The tax system will automatically harvest so much extra tax from workers' pay packets that it will start to drag down economic growth over the next few years unless the government acts, according to the Treasury.
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GST would hit poor hardest
Treasury modelling on the GST reveals the most vulnerable could be hit the hardest Fairfax's Peter Martin explains why.
Without any action from the federal government, rising wages will automatically push millions of wage earners into higher tax brackets, an effect called bracket creep.
"If you have higher and higher taxes" as a result, "it will be a drag on growth," Treasurer Scott Morrison said.
The drag is estimated by the Treasury to reduce GDP by about one-third of a percentage point of GDP after four years.
"We have to find a way to mitigate that now."
But the federal government has no intention of doing this by increasing the GST, the Treasurer said: "That requires more of a scalpel than a larger instrument," he said.
Mr Morrison's scalpel is now hovering over government spending and over at least three major federal tax concessions. Superannuation tax breaks for the well-off, negative gearing, and deductions for workers are under scrutiny.
Asked specifically about these three, Mr Morrison said: "That's entirely possible."
Money saved from any such surgery could be used to cut income taxes, staving off bracket creep.
The government's decided to dump the idea of raising the GST to pay for cuts to income tax because Treasury modelling showed that this would do nothing to boost economic growth.
"It's about growth, full stop," Mr Morrison said. But he cited three different exercises in estimating the effect of raising the GST to 15 per cent, and using the proceeds to cut taxes and pay compensation to people on welfare.
The Treasury's modelling showed a boost to growth of 0 per cent. An alternative model called the Murphy model showed a boost of 0.18 per cent and modelling by consultancy KPMG showed a gain of 0.3 per cent.
These would be permanent but one-off effects.
"That's a very modest contribution to growth," he said. Yet even so small a boost might be worth pursuing in a slow-growth world economy: "Growth is growth and every inch counts," Mr Morrison said.
But a closer look revealed that even these small growth effects would likely be unachievable, he said.
The modelling assumed that a 15 per cent GST would yield an extra $35 billion in revenue, he said. Of that, it calculated that $6 billion would be needed to compensate people on welfare for the increase in the price of most goods and services.
But it would cost much more to compensate others on low incomes. The Treasury modelling showed that, even after an offsetting rise in welfare payments, 91 per cent of people in the poorest fifth of the population would still need further payments to restore their purchasing power.
Another $2 billion would be needed to compensate independent retirees who were not receiving the pension, Mr Morrison said.
These extra compensation costs, plus the effects of negotiating a tax package through the Senate, could increase the compensation task dramatically: "What if it goes to $10 billion?"
Each extra dollar of compensation would be a dollar less that could be used for cutting income taxes. "The risks are very great and the rewards are very modest," the Treasurer summarised.
Interestingly, the Treasury modelling only envisaged using the GST revenue to cut income taxes, not company tax.
Yet it's established in economic experience and literature that this is the surest way to boost growth. Mr Morrison explained: "The proposition that you tax mums and dads more so companies can have a tax cut has an obvious problem."
Without any government action the average income tax rate on workers would creep up from 24.4 per cent of total wages to 26.6 per cent over the next four years, according to the Treasury.
This would erode disposable incomes and crimp consumer spending.
The effect would be a drag on economic growth equal to 0.35 per cent of GDP.
The modelling was received from the Treasury in the last week of January and the first in February, he said.
Acknowledging the storm raging in world financial markets as investors increasingly position in anticipation of a worldwide economic slowdown, Mr Morrison said Australia was well positioned regardless.
"We are seen as a stable and strong port at the moment, and that's good news, but that doesn't mean it's not raining outside."