We are once again flirting with using inflation as a backdoor tax |
Australia is again wrestling with familiar problems: stubbornly high inflation, net public debt approaching $1 trillion, and fresh demands for sharply higher defence spending driven by tensions in the Middle East. We are not yet in the crisis conditions of the mid-1970s, but the warning lights are flashing. Budget management and inflation control must once more be at the centre of economic policy.
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The trouble is that successive governments have boxed themselves in. They have locked in expensive, and in some cases unsustainable, tax and spending commitments. The system leans too heavily on personal income tax from working-age Australians, even as welfare payments to that same group have grown rapidly. With few politically palatable options for new taxes, the temptation is to let inflation quietly do the heavy lifting.
Economists have long known that inflation can serve as a convenient, undeclared tax. It erodes the real value of public debt and boosts income tax collections through bracket creep, as wage rises push workers into higher tax brackets without any new legislation. Recently, I was disturbed to hear that a former Treasury colleague, later a Reserve Bank governor, sees little problem in removing inflation protection from capital gains tax (CGT). That would be another form of stealth taxation, and history tells us where that road can lead.
My late friend, journalist Max Walsh, always urged me to study history closely before offering policy advice. The period 1973-75 offers particularly stark lessons. At that time, I advised the Mathews committee on inflation and taxation and later assisted Trevor Swan and Nugget Coombs in preparing budget options for the Whitlam government's "gang of three" - Gough Whitlam, Frank Crean and Bill Hayden - for the 1975 budget.
The context then was dire. Over the preceding three years, inflation had reached nearly 42 per cent. The effective marginal tax rate on the average worker was close to 50 per cent. Bracket creep had turned a progressive income tax into a blunt revenue bludgeon. Ordinary wage earners were being pushed into tax brackets once reserved for the very well-off.
Sir Frederick Wheeler, then secretary to the Treasury, moved me out of Treasury to work with Professor Swan and a small team of outsiders precisely because the system was breaking down. We needed a fundamental shift.
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The data that finally cut through came from the Australian Taxation Office, assembled by Charles Rennie. It showed that inflation-induced bracket creep had driven the average worker's tax burden above what it had been at the height of the Second World War. That comparison was politically explosive. It helped convince the prime minister that the tax system had become not only unfair but economically destructive.
The 1975 budget was crafted within very tight constraints, but it tackled some of these problems head-on. It took meaningful steps to ease bracket creep and, importantly, introduced a sole parent rebate for the first time - an early, targeted recognition of changing family structures and poverty risks.
At the same time, the budget closed a major loophole and made several other structural changes. The distributional impacts were blunt but transparent: around 2.8 million taxpayers were expected to be worse off, while about 2.2 million were better off. Crucially, around half a million low-income taxpayers were removed from the tax net altogether. For many of them, the cost of collecting the tax had exceeded the revenue raised.
The institutional reaction is instructive. Treasury, represented by John Stone, vehemently opposed the package. By contrast, tax commissioner Ted Cain strongly supported it. From his vantage point, the reforms simplified the system and relieved many low-income Australians of an unreasonable and inefficient burden. His practical view - that a tax system should be fair, efficient and administratively sensible - stood in sharp contrast to the rigidity within Treasury.
Why does this history matter now?
Because we are once again flirting with using inflation as a backdoor tax. Allowing bracket creep to run unchecked, or stripping inflation protection from CGT, shifts more of the burden onto workers and savers without an open political debate. It is easier for governments, but it is corrosive to trust. People feel squeezed, and they are right to feel that way.
Australia's current challenges - rising defence needs, high public debt, demographic pressures and an over-reliance on personal income tax - do require difficult choices. But those choices should be made transparently. If we need more revenue, governments should say so and legislate for it. If we want to tax capital gains more heavily, we should do it honestly, not by pretending that inflationary paper gains are the same as real income.
The experience of 1973-75 shows that letting inflation do the political work of tax increases is ultimately self-defeating. It can push average workers to breaking point, distort behaviour, and force hurried, crisis-driven reforms instead of considered, orderly change.
We should instead be pursuing explicit, well-designed reforms that broaden the tax base, reduce our dependence on ever-higher income taxes, and protect genuine savings from inflation. That might include a more coherent approach to consumption taxes, more efficient treatment of housing and superannuation, and a serious look at wasteful or poorly targeted spending.
What we cannot afford is to repeat the mistake of relying on stealth taxes dressed up as economic inevitability. The mid-1970s are not just an historical curiosity. They are a cautionary tale - and a reminder that the easiest fiscal options can prove the most damaging.
Daryl Dixon is a finance and superannuation expert who has advised governments in Australia and internationally on taxation issues and monetary policy.
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