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The fiscal illusion of inexpensive government

Date

Julie Novak

The largely hostile reactions against the federal governmentʼs big‑spending budget partly reflect existing fiscal arrangements concealing the true costs of public sector activities from most voters. The inconvenient truth is that the modern Australian fiscal system is inherently geared toward excessive, and ultimately unsustainable, levels of government expenditure.

Most voters retain a strong preference for government spending, in areas such as education, health, welfare, transport and so on, and especially for programs perceived to benefit them, their relatives, or other people they intimately know. By the same token, and despite occasional public protestations by some that they are willing to pay more of ‘'the price of civilisation'', people demanding such spending from their governments are typically loathe to fund the full costs of the programs themselves.

In an attempt to financially oblige voter demands for an ambitiously expansive portfolio of spending functions, governments forcibly impose great taxation burdens upon various components of private sector activity, such as market incomes and product sales. But financing public spending through taxation by no means resembles anything like the direct ‘'user pays'’ connection between payment for, and the acquisition and use of, outputs produced by market suppliers.

The traditional revenue‑raising rationale for taxation has become increasingly confounded with, amongst other things, ‘'equity'’ ideals dictating that people with a greater capacity to contribute to consolidated revenue, rather than those who more intensively use government services, should do so.

This is most clearly illustrated by income taxation data showing that individuals earning more than $80,000 a year, who rely less upon public sector services and transfers, contribute about 64 per cent of the total net income tax take, whereas those earning up to $37,000, much more heavily reliant on government spending, contribute about 4 per cent.

The income tax withholding regime, which requires employers to withhold tax from an employee’s pay check and transfer it to the government, further dulls the pain that most workers would feel if they were otherwise required to pay income tax instalments directly from their own accounts.

Politicians with short-term re‑election objectives have the incentive to keep offering up new and more kinds of spending programs regardless of affordability, and rather than living within the hard constraint of available taxation collections they often borrow heavily, which is tantamount to shifting tax burdens into the future.

The political class has tended to make a rod for their own backs by obscuring the costs of taxation, and exalting the benefits of spending, through the use of deceptive, error‑laden language in an attempt to acquire broadly‑based political support for an overly large public sector.

In this Orwellian world of fiscal ‘'doublespeak'', spending on consumption items and transfers are reclassified as ‘'investments'', taxes are relabelled as ‘'levies'’ or ‘'co‑payments'', increasing taxation is represented as a budget ‘'saving'', tax cuts are rebadged as ‘'spending'' and electing not to raise taxation is conceived as a generous ‘'subsidy'’ handout to the general public.

And as the federal government has felt all too painfully, false political impressions can readily be conveyed when forward program announcements, such as the Gonski school funding regime or the National Disability Insurance Scheme, are construed as the reality and, as such, cannot easily be amended or abandoned, even though they are not yet established.

What this all means is that recipients of government expenditure programs come to perceive transfer payments and services as effectively being ‘'free'', or close to it, and that they feel entitled to demand more of this spending as a basic right. Further, policy proposals which attempt to encourage recipients to at least appreciate that spending is costly, and even encourage them to recalibrate their demands accordingly, is intensely resisted within the political environment.

This explains why major political opinion polls have turned rather savagely against the Abbott government in the wake of its first budget, and why various groups have organised sporadic protests in capital cities against ‘'austerian'’ proposals such as the $7 Medicare ‘'co‑payment'’ and higher education reforms.

The misperceptions caused by the separation of government benefit receipt from the taxation imposed to fund it, labelled by economists as ‘'fiscal illusion'', also explains paradoxical polling results whereby concern about the overall size of Australian government is juxtaposed with an equally great concern to retain favoured spending activities.

The fiscal illusion exacerbated by the great disconnect in modern public financing systems, between spending programs benefiting favoured political constituencies and the imposition of taxation burdens upon unfavoured constituencies, calls for carefully applied and consistent policy reform resolutions right across the board.

A range of fairly simple administrative changes could be pursued to help inform the general public about the costs of running government programs and functions, including the levels of debt incurred as aggregate spending outruns available revenue.

Before the budget, the government announced it would provide a ‘'tax receipt'’ for personal income taxpayers informing them how much of their tax liability was spent on each budget area, as well as gross debt levels. This is a welcome step forward in the field of fiscal transparency, but much more can be done to counter the endemic fiscal illusion problem in our democratic system.

In addition to the budget itself, all other government statements presenting information with fiscal implications, such as press releases of policy announcements, should more clearly include details of the costs of initiatives. Another step would be for the government to establish detailed fiscal transparency online portals outlining spending activities in real time, similar to those readily available in the US states.

To ensure a more holistic assessment of the relative costs and benefits of government expenditures, the budget and all other major fiscal statements must include estimates of the marginal excess burden associated with raising taxes.

Most current services and transfers do not conform, at least very neatly, to the economic definition of a public good, and so this opens up the possibility of a greater reliance on user charges and fees, rather than on highly distortionary and discriminatory taxes, to fund programs.

The challenge of budget repair is not only to set Australia onto a fiscally sustainable path now, but to help ensure we don’t veer off track again by lifting the fog of fiscal misinformation that leads voters to believe they can all receive spending benefits on the cheap.

Dr Julie Novak is Senior Fellow, Institute of Public Affairs (www.ipa.org.au).

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