Save taxes by harnessing status quo bias

Save taxes by harnessing status quo bias

James Paterson — Australian Financial Review — 1 April 2018


Tomorrow Josh Frydenberg will hand down the first surplus budget since Peter Costello was treasurer. The road back to surplus has been too hard and too long. Putting in place default budget settings that are taxpayer-friendly will make sure it never happens again.

Long ago, psychologists identified the common human trait of status quo bias. Even when it is not always rational, we often have a preference to keep things as they are. Research has demonstrated that consumers often stick with default options, whether it is for car insurance, power companies or superannuation funds – even when financially better options are available to switch to.

Our political system exhibits similar traits. Policies that have been in place for some time are often very difficult to change materially, regardless of their effectiveness. Sometimes this is by design. For example, the bar for constitutional change is deliberately set high, because of the profound and potentially unintended consequences of doing so.

Other times, constituencies who benefit from current arrangements often energetically organise to defend the status quo and defeat reform proposals.

Our bicameral legislature exacerbates this trend. Securing passage of legislation through both houses, particularly the Senate, has proved challenging for recent governments. It is very difficult to envisage a time again when any government has control over the Senate.

This means that default policy settings are crucial, and are very unlikely to be fundamentally changed.

Nowhere is this problem more evident than in fiscal policy. As the National Commission of Audit identified in 2014, nearly 90 per cent of federal government spending is tied to legislation. Any government that wishes to alter that spending must secure passage of a bill through the Senate to do so.

Establishing these programs for the first time is rarely politically difficult. But once they become entrenched, even modestly restraining the growth in outlays has proven to be.

Our political system therefore has a strong bias towards establishing new spending programs and keeping in place in perpetuity, no matter how well they perform in practice.

Taxpayers and future generations are the biggest losers in this scenario. Over time, they will be called upon to fund ever greater spending and debt.

This is not a theoretical problem. Since the election in 2013, the government has had to overcome these barriers to reign in the unsustainable fiscal trajectory from the Rudd-Gillard era. Left in place, their policy settings would have sent spending to 26.5 per cent of GDP. After nearly six years of fiscal repair, that figure is 24.9 per cent and falling, which represents $400 billion of net savings.

But gross debt has still blown out to more than $540 billion, interest payments are $18 billion each year, and we will only now begin the massive task of paying it back before it is unjustly handed on to future generations.

It doesn’t have to be this way. Instead, our default fiscal settings could be taxpayer-friendly.

All new spending programs could have a sunset clause, expiring after say five years instead of increasing into eternity. If they were performing well, it would be easy to build political support for them to be renewed. If they were failing, they could be allowed to cease without requiring a new bill through both chambers.

The legislative debt-ceiling, which existed between 2007 and 2013 and started at just $75 billion, could be reintroduced. No government would be prevented from borrowing when necessary – but debt would not be allowed to continually grow without parliamentary scrutiny.

Income tax thresholds could be indexed to CPI or wages. Currently, if a government wants to collect more income tax from workers, it can simply do nothing, thanks to bracket creep. It would be more honest if governments were required to pass a bill to increase income tax rates.

The 23.9 per cent tax to GDP cap, which the Coalition has imposed as a fiscal rule on itself since 2013, but Labor opposes, could be legislated. Tax should not take a bigger and bigger slice of national income simply by inertia through measures like bracket creep. If a government wants to increase the proportion of economic activity it consumes through taxation, it should show it has the support of the Parliament to do so.

None of these ideas are a substitute for a political commitment to fiscal discipline. But putting in place default settings that are pro-taxpayer instead of pro-debt and pro-spending will make the future task of fiscal repair much easier.

This article was originally published in The Australian Financial Review.

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