Tax cuts: Rein in the visible hand

Oh no, not again. A debate about tax and welfare reform. The eyes of tax policy junkies light up, others gaze at the ceiling. Everyone wants to cut tax, but who's prepared to pay for it? There's nothing new about that battle.

But there is new opportunity. From July, there will be a situation Australia hasn't faced for more than two decades - a government majority in the Senate. This is where the backbench tax forum makes its stage entry: to provide a backdrop against which views about the future direction of taxation and welfare can be discussed afresh.

Tax revenue should be kept at low levels because the future is best served by leaving tax revenue in the hands of its present owners, the taxpayers. And this also requires further improving the tax and welfare systems to build workforce participation and productivity.

This is the policy formula the Government has consistently pursued. There have been three rounds of personal tax cuts, with a fourth from July 1 this year. The capital gains tax rate was halved. The company tax rate was reduced. Many state taxes were abolished as a result of the introduction of the GST. The withdrawal rates on income support payments have been reduced.

But we can do better, and with tax cuts we should always be looking to the next step. Bracket creep is just one reason for that. Increased employment and booming company profits also increase revenue.

The proposal to index personal tax thresholds as a means of constraining government spending may be a policy mirage. If tax thresholds were indexed from 1996, and the Australian Government had done nothing else to cut income tax, taxpayers would be handing over more to the Government than they do now. Indexation can actually take the heat off governments to keep cutting taxes. Much better to keep everyone's eyes on both tax collections and government spending.

Further opportunity is presented by Australia's enviable economic situation. GDP continues to grow strongly and steadily. Inflation is low, employment is high.

Government net debt levels are so low that policy officials are sitting around wondering how to handle a possible net asset situation. Australia is breaking ground where other western nations aren't - not Britain, the US or Canada. It's seminal stuff.

While there is pressure for governments to revisit capital gains and business taxes, the worst disincentives are found in the personal tax system.

The threshold for the top tax rate is one of the lowest proportions of average wages among developed nations. Australia's tax system is one of the most progressive, too, and the impact of this is felt in the high effective marginal rates of taxation across a range of middle incomes.

Providing meaningful tax cuts will require careful constraint of government spending and pursuing savings measures. If we only look to projected surpluses over the forward estimates there isn't much room to move; the underlying cash surplus reported in the Government's mid-year budget review totalled $24 billion from 2004-05 to 2007-08. And since then, the Government has rightly committed a significant amount to the rebuilding effort following the Indian Ocean tsunami.

Meaningful tax cuts require some hefty reductions in revenue. To lower the top rate by 1 percentage point - from 47 per cent to 46 per cent - would cost about $600 million a year. That's quite a bite into tax revenue for a cut that would deliver just $100 to the pocket of a taxpayer with taxable income of $80,000.