Removing the rorts

John Freebairn
John Freebairn

[WHO] Professor John Freebairn, veteran analyst of public policy.
[WHAT] The Commonwealth spends an unsustainable amount on 'middle-class welfare'.
[HOW] Widespread reforms, including to superannuation, negative gearing, pension ages and taxation of the family home.

Treasurer Joe Hockey is leading the government's campaign to ''end the age of entitlement'' and to usher in ''the age of personal and corporate responsibility''. It's a mammoth task. Social welfare and other big-ticket spending programs include many items recipients have come to see as inalienable entitlements, but they are entitlements the country may no longer be able to afford.

Put another way, the first law of public policy is the pig with its snout deepest in the trough squeals loudest when you try to pull it out.

Prime Minister Tony Abbott and Hockey have started to change public policy culture by refusing to continue to hand out taxpayers' funds to ailing businesses, including Holden, Toyota and SPC Ardmona. The message is that corporate welfare is coming to an end - although the drought package in recent days shows successful pitches can still be made for special assistance.

It would help the debate were the government to ask its policy research powerhouse, the Australian Productivity Commission, to publicly audit all other forms of corporate welfare. The agriculture and mining sectors, for example, receive billions of dollars a year in fuel subsidies, a partial rationale for which is that off-road vehicles don't use publicly funded roads.

Public finances are clearly under pressure. Before taking power, Hockey was declaring a fiscal crisis, and official figures show the budget deficit is far bigger than previously forecast. The deficit this year is tipped to exceed $50 billion, which, at 3.2 per cent of the economy as measured by gross domestic product, is three times the estimate in Labor's final budget last May.

Clearly, the new government's first budget will be tough. The government will load as much of the pain as it can into this budget, blaming the former administration and maximising fiscal flexibility as it seeks re-election in two years.

Today's guest in The Zone looks at how the government, which has commissioned an independent audit of spending to help find savings in the coming budget, might cut ''middle-class welfare''.

Professor John Freebairn holds the Ritchie chair in economics at Melbourne University and has been studying public policy, with a particular focus on spending and taxing, for more than three decades. A short video statement by Freebairn and the full transcript of our interview, in which he advocates a range of reforms, are at He will also be online for an hour from midday to respond to questions and comments, which can be submitted from this morning.

''Middle-class welfare'' refers to the payment of taxpayer-funded benefits to people on middle and upper incomes. Social security and welfare payments account for a bit more than a third of Commonwealth spending; there are potentially big cuts that can be made without necessarily hurting those in genuine need.

Freebairn is a defender of social security. ''As a society, I think we are in favour of transfers from those who have good jobs and good incomes and some wealth to those who are seriously disadvantaged.

''I don't think there is any debate about granting government money to people with disabilities, about granting money to people who have had a short-term disaster in terms of losing their job, or their small business fell over, or they have had a really adverse health problem.''

But he believes there are some egregious, unsustainable areas of middle-class welfare. ''It is a slippery concept. The simplest version is it is middle and higher-income people paying taxes and then getting some of the tax back in terms of, say, an age pension later on in their lifetime, or in family tax payments.''

He also cites as prime examples of middle-class welfare the tax concessions on superannuation, the negative gearing of investments, and the failure to adequately include the family home in the taxation system.

Before examining those, though, it is perhaps useful to put the Australian debate into a broader context. Yes, we do have a looming budgetary dilemma: Commonwealth spending growth is predicted by the International Monetary Fund to increase faster in the next four years than that of any other advanced nation, driven by increasing health spending and, to a lesser extent, social security outlays, as well as new programs, including the national disability insurance scheme, the so-called Gonski reforms to education, and mooted infrastructure investments. Either the government has to cut spending or raise taxes, or do a mixture of both.

Australia simply does not have ''big-taxing, big-spending'' governments, despite the rhetoric we sometimes hear. The best comparison is with other industrialised wealthy nations. Of the 34 nations within the Organisation for Economic Co-operation and Development, only Switzerland, Korea, Chile and Mexico have governments whose spending represents a lower proportion of GDP. It is a similar story on the taxation side; the Australian government's taxation revenue represents about 30 per cent of GDP, well below the OECD average of more than 36 per cent.

Notwithstanding the relatively small size of Australia's government, Freebairn believes there is much room for reform and savings. One of the biggest changes required, he says, is delaying access to retirement incomes. ''You can access your superannuation at age 60. You can access the age pension at age 65. The age pension age was brought in in 1908 when the average life expectancy was just 65.''

The former government legislated to increase the pension age to 67 by 2023, but Freebairn says that is insufficient. ''We would slowly bring the access age to superannuation and the access to the age pension to 70. Yes, you have to bring it in slowly. And then I would index it to life expectancy.''

But he says it would take a ''gutsy'' politician to reduce access to the age pension. ''It turns out that the age pension is used by about half of mature-age Australians for their sole source of income. Another 20 per cent to 30 per cent have a part pension. And that support is actually more generous than we provide to, say, people who are unemployed on Newstart.''

There is such widespread reliance on the age pension, despite it being means tested against income and assets. The problem, Freebairn says, is that the family home is not included.

''The principal barrier [to change] is political short-sightedness … As soon as I say I want owner-occupied homes to be in the assets test, a whole lot of people will say, 'Now I have got access to the age pension, but it's going to be taken away.' They are going to be noisy as hell.

''What we have got to explain, and have politicians really tell the story about, is this group is really doing pretty well at the moment.

''The more challenging one is that bringing the family home into the assets test is a potential gain for the next generation. They will have less pension income to pay out, so that means their tax rate can come down. It also means we will make it easier for the next generation to purchase their own home.''

The failure to take into account the value of owner-occupied homes is creating a massive distortion that fuels demand for houses because of the lower tax treatment, and exempting the family home from means testing for benefits, and from capital gains tax, is sucking funds out of more productive uses, Freebairn says.

The distortion is exacerbated by so-called negative gearing, which is, in effect, a subsidy from lower-income taxpayers to those who can afford to borrow to speculate on property and financial securities. Australia is one of only a very few nations that allow such speculators to reduce their tax bills by deducting their borrowing costs from their income.

Freebairn, like many others, argues that negative gearing is one of the main reasons first-home buyers struggle to get into the market - there are too many speculative investors chasing properties to negatively gear. About 1.3 million Australian households have negatively geared property investments.

Freebairn says the taxation treatment of superannuation also needs overhauling. People on middle and upper incomes get a huge break by being able to put extra money into superannuation at a tax rate of 15 per cent rather than at their marginal income tax rate. They then get it out tax-free at 60.

''All remuneration, whether it is wages, superannuation or fringe benefits, should be taxed at your personal rate.''

Freebairn believes one of the most pivotal reform options would involve a broader goods and services tax base, and increasing it to 15 per cent.

The extra revenue would replace distorting state stamp duties and would fund increases in social security payments and lower income-tax rates for reasons of equity. But, at least for this Parliament, changes to the GST have been ruled out.

The government has also ruled out changing the treatment of the family home. And its independent commission of audit is confined to looking at spending, so tax concessions - the root of much middle-class welfare - appear to have been quarantined. The first law of public policy, it seems, has already shackled the government in its desire to tackle entitlement.

This story Removing the rorts first appeared on The Sydney Morning Herald.