In an unusual move, Mission Australia and the Business Council of Australia recently co-authored a piece calling for a mature and open conversation about tax reform.
They join a chorus of voices, from the Grattan Institute, to the CEO of PwC, to Saul Eslake, all concerned about structural problems with our taxation system. Government revenues are in trouble, in part, because of the looming end of two great economic booms.
We’re all familiar with the tale of the squandered mining boom but a less familiar narrative is that of the squandered baby boom. Baby boomers are now starting to hit retirement age, striking fear into treasury and health bureaucrats worried about the spiralling costs of health-care and age pensions combined with falling tax receipts.
While increased life expectancy contributes to population ageing, the primary cause in the 20th century was falling fertility rates (number of births per woman). This is important in understanding the boom. An increase in the proportion of the population that is retired (old-age dependents) occurs as a result of a decrease in the proportion of the population that are under working age (child dependents). However, there is a lag between the two which means we have an economic sweet spot that is referred to as the “demographic dividend”, where there are fewer total dependents as a proportion of the population (see the area between the dashed lines in Figure 1).
Figure 1: Dependency ratios in Australia 1950-2050. Data points after 2010 are projections based on an intermediate birth rate scenario. Data compiled from http://esa.un.org/wpp/
This is the economic boom provided by the baby boom generation. The historically low total dependency ratio shown in Figure 1 meant that, for a 25 year period, more money was free to be used for discretionary spending and investment. This helped to propel economic growth and drove up incomes – and the effect was even more pronounced because it happened to coincide with major economic reforms. It also helped set high expectations on what the average Australian could afford to buy and the lifestyle they could afford to lead.
Instead of seeing the coincidence of the height of the mining boom and the baby boom as an opportunity to save for the retirement of the baby boomers and to foster industries to shoulder the burden after the inevitable decline of the mining sector, the Howard government put in place permanent income tax cuts. These were extended under the Rudd government. Now that these temporary booms are both coming to an end, those tax cuts are really starting to bite and it is becoming increasingly difficult to adequately fund the services we’ve come to expect from a modern western economy.
We are not yet entering an unprecedented level of dependency. It will take until about 2035 before we return to the dependency levels seen in the 1960s. However, there is clearly a major shift from young dependents to old-age dependents. If the costs were the same and borne by the same people, there would be no problem. But many changes have occurred. The savings from the reduction in family size have been applied to discretionary consumption, including much higher expenditure per child, so the total cost of raising children has actually increased. Little is left for transfer to expenditure on aged dependents.
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