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FiscalPolicyAustralia faces a number of major strategicchallenges over the coming years. Probably the most pressing, and politicallypainful, is the “structural fiscal deficit,” an issue that has come to publicprominence in the last few years. If the deficit is to be satisfactorilyaddressed, additional revenue measures will inevitably be required. The OECDsuggests raising the goods and services tax as well as the introduction of aland tax. Australia’s fiscal policy is heavily exposed to external risk andshould in the medium term establish a stabilization fund similar to thoseimplemented by other resource-rich economies (such as Norway).

 TaxesAt a broad level, the tax system achieves areasonably high degree of horizontal equity, with income generally taxed at thesame rate irrespective of the source of the income. The main exception arisesin respect of capital-gains taxation, where the family home is exempt fromtaxation and a 50% discount is applied to capital gains on other assets held atleast one year. The rationale for the discount is that it provides a substitutefor inflation adjustments.

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The income-tax system is moderately progressive, andthe only significant change in income-tax rates over the review period was a 2percentage-point increase in the top marginal income-tax rate, to apply only inthe 2014 – 2015 and 2015 – 2016 tax years. The main weakness of the tax system is that it ispro-cyclical, which is particularly problematic given Australia’s dependence oncyclical commodities. Specifically, both the Labor and coalition governmentshave failed to create a future fund in order to prepare for the end of theresources boom. Concerning efficiency, in 2008 the Labor governmentestablished a committee to review Australia’s tax and transfer system and makerecommendations to improve its functioning. The committee found that, in broadterms, the tax system functions well and does not unduly impede economicgrowth.

Nonetheless, a number of inefficient and inequitable aspects of theexisting tax system were identified, and the committee recommended 138 changes.Few of the recommendations have been adopted to date, but the coalitiongovernment released a discussion paper in 2015 outlining tax-reform issues thatwould be considered, and a process of community consultation is currentlyunderway. With regard to sufficient inflow of tax revenue, forseveral decades the federal government has on average raised sufficient revenuefrom taxation to meet expenditure commitments. However, concerns haveheightened in the review period that the federal government faces a structuraldeficit that will require difficult fiscal decisions in the near future, mostlikely involving a combination of reductions in spending and tax increases.Moreover, there is a long-standing concern about the fiscal sustainability ofstate and territory governments, which have very limited capacities for raisingrevenue.

Growth in health and education expenditure demands on the states andterritories in particular have outpaced revenue growth. BudgetsAs Australia’s fiscal position deteriorated furtherduring the review period, fiscal sustainability became a correspondingly moresignificant issue. The high commodity prices of the early to mid-2000sgenerated large increases in government revenue, to a significant extentderiving from corporate tax revenue. Much of the additional revenue was spenton income tax cuts and increases in family benefits and several otherentitlement programs. Corporate tax revenue has not recovered from the 2008 –2009 economic downturn, resulting in seven successive budget deficits averagingover 2% of GDP and forecasts of continued deficits under unchanged policysettings. With net federal government debt standing atapproximately 15% of GDP at the time of the review period, the fiscal positionis still relatively healthy, but the consensus is that Australia has a”structural deficit.” This means that, averaged over the business cycle,existing revenue streams will not adequately meet ongoing expenditure needsgiven current tax rates and expenditure levels. The reasoning is that commodityprices will not return to pre-2008 levels, and expenditure demands areprojected to increase over coming years, in part because of population aging.

Today, Australia’s very high primary deficit requires determined adjustment,but implementing change is apparently very difficult. As a response to thedeteriorating fiscal outlook, the government in 2013 launched a Commission ofAudit tasked with identifying policy options to reduce government expenditure(but not increase revenue) and restore fiscal sustainability. The Commissionreleased its reports in early 2014, recommending numerous sweeping changes,including cuts to welfare benefits, increases in patient contributions tohealth care, and increases in student contributions to higher education.However, Prime Minister Abbott conceded at the G-20 summit in 2014 that raisingpatients’ contributions and boosting student fees have both proven to beextremely difficult. The subsequent first budget of the Abbott governmentadopted the recommendations in part, and additionally included a temporary(two-year) two percentage-point increase in the top marginal tax rate and arestoration of the fuel excise’s indexation to consumer inflation (which hadbeen removed in 2001). While these budget measures, if fully implemented,would help restore fiscal sustainability over the medium term, the budget alsocontained revenue reduction measures – namely, the removal of the MineralsResource Rent Tax and the carbon tax – both of which passed both houses ofParliament.

More importantly, the Senate refused to pass several of theexpenditure measures, including cuts to higher education accompanied byderegulation of tuition fees, imposition of a patient co-payment forout-of-hospital health care, cuts to family benefits, a reduction in the rateof indexation of pensions and an increase in the minimum age of eligibility forthe Age Pension from 67 to 70. The 2015 – 2016 budget did not introduce anysubstantive new initiatives, and even as it was proposed, the government hadmade little progress in legislating the cuts proposed in its previous budget.However, the change in Liberal Party leadership and prime-ministerial change inSeptember 2015 has brought with it renewed attempts to find common ground withcross-bench senators. Agreement has purportedly been reached for moderatereductions in family tax-benefit expenditures. As of December 2015, theTurnbull government was considering a substantial increase in thegoods-and-services tax (GST) to 15%, but the discussions are in an early stage.

 Combined with the government’s failure to implementsubstantive measures to restore revenue, the blocking of the expenditure cutsmeans budget balance is unlikely to be achieved over the next several years.

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