On the limits of fiscal financing in Australia

Project stage: Working paper

[Working paper] [Brief slides]

Public engagement: https://www.austaxpolicy.com/budget-forum-2022-on-the-limits-of-fiscal-financing-in-australia/ Austaxpolicy: Tax and Transfer Policy Blog, 24 March 2022.

We examine the extent to which the Australian government could finance its pension and other expenditures, and its debt through changes to the tax system. Using a dynamic general equilibrium overlapping generations model with skill heterogeneity and uninsurable labor productivity risk, we simulate various changes to the tax system to estimate Laffer curves of tax revenue against tax rates and other tax parameters.

Our focus is on the peak of the Laffer curves beyond which further changes lead to declining revenues (fiscal limit); and the maximum potential revenue at the peak compared to the status quo (fiscal space).

We analyse the fiscal limit and space for consumption tax rates, company income tax rates and the progressivity and average level of taxation of personal income tax.

Key results:

There is considerable fiscal space in the Australian tax system. Of the taxes we analyzed, income tax generates the highest fiscal space. The fiscal limit is sensitive to capital mobility assumptions. At one end of the spectrum, with perfect capital mobility across borders, the fiscal limit is a flat tax rate of 75%. At the other end, when there is no foreign capital flows (closed economy) the fiscal limit is lower at 50%. This highlights the importance of foreign capital inflows in the context of tax revenue maximization.

On going work

Compiling appendices and finalizing paper.