The Henry Tax Review: A View from Constitutional Political Economy

Begin with a handful of simple propositions. Tax reform is a political exercise. Like any policy, decisions about the tax system are made through ordinary political processes and are victim to ordinary political forces. So while (we) public economists are inclined to think of tax system design as an essentially technical exercise, a little like "dentistry" (as Keynes hoped macro-economic "management" might become), in fact the purely political element is ineluctable and central. Perhaps, given the fate of the super-profits tax recommendation, this observation is hardly news; but public economics (especially in its tax reform advocacy aspect) has not been keen to recognise the fact or to include the political element explicitly in its models. That is one respect in which the "constitutional political economy tradition" associated with James Buchanan and his colleagues (among whom we number ourselves) is somewhat distinctive: in that tradition, public finance and democratic process are fellow-travellers! Tax reform is also a (small c-) constitutional exercise. If we think of the (small c) constitution less in terms of written documents and more as the set of the rules of the game by which a political society operates, then the tax system constitutes an important part of those rules. The tax system sets the frame within which people make their private market decisions (a bit like the property rights structure); and it sets the terms on the basis of which citizens make their collective decisions - specifically, by determining how the costs of public spending (both actual and potential) are shared among different groups of citizens. Both dimensions of this framing are important. Orthodox public economics focuses all its attention on the former; constitutional political economy (CPE henceforth) directs attention to both. One way of putting the point is in terms of a "two margins" approach. One margin deals with the relation within the set of private goods -between say wine and orange juice; or current and future consumption. The other margin involves the choice between public and private expenditures. Politics enters these two domains of choice in slightly different ways. It enters the first because the tax policies that bear on "private-private" margins of choice are politically determined. But the choice itself among private goods is exercised through markets. The private-public margin of choice is, by contrast, directly mediated through politics. Quasi-constitutional elements arise in relation to both dimensions. The political and the constitutional aspects of tax reform are in some tension. From the constitutional viewpoint, politics is part of the problem . But by necessity, politics is - and has fo be - part of the solution . Juggling that paradox is a central feature of any tax reform exercise. Here, basically, we aim to explore, against the background of the Henry Review, something of what that juggling exercise involves. In what follows, we shall seek to expose the political element first by recalling a similar exercise in tax reform in Australia's not-too-distant past. That will occupy us in Remember the alamo! . In The invisible second margin , we shall take up the "two margins" issue and attempt to explain something of what is involved in the contrast. This explanation will also help to clarify one aspect of the "constitutional" status of the tax system. In The case for stability , we shall emphasise another aspect of the tax system's quasi-constitutional status- namely, the general presumption in favour of stability. Tax reform: who needs it? and Non-barking dogs set against that presumption the various possible rationales for tax reform and test their relevance in the current climate. In Tax reform: who needs it? , we consider the Henry Review's apparent rationale and some of its implications. In Non-barking dogs , we consider some other, more or less familiar, arguments that the Henry Review seems to neglect. In System, system, system and Upholding the quasi-constitutional status we examine several aspects of the Henry Tax Reform exercise against the criteria that the CPE approach suggests: first, the "smorgasbord" approach to recommendations that the Review Panel seems to have adopted ( System, system, system ); and second, the choice of the incumbent Secretary of the Treasury as the Chair of the Review Panel ( Upholding the quasi-constitutional status ). Institution-making discusses briefly the Report's recommendations concerning the institutionalisation of tax reform; and Conclusion offers some summary conclusions.