Benchmarking Tax and Spending

(and how Australia became a leaner government than the US)

Published in the Party Room, Issue 3, Autumn 2006

Tax and spending should be viewed as two sides of the same coin.  If we want to tax less we will have to spend less. The only way to tax less and spend more is by borrowing and driving the Budget into deficit – a policy which brings worse problems when the consequences begin to catch up.

One of the values that Liberals hold dear is to be disciplined with government spending.  We should be careful about spending taxpayer’s money – because it is their money and because the less we spend the less we have to raise.

Lower spending…

When we compare how much we spend now to how much government spent ten years ago it is clear that the size of the government as a proportion of the economy has fallen. 

From 1995-96 through the ten years to 2005-06 the Australian government’s spending has declined from 25.3% of GDP to 21.6% of GDP.

I should add that this spending discipline has been achieved at some political cost.  Our opponents have opposed every sensitive area of spending restraint or cuts.

How do we compare internationally?

In their latest statistics, the OECD ranks Australia as the second lowest spending government amongst 28 developed countries of the world.  That’s right, second lowest.

Over ten years the all-government spending to GDP ratio has declined from 38.0% to 35.7%.

Over these ten years Australia has become leaner while Japan, Korea and the UK have been creating bigger governments.

In fact, an historic milestone was passed three years ago – which few people noticed – but government spending in Australia became lower than the USA. 

This is a fascinating development.  Many people hold the US up as the acme of lean government, but in 2003 Australian government spending as a proportion of GDP actually went below that of the US and has stayed underneath.

Our paths have been converging but Australia now has a leaner government than the US.

Some people may wonder – if spending in Australia has declined as a proportion of GDP, how is it that the Government can still be spending more in certain areas?

This is an important point to understand – the government has been spending more, but not at the same rate as the economy has been growing.  Government spending is declining as a proportion. 

It is hard to restrain expenditure at any time and especially hard to restrain it in a growing economy.  Every interest group has a good idea for new or expanded programmes.  And they usually argue that in a strong economy the Government can afford it.  Keeping control of costs requires daily vigilance.  But Australia has managed to do so and locked in Budget surpluses which will help us in the future when the ageing of the population will really give us trouble on the spending front.

…means lower taxes

If you are disciplined on spending it allows you to cut the tax burden.

And the record shows that the Australian Government has reduced its tax as a proportion of the economy.

The Commonwealth’s tax take to GDP peaked in Australia in 1986-87 at 23.7% of GDP.  In 1996‑97 it was 22.8% of GDP, and since then we have brought it down to its current level of 21.0%.  The Commonwealth Government has become smaller relative to our economy.

You can have endless arguments about the tax burdens in various countries.  The only way to properly compare them is to take all levels of government and measure that tax as a proportion of the economy.

How do we rank internationally?

When we compare ourselves to developed countries, the total government tax take of 31.6 per cent of GDP is the eighth lowest tax to GDP ratio of the thirty countries in the OECD.

Our recent performance has put us in an even better position than the OECD rankings would indicate, because our government budget is in surplus.  Many of those countries that in the OECD rankings have lower tax than Australia, like the US and Japan, have massive government deficits.  This means that while they may have a lower tax take now they are doing it in some part by postponing tax collection into the future.

Let me illustrate how this occurs.  Suppose the tax take to GDP ratio is 32%.  You can reduce it by 1% point or 2% points to 30% and fund it by running a budget deficit of 1% or 2% of GDP.  The budget deficit is financed by borrowing.   The borrowing will have to be serviced and repaid by future governments who will have to raise it by taxing future citizens.  The current generation lowers its tax bill sure, but only by increasing the tax bill of the next generation.  Has tax been cut?  Well only in the sense that one generation has transferred its liability to the next.

So what conclusions can we draw from these comparisons?

Firstly, amongst developed countries, Australia is at the low end of both taxing and spending comparisons.  Second, that over the ten year period of Coalition government both taxes and spending have declined as a proportion of GDP.

People can quarrel about subset arguments, but they should not allow subset gripes to cloud the big facts.

Let me just cover off a few subset arguments.

Firstly, some people say that we should not compare ourselves to OECD countries because it makes our position look favourable.  But this is the world league of developed countries.  It has gathered international statistical comparisons.  Historically we have always compared ourselves with our peers in the other rich countries.  This doesn’t negate other comparisons.  There is no point comparing ourselves to developing countries because we aren’t one and we don’t want to become one.  We are not going to have a developing country’s tax system unless we decide to scale down to the standards of social services that are delivered in developing countries. The health, education, aged care, pharmaceutical services of a developing economy is not what we have and not what we want. 

Secondly, some people say that the federal government’s tax take should include GST.  The trouble is that the same people who count GST as a federal tax then want to count all the state taxes it replaced as a reduction in state taxes.  This asks you to believe that in 2000 all the states unilaterally cut taxes (without losing a dollar) while the Commonwealth unilaterally increased them (without gaining a dollar).  It is statistical nonsense.  If you want to compare like with like then you have to include GST and all those state taxes as Federal taxes; or GST and all those state taxes as state taxes.  Redoing the classifications on this basis still leads to the same general conclusions.

As I said earlier the only way to avoid the effect of shifts of taxes between Federal, State and local government is to compare overall tax burdens against similar calculations in other countries.

None of this should be taken to mean that it is time to rest on our laurels.  My view is that we should strive to be amongst the first row, and an International Benchmarking Study will assist us to look at those areas when we lead and those areas where we lag.

We are in a relentlessly competitive world and we should aim to have taxes and spending as low as possible consistent with the standard of health, education, defence and security that our public is justly entitled to receive.