Statutory or Discretionary?
14.47. Given that the income tax schedule should be adjusted more regularly during periods of inflation, the question arises whether the adjustment should be an automatic one based on a formal statutory indexing procedure or merely discretionary.
14.48. The effect of an automatic adjustment mechanism would be to maintain a constant average rate of tax on any given level of real income, and income tax collections in real terms would increase only with increases in real income and the number of taxpayers in the economy. Since the income tax rate schedule is progressive, income tax collections would in these circumstances still rise more rapidly than gross national product, but not to anywhere near the same extent as would be the case if no automatic adjustments were made. On the assumption that expenditure commitments and corresponding revenue requirements of the government are determined in the light of factors other than growth in revenue, a government that permitted rates of income tax to be adjusted automatically to offset the effect of inflation could more frequently expect to face situations where the anticipated growth in revenue was insufficient to finance the desired level of expenditures.
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14.49. In a regime of statutory tax adjustments, a government that was unwilling to introduce discretionary increases in income tax rates would have to meet a short-fall of revenue by cutting back on expenditure. Some of the proponents of the statutory adjustment see the possibility of such an outcome as one of the strongest arguments for automatic procedures. They argue, in effect, that because inflation causes an automatic increase in revenue so long as rates are unaltered, restraints upon the disproportionate growth of government expenditure are diminished, financial discipline is relaxed and the public sector is encouraged to grow too fast. The implicit assumption here is that government and the electorate are insufficiently aware of the alternative possibility of reducing tax rates and in some way fail correctly to estimate the relative attractions to the community of lowering taxes or increasing real expenditure. While it must certainly be agreed that in a complex dynamic economy with a large public sector and many social services, wise choices between the ever-changing options are difficult to make, there nevertheless appears to be a growing awareness throughout the community that the option of lowering taxes does in fact exist and can be made effective through political pressure on the government.
14.50. A formal indexation of income tax scales might be a convenient administrative device if government spending in money terms were rising at the same rate as total national expenditure. In such a situation the automatic tendency of average rates of tax to increase with rising incomes would require regular tax cuts to obviate excessive budget surpluses of a deflationary kind, and the indexation would do much to ensure these cuts being automatically achieved. Even then there would be some complications in finding a statutory formula that took account of other taxes whose yields would be changing in other ways, and more in finding an appropriate index for the purpose.
14.51. Reality, however, is less stable than the conditions just assumed. As noted in Chapters 1 and 2, the share of the government sector in the national economy has been rising in recent years, and this trend may well continue. Hence even if the initial pattern of the rate structure were accepted as fair, and to be preserved, indexation of income tax rates would not simplify the government's decision-making process. It would do little more than make annual decisions about the mode in which additional finance was to be collected more difficult to explain. The new rates would appear as adjustments to what they would otherwise have been rather than to what they had been the year before. Such a measure might also have a confusing effect upon public opinion if, in line with the Committee's general approach, taxation of goods and services were increasing and the income tax scale being separately adjusted for this also.
14.52. The Committee is not persuaded of the need for statutory indexing: unless preceded by restructuring of rates
along the lines suggested earlier in this chapter, it would only serve to perpetuate the unsatisfactory features of
the present rate schedule. The Committee accepts, however, that in a period of inflation the rate schedule requires
more frequent adjustment. As an aid to regular review and informed debate, it would recommend that a statement be
attached to the Budget Papers each year showing how the rate structure would appear in the current year were rates to
be fully indexed for changes in the price level over the previous year. There would, of course, be problems in
choosing an appropriate price index and of deciding whether or not to allow for the effects on the index of changes in
rates of indirect tax. In the absence of
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any new official index, the present consumer price index might
have to be employed— preferably, the Committee would think, with the effects of discretionary changes in indirect
taxes removed.