Why Australian tax reform is doomed to fail

In a speech reflecting in part on the journey of tax reform this century, he noted the last successful tax reform in Australia was actually developed last century, when Howard and Costello finally got the GST to the finish line.

However, we can only hope the government ignores Henry's call. Tax reform is seriously needed - as Henry urges - but in the current policy environment, any major review of tax will almost certainly make things worse, not better.

There are two main reasons for this.

First, for a number of years now, policy debates around taxation have become hyper-fixated on the issue of fairness; to the exclusion of any other principles of good tax design.

As reflected in the Henry Tax Review itself, traditionally there are three principles of good tax system design with fairness being just one of those. But the other two - efficiency and simplicity - are also important.

Efficiency deals with minimising the negative impact of taxation on the economy. Poorly-designed tax systems create excessive amounts of deadweight loss. Deadweight loss comes from an inefficient allocation of resources, and it hurts everyone.

Simplicity is overlooked even more often, despite its importance. Simplicity doesn't just matter because people should be able to understand how they are taxed without professional advice, although this is important.

Overly-complicated tax systems inevitably have loopholes that are rife for exploitation. A simpler system is usually far harder to avoid. Estimates suggest Australians pay at least 125 different taxes, although 10 account for 90 per cent of revenue.

Of course, the number of taxes is not the only measure of complexity. Over time, the rules have expanded massively as we try to slice the tax pie ever more finely.

The simple fact is we are not headed towards a simpler, more efficient system. Instead, almost every step taken in the past 20 years has been towards a more complex and less efficient tax system, in an attempt to maximise the progressivity of every element of it.

The recent debate over the stage three tax cuts makes clear the folly of attempting wholesale reform of the system at this time.

When a significant portion of the policy landscape cannot even agree on returning accumulated bracket creep to those bearing almost the entire weight of the tax system, it should be clear 'tax reform' would simply be a licence to cherrypick a bunch of taxes to increase for 'equity' reasons.

There would be no trade-offs, no simplification - just a leap forward on the road to ever-bigger government.

This leads to the second reason tax reform would not generate a positive outcome.

Many in the policy community fundamentally misunderstand the problem tax reform should solve. Indeed, like Ken Henry and a number of members of the government, they are convinced the issue is insufficient revenue.

In fact, the biggest issue is that we are far too dependent on a couple of horribly inefficient taxes. And we are overly dependent on these taxes because spending is absolutely out of control in a number of areas.

Recent research by Robert Carling at the CIS has made the scale of these twin problems very clear.

He notes tax as a share of GDP (at market prices) has been growing for a number of years following the pandemic and currently is "close to the highest it has ever been in peacetime", at about 30 per cent of GDP.

He also calculates real tax per capita for the past 20 years, noting this has been growing at more than twice the pace of real GDP per capita for the past 10 years.

It is also worth noting these increases in taxation have come at a time when government debt has increased substantially at both the state and federal levels.

The reason for the tax increase and the debt increase is the same: significant temporary spending packages and sustained increases in permanent spending programs.

Of the two, the latter is the most pressing. However, surely even the big-government crowd must now admit pandemic spending was excessive both in magnitude and duration - as evidenced by the extended bout of inflation it caused.

Nevertheless, it is permanent spending that should worry us; especially in areas like the NDIS.

It will require a level of policy maturity - which has been in rare supply for years - to now bend down the NDIS cost curve. It's not like these problems were not foreseeable. As my then-colleague Andrew Baker warned back in 2012, the NDIS will "grow to become the new leviathan" of our welfare system.

Nor is it just the NDIS that is of concern. Despite the abject failure of the last round of massive increases in school funding to improve results, the government is clearly looking to repeat this failed experiment.

Meanwhile, the population continues to age, increasing spending on health and pensions, and pushing aged care costs through the roof.

The important thing to understand is these problems cannot be solved by tax reform. Increasing revenue won't fix it, because these costs are growing faster than any revenue source possibly will.

The desire for additional spending is effectively infinite.

That said, there are many areas where tax reform would be able to make a genuine difference to economic growth.

Lowering the tax burden, especially on companies, would be a great boost to business investment.

However, real tax reform requires a focus beyond equity and a willingness to make trade-offs. In the current political environment, neither can be found in sufficient quantities.

Consequently, it seems the best we can hope for is that tax reform stays in the too-hard basket.