Embrace the 'losers'

With the Federal Budget fast approaching, coupled with the public's perception that low interest rates and the COVID-19 pandemic means that governments have a licence to do things differently, I am continually being asked 'What should be done in the Budget?"

I think we should address the biggest barrier to reform - fear of losers.

The growth of social media, coupled with the vehemence of tabloid press, means that any mooted reform that creates a 'loser' will see a campaign run against that reform, even if the reform would create a net benefit for the community as a whole. The result is either no reform, or reform bastardised so that the real benefits are watered down, delayed or dismissed.

This comes up time and again, but possibly the two most prominent examples are:

• tax reform, where there is an expectation that every household in the lowest two quintiles (or maybe even more) should be no worse off as a result of any reform, and similarly for other major lobby groups such as self-funded retirees. Indeed, tax reform demonstrates an even broader form of 'loser' - the 'relative loser'. The angst created by any reform that provides a benefit to higher income earners (e.g addressing bracket creep whereby a smaller and smaller percentage of higher income earners pay an ever increasing portion of personal income tax) shows that each reform cannot make some better off (because there is always the perception that it is at the cost of others).
• reform of school funding intended to improve equity outcomes. As an example, the Queensland Audit Office noted that, "the Queensland Government’s commitment that no school will receive less funding using the revised ... model detracts from the purpose and needs-based intention of the model. Top-up payments to enable schools to be ‘no worse off’ can erode the intended equity principles of a needs-based funding approach”.

In a rational world we should acknowledge that sometimes reform for the greater good will have some stakeholders that are worse off. Politics and the pressure of social media and tabloid campaigns makes this a challenging test of leadership that successive Australian governments have not managed to overcome across a range of tricky policy areas.

So what we have seen across a range of policy areas is the concept that 'no one will be worse off' and that compensation should be provided to ensure this outcome. This language has the overture of there being a proprietary right to forever have the current arrangements.

The challenge with compensation and the 'no worse off' test is that some of the reforms are so large that compensation is not practical to make the reform self-funding, even though there may be broader economic benefits (e.g. comprehensive tax reform). This is particularly challenging when the government approach to costing reforms only looks at first-round impacts (i.e. not the broader economy-wide impacts of reform). Under this approach it is not surprising that reform is not supported; only part of the impact is being calculated.

Additionally, compensation is made more difficult because, as behavioural economics shows us, people fear losses more than they value gains. So if someone loses $10 from a reform they will need more than $10 in compensation for them to feel that they are no worse off.

While not intended, over-compensation is a not unheard of outcome from reform processes. We saw this with:

• the Howard Government's GST reform package that 'compensated' states and territories for the future loss of various indirect taxes, some of which did not end up being removed in some states
• the Gillard Government's 2013 proposal to introduce a fixed price on carbon dioxide emissions; generous compensation for the less well off that was paid even though the carbon price itself was not introduced (i.e the compensation led the loss, even though the loss never eventuated).

Unfortunately, compensation that over-compensates the perceived 'loss' can create new (or embed old) inequities.

On one level, we need to face up to the fact that there will be some reforms where there will be losers. Certainly, disruption should be minimised, and equity arguments need to be at the fore of a reform's design, but not every reform can be, or even should be, on the basis of everyone being no worse off.

But maybe now is the time to think different.

There is a public acceptance that COVID-19 disrupted the economy and governments needed to spend to provide the stimulus for the 'bridge to recovery'. But as we near the other side of the bridge, maybe we should instead be providing stimulus for the reforms we need to have sustainable post-pandemic economic growth.

If we are still looking to stimulate the economy, maybe [said with gritted teeth] we should be looking to 'buy' needed reforms. That is, let's do the hard yards, for example, on tax reform, with compensation for the immediate losers paid to grease the wheels of reform for longer term community benefits.

What could this reform look like? At the Commonwealth level, maybe we should see compensation to support:

• the removal of exemptions on a range of areas (e.g. GST, payroll, stamp duties, tax deductions, etc) with accordingly lower personal and corporate income taxes
• all States and Territories to transition to an annual land tax and abolish stamp duty on a timeframe that brings forward the benefits from the never-never
• the abolition of all tariffs and adjustment of those taxes that are least distortive to future economic activity (e.g. the GST)
• reform of retirement income arrangements (i.e superannuation and the age pension).

Maybe this can be done in a more thoughtful way than simply paying out cash to the currently disaffected; could we consider a protected sovereign wealth fund to top up affected cohorts over a number of years rather than a windfall for just the current 'losers'.

While I fear that I am giving in to a poor principle, maybe we just need to acknowledge that COVID-19 and our current environment means that we should think differently. If we are going to spend to further stimulate the economy then let's be sure we come out with a more productive and growth-oriented economy - let's embrace the 'losers' to get real reform done.

Thanks to Martin Stokie and Craig Fenton for thoughtful challenges and extensions to this article.