergency, their election, retaining a significant majority, but commentators have
language has shifted since election.21 There has not been a mini- attributed its subsequent loss in 1999 at least partly to the
harshness of its fiscal reforms.
19
Jones and Prasser (forthcoming) Source: Kamener and Tan (2012); Jones and Prasser (forthcoming)
20
Ibid.
21
For example, contrast statements in Griffiths (2013) with those in AAP (2013)

stakeholders and to reallocate resources. Leadership cannot be

spread too thinly, lest it lose its political influence. For their part,
Budget, and there is little sign that there will be policy changes senior public sector managers can only properly supervise the
announced in the Mid-Year Economic and Fiscal Outlook. A design and implementation of a limited number of policies at the
concerted and consistent effort is required to explain the extent of same time.
the budget issues.
Without prioritisation, there is a risk that governments will use up
Reform is also easier if there is a perception that the burden is their political capital on urgent, but relatively unimportant,
being shared across society. Obviously those with more capacity issues.24 If a government is to undergo the political pain of difficult
to pay should bear more of the burden. But if everyone the reform, it may as well make sure that the money the proposals will
wealthy and poor, young and old, businesses and households, save (or raise) is large enough to be worthwhile.
city and country is seen to be making sacrifices, it blunts the
power of any one group to complain about cuts. It also helps to The media also has an important role to play in this debate. Media
contribute to a shared understanding of the magnitude of change outlets frequently run stories about government spending or taxes
required. that make little effort to put numbers into context. For those who
do not follow budget debates closely, $100 million seems like a
3.2 Prioritisation and delegation huge number, but it is about one five-thousandth of the total
expenditure of Australian governments. This makes it hard for
Governments should pick a few significant reforms that will make voters to understand the scale of the issues discussed. The New
a large difference to the structural deficit. Prioritising budget York Times is working to better explain budget-related numbers;25
choices is important because major reform is hard; it takes the Australian media should follow suit.
political will, time and strong leadership to design and implement
good policy. As Paul Keating once said, the trick to government is Budget reform today also needs to be delegated. Budget repair
to pick three big things and do them well.22 Choosing a limited efforts need to involve those who will have to implement them, not
number of substantial reforms is important because a government just public servants in Treasury and Finance. Because line
can only alienate major interest groups so often before it is agencies often know aspects of the policy area that central
branded in public debate as out of touch.23 Senior government agency staff do not they are well positioned to identify feasible
ministers have limited time and energy both to persuade reform. Line agency staff are also more likely to own rather than
resist reforms that they have had a hand in designing. Both
22
Button ibid.. Nicola Roxon recently reflected on her time in government, noting
that the Labor Party needs to choose a few big areas and focus on them, taking
24
people with them. Roxon (2013) Ibid., p. 6
23 25
Daley, et al. (2012a), p. 6 Sullivan (2013)

Victoria and Canada gave agencies autonomy to determine how Tax increases have been important drivers of some, though not
they would meet savings targets. Coupled with strong central all, budget repair.30 Without major tax increases, budget repair will
oversight, it led to successful fiscal reform. be hard for Australia given that its government is relatively small,
major revenue sources like the GST are in structural decline (see
3.3 Tackling the tough choices Chapter 1), and we could not identify expenditure cuts large
enough to fix Australias long run budget challenges. The
If big change is required, all options for reform need to be on the promised tax review will need to be wide-ranging and taken
table, including both spending cuts and revenue increases. seriously by government.
Reform can succeed even if it involves difficult and ambitious
decisions. Overseas experience shows that ambitious plans are Almost all successful repair efforts have involved broad
just as likely to achieve their targets as modest ones,26 and expenditure cuts. Yet todays Commonwealth Government may
Australian governments have successfully repaired big budget have tied its own hands, ruling out cuts to health, education and
holes in the past. defence; major changes to superannuation; and changes to its
election commitments.31 The broad terms of reference given to
However, governments cannot rely on economic growth alone to the National Commission of Audit may give it scope to tackle
balance their budgets. Successful budget repair has historically these areas and at least build momentum for change after the
emerged from a combination of tight fiscal policy and increased next election.
economic growth.27 Fiscal repair is much easier when economic
conditions are favourable, but few, if any, governments have Repair plans are also more likely to succeed if they include
managed to simply grow their way out of trouble without structural reforms such as changes to the welfare system and a
undertaking budget reform.28 Although economic growth will repositioning of the role of the state.32 The proposals in this report
increase tax revenues, spending tends to grow at a similar rate. for reforms to the age pension and superannuation, and taxes on
Many government costs (such as welfare payments and service assets and consumption, are examples of such structural change.
delivery salary costs) are linked to wage levels that tend to grow
in line with the economy. Repairing the Commonwealths budget will probably require even
tougher decisions than in the past. Tougher decisions are
Previous experience does not dictate a particular balance required if a previous budgetary reform has already picked the
between revenue and expenditure measures for budget repair.29 low-hanging fruit.
26
Mauro (2011), p. 252
27 30
Ibid.; Abbas, et al. (2013) Mauro (2011), p. 253
28 31
Abbas, et al. (2013), p. 17 Crowe (2013)
29 32
IMF (2013b), p. 35; Mauro (2011), p. 257 Mauro (2011), p. 254

The Howard Government picked much of the low-hanging fruit of 3.4 Don't wait for tomorrow
budgetary reform, particularly in public sector management reform
and asset sales, after the last National Commission of Audit (see An incoming government needs to move quickly, as the Victorian
Balancing budgets: Supporting analysis). Recommendations that experience of the 1990s and others show.34 Governments must
werent adopted including restructuring federal financial implement tough reforms early in the electoral cycle, while the
arrangements, and changing pension indexation are no easier failings of the previous government are fresh in voters minds.35 It
now than they were then. is far easier for a government to build the case for and implement
policy change early in its term.36 A government needs to develop
At the state level, many of the recommendations of the 2012 support for its policies, while holding off the opposition.37 A
Queensland Commission of Audit have already been enacted in government that leaves difficult decisions to the latter half of its
other jurisdictions (examples include contestability in providing term faces the additional stress of re-election and more pressure
public transport, and divestment of energy assets).33 In contrast, from lobby groups.
the sweeping reforms adopted by the Kennett Government in the
1990s may have left relatively few easy wins for Victorias 2011 Once this early action has established credibility, fiscal repair is
Review of State Finances. best undertaken gradually, within a credible medium-term
strategy, supported by strong institutions,38 and with credible
There is certainly scope for new reforms today. Some program contingency plans to deal with unforeseen economic shocks.39
creep can usefully be pulled back. A new wave of service delivery
reform might focus on demand management given that uncapped Driven by the need for speed, governments often require a
programs like health and welfare are driving many of the budget commission of audit to report quickly. This creates the risk that it
challenges. But the Commonwealth Government shouldnt will lack the time for thorough analysis and will fall back on pre-
imagine that the National Commission of Audit will provide a set of conceived ideas not based on good evidence.40 Many of the
easy reforms that are big enough to fix the problem. Tough commissions of audit in the 2000s had significantly longer
choices will need to be made.
34
IMF (2013b), p. 30
35
Jones and Prasser (forthcoming)
36
Daley, et al. (2012a), p. 9
37
Haggard and Webb (1993), p. 143
38
IMF (2013b), p. 29-30; Mauro (2011). See further discussion of budget
institutions in Chapter 11.
39
Mauro (2011)
33 40
Costello, et al. (2013) Martin (2013)

timeframes, allowing more thorough work but also leading to more reduction in economic growth. The benefits of lower interest
complexity and more politically unpalatable recommendations.41 payments from reduced public debt are inevitably promises about
the future that people tend to value less.47 Governments have
It is concerning that in recent months both sides of politics have many incentives to run deficits, including the desire to give the
downplayed the urgency of Australias budget problems. Perhaps public the spending increases and tax cuts they say they want,
chastened by the experience of its predecessor, the new and to avoid leaving surpluses for their political opponents to
Commonwealth government has not set a date for the budget to spend.48
return to surplus. It has committed only to reaching a surplus of 1
per cent of GDP in 2023-24 a decade and three elections That is why Australias historic aversion to government debt may
away.42 not always be the perfect answer from the perspective of
economic theory.49 However, it may be a very good answer given
In the meantime, the prospects of slower economic growth and the political temptations to run deficits when it is not in the
rising unemployment have led some to urge a return to Keynesian countrys long-term interests. Unless governments are under
stimulus. The clouds on the economic horizon might tempt some constant electoral pressure to avoid debt, they will tend to find
to argue for a delay to reform. GDP growth has slowed to reasons to spend tomorrows tax dollars today, until they hit the
2.5 per cent.43 Unemployment has increased from 5.1 to hard limit of financial market tolerance, and borrowing becomes
5.8 per cent between April 2012 and October this year.44 More either high cost or impossible. While that limit is a long way off
people have less work than they would like.45 The OECD has today, reaching it would clearly be the worst of all outcomes.
cautioned against dramatic fiscal contraction in the short term, but
welcomed tightening in the medium term.46 In any case, the current economic situation may be as good as it
gets for some time. Current GDP growth of 2.5 per cent may well
We should worry about a tendency to look for any excuse to put be the long-term growth rate for many years. Economists such as
off reform until next year. There will always be reasons to put off Robert Gordon, Tyler Cowen, Stephen King, and some at the IMF
the hard political work of actual budget repair. Governments suggest that economic growth will be slower in developed
everywhere are keen to promise budgetary virtue, but less keen to countries for the next few decades, since there is no obvious
deliver it. Budget choices are hard, and no-one likes any short-run wave of productivity enhancing platforms, and ageing is starting to
41
Jones and Prasser (forthcoming)
42
Greber and Heath (2013)
43
ABS (2013a), as at June 2013 (trend)
44 47
ABS (2013l) Table 1, as at Oct 2013 (trend) See Buchanan and Wagner (1997); Kahneman (2012)
45 48
ABS (2013m) Eslava (2011)
46 49
OECD (2013b), p. 127 Macfarlane (2006)

reduce participation rates.50 As a result, future governments may

have even less ability to repay than current governments.
Similarly, while an unemployment rate of 5.8 per cent is high

relative to the last decade of the mining boom, it is much less than
the 7.7 per cent average of the previous decade.51 This rate of
unemployment was achieved after a year in which the
Commonwealth government reduced its spending by $3.8 billion
in nominal terms52 even if that statistic is much helped by timing
payments to fall in the earlier rather than the later financial year.
Furthermore, we have something of an insurance policy. If budget

repair leads to a significant rise in unemployment, then Australias
central bank still has some room to cut interest rates further to
stimulate the economy. Most central banks in the developed world
do not have that luxury.
50
Gordon (2012); Cowen (2011); King (2013); Abbas, et al. (2013), p. 6
51
ABS (2013l) Table 1; Grattan analysis
52
Treasury (2013b), p. 2

4. Framing budget choices

4.1 Criteria for choices Our approach uses three criteria that we believe are the critical
factors in prioritising budget reforms:
This report presents some potential choices to fix structural
budget deficits. We do not suggest that any Australian 1. Will the proposal have a significant impact on the budget
government will or should implement all of them. However, we deficit? In other words, is the financial impact of the proposal
have tried to identify as many choices as possible that would both big enough to make a difference? We classify proposals as
make a material difference to budget outcomes, and do not have having significant impact if they save at least $2 billion a year.
unacceptable social or economic side-effects. Australian We estimate the impact of all proposals once they are fully
governments may find many of the choices unpalatable, but given implemented, using 2012-13 dollars.
the size of their long-term budget challenges, it will be hard for
them to repair budgets without facing at least some of these 2. If the proposal saves more than $2 billion, what are its social,
choices. If they are all ruled off the table then Australians are distributional and economic impacts?
entitled to ask whether their governments are serious about
restoring budget balances. Social impacts: how will the proposal affect people and
their behaviour?
All of the budget choices presented are politically difficult. If they
were easy, they would have been made already. Australias Distributional impacts: how will it affect people in the
governments are small by OECD standards, and our public sector bottom 20 per cent of the income distribution?
operates more efficiently than most.53 This makes it harder to find
savings by cutting waste and shrinking non-essential services. Economic impacts: will it have positive or negative impact
on economic activity?
In this report, we provide an approach to assessing budget
choices that other policy actors can use as a model for prioritising 3. How confident are we in the size of the savings? Confidence
potential reforms. Even if many do not agree with our assessment will be high if there is concrete evidence about the size of the
of individual reforms, we hope that the model will be useful in potential benefits. That confidence is affected by factors such
providing a disciplined approach that tackles the highest priority as the complexity of the drivers, the uncertainties inherent in
reforms first. those drivers, the potential behaviour change as a result of the
proposal and the availability and quality of underlying data.
53
OECD (2012a); OECD (2012b)

We detail our findings on each of these criteria for each proposal is more contentious, and so we do not use it as a criterion for
in Balancing Budgets: Supporting Analysis. This also includes evaluating budget choices. 59
further details on methodology, including how social, distributional
and economic impacts were combined. Our assessment of the size of each reform is generally an
estimate. Setting priorities usually depends on relative size rather
Our focus on the size of reforms reflects the context of the than precision. A $5 billion proposal will contribute more to
Commonwealth Governments structural deficit of over 2 per cent balancing budgets than a $2 billion proposal, even if considerable
of GDP for the last six years ($30 billion in todays terms),54 and uncertainties exist in both estimates. The main task in setting
the long-term projected structural deficit of 4 per cent of GDP priorities is usually not in distinguishing between closely matched
across all Australian government budgets over the next decade proposals. Rather, it is mostly to sort out the subset of proposals
($60 billion in todays terms).55 Of course, smaller measures also that are materially better than others. A more complex model of
matter. Between 2009 and 2013 the Commonwealth government the economy that captures flow-on effects may be more precise in
made discretionary budget choices that improved its budget estimating the potential size of reforms, but we do not believe that
bottom line by $72 billion in 2013-2014. Of these, $13 billion were this would assist prioritisation much. The impact of most of the
the result of small measures worth less than $50 million a year.56 proposals we examine will depend on how people respond
However, inevitably a large portion of such substantial budget which is inherently impossible to predict precisely. If a reform is a
deficits will need to be corrected through major policy choices. priority, then often it is better to spend available resources on
implementation, and discover the precise impacts in practice.
In assessing distributional impacts, we focus deliberately on the
impact on the bottom 20 per cent of the income distribution As with our estimates of budgetary impacts, our estimates of
generally those who are worst off. This reflects a consensus in social and distributional impacts should not be treated with
Australian political culture that policy should assist those who are spurious precision. For many of these effects there is no common
less well-off to have opportunities to pursue lives that they have metric, and their relative importance depends on the weighting of
reason to value.57 Many argue that policy should also aim to different political values. For some the ultimate impact depends
distribute resources more equally.58 However, this latter approach on second-round effects that are difficult to predict. Consequently
our assessments are generally directional. They aim to produce
54
See above, Section 2.4 an informed discussion.
55
See Chapter 1.
56
Daley, et al. (2013), p. 51, which also shows how these budget improvements Our analysis in this report assesses choices that are likely to have
were accompanied by discretionary measures that cost the budget bottom line a substantial budgetary impact. There may be other reasons to
$59 billion in 2013-14.
57
See the discussion in ibid., p. 37
58 59
See Leigh (2013) Daley, et al. (2013), p. 36-37

undertake policy reform, such as improving social outcomes, we have arbitrarily assumed each would raise $10 billion a year;
protecting the environment or improving fairness of distribution the tax rates required to do so are discussed in Section 8.7.
within the community.60 However, these other policy ends are
beyond the scope of this report unless they are contained within We also examine asset sales (Chapter 10 below). These are not
proposals that have a substantial budgetary impact. included in our summary of proposals because the contribution of
an asset sale to the annual budget balance depends on the sale
We do not assess the political feasibility of implementing these price, government interest rate, and future dividends if the asset
choices. Any significant reforms are likely to encounter substantial remains in government hands - an analysis beyond our scope.
opposition. We aim to identify where political capital might be
expended so that it would make the most difference to improving We have only considered changes to budgetary policy as per the
outcomes in the interests of all Australians. Pre-election Economic and Fiscal Outlook, published in
August 2013.61 Some of the signature initiatives promised by the
4.2 Scope of choices incoming government are costly, and not enacting these may be a
better way to improve the budget balance (see Box 4.1).
The 20 proposals we examine in detail aim to cover all of the Nevertheless, these proposals are hypothetical until legislated,
spending reductions, tax exemptions, and new taxes that are and so have not been included.
commonly raised in discussions about budget repair. They include
all those we have identified in publications such as the Henry Tax Doubtless there are sensible proposals that we have failed to
Review and tax expenditure statements. They also include a identify. We hope, however, that the approach and analysis we
broad range of ideas raised with us in many external discussions present provides a starting point for others to build a more
about the material in this report. As well as proposals with a comprehensive picture of the choices available to Australian
budgetary impact of more than $2 billion a year, we also examine governments in the difficult task of budget repair.
a number of reforms that are popularly believed to have a large
budgetary impact, although our analysis suggests the impact
would probably be much smaller in practice. These include
abolishing negative gearing, public service cuts and reductions in
middle-class welfare.
As well as these specific proposals, we also briefly examine

possible increases to existing taxes. In our summary of proposals,
60 61
Daley, et al. (2012a), p. 7 See Treasury (2013c)

Box 4.1: Commitments of the new government 4.3 Summary of key choices
The new Commonwealth Government made a number of election The impacts of the 20 choices we analyse are summarised in
commitments that would have a significant effect on the long-term Figure 4.1.
budget balance (see Figure 2.5). Further budget improvement
might be achieved by not enacting some of these proposals: Some clear themes emerge from the figure. Proposals for better
targeting of support for older people (shown in brown) are
Expanded paid parental leave an extra $2 billion a year going generally larger and more attractive than other alternatives. Just
mostly to middle- and upper-income families (Section 9.5).62 four choices could improve the budget balance by $27 billion a
Cutting company tax results in foregone revenue of over year.67 The different components of reform of assets taxation
$3 billion per year.63 (shown in red) have very varied assessments. Broadening the
Changes to climate policy the net effect of abolishing the GST is an attractive reform, but other tax exemptions (shown in
carbon price and associated industry compensation, and light orange) are generally less attractive by and large these tax
introducing Direct Action, costs about $4.5 billion a year.64 exemptions have survived for good reasons. Tax increases
Increasing defence spending the commitment to increase (shown in yellow) could do more to improve budget balances, but
defence spending to 2 per cent of GDP in 10 years, from they usually have more negative side effects. A number of cost
current levels of 1.6 per cent, will cost around $8 billion at full reductions (shown in dark orange) have smaller side effects, but
implementation.65 their budgetary impact is also often smaller.
Although these commitments were offset by budget

improvements elsewhere in the Coalitions election platform (such
as a levy on large companies, the abolition of the schoolkids
bonus, and cuts to the public service and foreign aid) 66 it would
be possible to enact those improvements without the
accompanying spending, improving the budget balance.
Note: All costings are at full implementation, in $2013
62
Grattan analysis of Loughnane (2013a); PBO (2013b)
63 67
Grattan analysis of PBO (2013b) There is some interaction between the Age Pension asset test proposal and
64
Grattan analysis of ibid. the retirement age proposal. If the retirement age is lifted, the additional savings
65
Grattan analysis of Loughnane (2013b); Thomson (2013) from reforming the Age Pension asset test are reduced as fewer people are old
66
See PBO (2013b); Hockey and Robb (2013) enough to qualify for the Age Pension.

Figure 4.1 Budgetary, social and economic impacts of budget choices

Budget impact per year, 2103$ billion
Bracket creep Older age
Assets taxation
15 Cost reductions
CGT owner/occ. housing
Tax exemptions
GST broaden
Tax rises
Aged pension &

super age
Payroll tax Income tax
increase increase GST increase
10
Stamp Corp tax Property rate
duty increase increase
increase Aged pension
assets test
Super
Transport
contributions
infrastructure
Payroll tax Industry CGT discount
5 threshold Private health
rebate Super earnings
Higher ed. Negative
Fuel tax gearing
credit Fuel tax Defence
Mining indexation Pharmaceuticals
royalty School Cost-effective
class size medicine
0
Negative Neutral Positive
Social, distributional and economic impacts
Note: Proposals considered that would generate less than $2 billion are not shown. These include congestion charges, grants to first home-buyers, middle-class welfare, public sector
efficiency, avoidable hospital costs and end-of-life care. See Balancing budgets: Supporting analysis p. 48-9.

Spending reductions, including reform to the age pension assets Figure 4.2 Cumulative budgetary impacts of choice themes
test and increases to the pension age (which reduce pensions), 2013$ billion per year
and the variety of other spending proposals identified, add to 0 10 20 30
around $33 billion a year. Tax increases as a result of removing Pension and super access 12
exemptions add to around $50 billion a year. Higher tax receipts Super contrib. concessions 6
Super earn concess >60s Superannuation
3
as a result of increasing the age of access to pensions and Age Pension assets test 7 and pensions
superannuation would raise about $9 billion (Figure 4.2). interactions 1
CGT discount 5
Capital gains
Most of the remainder of this report explores these choices in CGT owner occ. 15 18
and housing
detail. Each choice is explored in Balancing budgets: Supporting Negative gearing 2
GST broaden 13
analysis, published in association with this report. Payroll tax threshold 6
Tax
Fuel tax indexation 3
exemptions
Fuel tax credit 3
Health insce rebate 3
Transport infrast costs 6
Industry support 5
Pharmaceutical spend 2
Marginal health 2 Other
School class sizes 3 spending
Defence spending 2
Higher edn subsidies 3
Note: interaction effects between CGT proposals are captured within the proposal for CGT
on owner-occupied housing, as shown in a lighter colour.

5. Packaging reform
All the proposals in this report would leave some people worse 5.1 One potential package
off, at least in the short run. In the last decade, governments have
been averse to making decisions that create identifiable losers.68 A package that would distribute the burden across the community,
Chapter 3 shows how important it is for pain to be shared: people affecting both rich and poor, and focus on the most attractive
may be more willing to accept the burden if they understand that opportunities identified in our prioritisation, would:
everyone is experiencing some pain. It is also harder for special-
interest groups to claim that their interests should not be broaden the GST
adversely affected when everyone in the community is sharing the
burden. raise the pension and super age
For these reasons, big and difficult reforms may be best include the primary residence in the Age Pension asset test
introduced in a package. A package can indicate the magnitude of
the overall problem and show that the burden is widely shared. It limit superannuation tax concessions.
can also include some (smaller) spending increases that mitigate
the impacts on those worst off and least able to absorb adverse The proposals in this package would contribute about $37 billion a
change year towards balancing budgets. The package picks up many of
the proposals that would do most to improve budget balances,
In developing a potential reform package, we considered the with relatively limited side effects
following criteria:
It would affect both rich and poor. Broadening the GST would
Prioritisation which proposals are big enough to care about? affect all income groups, but would hit low-income earners
Will they materially improve the budget deficit? hardest, although compensation could reduce most of the impact.
Raising the pension and superannuation age would affect all
Distributional impact how might proposals be combined so income groups. Including the primary residence in the Age
that a range of identifiable groups share the burden fairly? Pension asset test would primarily affect middle-income earners
people doing well enough to own their own house, but not so well
68
Daley, et al. (2013), p. 9. For example, see Megalogenis (2012); Tingle (2012)

that they do not qualify for the Age Pension.69 Limiting Limiting superannuation contribution tax concessions would affect
superannuation tax concessions would mainly affect high-income high wage earners in all age groups, but particularly those over
earners, who reap most of the benefits of tax concessions for the age of 60 who currently pay much lower rates of income tax
contributing more than $10,000 a year to superannuation. than younger people on similar incomes. Again, those who are
younger now pay their share in that they will also miss out on
The package would probably slightly reduce inequality overall, current, generous arrangements as they age.
consistent with some but by no means all efforts to improve
budget balances around the world.70 Broadening the GST affects the spending of all Australians. Older
Australians who are not working are likely to prefer other tax
The major sensitivity with this package is that all of the reforms changes such as income tax increases that inherently affect them
appear to affect older Australians more. This may be more less.
perception than reality, but it would be an important issue to
manage. The skew of Australias current tax and welfare systems explains
why the proposed package would have a greater impact on older
Increasing the pension and superannuation preservation age Australians in the short term. Our tax and welfare system is
mainly affects those aged about 50 to 55 in the short term. generally tightly targeted to those most in need. The biggest
Assuming that the eligibility ages are lifted gradually, those exception is pension and superannuation systems, which are
already retired would be unaffected. All Australians who are under substantially age-based rather than needs based. Inevitably,
50 today will share the burden in the future as they age. Many reforming these arrangements emerges as a high priority that
under the age of 45 may believe that increase is inevitable and would substantially improve budget balances with relatively
in any case the effect is at least 20 years away. limited side effects.
Including owner-occupied dwellings in the assets test primarily Other packages might be designed around a different
affects those over 65 although obviously these rules will apply combination of proposals. The key task is to group together major
to everyone when they are older. reforms in ways that demonstrate that everyone in the community
is sharing the burden of budget repair.
5.2 A package for federalism

69
People in this cohort are likely to be middle-income earners over their
lifetimes, and although their income in retirement is likely to be less than when Packaging reforms together can also help to overcome the politics
working, their disposable incomes can often be relatively high: see Phillips and of federalism, and ensure that both Commonwealth and state
Nepal (2012)
70
Rawdanowicz, et al. (2013), p. 27-28

governments pull their weight in improving budget balances. when property prices are falling).71 This reform would not improve
State budgets much, but it would substantially improve the
Broadening the GST would transfer substantial additional revenue efficiency of the tax system, and lift economic growth.
to states if current arrangements were maintained. The
Commonwealth would incur much of the political pain in Any such package would reduce vertical fiscal imbalance (see
broadening the GST. To improve its budget, the Commonwealth glossary) between the Commonwealth and states. Many say that
might reduce some of the tied grants paid to the states that because states dont raise half the revenue they spend, they tend
provide about 25 per cent of their revenue although inevitably towards less responsible budgets.72
these are in program areas where the Commonwealth (at least in
the past) saw substantial political benefits from involvement.
Such a substantial contribution to state government budgets and

autonomy provides an opportunity to lock in other reform. One
option would be to make the increased GST revenue conditional
on states also reforming payroll tax thresholds. But while this
might contribute up to $6 billion a year to State government
budgets, it is unclear that this reform would substantially improve
long-run economic growth given its potential impact on
unemployment. Alternatively, the Commonwealth might make the
increased GST conditional on states reducing their payroll rate,
but also abolishing the payroll tax threshold, which would provide
some efficiency gains (see Section 8.2).
A better alternative might be to make the increased GST revenue

conditional on states reducing stamp duties and increasing
property rates over time. This reform, while politically difficult,
would make it easier to sell property to whoever values it most
highly. It also reduces the vulnerability of state budgets to falling
revenues when there are fewer property transactions (typically
71
For discussion of the merits of this reform, see Daley, et al. (2012a), p. 33-34;
Kelly, et al. (2013), p. 32-33
72
See Eyraud and Lusinyan (2011)

6. Superannuation and pensions

Improving the targeting of pension and superannuation policy is Pension assets test. Although a government is unlikely to make all
the largest single theme among the budget choices we have these choices simultaneously, collectively they could improve
identified. budget balances by $27 billion a year.74
Obviously these choices primarily affect older Australians in the 6.1 Pension and superannuation preservation age
short term. They emerge as high priorities because tax and
welfare policies for older Australians are less well-targeted to Increasing to 70 the age of access to the Age Pension and
those most in need than are other policies, and consequently superannuation (the retirement age) is one of the most
there are more opportunities for change that deliver substantial economically attractive choices to improve budgets in the medium
improvements to the budget with relatively few side-effects. term. It could ultimately improve the budget bottom line by
These choices will affect all Australians as they age, not just the $12 billion a year in todays terms, while producing a lift in
current older generation. economic activity of up to 2 per cent of GDP.75 The principal
adverse social consequence is that some who would prefer to
Budget measures that affect older Australians may also be stop working earlier will not be able to afford to do so. Given
appropriate because older Australians are putting most pressure increasing life expectancy, this is a reasonable burden.76
on government budgets. As we showed in Budget pressures on
Australian governments, the largest spending increases over the Increasing the retirement age would almost certainly lead to many
last decade have been increased spending on health (where more people choosing to work for longer. There is a noticeable increase
is spent per capita on older people than on younger people) and in the number of people who retire once they can withdraw super
on the Age Pension. Both of these spending categories grew tax free, and another jump once they become eligible for the Age
substantially faster than GDP, not because of the ageing Pension (Figure 6.1).
population, but because of explicit and implicit choices to spend
more per person of a given age.73
The key choices we identify are increasing the age of access for
the Age Pension and superannuation, limiting tax concessions for
superannuation, and including owner-occupied housing in the Age 74
This costing is based on all measures being introduced, and includes likely
interaction effects between the proposals.
75
Daley, et al. (2012a)
73 76
Daley, et al. (2013) A recent analysis of ageing policy can be found in PC (2013)

Figure 6.1 Age of eligibility for superannuation and Age Pension age by 6 months every year starting in 2015, and it would then
affects retirement decisions reach 70 by 2025.
Cumulative per cent retired, males
80 The age of access to superannuation is legislated to rise from 55
to 60 by 2024, although there are already substantial restrictions
and tax penalties on superannuation withdrawals between 55 and
60. The age of unfettered access to superannuation could be
60 increased from 60 by 6 months every year starting in 2015, and it
Eligible for would then reach 70 in 2035. Once the substantial increases in
tax-free life expectancy of the last 30 years have been incorporated into
super the access ages as proposed, then it may be appropriate to index
40 the access age for age pension and superannuation to life
Eligible for
expectancy.
pension
This phasing would still have a substantial effect within a decade.
20 The benefit to the budget bottom line would be approximately
Public
sector
$12 billion by 2023, and about $15 billion by 2035 in todays
54/11 dollars.
0 People working for longer would improve medium-term budget
51 53 55 57 59 61 63 65 67 69
balances in a number of ways. First, they would pay income taxes
Source: Grattan analysis of ABS (2011a)
Note: Assumes that differences in labour-force participation rates between cohorts 1 year for longer increasing income taxes by about $9 billion a year in
apart in age reflect retirement rates. todays terms by 2035, on our calculations. Second, they would
continue to contribute to their superannuation accounts for longer,
It is probably only feasible to increase pension and
and so would self-fund their retirement for longer. Third, Age
superannuation ages gradually over several years. Current
Pension payments would reduce by at least $3 billion a year in
legislation will increase the pension age from 65 to 65 in 2017,
todays terms, on our estimate. This third saving is primarily from
and then by 6 months every 2 years until it reaches 67 in 2023.77
those who retire onto part pensions. Those who qualify for the full
This timetable could be accelerated to start raising the pension
Age Pension in the early years of retirement were usually
receiving other welfare benefits such as the disability pension
immediately beforehand. For this group, changing the age of
77
DHS (2013a) eligibility for the Age Pension will not reduce welfare payments;

instead it will merely change the category of payment received.78 15-year old boy could expect to live to 64; a 15-year old girl to 67.
Those who survived to receive the pension did not spend much
Unlike almost all the other budget choices examined, this time drawing it: on average male recipients would spend a little
proposal would increase economic activity. A higher retirement over 11 years on the pension, while women would draw it for 17.82
age that encourages more mature-aged people to work for longer
would produce a sizeable increase in economic activity. Our Today, the Age Pension age of eligibility is 65 for men and
previous work identified this as one of the few policy game- women, though this will increase slowly to 67 by 2023. Life
changers for economic growth, with analysis estimating that expectancy for 15-year old boys is 80 today, and almost 85 for
increasing the retirement age to 70 would increase economic girls. Half the men going onto the Age Pension at 65 today will
activity by about 2 per cent once fully implemented.79 receive it for more than 19 years; half the women for more than
22.83
There would be some social costs to people working for longer.
Contrary to popular belief, there would be little impact on The value of this increased life expectancy, and its link to active
volunteering, and life satisfaction would not be materially lower.80 lives, is perhaps best illustrated by the boom in travel over the last
However, some people prefer to retire early, and some of them few decades. As the CEO of a leading tour operator remarked
would no longer be able to afford to do so. recently:
Yet this is a reasonable burden to impose. Life expectancy has Modern medical science is [a] gift that keeps on giving! New
increased substantially, while the eligibility age for the Age knees and hips, as well as heart stents especially heart
Pension did not move for men between 1908 and today. stents are giving my customers another 10 to 20 years of
Increasing life expectancy is largely due to health care travelling.84
improvements that are themselves putting the greatest pressure
on budgets.81 Increasing the age of access to superannuation would not be a
regressive policy change, because any reduction in choice would
When the Age Pension was introduced in 1908, the age of primarily affect those with higher incomes. Those who withdraw
eligibility was set to 65 for men and 60 for women. At that time, a their super early are almost always those on higher incomes
(Figure 6.2).
78
Horin (2010) Most of this group receive Disability or Carers Pension rather
than Newstart, and so there is little difference in benefits when moving to the
Age Pension: Gregory (2012)
79 82
Daley, et al. (2012a) ABS (2008)
80 83
Ibid. Daley, et al. (2012a)
81 84
Daley, et al. (2013) Kohler (2013)

Figure 6.2 Proportion of age cohort withdrawing payment from their eligibility for the disability pension might also use less stringent
superannuation account tests of whether a person aged over 65 has such a severe
Per cent impairment that they are unable to work.86 This is preferable to
40 setting a lower than ideal retirement age for all people because of
concern for this particular group.
Of course, policies that encourage employment of older workers

30
Top half of income would also help. However, as we showed in Game-Changers,
distribution pension eligibility ages are the biggest driver of retirement
decisions around the world. In Australia most people retire
20 because they choose to do so rather than because they are
unable to find employment.87
Bottom half of
income distribution 6.2 Superannuation contribution tax concessions
10
At present, employees are only taxed at 15 per cent for the first
$25,000 or $35,000 for those aged 59 and over that they put
0
into their superannuation account each year. Reducing these
thresholds to $10,000 could raise up to $6 billion a year. The
55 56 57 58 59 60 61 62 63 64
change would have little impact on low-income earners, as the
Age vast majority of contribution tax concessions benefit older workers
Source: Grattan analysis of ABS (2011c)
on high incomes. There would be some negative economic impact
as older workers would pay more income tax, and so have less
The primary concern with increasing the retirement age is the incentive to work. It may also reduce national savings.88
increased burden on those who are not fit to work at age 65. Yet
this is a declining proportion of the population.85 The needs of this
group would be best addressed by allowing earlier access to
superannuation for those who have a disability. Assessments of 86
Although this might create some leakage into the disability pension, by
definition these people would currently be on the Age Pension, so there would
85
The proportion of the workforce in the most physically demanding sectors be no net increase in welfare payments.
87
(agriculture, construction and manufacturing) has dropped from about 28 per Daley, et al. (2012a), p. 52-53
88
cent to 20 per cent in the last two decades, and these trends are likely to For a discussion of the relationship between superannuation and national
continue. See Lowe (2012) savings, see Gruen and Soding (2011)

Superannuation differs from regular savings because it attracts threshold will apply to those over 50.91 By comparison, savings
significant tax concessions. Contributions made from pre-tax outside of superannuation are generally made from post-tax
earnings are only taxed at 15 per cent up to the $25,000 or earnings, and so in effect contributions are taxed at the persons
$35,000 thresholds.89 Earnings from superannuation funds are marginal tax rate, which is 38.5 per cent for many taxpayers.
only taxed at 15 per cent during the accumulation phase (usually
pre-retirement) and not taxed at all when supporting retirement These arrangements lead to workers over 60 paying substantially
income streams; earnings from other savings are taxed at the less income tax than younger workers with similar incomes. They
persons marginal tax rate.90 People especially high-income can arrange their affairs so that the first $35,000 of income is
earners who save through superannuation usually pay deposited to superannuation from where it can immediately be
substantially less tax than if they save through other investments. withdrawn tax free (conditional on a superannuation balance of
more than $350,000), but is not included in taxable income. As a
Superannuation savings can be taxed at three points: when they result a 61-year old working full-time on the Australian average
are put into a superannuation fund (known as contributions); when wage of $77,000 a year may pay at least $5000 less a year in tax
they earn income (known as accumulations, which include both than a person under 60 who only makes compulsory
capital gains and income); and when they are withdrawn or superannuation contributions of 9.25 per cent.92
produce an income stream.
Superannuation earnings also attract less tax. Capital gains made
In Australia, superannuation contributions from pre-tax earnings on assets inside a superannuation fund are taxed at 10 per cent,
are effectively untaxed for those earning less than $37,000 a year. and other income interest and dividends is taxed at
For those earning more, contributions up to the thresholds are 15 per cent. Franking credits (tax paid on behalf of the
taxed at 15 per cent, and over the thresholds at the persons shareholder by a company) may be used to offset a tax liability
marginal tax rate (which can be as high as 46.5 per cent). In within the fund, including capital gains.93 By comparison, earnings
2014-15 these thresholds will be raised to $30,000 of on savings outside of superannuation are again taxed at the
contributions in a single year for those under 50, and the $35,000 marginal tax rate 38.5 per cent for many taxpayers.
89
Changes announced in the 2013 budget would tax contributions from those
earning more than $300,000 a year at 30 per cent (Swan and Shorten (2013)).
91
The Coalition government has not announced any change to this policy (see ATO (2013a) The threshold is indexed to CPI and rounded to the nearest
Hockey and Robb (2013); Hockey and Sinodinis (2013)). $5,000: it is expected to lift to $30,000 in 2014-15.
90 92
Changes announced in the 2013 budget would tax earnings above $100,000 a These calculations do not include additional tax concessions from the Seniors
year that are supporting income streams at 15 per cent (Treasury (2013a) BP2, and Pensioners Tax Offset. Depending on the spouses income this might
p. 41.) The Coalition government has announced that it will not proceed with reduce the tax payable by a person aged 65 or over by another $1600.
93
these changes (Hockey and Sinodinis (2013)). ASIC (2013c)

Some retirement systems in other countries balance tax The proposal would have limited social impact. It would have
concessions on contributions and accumulations by taxing almost no impact on the bottom 20 per cent, as superannuation
withdrawals. In Australia withdrawals from superannuation contribution concessions mostly benefit older people on high
accounts are generally untaxed if the person is aged over 60.94 incomes, as Figure 6.3 shows. Capping superannuation tax
concessions would also support gender equity as the current
Our proposal would reduce the concessional contributions
threshold to $10,000.95 Contributions above the threshold would Figure 6.3 Superannuation concessions and government benefits
be taxed at the marginal rate. After taking into account the $000 per person per year, income earners within age group
interaction between deposit and accumulation tax concessions, Income decile within age group
this proposal would increase Commonwealth tax revenues by 1 2 3 4 5 6 7 8 9 10
Super
around $6 billion when it was fully implemented. Not all the 10
concessions
superannuation contribution concessions would become revenue Under
if they were revoked.96 However, we expect that income tax would 35 5 Government
be paid at marginal rates on almost all of the income that would benefits
otherwise attract a superannuation contribution tax concession. 0
Although some investments would be switched into other asset 35 10
classes, there is no alternative investment that allows taxpayers to to 54
avoid paying income tax on earnings before they are invested. 5
0 Able to
contribute
94
ASIC (2013a). More complex rules apply to taxation of withdrawals by peopled 55 and 10 earnings to
aged between 55 and 60. over super and
95
There is considerable uncertainty about the superannuation balances of those 5 immediately
making concessional contributions into their superannuation accounts. Some withdraw
who are making contributions are catching up on not having had a
superannuation guarantee for much of their working career. Others are simply 0
using the rules to minimise their tax. Given the available data, it is impossible to
tell what proportion of super contributions are made by each group. However, Note: Assumes those aged 60 and over with income over $60,000 contribute the full
data from the ATO (2013c) suggest that those with the capacity to make large amount allowed by the concessional cap.
contributions are among the richest 30 per cent of those in their 60s. The Source: Grattan analysis of ATO (2013c)
Household Expenditure Survey, which gives a survey-based estimate of
superannuation balances, suggests that the top 30 per cent of those in their 60s
are more likely to have large superannuation balances (ABS (2011c)).
96
Treasury (2013d)

superannuation concessions primarily benefit men (and their concessions that in effect mean that younger workers on similar
female partners).97 incomes must pay more tax. Most people would like to be rich
both before and in retirement. If some are to have higher
Tightening these tax concessions is unlikely to substantially retirement incomes, the question is who is going to pay for it. As
reduce the draw on the Age Pension. Those in the top 10 per cent Figure 6.4 shows, even after the concessions are reduced, those
of earners aged 35 to 54 are likely to have sufficient savings that on higher incomes will still receive substantially greater
they will not qualify for an Age Pension.98 And those in the top concessions than other taxpayers.
three earning deciles aged 55 and over would probably save
anyway. The superannuation concessions probably do increase Figure 6.4 Superannuation concessions withdrawn by proposal
their retirement incomes, but only at the cost of younger people $000 per person per year, income decile within age group
paying more tax. Income decile within age group
1 2 3 4 5 6 7 8 9 10
Tightening superannuation tax concessions might reduce 10 Super
concessions
workforce participation because it would increase marginal rates Under withdrawn by
5
of income tax for those over 60. Assuming a 10 per cent reduction 35 proposal
in take home pay leads to a 2 per cent reduction in participation,99
0 Remaining
we estimate the proposal would reduce labour force participation super
for those aged 60 to 70 by about 0.5 per cent, reducing income 10
concessions
tax by about $0.3 billion. 35
to 54 5
Nor would the proposal undermine the superannuation system.
The articulated purposes of the superannuation system are to 0 Younger
workers get
provide an adequate level of retirement income, relieve pressure 10 more
on the Age Pension, and increase national savings.100 Yet these concessions
aims need to be balanced against the many other purposes of 55 and because
5 higher average
government. Merely increasing retirement incomes of older over earnings than
workers is not sufficient justification for providing substantial tax older age-
0 group
97
Jefferson (2012)
98 Notes: Assumes those aged 60 and over with income over $60,000 contribute the full
See Figure 6.7 showing that few households in the top 10 percent qualify for amount allowed by the concessional cap.
an Age Pension. Source: Grattan analysis of ATO (2013c)
99
Saez, et al. (2012)
100
Treasury (2013d), p. 21

We recommend changes to taxation of contributions rather than The proposal would tax all earnings on superannuation at
withdrawals, which would be administratively complex and 15 per cent, restoring the taxation arrangements that existed until
potentially extremely costly. Changes to withdrawal rules raise late 2006. The proposal would have little effect on low income
difficult questions of how to treat superannuation that has already earners. As Figure 6.5 shows, the richest 10 per cent of those in
been contributed, and now cannot be withdrawn. These their 60s receive most of the benefit of this tax exemption, worth
contributions were made with expectations that they would be on average around $100 a week to them.104 By contrast, those in
treated according to the existing rules on accumulation and the bottom 20 per cent, with limited superannuation balances,
withdrawal. An alternative proposal would tax all contributions at barely benefit from this concession.
the taxpayers marginal rate, but exempt all earnings from tax.101
Again this would be administratively complex, as all previously Figure 6.5 Income by source for those in their 60s
contributed superannuation funds would then be taxed at a $000 per person per year
different rate to all newly contributed funds. 180
6.3 Superannuation earnings tax concessions 150
Taxing superannuation earnings of those over 60 at 15 per cent

(as for younger taxpayers) would yield $3 billion in additional tax 120
revenue. The measure would have minimal effect on the bottom Other income
20 per cent of income earners, as they receive very little in 90
superannuation earnings.
Superannuation accounts held by over-60s do not pay tax on 60

earned income, such as dividends, interest and capital gains, so
Age Super income
long as the account-holder is making some withdrawals.102 30 tax concession
Pension
Superannuation accounts held by under-60s, by contrast, pay
15 per cent tax on all income.103 Super
0 income
1 2 3 4 5 6 7 8 9 10
Gross income decile
101 Source: Grattan analysis of ABS (2011c)
Freebairn (2013a)
102
ASIC (2013a)
103
This anomaly was excluded from the terms of reference of the Henry Review:
104
Treasury (2010a) Based on Grattan analysis of ABS (2011c)

6.4 Age pension asset test Figure 6.6 Age pension expenditures and household wealth
Age Pension expenditures, 2012-13, $ billion
Including owner-occupied housing in the calculation of a retirees 45
eligibility for the Age Pension would contribute about $7 billion a
40
year to the budget.105 The change would also encourage people
to downsize to housing which may be better suited to their needs, 35
enabling more efficient use of the existing housing stock. The
30
change would have little impact on those in the bottom
20 per cent of incomes because they do not have enough wealth 25
to put them over the asset test threshold. The impact on low-
20
income retirees with high-value houses would be mitigated by
allowing them to claim the pension that would be paid back when 15
their house is eventually sold.
10
Currently an assets test is applied to the Age Pension. Those with 5
net wealth above a threshold have their payments reduced
progressively. The assets included in the asset test include most 0
<$100K $100K - $200K - $300K - $500K - $750K - $1M - >$2M
forms of wealth, such as cash deposits, shares, superannuation
$200K $300K $500K $750K $1M $2M
balance and investment properties but not the primary
residence. Although there is a slightly lower threshold for those Household wealth
Source: Grattan analysis of ABS (2011c)
who own their own home, this effectively only takes into account
the value of the residence up to $142,500. Consequently, many Of mature age households with a million dollars in net assets,
Age Pension payments are made to households that have about 80 per cent receive welfare benefits. On average they
substantial property assets. Almost $20 billion of these payments receive more than $200 a week (Figure 6.7).
around half of the total are made to households with more
than half a million dollars in net assets (Figure 6.6).
105
This estimate is based on Grattan analysis of ibid. and HILDA (2012)

Figure 6.7 Household assets and Age Pension eligibility the debt would be included in calculating the asset test. Over time
Household net wealth for mature-aged households, $ million the net asset value might reduce so that the person was eligible
Household wealth percentile for the pension without accumulating further debt. By definition the
0 10 20 30 40 50 60 70 80 90 person would always retain a net equity in the dwelling of at least
4
the asset test threshold.
3
Current asset
2 $1m in wealth
test threshold On our estimates, such a reform would improve the budget
1 bottom line by about $7 billion a year on an accounting basis,
0 though only about $5 billion a year on a cash measure. The
Per cent of mature-aged households receiving government benefits difference is the value of the debt accumulated by the government
100 that will be realised when houses are ultimately sold.
50
This proposal would also treat homeowners and renters more
0 fairly. Home-owners would be able to access benefits equivalent
Dollars per week received by those receiving government benefits to rent assistance, but the same assets test threshold would apply
400
to both home-owners and renters.
200
In addition to their cash payment, Age Pension recipients are
0 eligible for significant concessions on services such as car
Note: Mature-aged households refers to households in which the household reference registration and third party insurance, utilities, rates and health
person, generally the head of the household, is of Age Pension age (65 and over).
Source: Grattan analysis of ABS (2011c) expenses. These benefits are available to those receiving a part
pension of any value, so the majority of mature-aged households
Including owner-occupied housing in the Age Pension assets test are currently eligible.107 Reducing the number of people eligible
raises significant concerns that the change would hurt asset-rich for the Age Pension thus has the potential to reduce concession
but income-poor households. An equitable solution would be to expenditure for states, improving their budget position.
allow people who fail the asset test due to the value of their
dwelling to receive the age pension. However, the government However, the proposal would leave untouched other age-based
would accumulate a claim against their dwelling, which it would welfare schemes, including the Senior Australians and Pension
reclaim when the dwelling was transferred or sold.106 The value of
107
Grattan analysis of ABS (2011c), see Figure 6.7. Commonwealth-state
106
In effect the scheme would be similar to including dwellings in the asset test, agreements prevent states from restricting eligibility for concessions to full
and the government providing a no-interest reverse-mortgage. pensioners. See Treasury (2010b) Section D6

Tax Offset (which reduces income tax rates for those over 65) and
the Seniors Health Card (which further subsidises medical costs
for those over 65 but not eligible for a pension).
The change would also have substantial positive economic and

social effects. The current Age Pension asset test encourages
many retirees to stay in houses which may be larger than they
need. If a retiree moves into a smaller house and has a surplus,
this surplus is included in the Age Pension asset test, and the
pension reduced accordingly.108 Despite some policy attempts to
smooth the transition to more appropriate housing,109 many
retirees face reduced retirement incomes if they move into a
smaller dwelling.
Removing barriers to downsizing would enable more efficient use

of the existing housing stock particularly important when supply
of new housing stock is constrained.110
The current Age Pension test also encourages retirees to hold

more of their wealth in a highly concentrated asset: their
residence. A reformed asset test would encourage retirees to
invest in a more balanced portfolio. It would also reflect that older
owner-occupiers have been the primary beneficiaries of the very
large real increases in house prices over the past 40 years, which
are unlikely to be repeated in future now that interest rates cannot
fall much further.
108
ASIC (2013b)
109
Net receipts up to $200k from the sale of a dwelling held more than 25 years
may be quarantined from the asset test for 10 years or until they are used. See
Chancellor (2013)
110
See Kelly, et al. (2011)

7. Capital gains tax and housing

Change to the tax treatment of housing and other assets has investment types such as dividend imputation, capital gains, and
been widely discussed as a way to improve budget balances. superannuation, result in real effective marginal tax rates for a
Options that have been canvassed include reducing the capital high-income earner ranging from 70 per cent (on bank deposits)
gains discount on assets, taxing the capital gain on the largest to -30 per cent (on superannuation).113 This report focuses on
single asset class in Australia owner-occupied housing and reforms that would contribute to balancing budgets, although
eliminating the ability to negatively gear investments, typically obviously rationalizing the taxation of investments as well is
investment properties. Our analysis shows that abolishing the preferable.
capital gains tax discount is attractive; levying capital gains tax on
owner-occupied housing could have large negative social and 7.1 Capital gains discount
economic side-effects, and abolishing negative gearing would
raise little budgetary revenue in the long run. Eliminating the capital gains tax (CGT) discount to tax capital
gains at the same rate as income could raise $5 billion a year in
Many of these proposals also affect home ownership, the extra revenue.114 The additional revenue raised is relatively
availability of housing, and the equitable treatment of renters and uncertain, and depends on future asset price appreciation and
owner-occupiers. While these important policy objectives were interest rates. There might be some reduction in the numbers of
discussed in the recent report published by Grattan Institute, individual entrepreneurs setting up businesses. There would be
Renovating housing policy,111 this report focuses on the extent to little impact on people in the bottom 20 per cent of the income
which the proposals might improve budget balances. distribution.
Instincts that these proposals would yield substantial revenue may Capital gains tax is levied on assets that are sold for more than
be based on the very large increases in property prices over the their nominal cost plus the cost of improvements. The introduction
last two decades. Yet these increases were largely based on of capital gains tax in 1986 ensured that all sources of income
long-term reductions in inflation rates and interest rates, which are were taxed.115 Before this income from capital investments was
unlikely to be repeated in future.112
113
Pressure to reform this area also stems from inconsistencies in Treasury (2010b) Vol 1, p. 67
114
In 2012-13, the capital gains discount was valued at $5.4 billion with
the taxation of different investment types. Rules for specific $4.7 billion provided to individuals and trusts. This excludes exemptions for
owner-occupied housing. Treasury (2013e), p. 5, 7
111 115
Kelly, et al. (2013). The principle of comprehensive income was outlined by Haig and Simons in
112
Ellis (2013) the early 20th century and discussed by Evans (2002), p. 119

not taxable and people could reclassify ordinary income as capital investment is sold.122 Not surprisingly, all of the arguments for the
gains to avoid paying tax.116 capital gains tax discount are contested123 and some
commentators argue that the discounts reduce equity.124
Initially, capital gains were calculated as the difference between Freebairn describes the capital gains tax regime as an
an assets purchase price (indexed for inflation) and selling unsatisfactory hybrid with limited logic.125 Nevertheless, the Rudd
price.117 Since 1999, capital gains have been calculated as the government explicitly rejected changes to the discounts in its
difference between an assets purchase price (not indexed for response to the Henry tax review.126
inflation) and selling price, less a discount.118 Under that discount,
individuals and trusts are taxed on 50 per cent of their capital There are good arguments to abolish the capital gains discount
gains, and superannuation funds on 67 per cent of their gains.119 altogether. Other forms of investments and income from working
A range of special provisions apply to small businesses.120 are taxed at the marginal rate of income tax. On other
investments (such as bank deposits), investors are not
The discounts were rationalised on the basis that they encourage compensated for inflation, and effectively pay tax on the nominal
people to become entrepreneurs and invest in riskier assets. value of their investment. It is not obvious why returns on
Proponents argue that the discounts compensate for capital gains investment should be taxed less than returns from working.
being eroded by inflation, double taxation on savings and reduce
potential lock-in effects created by the tax.121 However, other If the discount were abolished entirely, additional tax of $5 billion
forms of investment such as bank deposits are similarly would have been collected in 2012-13.127 It is likely that investors
eroded by inflation and double taxation, but receive no discount, would attempt to change their investment strategy in response.
and tax is payable each year rather than being deferred until the However, it is difficult to see an alternative strategy that would
become more attractive, and so reduce the amount of tax
collected if investors moved to alternative investments.
116
Ibid., p. 118. The incentive to reclassify income as capital gains still exists as
a result of the 50 per cent discount, but is weaker than when capital gains were The proposal may have negative social and economic effects.
untaxed.
117
Removing the discount may reduce investment in new
As a result of grandfather provisions, capital gains tax is only levied on
assets acquired after 1985.
118 122
Other changes introduced at the same time included abolishing averaging Capital gains are taxed on sale rather than by estimating the increase in
provisions, rationalization and extension of a series of small business retirement value and paying tax each year.
123
and roll-over concessions and the removal of depreciable assets from the CGT For example, see Burman (2009) p. 113-114 and Evans (2002) p. 120-122
124
regime: Evans (2002). For example, see Evans (2002), p. 127
119 125
Ibid. Freebairn (2012), p. 22
120 126
Wood, et al. (2006), p. 23 Lester (2010)
121 127
Burman (2009), p. 114 Treasury (2013e)

businesses, since the returns from selling a successful business as inflation (the original 1985 design for CGT). This would
would be lower.128 This effect may be limited: the discount is calculate real capital gains, accounting for inflation. Alternatively,
smaller for superannuation funds and does not apply to larger the discount could be reduced to 40 per cent, but capital gains
businesses. For individuals and small businesses there are would still be calculated on the nominal cost base.134 These
already a range of exemptions (not affected by this proposal) that arrangements would generally collect more tax than the current
limit the effect of capital gains tax. In any case, capital gains paid
on the sale of businesses are a small proportion of the total tax Figure 7.1 Proportion of taxpayers, income and total capital gains
collected: most of the tax is paid by individuals on share-market Percentage of total, by income tax bracket, 2010-11 tax returns
investments and investor housing.129
100%
The proposal may have the disadvantage of increasing asset
lock-in effects: investors might avoid selling assets that would $180k+
produce capital gains.130 As a result, it would discourage 80%
rebalancing portfolios in order to maintain diversity.131
Abolishing the discounts would have little impact on people in the 60%
bottom 20 per cent of the income distribution, and would be
strongly progressive.132 As Figure 7.1 shows, high-income earning $80-$180k
individuals benefit the most from capital gains tax discounts. 40%
2 per cent of the highest income earners earn 52% of the capital
gains. Compared to lower-income earners, higher income earners 20%
are more likely to have additional income that can be invested.133 $37k-$80k
$20k-$37k
In order to reduce the effect on investment decisions by removing 0%
<$20k
the discount, capital gains tax could be calculated as the sale Taxpayers Income Capital gains
price less the cost base of the asset increased at the same rate
Note: Tax free thresholds changed between 2010-11 and 2012-13. 2010-11 data is
presented in 2012-13 tax brackets as closely as data allows.
128 Source: Grattan analysis of ATO (2013c) Detailed table 2.8
OECD (2006); Djankov, et al. (2010)
129
See Balancing budgets: Supporting analysis, p. 16
130
For example, see Dai, et al. (2008)
131
OECD (2006)
132 134
Treasury (2010b) Vol.1, p. 66 Treasury (2010b), p. 80. This would work in conjunction with changes to the
133
Evans (2002); Burman (2009), p. 116-117 way savings are taxed.

discount arrangement, depending on the rate of asset price increase to $36 billion a year if the capital gains tax discount were
appreciation, inflation, and how long the asset is held.135 However, also abolished.136
it is unclear why these intermediary proposals would be preferable
to simply abolishing the capital gains tax discount altogether. Relatively little tax would be raised for many years if all existing
holdings were exempted from the tax (similar to the exemption of
7.2 Capital gains exemption for owner-occupied housing all assets acquired before the capital gains tax was first
introduced).
Making owner-occupied housing liable for capital gains tax could
generate additional tax revenue of $15 billion. However, The potential tax revenue would be substantially reduced if
collections could be anywhere between zero and $36 billion, owner-occupiers were allowed to deduct expenses incurred in
depending on whether the capital gains tax discount of owning the house, particularly mortgage interest. If this had been
50 per cent remains in place, whether owners are allowed to claim permitted in 2012-13, mortgage interest deductibility would have
tax deductions for the interest paid on home mortgages, and offset most of the capital gains. Based on a 10-year average,
future rises in house prices. However, the proposal would have about $63 billion in interest was paid annually on owner-occupied
substantial negative social impacts. It would discourage moving housing, entitling owners to deductions valued at about
house since home sales would crystallise liability to pay capital $19 billion,137 compared to potential capital gains revenue of
gains tax. Young purchasers would be tempted to choose around $18 billion if the 50 per cent discount is retained, as shown
oversized housing to reduce the number of home moves they in Figure 7.2.138 Some tax would nevertheless be paid by
make over a lifetime If mortgage interest can be deducted from individual taxpayers with low leverage or with houses that rose in
income tax, this would encourage home-owners to consume more value quickly.
and save less. The policy might well reduce home ownership
rates.
If capital gains tax is charged on owner-occupied housing with the

50 per cent discount that applies to capital gains on other assets,
it could generate about $18 billion a year in gross revenue based
on a 5-year average. After allowing for alterations and additions, 136
Treasury (multiple years), based on five year average between 2008-09 and
the net capital gain would be $15 billion. The tax payable would 2011-12.
137
RBA (2013b), Table D2, RBA (2013a), Table F5
138
Deductions for alterations and additions were significantly less, valued at
$2 billion, assuming that all alterations and additions are undertaken by owner-
occupiers and an average marginal tax rate of 30 per cent. This does not include
135
See Balancing budgets: Supporting analysis, p. 17 deductions for maintenance. ABS (2013d); ABS (2011b)

Figure 7.2 Fiscal impact of collecting CGT on owner-occupied There would be less tendency to over-leverage, and the tax
housing revenue would be substantially larger, if owner-occupiers were not
$ billions / year allowed to deduct mortgage interest. This might be justified on the
40 basis of imputed rent. If owner-occupiers were treated equitably
with renters and landlords, they would pay tax on the rental value
35
of the dwelling but claim the mortgage interest against this
30 income.140 Tax is not levied on imputed rents in Australia, and so
mortgage interest is not deductible against it. Consequently, it
25 might be considered fair to disallow owner-occupiers from
20 deducting mortgage interest from their capital gains.
15 However, there would be substantial adverse social and economic
10
effects. The policy change could exacerbate lock-in effects, with
people delaying selling their houses in order to avoid capital gains
5 tax. People would over-invest in housing relative to their
immediate needs. Some would buy a first home larger than they
0
currently need (to delay incurring a CGT liability associated with
CGT revenue Tax deductions If no CGT Tax decrease
up-sizing); others would hold on to homes that no longer meet
from owner on alterations discount from mortgage
occupied and additions interest
their needs.141 The increase in demand for larger housing would
housing deductions make the existing stock more expensive for those who would
really value the additional space. Housing lock-in may also
Note: Assumes no CGT discount, total value of alterations and additions are attributable to discourage people from moving to housing closer to their
owner-occupiers and an average marginal tax rate of 30 per cent. employment, limiting job mobility and increasing transport costs. It
Source: ABS (2012, 2013); RBA (2013)
would also limit capital gains tax revenue in the short term,
However, allowing tax deductibility of mortgage interest although in the long-run similar amounts of capital gains tax would
encourages households to maintain higher leverage, increasing be levied if sales are merely delayed.
their vulnerability to an economic downturn, as the US
experienced over the past 5 years.139
140
Kelly, et al. (2013), p. 24
141
Stamp duties paid when a house is sold already have these effects (see ibid.:
139
Bartlett (2012), p. 108-109 CGT on owner-occupied housing would make them worse).

The proposal might also significantly reduce home ownership includes gains on three years of very rapid house price
rates. It would reduce the return on housing for owners relative to appreciation, largely driven by a one-off reduction in interest rates,
landlords. as Figure 7.3 shows.
The budget impact would also depend on other factors that are House price appreciation in future may be much slower. Imposing
inherently difficult to predict. Apart from the policy choices made, capital gains tax may itself reduce demand and therefore house
these factors include tax collected would depend on house price prices, reducing future tax revenue. The actual tax collected could
appreciation rates, initial leverage, interest rates, and repayment well be substantially less than the headline tax expense of
rates. Notional capital gains tax foregone over the last decade $15 billion.
Figure 7.3 House price appreciation and interest paid 7.3 Negatively geared investments
Per cent per year
Negative gearing allows taxpayers to deduct any losses they
15
make on investments (including mortgage interest) from their
House price overall income when they calculate their tax liability. Under the
appreciation (nominal) proposed reform, investors would no longer be able to deduct
10
these losses against wage income. However, they would be able
Interest to carry forward any losses and deduct them against any capital
paid/house value gain they make when the investment is sold. The proposal would
5
contribute about $4 billion a year to the budget in the short term,
falling to approximately $2 billion a year in the long term. The
change could increase rates of home ownership by reducing
0
demand for investment properties. The change would have little
impact on those in the bottom 20 per cent, who own relatively few
investment properties.
-5
Negative gearing is a popular way to reduce personal income
tax.142 In the ten years to 2010-11, 1.2 million taxpayers recorded
-10
1996 2001 2006 2011
142
While negative gearing is most commonly used for investment properties, it
Source: Grattan analysis of ABS (2013j); RBA (2013c); RBA (2013a) can also be used to fund investments in other assets such as shares. Any
change in tax rules should apply to all asset classes.

net losses of $13b on investment properties.143 As an investment The precise reduction in future capital gains tax would depend on
and tax strategy it is attractive because while losses (including future house price appreciation and the level of gearing of each
interest on borrowings) are fully deducted against taxable income, individual investor. However, since net rental losses are larger
any capital gains are usually taxed with a 50 per cent discount, than the capital gains tax liability, it is likely that investors forced to
and tax is not payable until the asset is sold.144 As a result defer their negative gearing benefit will end up paying no capital
negative gearing can be an attractive means to reduce and defer gains tax when they sell their properties. Assuming no change in
personal tax liabilities. investor behavior, the net budget benefit to government would
therefore be only about $2 billion a year. While this would be the
Under the proposal, investors would not be allowed to claim long-run effect, in the shorter run it could improve budget
losses on investments against other income (particularly wages
and salaries). However, to maintain parity with the remainder of Figure 7.4 Budget impact of abolishing negative gearing with
the tax system, they would be able to carry forward these losses losses offset against capital gains tax liability
and claim them against the capital gains liability once the $ billion, based on tax returns, 10-year average
investment is sold.145 5
4
The proposal would generate additional tax revenue in the short
3
term, although the potential revenue is particularly sensitive to 10-year
changes in the housing market. Applying the average marginal tax average 2
rate to the average annual net rental losses of $13 billion would 1
yield $4 billion in additional tax revenue.146 Under the proposal, 0
however, in the medium term this $13 billion loss would be offset 5
against future capital gains. Between 2001-02 and 2010-11, on
4
average investors made annual capital gains on real estate of
$14 billion, which was discounted to $7 billion, incurring tax 3
2010-11
liabilities of $2 billion (see Figure 7.4).147 2
1
0
143
Inflated to 2012-13 dollars. ATO (2013c), Detailed Table 2.1 Tax revenue from Tax on capital gains Net budgetary
144
See above Section 7.1 abolishing negative foregone when gain
145
Eslake (2013) gearing interest losses
146
ATO (2013c) Detailed table 2.1, Grattan analysis, 10-year average, converted capitalised
to 2012-13 dollars. Source: ATO (2013); Grattan analysis
147
Ibid., Table 7.6, converted to 2012-13 dollars

balances by $4 billion a year. If the capital gains discount were 1985 and 1987 in Sydney and Perth. (see Figure 7.5).151 During
reduced (see Section 7.1), then the budget benefit of abolishing this period when negative gearing was not permitted, rents did not
negative gearing would be smaller as the carried forward losses increase particularly rapidly in Melbourne, Brisbane or Adelaide,
offset a greater amount of future tax liability. and it appears that the Perth and Sydney rental increases were
driven by unusually low vacancy rates
If the proposal induced property investors to invest in other
assets, tax revenue would be even higher. Alternative Figure 7.5 Rents and vacancy rates, largest cities
investments will not usually produce a tax deduction against Rents Vacancy rates
income indeed any switch to investments that generated a Percentage change from year earlier Per cent, moving annual median
20 6
positive return would increase the tax collected. No negative No negative
gearing gearing
Sydney
There are other ways to reform negative gearing. The Henry Tax 5
16
Review proposed to both discount net rental losses by 40 per cent Perth Brisbane
(this discount would also apply to other types of deductions),148 4
and to increase taxable capital gains from 50 to 60 per cent 12
Adelaide
(reducing the capital gains discount from 50 to 40 per cent).149
Based on 2010-11 figures, this proposal would generate about 3
$1.6 billion in additional tax revenue, assuming no change in 8 Melbourne
Melbourne
investor behaviour. 2
Abolishing negative gearing would have a number of positive 4 Perth

Adelaide 1
social outcomes.150 It may increase home ownership rates by Brisbane Sydney
reducing returns at the margin for landlords relative to first
homebuyers. This could then increase investment in other more 0 0
productive assets. 85 86 87 88 89 85 86 87 88 89
Note: shaded are indicates the period from July 1985 until September 1987 in which
Although many say that abolishing negative gearing would negative gearing was not available for property investments
increase rents, this is a folk memory based on increases between
Source Kelly, Harrison, et al. (2013) p.26, citing ABS, REIA via Eslake (2013)
148
Treasury (2010b), p. 33-34
149
Ibid.
150 151
See Kelly, et al. (2013) Eslake (2013)

In theory, negative gearing should have no effect on rents: for claim the most under negative gearing, but those with incomes
every landlord that sells, there would be a renter that buys and under $20,000 per year made surprisingly large losses totalling
becomes a home-owner. The supply of rental properties would fall over $2 billion (Figure 7.6).
at the same rate as the number of renters.
Figure 7.6 Total rental loss by taxable income bracket after
Nor is the abolition of negative gearing likely to affect construction deductions
of new dwellings, as almost all of investment property loans are $ billion, 2010-11
now for existing dwellings.152 There might be some impact on $6
construction rates as abolition of negative gearing would depress
house prices. However, the market for new housing, typically at $5
the edge of cities, is somewhat detached from the market for
established housing, typically closer to the centre of cities.153
$4
Consequently, lower prices for established housing will only have
a limited effect on prices, and therefore supply, of new housing. $3
Abolishing negative gearing on other assets, particularly share

$2
investments, would have little impact. Investors borrow relatively
little to invest in shares and managed funds outside of
superannuation. Even at the height of the share market boom, $1
only about 10% of investments outside of superannuation were
funded by borrowing;154 since then margin lending has reduced by $0
71 per cent from its peak in 2007).155 <$20k $20k to $37k to $80k to $180k +
$37k $80k $180k
Abolishing negative gearing would have limited impact on those in
Notes: The tax-free threshold was increased from $6,000 in 2010-11 to $18,200 in 2011-
the bottom 20 per cent, although there are a number of low- 12. 2010-11 data is presented in current income tax brackets as closely as data allow.
income earners who own investor property and make substantial Source: ATO (2013), Grattan analysis
losses. Taxpayers with incomes between $37,000 and $80,000
152
RBA (2013c)
153
Kelly, et al. (2011), p. 13
154
See Daley (2007)
155
RBA (2013c) Table D10

8. Other tax exemptions, introductions, and increases

Governments could choose to reduce deficits by increasing their focuses on a mining tax given the salience of this issue in the
revenue. They could do so by reducing tax exemptions, Henry Tax Review, the recent history of tax reform, and the
increasing taxes or introducing new ones. In general, the unusual size of Australias mining sector, in which more was
economic cost of tax increases is considerable. invested over the last decade than in any other country.156 Other
new taxes emphasised by the Henry Report are those that put a
Eliminating tax exemptions (often known as tax expenditures) price on externalities. Congestion taxes may have useful
generally distorts economic activity less than introducing new outcomes, but experience shows they do not raise much revenue,
taxes or increasing existing taxes. Tax exemptions, by their very as discussed in Section 8.6. There is much to be said for pollution
nature, shape decisions to earn, spend, or invest. Eliminating taxes (including carbon taxes), but given the wider political issues
them can level the playing field, increasing economic efficiency involved they are beyond the scope of this report.157
and reducing unfairness. However, tax exemptions can have
worthwhile policy objectives that justify any loss of efficiency Finally, governments could simply increase the rates of existing
taxes. Again, the range of options is very large, but by way of
Tax exemptions already discussed include superannuation tax comparison in Section 8.7 we indicate the rate increases required
concessions, the exemption of owner-occupied housing from to raise an additional $10 billion a year from each tax, as well as
capital gains tax, and capital gains discounts. Other major tax briefly considering their collateral impacts.
exemptions described below in Sections 8.1 to Section 8.3 are
the exemption of several expenditure categories from the GST, 8.1 Broaden the GST
the exemption of small businesses from payroll tax, and the
exemption of various businesses from normal rates of fuel tax. About $13 billion a year could be raised by extending the GST to
cover private spending on fresh food, health, education, childcare,
Most taxes inherently grow roughly in line with GDP. The water and sewerage, while increasing welfare benefits to reduce
exception, which creates an ever-widening hole in the the effects of the change on those worst off. The choice is
Commonwealth budget, is fuel tax. As the tax is set as a fixed attractive. It adds substantially to the collective budget bottom line
amount per litre that has not been indexed to inflation since 2001,
the value of the tax inherently falls behind increases in GDP and
government expenditure, as Section 8.4 discusses. 156
Minifie, et al. (2013), p. 7
157
On carbon taxes as the least bad way to reduce carbon pollution see Daley
New taxes might be proposed. The analysis in Section 8.5 and Edis (2011) and OECD (2013a). On congestion taxes, see Treasury (2010b)
Vol 2, p. 373

of Australian governments.158 It drags relatively little on the consumption taxes are a lower percentage of GDP (and corporate
economy as it discourages working or investing less than most taxes are a higher percentage) than in most of the OECD.163
other taxes. Eliminating exemptions reduces time wasted in
definitional issues. It has few social impacts, and the effect on Private spending on a range of categories is currently exempt
people in the bottom 20 per cent of the income distribution would from GST, as Figure 8.1 shows. If the tax were extended to cover
be largely mitigated by increases in welfare. fresh food, health, education, child care, water and sewerage,
governments could have raised an extra $15 billion in 2012-13.164
Almost all taxes drag on economic growth. But the GST, a form of This figure takes into account the effects of consumer behaviour
consumption tax, is a relatively efficient tax. It does not change due to increased costs, and leaves exemptions in place
discourage earnings or investment nearly as much as income and for a number of areas where applying a GST is particularly
corporate taxes. It is hard to avoid on a large scale. It distorts difficult.165 Using 10 per cent of this revenue to compensate lower-
behavior less than other potential state government revenue income households for the regressive impact of the tax more
sources, such as payroll tax and stamp duties.159 If governments than these households in fact spend would still improve budget
want to increase the amount of revenue they raise, it will harm balances by $13 billion.166
growth less to do so with GST revenue than with most other
taxes.160
Australias GST covers about 60 per cent of a comprehensive

consumption tax base.161 This gives Australia the seventh-lowest
coverage ratio amongst 32 OECD countries.162 Australias 163
Daley, et al. (2012b), p. 27
164
Treasury (2013e), p. 212-213
165
Under this proposal, exemptions would remain for international transactions
including international education, financial services, existing residential housing,
supplies by charitable institutions, and administrative purposes (e.g. very small
158
Under existing legislation which the Commonwealth Parliament could businesses). Financial services are input taxed: financial services providers pay
amend state governments benefit from any increase in GST revenues. GST on their inputs, but do not charge GST to consumers. Applying GST to
159
Although increasing the GST reduces the real value of working, it has less housing would be very complex. Owner-occupied housing is effectively treated
impact than a higher rate of income tax, if nothing else because it has less as being input-taxed, rather than applying GST to imputed rents. GST is not
psychological impact because it is not visible in take-home pay. applied to residential rents to maintain neutrality between owner-occupiers and
160
See PwC (2013), Mirrlees, et al. (2011), Daley, et al. (2012a) and Treasury investors. See ibid., p. 230.
166
NSW (2011) for a more comprehensive discussion of the effects of various taxes Households in the bottom quintile account for around 9 per cent of
on growth. consumption, so should be compensated equivalently (Grattan analysis of ABS
161
Freebairn (2013b) (2011b)). Note this more precise data on consumption by the bottom 20 per cent
162
Treasury (2012b), p.155 updates the estimates in Daley, et al. (2012a), p. 33.

Figure 8.1 Foregone tax revenue from expenditure excluded from administrative costs as businesses which deal in both exempt and
GST non-exempt goods simplify their accounting. Having fewer grey
Foregone revenue by exemption category, 2012-13, $b lines between exempt and non-exempt categories reduces
opportunities for tax avoidance and lobbying by rent-seekers for
Fresh food
exclusion of particular goods.167
Health
Increasing GST revenue would discourage states from raising
Education Proposed other more inefficient taxes because they are raising less through
inclusions
Water/sewerage the GST than originally expected.168 The introduction of the GST
in 2000 was intended to create a sustainable revenue base for
Child care state governments, who faced rising expenditure pressures. It
Financial services
worked for the first few years GST grew at average of
8.3 per cent a year up to 2007-08. But between 2008-09 and
International education Proposed to 2011-12, the average increase was only 2.2 per cent and has
remain
been very volatile.169 In this time, household savings rates have
Importation threshold exempt
gone up,170 reducing GST by about $10 billion. Households have
Other international spent relatively more on GST-exempt categories, particularly rent
and mortgage interest, and to a lesser extent health and
Other education (Figure 8.2), reducing GST by about $2 billion.171 Tax
0 2 4 6 exempt international internet transactions have grown (Box 8.1),
reducing GST by about $0.7 billion. As a result, GST takings have
Note: Excludes foregone revenue from housing, as comparable estimates are not declined relative to both GDP and total consumption over the past
available. decade (see Figure 2.3 above).172
Source: Grattan analysis of Treasury (2013e) and ABS (2013k) Table 11.1
Instead of broadening the GST base, the government could raise

similar revenue by increasing the rate from 10 to 13 per cent,
while maintaining existing exemptions (see Section 8.7 below) 167
Eslake (2011); Freebairn (2013b); PwC (2013)
168
and providing similar compensation. 169
Eslake (2011)
Treasury (2012b), p. 153
170
There are a number of reasons to favour broadening the base ABS (2013o)
171
The shift in spending towards untaxed categories is about 3% of total
over increasing the rate. A broader GST is simpler and more household expenditure of $708 billion. ABS (2013b) Table 42
efficient than a limited one. A broader based tax may have lower 172
Treasury (2012b)

Figure 8.2 Changes in consumer expenditure by GST liability Box 8.1: GST on overseas internet purchases
Change in share of household expenditure, 2004 2010, per cent
3 The GST importation threshold, through which imports of goods
Remain exempt from overseas worth less than $1000 are exempt from GST, has
2 attracted considerable commentary, including from state
premiers.174 But this exemption only cost $0.65 billion in foregone
1
Proposed revenue in 2012-13.175 It was established because the cost of
inclusions collecting the tax on small transactions (estimated at $2 billion a
GST liable
0 year in 2011) was greater than the revenue that would be
collected.176 Once administration costs are factored in, halving the
-1 threshold to $500 might raise $0.02 billion a year from items
entering Australia via international mail.177 As online retailing
-2
becomes a greater share of purchases, and new transaction
technology reduces collection costs, change might be worthwhile.
-3
In particular, a substantial portion of the revenue could be
collected from a small number of online retailers greater than a
-4
threshold size, responsible for most of the transactions.178
Other GST Taxable Fresh Health Education Other Housing
liable food food inclusions
The competitive disadvantages of the Australian retail sector run
deeper than paying GST. As the Productivity Commission
Source: ABS (2012a) showed, industry productivity and regulatory barriers are bigger
problems.179 However, pressures on Australian retailers to
There is no obvious reason for these trends to reverse in the improve their productivity would be weakened if GST were
foreseeable future. Savings rates are now close to long-run charged on all international internet purchases, deterring retailers
averages, with the low savings rates in the late 1990s and early with small volumes from entering the Australian market.
2000s looking like a historical anomaly. Nor is the rise in health
spending likely to slow significantly as the population ages: older
people spend a much higher proportion of their income on 174
Koziol (2013); Treasury (2012b), p. 159
health.173 175
Treasury (2013e), p. 195; EY (2012), p. 1
176
Productivity Commission (2011), p. 169
177
Grattan analysis of Treasury (2012c), p. 193-4
178
Treasury (2012b), p. 160; EY (2012)
173 179
Productivity Commission (2005), p. 264 Productivity Commission (2011)

A GST is regressive. People with lower incomes tend to save system. It is very difficult to target GST exemptions on some
less. As a result, GST paid is a greater proportion of their income. products to certain groups.182
However, those on higher incomes pay much more GST per
person. The wealthiest 20 per cent of households spend almost Some of the increased revenue raised from a broader GST should
six times as much on fresh food as the poorest 20 per cent; the be used for income redistribution. There is a risk that any
exemption of fresh food from the GST benefits those wealthy compensation will be eroded through bracket creep and low
households to the tune of $2 billion a year.180 indexation of benefits, as happened in New Zealand, so continued
Figure 8.3 shows that low-income households do not spend a Figure 8.3 Proportion of household consumption spent on goods
significantly greater proportion of their consumption on the goods proposed for inclusion in the GST base
proposed for inclusion in the new GST base. This indicates that a % of household consumption
broader GST would not be significantly more regressive than 20
current arrangements. 18
However, any regressive effects from a broader GST should be 16

dealt with through welfare transfers and income tax cuts at the 14
lower end.181 It is better to pursue equity through the tax and
welfare system as a whole, rather than making the GST more 12 Health
complex in an attempt to protect those on lower incomes. As the 10
Henry Review noted:
8 Education
A narrower GST does not mean it is fairer, but adds 6
complexity. Income redistribution to make Australia fairer is 4 Exempt
primarily the job of the personal income tax and transfer
2 food
system. This means that other taxes and charges can be used
in the most efficient way, reducing the overall complexity of the 0
Lowest Second Third Fourth Highest
Household income quintile
Source: Grattan analysis of ABS (2013i)

180
Treasury (2010b) Vol 1, p. 286
181 182
Henry (2011); Freebairn (2013b) Treasury (2010b) Vol 1, p. 286

attention needs to be paid to the impact of the tax-transfer system international student fees. Doing so would reduce the additional
on those worst off.183 Unfortunately, the opposite may be a bigger tax raised by $0.7 billion a year.187
risk: governments under budget pressure may squeeze welfare
benefits and community services even harder. GST on education would result in government taxing a service
that it also subsidises. There would be less churn of tax if
What are the risks of broadening the GST? Taxing private government simply reduced the subsidy.188 This may well be a
expenditure on fresh food could lead to people spending more on first-best option. However, given the difficulties of reducing
processed foods, leading to poorer, long-term health outcomes.184 government subsidies for education (at least in nominal terms),
Yet Treasury estimates suggest that spending on these broadening the GST to include education may be a more
categories is relatively inelastic, so there may not be much palatable option since it would be seen as imposing a universal
change in consumption.185 Similarly, higher prices for education rule across the economy.
could lead to parents moving children into government schools,
and students choosing not to enroll in higher education. But Expanding coverage of the GST to include health would increase
demand for education also seems to be relatively insensitive to the price paid by consumers for a number of subsidised health
price: changes in private school fees and higher education services and products, including private health insurance,
contribution amounts have not significantly affected choices in the pharmaceuticals and medical services. The GST exemption
past.186 There are other potential side-effects, including whether currently acts as a hidden and indirect subsidy for these services
increases in child-care costs might reduce workforce participation and products. If government, on policy or equity grounds, wishes
rates. This would require further attention. to ensure no net change in the price to consumers of a subset of
previously GST-exempt products and services, a better public
GST on international student fees may reduce the policy is to increase subsidies to these so the total subsidy is
competitiveness of Australian higher education. By analogy with direct and overt rather than a hidden subsidy through GST
other exports, it may be appropriate to rebate or waive exemption. The Commonwealth is responsible for the key health
care services and products that would be affected by these
changes. The current GST exemption for these services and
products thus effectively represents a subsidy from the states
183
Davidson (2000). See ACOSS (2012) for analysis showing that the the beneficiaries of GST revenue to the Commonwealth.
purchasing power of NewStart allowance has fallen far below its pre-GST level,
eliminating the value of the compensation introduced at the time, and Daley, et
187
al. (2013), p. 19 illustrating the severe pressures on NewStart households. Grattan analysis of ABS (2013k) Table 11.1, which indicates that international
184
Veerman and Cobiac (2013) students at all levels of education spent $6.8 billion on fees in 2012.
185 188
Treasury (2013e), p. 212 See Norton (2012) for discussion of whether these subsidies should be
186
Norton (2012); Jensen, et al. (2013), p. 57; Treasury (2013e), p. 213 reduced anyway.

Increasing the subsidy to private health insurance, benefit-paid (Queensland and the Northern Territory use a deduction system
pharmaceuticals and medical services to offset the GST increase but a similar structure applies). The threshold varies by state, from
is estimated to cost $2 billion.189 This cost has not been included as low as $550,000 in Victoria to $1.75 million in the ACT.191
in the budget impact above.
The net effect of eliminating the thresholds would increase the tax
There might be concerns that a GST on private health and revenues of Australian governments by $6 billion a year. It would
education spending would create market distortions between increase State payroll tax revenues by $8 billion a year.
private and public service providers. However, competitive Businesses deducting this tax as an expense would reduce
neutrality is not an object of current education and health policy, Commonwealth company income tax revenues by approximately
as government already provides higher subsidies per student or $1.5 billion,192 and the Commonwealth would also be liable for
patient for government-supplied services. increases in unemployment benefits (discussed below), which
could amount to $0.5 billion.
8.2 Payroll tax threshold
Views differ on whether eliminating the payroll tax threshold would
Removing the threshold below which payroll tax is not payable increase unemployment. Some believe there would be little
would contribute a net $6 billion a year to Australian government impact because most workers would ultimately accept a drop in
budgets. However, this choice may be relatively unattractive wages rather than become unemployed. Others believe some
depending on the impact on unemployment. Any substantial wages paid would increase due to the interaction of awards,
increase in unemployment reduces economic activity, and has minimum wage laws and payroll tax. By increasing the floor on
serious social impacts on the bottom 20 per cent. On the other these wages, payroll tax would increase unemployment.
hand, broadening payroll tax to include all employees may
increase economic efficiency by encouraging activity to move Cross-country evidence does not strongly support the claim: many
from less efficient small firms to more efficient large firms. European countries have much higher payroll taxes levied as
social security charges and historically, some have lower
Payroll tax is the largest single state tax, contributing $21 billion to unemployment rates than Australia.193
state budgets in 2012-13.190 Businesses with payrolls below the
threshold do not pay the tax. Those with larger payrolls pay tax at Estimates of the sensitivity of employment decisions to payroll tax
a single marginal rate on payroll amounts above the threshold rates vary widely: a 1 per cent increase in labour costs is
189
Grattan analysis of ABS (2011b) and ABS (2013a)
190 191
DTF NT (2012); DTF SA (2012); DTF Tasmania (2012); DTF Victoria (2012); Treasury NSW (2013)
192
Treasury ACT (2012); Treasury and Trade Qld (2012); Treasury NSW (2012); Grattan analysis of ATO (2013c) and ABS (2013f)
193
Treasury WA (2012) Nickell (1997)

estimated to increase the unemployment rate by anywhere There would be some additional compliance costs for firms that
between 0.04 and 1.01 percentage points.194 The median are brought inside the tax net. Some surveys of small business
estimate of the studies reviewed is an increase of owners estimate the compliance cost for business could be as
0.35 percentage points. In Australia, and given existing payroll tax high as $0.6 billion a year.198 However, the cost of change is likely
rates, this would imply that eliminating the payroll tax threshold in to be substantially lower given the growing popularity of standard
all states would increase unemployment by approximately 40,000 package payroll systems amongst small businesses, and the
people. The direct fiscal cost to the Commonwealth budget of options of administering the tax through workers compensation
such an unemployment increase would be around $51 million per systems or the Commonwealth PAYG tax base.
year.195 The flow-on costs of higher unemployment, slower
economic growth and poorer social outcomes are difficult to On the other hand, abolishing the threshold would reduce
quantify but they would be significant. economic distortions that encourage smaller, less productive
firms. The same employee costs about 5 per cent more to a firm
Timing would be very important. Analysis conducted for the with a payroll above the threshold. Small businesses generally
Australian Fair Pay Commission found that increases in minimum have lower productivity per employee than larger firms.199 On this
wages affect unemployment rates more during a recession than basis, the NSW Treasury estimates that abolishing the payroll tax
when employment is growing.196 threshold would produce an extra 8 cents of economic activity for
every dollar of revenue raised implying an increase economic
Beyond these costs to government and society, individuals face activity in Australia by around $0.6 billion a year.200 Presumably
specific costs from unemployment. The direct financial cost to the basis of this calculation is that abolishing the threshold would
households of this increase in unemployment, in the form of the encourage economic activity to move towards larger more
difference between their previous earnings and the amount they efficient firms.201
receive in unemployment benefits, would be about $0.9 billion a
year.197 Despite the significant revenue available from reducing the
threshold, some states and territories have historically competed
to increase their payroll tax thresholds with the aim of attracting
194 mobile businesses to their jurisdiction (Figure 8.4).202 However,
Karanassou and Sala (2008); Hutchings and Kouparitsas (2012); Dixon, et al.
(2004); Debelle and Vickery (1998); Dungey and Pitchford (1998); Lewis and
MacDonald (2002); Carne (2007); Treasury (1996);Stacey and Downes (1995);
198
Bernie and Downes (1999); Treasury NSW (1999); ABS (2012b); ABS (2013c); Lignier and Evans (2012)
199
ABS (2013l). See Balancing budgets: Supporting analysis, p. 25 OECD (2013c)
195 200
Grattan analysis based on Treasury (2013c) Treasury NSW (2011), p. 11. See also Dixon, et al. (2004)
196 201
Australian Fair Pay Commission (2009) Treasury (2010b) Vol 1, p. 298;
197 202
Grattan analysis of ABS (2013c) Table 14a-14h Gabbitas and Eldridge (1998); Treasury (2012b), p. 169

Figure 8.4 Payroll tax thresholds over time 8.3 Fuel tax exemptions
Tax threshold ($m)
2.0 Halving the exemptions that reduce the fuel tax paid by a variety
of commercial users would contribute around $3 billion a year to
ACT the Commonwealth government budget. However, a higher
effective tax rate would reduce economic activity, particularly in
1.5 NT coal mining and agriculture, also reducing corporate and income
taxes.
Qld Ordinary users of petroleum fuel pay an excise of

1.0 Tas 38.1 cents per litre of fuel.203 Commercial users of fuel such as
freight trucks can usually claim a tax credit so that they pay
WA
NSW 12 cents less than this. Those using fuel in mining (generally off
SA public roads) effectively only pay excises of about 6 cents a litre,
Vic
0.5 and forestry and agriculture users (also generally off public roads)
pay close to no fuel tax.
The current exemptions are worth about $5.8 billion.204 Halving

0.0 this would add about $3 billion to the Commonwealth budget.
2000 2002 2004 2006 2008 2010 2012
Fuel taxes paid by commercial users drag substantially on
Source: NSW Treasury (2000-2013) economic activity because inherently they are a tax on business
over the past decade, only the two territories have increased the inputs. Fuel excise can nevertheless be justified as economically
threshold materially faster than inflation. efficient if it is considered as a form of user pricing for road
building and maintenance, the costs of congestion, and vehicle
pollution.205 It is imprecise, but relatively easy to collect. However,
203
ATO (2013b)
204
Treasury (2013a), BP 1 p. 6-41
205
Treasury (2010b), E 3-2 p 375. Fuel excise collects $15 billion a year, from
which about $6 billion are returned in FTC Treasury (2013a) BP 1 p. 6-41. Motor
vehicle registration revenues are around $8 billion. Annual road building costs

this justification for fuel excise on business inputs implies that off- a result, the Howard Government abolished indexation.207 This
road use should be exempt. exacerbated the structural decline in the fuel tax base, growing
more slowly than GDP given declining per capita car use, and
Reducing fuel excise exemptions would have several unattractive increased fuel efficiency.
collateral impacts. It might substantially reduce economic activity,
particularly in thermal coal mining and agriculture. As their At current volumes, the decision to abolish indexation has
products are internationally traded, they would have little ability to reduced government revenues by a little over $4 billion in 2013-
pass on the increased costs. Any reduction in the activity of these 14. However, higher priced fuel would probably lead to reduced
industries would hurt regional communities largely dependent on fuel consumption. Judging the impact is difficult: actual oil price
them. Many of these areas are already struggling economically. increases swamp the impact of fuel tax indexation (Figure 8.5). If
The impact on economic activity is likely to be substantial relative excise had been indexed since 2001, fuel prices would be about
to the additional tax collected. Grattan analysis suggests the 10 per cent higher; if this reduced use by 5 per cent,
effect could be around $0.5 billion. Commonwealth tax revenue would be $1 billion a year lower. On
this basis the net increase in Commonwealth tax revenue would
8.4 Fuel excise indexation be $3 billion a year.
Reintroducing fuel excise indexation would contribute around Reintroducing fuel excise indexation would hit the bottom
$3 billion, after compensatory welfare increases, at minimal social 20 per cent of households hardest. These households spend
and economic costs. about 6 per cent of their income on fuel. The richest 20 per cent of
households only spend about 2 per cent.208 This could be
Most fuels in Australia attract several taxes, including an excise, remedied through the tax-transfer system. Returning the increase
and the GST. The GST component automatically increases as the to the bottom 20 per cent would consume 8 per cent, or
price of fuel increases. Between 1983 and 2001, the excise approximately $320 million of the additional $3 billion raised.209
component was increased each year by the rate of consumer
price inflation. Although the excise was cut by 6.7 cents per litre
as part of the GST package, petrol prices continued to rise.206 As
of the GST and keeping petrol prices constant. Costello and Coleman (2008),
p. 154
207
were around $16 billion in 2009 (DIT (2009)), and in 2010, accidents were Treasury (2002); Costello and Coleman (2008), p. 154. This was in addition
reported to cost $15 billion; see Treasury (2010b) p 390. to a further cut to the excise of 1.5 cents per litre.
206 208
The combination of the cut in excise, together with other savings from the tax Grattan analysis of ABS (2011b)
209
package was intended to amount to 1.5 cents per litre, cancelling out the impact Grattan analysis of ibid.

Figure 8.5 Fuel prices with and without excise indexation 8.5 Mining taxes
Cents per litre
200 A mining tax could be designed as a federal export tax on
minerals, set at 50 per cent of the portion of the price above
nominated thresholds. A well-designed tax might capture a lot of
Plus excise with CPI indexation
revenue in the short term. But once prices drop in line with most
150 analyst forecasts, a new mining tax would probably collect little
more than $3 billion a year after 2017. The tax would discourage
Actual petrol
some investment and economic activity. Its effects would be far
prices, Perth more acute when prices fall
100
The combination of Australias mineral resources and its strong
institutions have attracted world-leading levels of investment.210
Inherently these resources cannot be moved, and when prices
50 remain as high as they have been over the last decade, profits
can be substantially higher than the cost of investment. Mining
taxes seek to capture some of these profits (or excess rents) to
benefit the community.
0
2001 2003 2005 2007 2009 2011 2013 Mining taxes can be designed in a number of ways. The most
Source: Grattan analysis of ABS (2013e) and Fuel Watch WA (2013)
efficient design in theory is a profits tax (such as the original
Most of the economic costs of reintroducing fuel excise indexation design of the Resource Super Profits Tax) whereby government
can be reduced using the existing fuel tax credit scheme. This takes a share of both the profits and losses. Its effect is the same
scheme rebates much of the tax on fuels paid by producers, as government buying shares in mines whenever miners invest in
minimising its impact on economic activity. mining projects. In theory the tax is more efficient because it does
not affect returns to private shareholders, and so does not affect
their investment decisions.
However, there are substantial problems in practice. The design

requires that the government pays out (either in tax credits or
210
Minifie, et al. (2013), p. 7

cash) when a mine loses money. Investors will be adversely high enough for each mineral that most investments would
affected if they or their financiers do not trust governments to proceed anyway.
make good on this promise. As one commentator put it:
Mines vary widely in how cheaply minerals can be extracted from
There will be times when the government is writing cheques to them. More costly mines are more acutely affected by cost
miners. Imagine that the economy is tanking and mining profits increases, including taxes such as royalties payments. For some
are way down. How politically feasible is it to believe that the minerals (especially iron ore), most Australian production comes
government will write cheques to miners apparently theyre from inexpensive mines, which would be relatively unaffected by
all foreigners anyway and not send that same money to increases in tax (Figure 8.6).
Australians?211
Figure 8.6 Cost curve for global iron ore mines
Mining taxes can also be designed as royalties. These are used Cost per tonne, $US/t iron ore 62% equivalent, CFR
extensively by Australian states, which essentially sell minerals to
mining companies. The royalty may be determined by the market 140
price of the underlying mineral, the energy content, or a price per Forecast price 2013
tonne.212 As royalties increase the costs of inputs, they reduce 120
Rest of
investment and operation of more costly mines. However,
world
royalties have a number of advantages: they are easy to explain, 100
Forecast price 2015
difficult to game, and relatively efficient if the level of royalty is
linked to the price.213 80
60 Australian mines
There are some constitutional difficulties with the Commonwealth
Government levying simple mining royalties.214 However, the
40
Commonwealth could levy an analogous tax as an export tax. It
could be set as a percentage of the price above a threshold set 20
211
Davidson (2010) 0
212
DoI (2013) 0 200 400 600 800 1000 1200
213
Although KPMG Econtech (2010) estimated that royalties substantially Millions of tonnes produced per year
reduce economic activity, others argue that these estimates are implausibly high.
See Pincus (2012) Source: Credit Suisse (2013), Goldman Sachs (2013), Deutsche Bank (2013)
214
s.114 of the Commonwealth Constitution prohibits the Commonwealth from
imposing a tax on property belonging to a State.

Other minerals, like thermal coal, are extracted at a cost closer to Figure 8.7 Mining prices, export volumes, and potential tax revenue
the sale price. Increased taxes would more severely affect Forecasts
Prices 300
investment and output of these mines. Avoiding substantial
(2013$US 200 Coking coal
negative effects would depend on the Commonwealth accurately /t FOB)
selecting the price thresholds for the tax so that they did not Iron ore
100
substantially deter investment. However, the Commonwealth Thermal coal
0
government is unlikely to be able to levy substantial revenue
through such an export tax in the near-term. Our analysis of price Export 900
volumes Iron ore
and volume forecasts by Goldman Sachs, Deutsche Bank and the 600
(Mt/yr)
Bureau of Rural and Energy Economics suggests that even a
300 Thermal coal
fairly heavy tax on the exports of minerals would only raise about
$3 billion a year by 2017, beyond which analysts are wary of Coking coal
0
forecasting prices.215 Most prices are forecast to fall below
Hthetical 30
thresholds at which substantial investment and operation would
past and
become marginal, and volume increases are unlikely to fill the gap 20 Iron Coking
future tax
(Figure 8.7). revenue 10 ore coal
(2013A$b) Thermal coal
Mining taxes designed in this way also provide very volatile 0
revenues. The danger is that the revenue is committed to long- 2005 2007 2009 2011 2013 2015 2017
Assumes threshold prices of $90/tonne for 62% iron ore FOB; $75/tonne for thermal coal
term recurrent spending, rather than saved to a fund that can and $120 for metallurgical coal in constant $2008 terms.
provide more sustainable revenues over a longer period.216 A Source: Grattan analysis of Credit Suisse (2013), Goldman Sachs (2013), Deutsche Bank
(2013), BREE (2013).
government today might want to help future generations by
imposing an export tax today. But such an approach will provide
little revenue for medium-term budget pressures.
215
Goldman Sachs (2013)
216

8.6 Congestion charges their impact on equity, and the extent to which they reduce
economic efficiency by distorting decisions to work, spend, or
If implemented well, congestion charging can be effective in invest.221 These considerations are similar to those in our general
reducing traffic congestion and making more efficient use of framework for assessing budget proposals: budgetary impact,
existing road infrastructure.217 In theory, it could also raise social, distributional and economic impacts, and confidence that a
revenue. For example, some estimate that a charge of 10 cents policy change will have the budgetary result intended.
per kilometer travelled in the Sydney metropolitan area could
raise up to $3 billion in revenue.218 The exact amount of revenue To put other specific proposals into context, we can briefly
raised is highly dependent on the design of the scheme. compare the major taxes that already raise more than $10 billion
a year in revenue, as shown in Table 2.
However, international experience shows that it is very politically
difficult to implement congestion charging unless the majority of There is no obvious limit to the size of tax rises, which depends
the revenue is directed towards improving public transport on the rate chosen. To compare proposals, we can ask how much
infrastructure.219 There is no reason to think that Australia is would tax rates change to raise $10 billion?
different in this regard; surveys here suggest that road pricing
proposals have much more public support if funds are used to In general, corporate and income taxes distort economic activity
lower car registration charges, eliminate existing tolls, and more than consumption and land taxes.222 Increasing taxes
improve public transport.220 A congestion charge regime would generally tends to distort economic activity more than removing
have to be close to budget-neutral to be feasible. tax exemptions that are by definition aimed at encouraging
specific activities. Tax expenditures also tend to benefit the rich
8.7 Tax increases more than the poor.223 Many of these tax exemptions (often
described as tax expenditures) are discussed above.
Budget outcomes can always be improved by raising the rates of
existing taxes. The social and distributional impacts of major taxes vary. Any
assessment needs to distinguish between who pays the tax and
A comprehensive assessment of alternatives for tax reform is who bears the burden (because the tax reduces their resources in
beyond the scope of this report. Relevant considerations include the long run). For example, corporate and payroll taxes are levied
on corporations, but individuals ultimately bear the burden.
217
Treasury (2010b) Vol 2, p. 379
218
Unpublished analysis cited in University of Sydney (2012); see Hensher and
221
Mulley (2013) PwC (2013)
219 222
Albalate and Bel (2009) See ibid., Mirrlees, et al. (2011); Daley, et al. (2012a); Treasury NSW (2011).
220 223
See, for example, Hensher, et al. (2013) and Palmer (2010) Rawdanowicz, et al. (2013)

Table 2: Impact of increasing large taxes to raise an additional $10b The key question is how the burden is distributed: between
Tax Revenue Rate change to Econo. Impact on Australian and foreign individuals, and between rich and poor.
raised (yr) raise $10b/yr Impact bottom 20% Such a complex assessment is beyond the scope of this report.
($GDP/yr)
Personal $161b Raise marginal -$2.4b Neutral bottom Increasing the rate of GST raises many of the same issues as
income (2012-13) rates by 2 20% pay little/no broadening its base. In practice it would need to be accompanied
percentage points income tax
by increased welfare payments to mitigate the effects on those
Company $68b Increase rate from -$4.0b Mod. negative worst off, which would consume about 10 per cent of the revenue
income (2012-13) 30% to 34% lowers
employment and raised (see Section 8.1 above).
real wages
GST $50b Increase rate from -$0.8b Mod. negative
Our analysis has focused on increasing property rates rather than
(2012-13) 10% to 12% regressive land taxes. The existing state land tax base has very substantial
impact mitigated exemptions not least owner-occupied property and so is a
by welfare very inefficient tax base. By contrast, property rates (currently
Payroll $20b Increase average -$4.1b Negative levied by local councils) have very few exemptions. It is
(2011-12) rate from 5.5% to discourages constitutionally possible for state governments to levy a property
9.1% employment
rate in addition to local council rates (such as the Victorian
Property $13b Increase revenue -$0.2b Mod. negative governments Fire Services Levy). However, it would be politically
rates (2011-12) by 75% few in this group
own property
very difficult to increase property rates without simultaneously
reducing stamp duties.224 While this would boost economic
Stamp $12b Increase average -$3.4b Mod. negative
duty rate on median few in this group productivity, it would do little to improve budget balances.
(2011-12)
home from 4.8% own property
to 8.9% 8.8 Bracket creep
Note: Economic impact based on estimates of marginal excess burden by KPMG Econtech
for the Australias Future Tax System Review (Treasury (2010b). Estimates of excess As an alternative to raising the rate of income tax, bracket creep
burden vary substantially: see for example Treasury NSW (2011). See Balancing budgets:
Supporting analysis p. 27 for further detail.
can help repair the budget, albeit not equitably. Not increasing tax
Sources: Grattan analysis of KPMG Econtech (2010); Daley et al. (2012a); b); PwC (2013); thresholds substantially increases income tax receipts as a
Rawdanowicz et al. (2013); ABS (2013o) Tables 10 and 18; Treasury (2013a); Treasury percentage of GDP. When tax thresholds are not increased, wage
NSW (2013); ABS (2013h) Table 7
inflation pushes incomes into higher tax brackets. Individuals then
224
As recently implemented by the ACT, and proposed by many, including
Daley, et al. (2012a) and Kelly, et al. (2013).

pay more of their income in tax, even if the purchasing power of

their income has not increased.
Bracket creep can be valuable to the Commonwealth

Government. Assuming 2.5 per cent wage inflation for the next
decade, maintaining current personal income tax thresholds
would increase Commonwealth taxes by about $16 billion in
todays dollars.225
Bracket creep falls squarely on middle-income earners. A person

at the 50th percentile of the income distribution would pay an
additional 4 per cent of their income in tax, while someone in the
top 10 per cent would pay only an additional 2 per cent. The
bottom 20 per cent would pay only 1 per cent of their incomes.226
225
Grattan analysis of ATO (2013c)
226
Grattan analysis of ibid.

9. Spending cuts
Governments can improve their budget position by reducing Australian government spending on infrastructure is currently at
spending. Reducing Age Pension spending by including owner record levels. ABS data indicates that $18.8 billion was spent on
occupied housing in the assets test is discussed above. This transport infrastructure engineering construction for the public
chapter discusses a large number of other choices. They include sector in 2011-12. As Figure 9.1 shows, this is the highest annual
reducing spending on transport infrastructure, industry support, spend as a percentage of GDP since records began in 1987.227
defence spending, school class sizes, higher education subsidies
and pharmaceuticals. In the unlikely event that governments Figure 9.1 Engineering construction work done for the public
chose to implement all of these changes, they could improve sector
budget balances by $23 billion. For most of these spending % of GDP
reductions, execution would need to be unusually good to avoid 1.4%
very undesirable social and economic side-effects
Harbours
1.2%
This chapter also discusses a number of other proposals that are Railways
often raised but where the potential savings appear to be limited.
1.0%
These include middle-class welfare and public service spending, 1987-2012 average Bridges
9.1 Infrastructure spending 0.8%
Roads,
Reducing high levels of Australian government spending on 0.6%
highways
transport infrastructure could save up to $6 billion a year. The subdivisions
economic and social impacts would depend on how well the 0.4%
remaining expenditure was prioritised, and how well costs were
controlled. The substantial lift in expenditure over the last five 0.2%
years includes a number of projects where the projected benefit:
cost ratio was low, and then actual costs were higher and benefits 0.0%
lower than expected. If fewer low value projects were selected, a 87 89 91 93 95 97 99 1 3 5 7 9 11
return to historic spending levels might well have little economic
Source: ABS (2013g) Table 11
impact.
227
ABS (2013g) Table 11

If spending returned to the long-run average of 0.84 per cent of cities.231 But there are other ways to do this aside from building
GDP from its current high of 1.26 per cent, it would add big infrastructure. Previous work by Grattan Institute has
$6.3 billion a year to the budget bottom line.228 demonstrated that infrastructure doesnt necessarily increase
economic growth.232 It can do so, but only if it is the right
Governments are spending more than ever, but its questionable infrastructure in the right place, at the right time, for the right
whether they are getting good value from that spending. Making price.233
better choices about what to build, and building it more efficiently,
would produce the same outcomes at lower cost. There are two ways to reduce transport infrastructure spending
without materially reducing outcomes. The first lies in making
There have been persistent calls in Australian public debate in better choices about what infrastructure gets built. While some
recent years to increase government spending on infrastructure. It progress has been made with the establishment of Infrastructure
is said that Australia has an infrastructure deficit of more than Australia and its processes to recommend infrastructure priorities
$700 billion,229 a claim that seems to be based more on a wish list to the Commonwealth Government, there is a long way to go.
devised by engineering and construction firms than on any Governments continue to promise investment in projects that
rigorous economic analysis. Recently, the new Commonwealth dont have rigorous benefit cost analyses ahead of those that
Government and some commentators have suggested that going do.234
further into debt to fund infrastructure would be their preferred
approach to boosting economic growth.230 Even when these analyses are followed, they do not guarantee
value for money. Analyses for transport infrastructure systemically
Improving the capacity of transport system in Australia is critical overestimate the benefit cost ratios of projects. As Figure 9.2
for supporting growth and maintaining quality of life, particularly in shows, an international survey of large infrastructure projects
found that project costs are typically at least 20 per cent higher
than forecast.235 A litany of local examples from the cost
228
Analysis of infrastructure investment is severely restricted by data availability.
Determining exactly how much government spends on infrastructure, and on
what types of infrastructure, is difficult because not all infrastructure expenditure
appears directly in the headline budget balance; some is treated as capital
231
expenditure and so is captured in the budget via interest and depreciation costs, Kelly, et al. (2013)
232
and some is spent outside the general government budget by government- See Daley, et al. (2012a) and Daley (2013) for a further discussion of the
owned corporations. Rigorous post-hoc evaluation of projects is rare, making it relationship between infrastructure and economic growth.
233
difficult to assess value for money: see Balancing budgets: Supporting analysis, Eslake (2010)
234
p. 33 See, for example, Wiggins (2013); Infrastructure Australia (2013); Flyvbjerg
229
Engineers Australia (2010) (2009); Davies (2013); Dobes (2008); Ergas and Robson (2010)
230 235
See, for example, Bassanese (2013) Flyvbjerg (2009)

Figure 9.2 Actual spend and traffic relative to forecasts for large Governments seem reluctant to invest financial or political capital
transport projects in alternatives to major transport projects.237 Evidence suggests
Spending relative to forecast, avg % Traffic relative to forecast, avg % that pricing for demand management, such as road user charges,
50 20
is a highly effective way to make use of existing transport system
capacity and reduce the need for costly new investment.238 But
45
10 while state governments have used road pricing to fund new
40 projects, they have been reluctant to impose it on existing road
0
35 infrastructure. Another option is to consider the value of small,
-10 local infrastructure upgrades to remove bottlenecks. These local
30
solutions often have much better benefit cost ratios.239
25 -20
20 A second broad avenue for cutting expenditure is to reduce the
-30
costs of projects once they are chosen. In Australia, construction
15
-40 costs have risen faster than prices in other industries, and are
10 higher than those in many comparable countries. The causes of
5 -50 these high costs are complex and intertwined, and some are
probably unavoidable. The mining boom has created skills
0 -60
Rail Bridges & Road Rail Road shortages in construction industries. Many projects are
tunnels constructed in areas with existing residential and commercial
Note: Cost overrun data based on analysis of 258 projects in 20 countries; traffic forecast
activity, which tends to cost more and take longer due to efforts to
data based on analysis of 208 projects in 14 countries. minimise disruption to travellers. The structure of the construction
Source: Flyvbjerg (2009) industry creates few incentives to keep costs down. There is a
overruns for the Myki ticketing system in Melbourne to the highly strong union presence, and oligopolies at the level of major
optimistic initial traffic forecasts for the Clem7 Tunnel in Brisbane, construction firms as well as many materials suppliers. State
the Cross City Tunnel in Sydney, Eastlink in Melbourne, and the
Sydney and Brisbane airport trains demonstrates that Australia
is not immune from this dynamic.236 Unfortunately, rigorous
evaluation is hampered by lack of availability of data.
237
Wiggins (2013)
238
Infrastructure Australia (2013)
236 239
Davies (2010); Davies (2012) Eddington (2006)

governments effectively are single purchasers for major projects desalination plants and other big water infrastructure projects,
in each jurisdiction, hindering attempts to benchmark costs. 240 when other, cheaper options were available.245 In transport, the
trend is visible in the preference for large road tunnels rather than
There is also plenty of evidence to suggest that the way projects smaller surface projects, and in efforts to build infrastructure that
are regulated and run is causing delays in projects, driving costs can withstand natural disasters, even in places where such
up.241 Project proponents face complex and overlapping disasters do not happen.246
regulatory standards: the Productivity Commissions draft report
on major project development assessment processes indicates The Commonwealth Government has recently commissioned an
that streamlining is feasible.242 Other governance and Productivity Commission inquiry into infrastructure costs,
procurement issues include poor scoping to define the real need competitiveness and productivity, which will be useful in better
and the most efficient way to meet it; poor project planning and understanding how costs might be reduced.247
performance management; gaps in project governance skills in
the relevant areas of government; and a lack of independence Shifting infrastructure spending off the government balance sheet,
between project governance and project delivery agencies. either via government-owned corporations or public-private
Infrastructure Australia has suggested that better project partnerships, doesnt necessarily help the budget position. If the
management could produce cost savings of 20 to 50 per cent.243 infrastructure generates enough revenue to cover its costs, then
the budget position would be similar, whether or not government
Across the infrastructure spectrum, Australian governments seem retains ownership, depending on the price for which the
to have a tendency to gold-plate infrastructure: building projects government sells the right to construct the project. If government
to the highest possible specifications even if these are not has to fund a gap between future revenue and costs, then again
necessary. This drives costs higher. In the energy industry, the future budget impact is similar whether or not government
government-owned electricity companies invest more in capital retains ownership. The budget position is only improved if private
infrastructure per customer than do private companies, at rates sector ownership leads to lower construction or operation costs,
that cannot fully be explained by higher regulatory standards, and these benefits outweigh the fees charged by investment
rising peak demand, and the need to replace ageing assets.244 banks for their services in establishing the partnership and the
State governments have invested large amounts of money in higher borrowing costs faced by private companies compared to
governments.
240
Infrastructure Australia (2013); Turner & Townsend (2012); Grattan analysis
of ABS (2012a); ABS (2013a); ABS (2013n)
241
Taylor, et al. (2012); Caravel (2013); Infrastructure Australia (2013)
242 245
Productivity Commission (2013a) PricewaterhouseCoopers (2010)
243 246
Infrastructure Australia (2013) Discussed in Wiggins (2013) and Ludlow ibid.
244 247
Wood, et al. (2012) Productivity Commission (2013b)

Public-private partnerships can also impose discipline to prioritise There is little confidence that traditional industry support leads to
projects where a private sector firm is prepared to invest on the additional innovation, employment or productivity. Evidence
basis that future revenue will be greater than the constructions suggests that industry subsidies are not effective at supporting
costs. However, with the failure of toll roads from Clem 7 to the regional economic growth, or at creating growth industries, and
Lane Cove Tunnel, the private sector is increasingly reluctant to that government subsidies distort industry decision-making.251
take on projects, unless governments guarantee the future
revenue, which removes any private sector discipline to ensure Much modern industry support at least nominally pursues policy
benefits are greater than costs. aims other than supporting industry for its own sake. Examples
include subsidies to encourage carbon emissions reduction or
Governments are more likely to get fair value for infrastructure research and development.252 There is little evaluation of most
once usage patterns have been established in practice. industry support, so it is difficult to tell if the subsidies drive activity
Transferring existing infrastructure to the private sector can help beyond what would occur anyway. In some cases, these goals
reduce debt, although its impact on deficits will vary, as discussed may be better pursued through other means.
in Chapter 10.
Some industry support, such as some manufacturing industry
9.2 Industry support assistance, maintains relatively low-skilled jobs in regional areas.
Without support, the jobs would probably not exist. If it is
Australian governments spend more than $16 billion a year on withdrawn, these areas are likely to face high unemployment rates
industry-related policies and programs, through tariff assistance, and consequent social dislocation, with consequent costs to the
tax concessions and direct spending.248 Despite popular welfare and education systems. If the industry is the major
perceptions, service industries get more in subsidies and tax employer in a region, as tends to be the case in automotive and
concessions than do manufacturing or primary production agriculture, there may be significant economic and social effects
industries, although the latter get much higher rates of support on the local community. People are often reluctant to move, and
relative to the value they add to the economy.249 A 50 per cent cut this results in higher unemployment.
to Commonwealth and state budgetary support to small business,
specific industry sectors and industries, and regional adjustment Ironically, governments that continue to prop up struggling
programs, could improve the budget bottom line by more than industries can exacerbate this problem. By providing hope that a
$5 billion.250 region will continue to offer the same jobs as in the past,
248 251
Productivity Commission (2013c); Daley, et al. (2013) For a more detailed discussion of the effectiveness of industry policy, see
249
Productivity Commission (2013c) Daley, et al. (2012a) and Daley, et al. (2012b)
250 252
Grattan analysis of ibid. and Daley, et al. (2013) See Wood and Mullerworth (2012)

governments encourage people to put off the hard decision of justified, in the face of a range of special interest groups with
moving. In practice, when substantial industries close, most much to lose.
workers rapidly find alternative employment253 although it is
often at a lower wage precisely because the new job is in an 9.3 Health spending
unsubsidised industry.
Reducing high levels of health spending could save up to
In this sense, industry support can be less about supporting an $9 billion per year through a variety of measures. Few health
industry and more about assisting a community through a proposals on their own create significant savings, but when
transition. Even so, this type of industry support is highly combined, can save a large amount offsetting the recent growth in
inefficient. For example, steel industry assistance under carbon health spending. These measures include abolishing the private
price compensation measures will cost $36,000 per year per health insurance rebate, improving pharmaceutical pricing and
worker.254 Such a sum would be better directed to more reducing avoidable hospital costs. While some proposals will have
sustainable initiatives such as education and training to prepare positive economic impacts, there are moderately negative social
workers for jobs in growth industries. impacts should these proposals affect access to and timeliness of
treatment for some people.
Cutting all industry support would thus have some detrimental
social and economic outcomes, at least in the short term. Yet the Growth in health spending over the past 10 years accounts for the
evidence or lack of evidence of benefits from current support largest increase in Australian government expenditure above
suggests there is significant scope for savings.255 The reduction GDP growth. The increase is largely due to an increase in
proposed leaves untouched support for research and spending on hospitals. If health expenditure continues to grow, it
development, carbon emissions reduction, and export assistance. will consume an extra 1.5 percentage points of GDP by 2023.256
In all these cases, there is at least an arguable case for broader
public benefit. This additional spending brings substantial benefits. Life
expectancy continues to increase and quality of life has improved.
As with many of the spending proposals identified, high quality Life expectancy in Australia is among the highest in the world, and
execution would be required. Governments would need to make health spending per person is relatively modest. This suggests
good decisions about which industry assistance is and is not that only genuine innovations will produce savings that do not
harm the quality of health care.257
253
Beer (2008), p. 324
254 256
Productivity Commission (2012) See above Figure 2.6
255 257
Daley and Lancy (2011) OECD (2010)

Within the health system, there is no one magic bullet that will rein Cost effectiveness of treatments: Costs could be reduced
in spending. Rather, a number of smaller measures to improve by systemically using lowest cost procedures and medicines
efficiency may reduce health costs below projections: that provide the same benefit to patients as more expensive
options. Costs could also be reduced by not using procedures
Private health insurance rebate: Removing the private if on balance they are not beneficial or if there is no evidence
health insurance rebate could save $3.5 billion in expenditure. that they work.262 Based on the UK experience, these
258
Savings of $5.5 billion from the cost of the rebate would be approaches could save up to $2 billion in Australia.263
offset by an increase in demand for public hospital services.259
Preventative strategies: Strategies to prevent illness, such
Pharmaceutical pricing: A previous Grattan Institute report as increasing alcohol taxes, could help to reduce health costs
264
estimated that up to $2 billion per year could be achieved by in the long run.
changing the way government pays for pharmaceuticals.260
The Grattan Institute Health Program continues to contribute to
Avoidable hospital costs: A forthcoming Grattan Institute work to define these policy options more precisely.
report suggests there is wide variation in costs between
hospitals for the same procedures.261 Reducing costs that may 9.4 Other spending reductions
be avoidable could reduce hospital spending by up to
$1 billion per year. We have analysed a number of other proposals, including
plausible reductions in defence spending, increasing school class
sizes, and reducing student subsidies for higher education.
End of life care: Initial Grattan analysis suggests that that the
Individually, each of these is worth $2 billion to $3 billion.
cost of hospital admissions in the year before death (for
Collectively they could improve the budget bottom line by
people aged over 65) may be around $2 billion a year.
$8 billion. They are described in more detail in Balancing budgets:
Offsetting costs are not captured in this analysis, including
Supporting analysis.
alternative health care and support provided outside hospital,
which would probably reduce the budget impact to less than 262
$1 billion. Although the cost of end of life care is substantial, The UKs National Institute for Health and Care Excellence (NICE) is an
independent body that provides evidence-based guidelines and advice in public
there are few concrete proposals to reduce it. health, develops standards and performance metrics for public health and social
services and information services. It provides a do not do database outlining
258
Treasury (2013a), p. 6-27 clinical practices that should be discontinued or not used routinely by health
259
Grattan analysis of Segal (2004) and Cheng (2013) professionals. See NICE (2013b)
260 263
Duckett, et al. (2013) Grattan analysis of NICE (2013a) and Department of Health - UK (2010)
261 264
Duckett, et al. (Forthcoming) Doran, et al. (2013)

However, in order to reduce school or defence spending without Most family payments are made through Family Tax Benefit (FTB)
significant adverse effects, execution would have to be unusually Part A, which will cost the budget $14.3 billion in 2013-14.266
high quality. Governments would have to selectively keep the Families with an adjusted taxable income of $48,837 or less
better teachers as teaching workforces reduced. They would have receive the full rate of payment.267 Families earning more than this
to keep high value, and cut low value defence spending, despite have their FTB payment reduced as their earnings increase. The
regional political pressures. By contrast, reducing student upper income limit varies depending on family composition, but a
subsidies for higher education would be relatively straightforward two-child family that earns more than $113,000 pre-tax will not get
to execute. FTB Part A payments.268
9.5 Middle-class welfare Family Tax Benefit Part B, which will cost the budget $4.6 billion
in 2013-14, has more generous thresholds, and so is available to
Conversations about Australian government budgets frequently more middle and upper-income families.269 It is paid to single-
assert that there are large savings in middle-class welfare. A parent families with an annual adjusted taxable income under
small number of high-profile payments to families with children $150,000, and to two-parent families where one parent has little
seem to drive this discussion. Yet compared to the scale of or no income and the other parent earns up to $150,000 p.a.270
Australian government budgets, the amount going to well-off
families via these payments is small: around half a billion per Payment rates for FTB taper rapidly, so relatively little of the
year. Australia has the most tightly targeted welfare system in the payment goes to families earning incomes above the median for
world. The major recipients of middle class welfare in Australia their household type.271 Less than $2 billion of FTB are paid to
are people over the age of 65, and proposals to address this are families in the top 40 per cent of households ranked by income
discussed in Chapter 6. (Figure 9.3)
The idea that governments should provide some support to

families in need for the costs of raising children is relatively
uncontroversial. The Henry Tax Review found that appropriately
targeted family payments were important for supporting lower- 266
FaHCSIA (2013)
income families with the cost of raising children; supporting 267
For reference, a couple with children at the median of the working age
parents of young children to balance work and family; and population earns $90,500 in equivalised disposable income. See Phillips and
improving horizontal equity between taxpayers who support Toohey (2013).
268
children and those who do not.265 269
DHS (2013b)
FaHCSIA (2013)
270
DHS (2013c)
265 271
Treasury (2010a) Phillips and Toohey (2013)

Figure 9.3 Distribution of Family Tax Benefits payments by family parenting payments, would save an additional $1.5 billion a
disposable income decile year.272
$ billion, per year
20 The two payments most often condemned as middle-class
18 welfare are the Schoolkids Bonus and the Baby Bonus, but
theyre a small problem thats getting smaller. Both are now
16 restricted only to recipients of FTB Part A, and so are more
14 closely targeted to lower-income families than before. The
Schoolkids Bonus (which the current government has pledged to
12
abolish273) will cost $1.3 billion in 2013-14.274 The Baby Bonus will
10 cost $0.4 billion in 2013-14. From 1 March 2014 it will no longer
8 exist as a separate payment, but will be paid as a loading on FTB
Part A. Families who take up Paid Parental Leave will not get the
6 loading.275
4
Middle-class welfare will increase over the coming years if the
2 incoming government implements its Paid Parental Leave
0 scheme.276 The scheme will provide mothers with 26 weeks of
1 2 3 4 5 6 7 8 9 10 paid parental leave at their actual wage (capped at $150,000) plus
Family disposable income decile superannuation. The existing scheme pays mothers the minimum
wage for 18 weeks, and is not available to those earning over
Note: Includes Family Tax Benefits Parts A and B. Income deciles refer to equivalised $150,000.277 The gross cost of the scheme is estimated at
household disposable income for families whose survey reference member (generally the $5.7 billion in 2016-17, compared with $2 billion for the scheme
head of the household) is under 60. currently in place. Taking into account the further $1.6 billion in
Source: ABS (2011c)
reduced costs and increased revenue to government expected to
Abolishing FTB Part B payment for families with combined taxable
incomes of above $100,000 would save the budget around 272
Unpublished NATSEM modelling, cited in Karvelas (2013)
$0.5 billion a year. Applying tougher participation requirements for 273
Hockey and Robb (2013)
those with children of school age, similar to those now required for 274
FaHCSIA (2013)
275
Ibid.
276
As discussed in Box 4.1 on p. 18, this is not included as a potential saving
because it is not yet legislated.
277
Loughnane (2013a)

arise from the scheme, the net budget impact is around deciles, and reforms are attractive choices for repairing budget
$2.1 billion.278 The majority of this additional funding will go to balances.
middle- and high-income earning women. A woman earning
Figure 9.4 Redistribution of welfare payments in OECD countries
$32,000 per year will be around $5,000 better off under the new
Public payments to households as a proportion of population disposable
scheme, while a woman earning $85,000 will be around $31,000 income, mid-2000s
better off.279
40
Looking more broadly than specific payments to families, Australia 35
has one of the worlds most tightly targeted welfare systems.
Figure 9.4 shows that Australian government payments do more 30
to redistribute welfare payments to the poorest 20 per cent of
25
households than does any other OECD country except Denmark.
42 per cent of transfer spending goes to the poorest 20 per cent, 20
while only 3 per cent of transfer spending goes to the richest Transfers
15 to others
20 per cent. 280
10
Looking more broadly at in kind transfers government spending
on services that people use these are fairly constant in dollar 5 Transfers
terms across income groups and age groups.281 to poorest
0
20%
Austria
Poland
Sweden
Ireland
Neth.
OECD-23
France
Slovak R.
Belgium
Czech R.
Germany
Switz.
Japan
Denmark
Norway
Australia
NZ
Italy
Finland
UK
Luxem.
Canada
Korea
US
If Australia has a problem with middle-class welfare, most of the
recipients are aged over 65. Australian welfare policies
systemically favour older people over the young, and older people
pay less tax and receive more benefits than younger households
with similar incomes.282 As discussed in Chapter 6, current Note: Incomes are equivalised
arrangements for the Age Pension and superannuation provide Source: Grattan analysis of Whiteford (2010)
significant benefits to those in the middle- and upper-income
278
PBO (2013b), p. 30
279
Loughnane (2013a)
280
Whiteford (2013)
281
Daley, et al. (2013), p.43
282
Tapper, et al. (2013)

9.6 Public service cuts nationally, this suggests that a 2.5 per cent cut across all levels of
government (with similar exemptions for front line staff as in
Other conversations about budgets frequently assert that large Victoria) would save only $1.5 billion a year. The new
deficits could be remedied by cutting a bloated public service. Commonwealth Government has committed to an additional
0.25 per cent efficiency dividend on the Australian Public Service,
By international standards, the Australian public sector is which will raise $0.2 billion in 2016-17.288
relatively efficient. The OECD identifies Australia as an example
for other countries to follow in this regard, with small general Beyond a certain point, efficiency dividend-style approaches may
government employment and large efficiency gains in recent reduce the capacity of the public service to fulfill the functions of
years.283 government.289 Cuts are indiscriminate, making little distinction
between high-value and low-value functions of government, or
Across-the-board reductions in funding for government between departments which are already operating efficiently and
departments have long been used to improve efficiency and those with fat available to trim. Given the relatively large efficiency
reduce costs. In recent years, annual reductions, or efficiency dividends imposed in recent years, the scope to reduce savings
dividends of 1.25 to 1.5 percent have been applied to the via the usual suspects of travel, hospitality and advertising is
departmental expenditure of most Commonwealth and state small.290 That leaves staff cuts.
agencies. Some governments have made further cuts above this
base rate. 284 Another proposed option for savings is to simply reduce the public
sector headcount. The new government has already announced
While such cuts may be useful discipline to reduce wasteful that it will cut 12,000 staff from the Australian Public Service,
spending and drive efficiency, they do not raise significant funds. which if implemented as planned will save $1.2 billion in 2014-15
In 2011, the Commonwealth imposed an additional efficiency and $1.9 billion by 2016-17.291 It is not obvious that these savings
dividend of 2.5 per cent (on top of the base rate of 1.5 per cent) are feasible. When the public sector is being squeezed, attrition
for the 2012-13 budget year.285 This was estimated to raise rates fall, as people hold onto existing jobs for fear of not finding
$0.5 billion a year.286 In this years budget, the Victorian another. When the Howard Government began public service cuts
Government projected that increasing its efficiency dividend from in 1996, the resignation rate fell by 11 per cent, the retirement rate
2 to 2.5 per cent would raise $0.05 billion a year.287 Extrapolating
283 288
OECD (2012b) PBO (2013b), p. 42
284 289
Horne (2012); Horne (2013) MacDermott and Stone (2013)
285 290
Horne (2012) Bartos (2011)
286 291
Treasury (2011) PBO (2013b), p. 41. This cut is in addition to the effect of the efficiency
287
Victorian Government (2013) dividend and cuts to the former Department of Climate Change.

by 60 per cent, and dismissals by 80 per cent.292 To achieve staff Australia faces.295 For example, the Commonwealth Department
cuts of the size proposed, retrenchments may be needed and of Health and Ageing will only spend $0.6 billion on employee
redundancy payouts will erode proposed savings. expenses in 2013-14.296 If the entire department were abolished,
some of this money would be saved, but much of the work those
Staff cuts tend to be pursued via voluntary redundancies, which staff were doing would need to be taken up by state governments,
weaken the public service as high-quality people who are which would have to spend more. And some functions, such as
confident of finding another role are more likely to leave. They regulating the safety and efficacy of medications, should stay with
may also reduce the quality of services: even though frontline staff the Commonwealth Department rather than being duplicated by
are usually nominally quarantined from such cuts, having fewer eight states and territories.
back office staff may push administrative work onto frontline staff,
leaving them with less capacity to deliver services. A much better The primary value of reducing federal-state overlap may be not in
approach to public sector savings is to take the time to identify budgetary savings, but in better use of senior management.
functions that no longer need to be delivered, or can be delivered Federal-state interactions inevitably consume a large portion of
differently, and target savings appropriately. senior management time in both Commonwealth and state
bureaucracies. With less overlap, more of this time would be
9.7 Federalism reform spent in managing and pursuing substantive reform.
Some suggest that there are significant savings in abolishing one In any case, governments of both political colours have been
or more departments usually health or education and reluctant to give up control. For example, the 1996 Officer
transferring their functions to the states. The first stated task of Commission of Audit recommended that the Commonwealth
the new National Commission of Audit is to assess the current transfer many functions, including health and education, to the
split of roles and responsibilities between and within the states, but this recommendation was never implemented.297
Commonwealth Government and state and territory
governments.293 The Commonwealth can relieve pressure on its budget by simply
ending its spending in an area of shared responsibility (such as
There is obvious room to reduce duplication between hospitals), and leaving states to manage the entire area but with
Commonwealth and state public services.294 However, the budget no change in funding. This would be particularly tempting in
savings are likely to be small relative to the budget problem
295
There is little good evidence on the savings possible from changes to federal
financial arrangements, and much of what does exist is contradictory. See Daley,
292
Mannheim (2013) et al. (2012b), p. 28-9
293 296
Hockey and Cormann (2013) DoHA (2013)
294 297
See, for example, the reforms proposed in OECD (2012b) Officer, et al. (1996)

health, where spending is growing much faster than GDP.

However, this would simply transfer the Commonwealths
budgetary problems to the states which generally have less
ability to adjust given their constitutionally limited tax bases.

10. Asset sales

Asset sales, or privatisations, are frequently put forward as part of The sale of government business enterprises has played an
proposals to improve budget balances and reduce debt.298 important role in reducing the existing stock of debt in Australia.
As Figure 10.1 shows, most of the net debt reduction achieved in
However, the relationship between selling assets and improving the early years of both the Kennett and Howard governments
the budget bottom line is not straightforward, with the impact came from asset sales.
depending on the type of asset and the budget measure used.299
Figure 10.1 Value of asset sales and net debt reduction
Selling a government business enterprise (a financial asset) $ billion (nominal)
provides a cash inflow to government which, if used to pay off 60
debt will reduce net debt. However, the proceeds of the sale are
not directly included in either of the main measures of the budget 50
balance (underlying cash or fiscal balance). Other
40
Other
The impact of selling a government business enterprise (such as Energy
Medibank Private) on the budget balance is indirect. The Airports
30
government will no longer earn dividends from the sold asset, Telstra
reducing future revenues. If the government uses the revenue 20
from the sold asset to pay off debt, it will pay less interest on the
debt. Ultimately, budget balances are only improved if the 10
governments dividends from the sold asset are less than the
interest on the sale price of the asset. 0
Value of asset Reduction in net Value of asset Reduction in net
Given the many variables involved, its difficult to quantify the sales debt sales debt
potential of asset sales to contribute significantly to budget repair. 1993-1999 1992-2000 1996-2001 1997-2002
Victoria Commonwealth
298
Analysing the broader costs and benefits of privatisations, while a subject of
lively debate, is beyond the scope of this paper: see Abbott and Cohen (2013) Source: Treasury (2013a); Kamener and Tan (2012); Abbott and Cohen (2013)
299
For example, the effect of an asset sale will be different for each of: headline
cash balance, underlying cash balance, fiscal balance, net debt, net financial
worth, net worth.

However, assets can only be sold once. The Commonwealth has

relatively few remaining options for asset sales. Most of the
infrastructure it still owns is not likely to be attractive to the private
sector.300 The sale of Medibank Private is expected to raise
around $4 billion.301 Commentators have suggested that the
Australian Rail Track Corporation, Snowy Hydro Australia Post,
Air Services Australia, Defence Housing Australia and the HELP
higher education debt could also be sold.302
In some states there is more potential for asset sales.

Infrastructure Australia estimates that Australian governments
hold more than $100 billion worth of commercial infrastructure
assets, including in energy, water, transport and plantation
forestry.303 For example, the New South Wales, Queensland and
Western Australian governments still own major energy
businesses that could be sold.304
300
Infrastructure Australia (2012)
301
Crowe (2013)
302
AAP and Swan (2013); Creighton (2013); Norton (2013)
303
Infrastructure Australia (2012), p. 5
304
Wood, et al. (2012), p. 10

11. Budget maintenance

Assuming that governments balance Australian budgets, what can transparency in forward expenditure planning, has improved its
help to maintain this balance? practices in recent years.307
Governments of all political colours have a tendency to let budget Australias public policy culture has long been averse to budget
discipline lapse. As Figure 11.1 shows, the commitments of the deficits and public debt.308 Politicians are expected to explain how
Commonwealth and state governments to reduce spending
growth over the forward estimates are extremely ambitious Figure 11.1 Real expenditure growth by government term
compared to their recent records. Cumulative annual growth in real expenditure, % p.a.
7
Cth NSW WA Victoria Qld
11.1 Budget processes and mindsets 6 Forward
By and large, Australian governments already have robust and 5 estimate
transparent structures for budgeting.305 Many of the mechanisms Coalition
4
that bodies such as the OECD recommend for this purpose have Labor
been in place in Australia for many years and are unremarkable to 3
most Australian policy-makers. These include the use of accrual
2
accounting; the publication of forward estimates for spending and
revenue beyond the budget year; establishment of the Future 1
Fund and the Intergenerational Report; outcomes-based
0
budgeting; and the processes for pre-election budget
accountability and the formulation of fiscal policy set out in the -1
Charter of Budget Honesty.306 The relatively recent establishment
2015-17 FE
2014-17 FE
2014-17 FE
2014-17 FE
2014-17 FE
1997-04
2005-08
2009-14
2004-07
2007-11
2011-13
2005-09
2009-13
2003-07
2007-11
2011-13
2004-07
2007-09
2009-12
2012-13
of the Parliamentary Budget Office provides a further layer of
scrutiny. Even the Department of Defence, notorious for lack of
Source: Grattan analysis of Commonwealth and state budget papers

305
See Blondal, et al. (2008) for a comprehensive overview of budgeting in
Australia, and OECD (2012b) for more recent developments.
306 307
See Officer, et al. (1996); Blondal, et al. (2008); OECD (2012b) and IMF Lewis (2012)
308
(2013b) for more detailed discussion of optimal budget institutions. Macfarlane (2006)

they will pay for their promises, and accusing an opponent of 11.2 Fiscal rules
increasing government debt is a potent political weapon. This puts
Australia in a much better fiscal position than most other Unlike many other countries, Australia does not have legislated
developed nations, whose governments have been able to run fiscal rules that specify a numerical budget target. Instead, it takes
large deficits with little public pressure. a principles-based approach that requires the Commonwealth to
release an annual Fiscal Strategy Statement that complies with
Yet some things could be done better. There could be more use legislated Principles of Sound Fiscal Management. The
of lapsing programs with a fixed deadline for evaluation before Statement must specify the governments long-term fiscal
further funding is committed. It would help to have a better culture objectives and the measures by which fiscal policy will be set and
of assessed pilots and program evaluation, with approaches more addressed. There are no legislated penalties for non-compliance
resistant to being gamed by departments and interest groups. with these targets, but the government must report on its
This would also require a change in political culture, to give performance via the budget papers and related documents.310
governments the space to admit that they had spent money on
something that did not work, rather than pretending that it did to Since this framework was introduced in 1998, governments on
save face. both sides of politics have used the Statement to set medium-term
fiscal strategies to achieve a balanced budget over the economic
Budgets will continue to face pressure from entitlement programs cycle. Both sides have committed to fiscal rectitude outside the
such as Medicare and the Pharmaceutical Benefits Scheme Statement, usually by promising to achieve a specified surplus in
that grow in response to demand rather than due to specific a defined timeframe, and to constrain growth in taxes or spending.
government decisions. Given that health is the biggest source of
expenditure growth for Australian budgets, governments will have A principles-based approach has the great advantage of flexibility
to find ways to address this.309 in the case of a period of below-trend growth or an international
fiscal crisis. While flexibility carries risks, in the right
In some senses, maintaining discipline over revenue is more circumstances it can have significant advantages.311 Some argue
straightforward. There are simply fewer opportunities for the that the success of Australias inflation targeting regime is due to
Commonwealth Government to cut into its own revenue streams the level of discretion given to policy-makers to adjust to
than to increase spending. The Commonwealth will need to circumstances. While initially criticised when established, the
ensure that any new revenue sources are well-designed (in flexible regime has come to be seen as a benefit rather than a
contrast to the previous governments mining tax regime) so that
they raise the funds they are intended to. 310
A more detailed discussion of the regime can be found in Blondal, et al.
(2008)
309 311
Daley, et al. (2013), p. 14 IMF (2013b), p. 41

cost, and has been emulated by other countries. When combined of national income.316 In practice, countries have either
with Australias traditionally conservative fiscal mindset, and manipulated their fiscal data to appear to comply, or ignored the
proper transparency, the flexibility of our fiscal rules may bring the rules altogether when crisis hit.317 Many countries also have their
same benefit.312 Certainly, the OECDs view is that Australias own deficit rules that have proved similarly problematic.318 Chile
current system has served it well.313 There is also some evidence has had a more successful experience, but it appears to be
that "appropriate institutional arrangements deliver better fiscal somewhat of an outlier.319
outcomes than simple, mechanical fiscal rules.314
A better approach may be to follow the United Kingdoms new
The risk with Australias approach is that while governments approach, which combines short-term flexibility with a firmer
commit to a balanced budget over the economic cycle, there is timeframe for a return to a balanced budget. The UK government
no clear way of defining where the current year sits in the cycle. replaced the Fiscal Responsibility Act with a fiscal mandate that
This gives governments plenty of wriggle room to continue to run states that the structural current budget must be forecast to be in
budget deficits by claiming that the economy is not yet in good balance or in surplus by the end of the rolling, five-year forecast
enough shape to justify a surplus. horizon. As the Institute for Fiscal Studies states:
Some have proposed avoiding this problem by establishing an The fiscal mandate has much to recommend it [ ] It constrains
independent body to set fiscal rules for government, as the the government over the medium term to borrow only to
Reserve Bank does for monetary policy.315 This is problematic for finance investment spending, while allowing the flexibility to
a number of reasons, not least that it would require constant provide short-term stimulus in periods when the economy is
adjustment of tax rates to maintain budget balances within the underperforming and giving time for fiscal policy to adjust to
recommended range. shocks.320
In any case, the recent experience of fixed fiscal targets in other Australias budget processes would be strengthened if the new
countries has not been edifying. The European Unions Stability Commonwealth Government adopted such a rule as part of its
and Growth Pact requires countries to deal with normal cyclical first Fiscal Strategy Statement, rather than continuing the vague
fluctuations while keeping the government deficit below 3 per cent commitment to a balanced budget over the economic cycle.
316
312
European Council on the Stability and Growth Pact (1997)
Gruen and Sayegh (2005) 317
Uren (2013)
313 318
OECD (2012a) See, for example, discussion of the UK situation in Emmerson, et al. (2013)
314 319
Daban (2011) Daban (2011)
315 320
Gruen (1997); Carling and Kirchner (2009) Emmerson, et al. (2013)

Combined with Australias stronger culture of deficit aversion, it 11.3 Data and reporting
would sharpen the governments incentive to balance the budget
in the medium term. State governments should adopt a similar No government entity has a remit, or much incentive, to consider
rule. Australian budgets as a whole rather than on a jurisdiction-by-
jurisdiction basis. This distorts our understanding of the real fiscal
Ideally, the Parliamentary Budget Office should be given a situation, and reduces accountability if governments try to balance
mandate to report on whether budget outcomes are consistent their budgets by cost-shifting onto other jurisdictions (see Section
wth the Fiscal Strategy Statement, again following the approach in 9.7). The OECD has suggested extending the scope of the
the UK, where the Office for Budget Responsibility has a remit to Parliamentary Budget Office to enable it to report on state as well
assess governments compliance.321 This year Australias as Commonwealth budget issues. 325 Extending the scope of the
Parliamentary Budget Office also produced an estimate of the Intergenerational Report to include state governments would
structural budget balance.322 Repeating this exercise annually further improve the information available to policy-makers.
would inform fiscal policy. Similar reports should be produced for
state governments. Good budgeting requires good data, and fiscal analysis in
Australia is hampered by a lack of it. A good start would be for
Those advocating budget rules sometimes relate them specifically jurisdictions to make the data in their budget papers available in a
to saving the proceeds of the Australian mining boom. Some form that can be easily analysed by those outside government (for
countries, such as Norway, reserve commodity price windfalls into example, as a spreadsheet rather than a PDF file). Improving the
a sovereign wealth fund. As Grattan Institutes report The mining comparability of data over time and between jurisdictions would
boom: impacts and prospects notes, Australias situation is also enable better analysis. The Uniform Presentation Framework
sufficiently different to such countries to justify a separate (UPF) and the ABSs Government Finance Statistics are useful in
approach.323 The OECD, while suggesting that Australia consider ensuring that basic financial data such as operating statements
establishing a stabilization fund, also notes the differences and balance sheets is comparable. Governments also need to
between Australia and other nations, and acknowledges the ensure they maintain appropriate central records of their own
difficulty in establishing such a fund. 324 activities so that expenditure can be tracked over time when
responsibilities move between departments and ministries.
321
ibid.; Uren (2013)
322
PBO (2013a)
323
324 325
OECD (2012a) Ibid.

11.4 Tax expenditures their budget papers. But tax expenditures are inherently
challenging to measure and interpret, and the figures provided
Budget discipline could also be improved by being more explicit cannot be reliably compared with budget expenditures.329 There
about tax expenditures. Tax expenditures are concessions and are no uniform reporting standards that enable comparisons over
exemptions that reduce the revenue that a government otherwise time, or between different state governments.330
would have collected. Examples include the exclusion of fresh
food from the GST, exemption of owner-occupied housing from
capital gains tax, and exemption of small businesses from payroll
tax.
In 2011-12, the Commonwealth reported tax expenditures of

$111 billion, and the states reported $28 billion.326 While the
reliability of these estimates varies, the sums involved are clearly
big enough to make a difference to the budget outcome. However,
they are not usually counted when considering the amount
government spends on a particular policy area and are not subject
to ongoing Parliamentary scrutiny as they do not appear in
appropriation bills.327 In general, they get far less attention from
the media and policymakers than direct budget expenditures.
Not all tax expenditures are bad. They can be significant

loopholes that enable tax avoidance, but they can also produce
beneficial social outcomes and improve efficiency. However, their
relative lack of transparency and accountability can impair budget
sustainability.328
The Commonwealth Government publishes a Tax Expenditures

Statement each year, and states provide similar information in
326
Treasury (2013e); Grattan analysis of state and territory budget papers
327 329
ANAO (2013) Treasury (2013e); ANAO (2013)
328 330
Martin (2013); Treasury (2010b); Officer, et al. (1996) Treasury (2010b)

Conclusion
This report shows the tough choices that Australian governments
need to make to balance their budgets. If they ignore their
substantial and widening deficits, they will hand a heavy burden of
debt and interest payments to the next generation.
Many of the choices we have discussed are sacred cows. Even to

raise them may sound crazy-brave. But governments not
prepared to tackle any of these reforms are unlikely to rein in their
deficits. There just arent enough feasible alternatives big enough
to bridge the gap. If governments rule out all the tough choices
discussed in this report, then they are obliged to propose
plausible alternatives.
We inherited a prosperous Australia. We need our governments

to make tough choices so that it stays that way.

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November 2013

Grattan Institute is an independent think-tank focused on Australian public policy. Our

This report may be cited as:

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Chapter 5 indicates how the key reforms might be packaged

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Table 1: Summary of impact of proposals over $2 billion considered in this report

Other tax GST base $13b Negative 49 Pharmaceuticals $2b Positive 70

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2. We have a budget problem

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Revenues have also fallen with the Global Financial Crisis

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Source: Daley et al. (2013)

Future pressures on Australian government budgets could reduce -8%

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Welfare costs are also likely to increase. Those on workforce

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Relatively little of the most rapid increases in annual spending can

Recurring structural deficits inevitably lead to higher levels of

Given the size of current underlying and projected budget deficits,

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3. Mindsets and approaches for budget repair

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stakeholders and to reallocate resources. Leadership cannot be

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reduce participation rates.50 As a result, future governments may

Similarly, while an unemployment rate of 5.8 per cent is high

Furthermore, we have something of an insurance policy. If budget

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4. Framing budget choices

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As well as these specific proposals, we also briefly examine

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Although these commitments were offset by budget

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Figure 4.1 Budgetary, social and economic impacts of budget choices

Aged pension &

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5.2 A package for federalism

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Such a substantial contribution to state government budgets and

A better alternative might be to make the increased GST revenue

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6. Superannuation and pensions

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