Volatility

Volatility is another important factor to consider in the tax mix. Some sources of revenue, just like spending, are more reactive to fluctuations in economic activity. Revenue volatility can be a significant challenge for governments as they try to manage budgets. However, volatility can assist if it functions as an ‘automatic stabiliser’ for the budget and economy, where the tax and transfer system operate to decrease spending (or increase the tax take) during ‘boom’ periods and increase spending (or decrease the tax take) during economic downturns without requiring any direct policy intervention.

For example, during a recession income tax receipts decline as wages and profits fall, and spending on unemployment benefits increase with rises in unemployment, cushioning the financial stress for households and the economy.

The net impact of these automatic responses by the tax and transfer system is the transfer of the debt generated by the downturn from households, which are often poorly placed to manage it, to the government, which has significant capacity to deal with rapidly changing economic circumstances.

The Australian Government has a much larger budget than the states and provides fewer essential services such as hospitals, schools, utilities and emergency services, and therefore is better placed to manage the debt. 

In this context, an effective mix of taxes may be relatively non-volatile taxes levied by the states, together with some taxes levied by the Australian Government which respond promptly and strongly to economic booms and downturns.

For state and local government taxes, land tax and council rates are consistent sources of revenue, while stamp duties are highly volatile and sometimes disconnected to broader economic activity.

The GST is highly responsive to economic activity, being a tax on household spending. Concessions for stable spending items such as some food, health and education enhance the GST’s effectiveness as an automatic stabiliser. The narrower base means that the GST in part acts as a tax on discretionary spending which increases in times of prosperity and decreases in downturns.

Income taxes act as automatic stabilisers, although tax payment systems can slow their impact. In Australia, businesses usually pay tax in regular instalments based on the previous years’ income, such that when income suddenly changes the tax system will take some time to ‘catch up’. While income taxes are somewhat less effective at responding rapidly to economic downturns, bracket creep can act effectively in response to an economy steadily approaching capacity constraints. Bracket creep has also often resulted in significant budget repair in the years following a downturn.