The Productivity Commission expects the gap between fuel excise revenue and road use will continue to widen (even with indexation from 2015). Source: Productivity Commission

There’s a lot to take issue with in the Abbott government’s first budget but I was delighted, after having been away for a few weeks, to find on my return that the government has found a way to implement its proposal to restore indexation of the fuel excise.

The Government will implement indexation by regulation, although this mechanism will require the endorsement of Parliament within 12 months.

I was disappointed though to see that both Labor and the Greens continue to oppose indexation and hence to support what is in effect a continuous lowering of the tax on petrol and diesel.

I’ve written about this before (e.g. Shouldn’t the Greens and Labor be supporting indexation of the fuel excise?), but it’s worth reviewing the reasons why restoring indexation is good policy.

First, contrary to the claim of Labor and the Greens, it’s not a “new tax”. As the word suggests, ‘indexation’ is essentially an administrative tool that merely maintains the real value of an existing tax. It halts the continuing erosion of the 85 year old excise by inflation; that’s been going on ever since John Howard abolished indexation in 2001. At that time the excise made up around 40% of the price of a litre; by 2014 it had declined to about 25%. (1)

Second, the Productivity Commission estimates that, since 2000-01, net revenue from fuel excise has fallen by about 30 per cent in real terms, largely due to abolition of indexation. Over the same period, road use (total kilometres travelled) has grown by about 25 per cent, and the unit cost of road construction and maintenance by over 40 per cent.

Third, by halting the current real reduction in the excise, indexation claws back some of the currently unpaid social costs of driving. Over time, it helps give motorists an incentive to make fewer journeys and shorter trips, as well as shift to more fuel-efficient vehicles. It helps encourage mode shift by making alternative modes like public transport, walking and cycling more attractive relative to driving.

Fourth, it generates significant additional revenue for public purposes ($2.2 billion over the next four years) that will be available for this and future governments. The Abbott government is promising that only the extra revenue from indexation will be hypothecated to roads (but not the much larger revenue stream from the base 38.1 cents per litre) but that’s misleading because the Government hasn’t committed to using it to fund any additional expenditure on roads.

Hence Greens’ leader Christine Milne’s objection to indexation because of the hypothecation provision is a non-issue. Yet on Sunday, Insiders’ panellist Phillip Coory reported that Ms Milne continues to reject indexation even though the Government offered to remove the proposed hypothecation provision.

Fifth, the equity effects of indexation are not a deal-breaker. It’s true that it will hit lower income travellers the hardest, just as indexation of public transport fares does. That’s true of any increase in consumption taxex, or any price increase for that matter.

The equity impact of individual policies shouldn’t be judged solely in isolation; the overall equity effect of the entire tax-transfer system is what needs to be considered. But even on a narrow view, there’s a number of other points that need to be taken in to account.

  • Equity concerns relate primarily to the level of the excise on petrol (38.1 cents per litre at present); the current initiative relates only to maintaining that level in real terms. Neither Labor nor the Greens oppose the concept of taxing petrol; they don’t oppose the level of the tax either.
  • Taxes on motor fuel are already extraordinarily low in Australia compared to other OECD countries.
  • Just as the fuel excise will increase by CPI, so too will the incomes of motorists. Salaries, wages, pensions and transfer payments will generally increase at, or in many cases above, the CPI.
  • Lower income drivers can be protected from income effects just as eligible public transport travellers are protected by concession fares. The Grattan Institute says the poorest 20% of households could be compensated for indexation of the fuel excise if just 8% of the additional revenue raised were returned to them through the tax-transfer system.

Indexation is as obviously sensible today as it was when Bob Hawke introduced it in 1983. As Richard Dennis has explained, it was also sensible on those occasions in the recent past when the Greens called for its reintroduction.

Back in 2006, the Greens included the abolition of fuel tax indexation on their list of the top ten budget mistakes made by John Howard. Indeed, they rated it number 1. In 2006, they also called for the reintroduction of fuel tax indexation to fund a climate disaster fund. And in 2010, they had the reintroduction costed by the Parliamentary Budget Office (PBO) as part of their election platform.

Labor and the Greens should send a signal to the electorate that essentially administrative policies like indexation should be above political opportunism.

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  1. In order to hose down public displeasure at the additional cost imposed by the GST, John Howard reduced the fuel excise by 1.5 cents per litre in 2001 and abolished indexation.