RBA Assistant Governor Luci Ellis gave an interesting speech yesterday.
For a little while now, the team at the Bank has been grappling with how one might reconcile apparently weak national accounts figures with the noticeably stronger labour market data.
One of the arguments she makes is that we’re paying too much tax. Mind you, she doesn’t quite say it in those terms.
When we think about household income available for consumption and saving, economists usually talk about household disposable income. This is income net of taxes, net interest payments and a few other deductions like insurance premiums. Income payable – the things deducted from gross income to calculate disposable income – increased by nearly 6 per cent in 2018. This was significantly faster than growth in gross household income.
Despite the relatively weak picture for household income growth, the tax revenue collected from households has grown solidly in recent years. It’s normal for growth in tax revenue to outpace income growth a bit: that is how a progressive tax system works. A useful rule of thumb is that, in the absence of adjustments to tax brackets to allow for bracket creep, for every one percentage point of growth in household income, taxes paid by households will on average increase by about 1.4 percentage points. That’s an on-average figure, though. The actual ratio can vary quite a bit.
In the past year, taxes paid by households increased by around 8 per cent, more than double the rate of growth in gross household income of 3½ per cent. So the ratio is more like a bit over two-to-one at the moment, rather than 1.4 to one. That is at the high end of the range this ratio reaches, but as this graph shows, it is not unprecedented (Graph 12). But this effect has cumulated over time, so that the share of income that is paid in tax has been rising (Graph 12, bottom panel).
What is noteworthy is that for all of the past six years, growth in tax paid has exceeded income growth by an above-average margin, at a time when income growth itself has been slow (Graph 13).
There are likely to be several things going on here. Aside from the usual bracket creep, some deductions and offsets have declined, boosting the overall tax take. Interest rates on investment property loans are now higher than for owner-occupiers, but overall the interest rate structure on mortgages is lower than it was a few years ago. So landlords will have lower tax deductions for interest payments on loans on investment properties. At the same time, the significant run-up in housing prices in some cities over the past decade will have increased the capital gains tax liability paid by investors selling a property. Turnover in the housing market has declined. But as best we can tell, the price effect has dominated the effect of declining volumes, and total capital gains tax paid has increased.
Compliance efforts and technological progress in tax collection have boosted revenue collected from a given income. The Tax Office reports that its efforts to raise compliance around work-related deductions have boosted revenue noticeably (Jordan 2019). The next wave of this effort, focused on deductions related to rental properties, could result in further boosts to revenue.
Some of these drivers boosting tax paid could persist for a while, but they aren’t permanent. For example, the earlier period of strong housing price growth will only increase capital gains tax revenue if the asset was owned during that period. It can be expected to become less important, the further into history it passes. Similarly, increased compliance increases the level of tax paid on a given level of income. It is not a change in the trend growth rate in tax paid. That said, the effect could last for a while as efforts shift to different aspects of compliance.
Normally I’d be very sympathetic to this sort of argument – but it doesn’t quite make sense to me.
So changes to the tax system and greater enforcement of existing taxes has led to increased revenue to the government and consequently less revenue in the household sector. Maybe. But very often paying tax is a “nice” problem to have – especially compared to the alternative. All those people who have gotten jobs over the last few years shouldn’t be complaining that they have less to spend because of taxation. They are better off working and earning an income despite taxation. A lot of what we see in the speech is – as Ellis argues – how the tax system is designed to work.
Now I’m happy to concede that a progressive tax system distorts the economy and has all sorts of problems associated it it, but those issues are not new. Looking at the two graphs the current taxation situation isn’t unique. Household tax to income has been higher in the recent past. The current relationship between growth in income tax paid and growth in total income is not unusual.
To my mind this is a crowding out problem. Too much taxation revenue is being being raised. Too much unproductive government spending is occurring. The answer to Ellis’ question is found in her speech when she says:
Transport and renewable energy projects have been quite important. Public demand, both consumption and investment, is supporting growth.
When you move large amounts of resources from positive net present value activities to negative net present value activities you can’t expect the economy to keep humming.