TEN PRINCIPLES FOR TAX REFORM: PRINCIPLE ONE

November 3, 2009

Australia's tax system needs principles that go beyond efficiency, equity and simplicity, says Robert Carling, a Senior Fellow with the Center for Independent Study. 

For example, he recommends that total taxation should be capped as a proportion of gross domestic product (GDP).  Because taxes are levied under the coercive power of the state, the revenue maximizing level bears no necessary relation to the optimal size of the government and in all likelihood far exceeds it:

  • General government spending in most developed countries is above 35 percent of GDP, and for many it is closer to 50 percent.
  • In Australia the figure was close to 35 percent in 2007-2008.
  • Researchers concluded that optimal government spending (excluding government-owned enterprises) is around 30 percent of GDP.
  • Researchers using a different approach calculated optimal government spending for the United States and came up with 23 percent of GDP, which is well below the actual tax burden.

In the context of fiscal responsibility legislation therefore, a cap on tax revenue share of GDP is desirable.  Tax reforms that reduce revenue may at first sight appear unaffordable at a time of large budget deficits, but a reduction relative to a growing revenue baseline would be manageable, says Carling:

  • This would involve implementing reform in stages over a number of years so that tax revenue, while still growing, would grow at a rate below the growth of GDP.
  • If the growth of tax revenue is too slow, so must the growth of government spending be slowed.
  • This would require a marked change in the behavior of governments at all levels.

It is desirable to obtain an agreement of all governments to a national tax/GDP ratio, which would cover all taxes and be unaffected by any future reallocation of tax powers between the levels of government.  Revenue maximization may be best for the rulers, but it is not best for the ruled, says Carling.

Source:  Robert Carling, "Total Taxation Should Be Capped As A Proportion of GDP," Policy, November 29, 2009.

 

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