Budget provides a chance to carve out the path to higher productivity

Productivity growth results in more valued output per unit of production input, or the same output for fewer inputs. Growth of productivity requires changes involving the adoption of new technology, better management and work practices, and reallocating the product mix and production methods from less valuable to more valuable options.

Higher productivity provides a sustainable base for higher living standards, greater equity of opportunity and outcomes, and better opportunities to protect the environment. The achievement of higher productivity requires changes in behaviour and decisions by governments at all levels, businesses large and small, and all employees. Reform of federal, state and local government budgets offer important opportunities to assist national productivity growth.

Consider the role of Australian governments in the economy. Via taxation they effectively redirect about 31% of the economy’s limited labour and capital from the private sector for public use. About a quarter of national production - including defence, law and order, education, health, transport, garbage collection and disposal, and national parks - are government expenditures funded by tax revenues. Other revenues are distributed as social security payments to the less well-off to assist in meeting social equity goals.

Government budgets spell out the details of taxation and expenditure programs. In framing their budgets, Australian governments - at the federal, state and local levels - have a rich potential agenda of reform options to significantly improve productivity if they are willing to articulate, communicate and then implement reforms.

Taxation transfers labour and capital from use by the private sector for use by the public sector. At the same time, taxation changes relative prices faced by households and businesses in the private sector. These relative price changes alter decisions, such as work versus leisure; spend now or save and spend in the future; the type of business organisation; the mix of saving and investment choice options; and so forth. In the absence of market failures, changes in these decisions are less productive in a national sense, and in this way taxation reduces national productivity.

2009’s Henry Review recommended a comprehensive set of productivity-enhancing reforms to taxation. Adoption of the reforms was estimated to increase productivity equivalent to between 2% and 3% of national income, or a gain of $25 to $40 billion in 2010-11 values. To date, few reforms have been made, and the changes to taxation over the last few years have been piecemeal at best.

Here are some of the reform options for consideration. First, there are improvements in productivity, simplicity and generally also in equity to be gained from a package of reforms which remove special tax exemptions and concessions. This will broaden the tax base, place a similar tax burden on alternative choice options and the revenue gain can be used to fund a lower tax rate.

Broader base and lower rate packages are on offer for labour income, by treating all forms of labour remuneration, including superannuation and fringe benefits, the same as wages and salaries; the GST, by adopting a New Zealand-style comprehensive base and using some of the revenue gain to more directly compensate those on low incomes through lower income tax and higher social security payments; removing accelerated depreciation and other business tax expenditures for a broader business tax base and lower rate; and state payroll and land taxes.

Second, the Henry Review found large differences in the productivity loss effects of different taxes, and recommended changes in the mix of different taxes.

Examples of productivity-enhancing tax mix changes include: replacing the current state royalty or quantity base special tax on minerals with an economic rent base tax; replacing state stamp duties on property transfers and insurance with land taxes and perhaps also a larger GST; shifting the income tax from internationally mobile capital to income earned on immobile land and natural resources, and also labour, noting that labour ultimately gains from more capital per worker and higher real wages. A GST for income tax change, as adopted in the UK and NZ in 2010, is another reform package to raise productivity.

Third, the structure of and levels of additional taxation on motor vehicles, pollution, alcohol and gambling could be redesigned to more directly and effectively correct for market failures and so raise productivity.

On the expenditure side of government budgets, there are many opportunities to increase productivity. Governments have an ongoing stream of changes in technology, work, and management practices available to improve the productivity of government supplied defence, education, health, and other services.

In Australia, there are large potential gains by reducing overlaps, conflicts and the blame game between different levels of government-provided health, education and other services.

Second, much greater productivity is on offer from more formal, public and transparent evaluations in choosing infrastructure projects. The hidden political decisions under the false guise of “confidential business information” associated with, for example, the NBN, Building the Education Revolution (BER) and desalination plants should cease.

Third, the Henry Review, and many others, propose reforms to rationalise and simplify the various instruments of the social security system.

Tomorrow’s budget provides an opportunity for the federal government to lead the way on the productivity agenda by outlining significant reforms to taxation and expenditure. A commitment to increasing productivity growth is fundamental to ensuring Australia’s future economic prosperity.

John Freebairn does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.