Treasurer Joe Hockey was slammed by commentators earlier this week for getting his facts wrong on income tax. But was the incident an error or a calculated ploy?

To recap, Mr Hockey told 3AW’s Neil Mitchell:

When Australians spend the first six months of the year working for the government with tax rates nearly 50 cents in the dollar, it’s a disincentive [to work].

You’re working July, August, September, October, November, December just for the government and then you start working for yourself … We’ve got to bear in mind that bracket creep is going to take middle-income Australians into the second-highest tax bracket over the next few years, which is a disincentive for people to work.

This statement was picked apart by numerous commentators, such as Ben Phillips of the National Centre for Social and Economic Modelling (NATSEM), because nobody in Australia hands over 50 per cent of their earnings to the ATO.

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Without repeating all of Mr Phillips’ arguments (read it in full here), it’s enough to note that even the top three per cent of high-income earners pay an average tax rate of 32 per cent – and that’s before numerous tax minimisation strategies, such as negative gearing of property investments and superannuation tax concessions, are brought into the picture.

Median wage earners pay about 19 per cent in income tax. So rather than working “July, August, September, October, November, December”, as Mr Hockey suggested, the median wage earner was done “working for the government” on September 7.

The PM with Joe Hockey. Photo: Getty

So why would the Treasurer make such an outlandish statement? Certainly not because he can’t tell the difference between marginal tax rates and average tax rates.

No, this was a political move aimed at securing longer-term economic reform.

And there was nothing ‘sloppy’ about the comment in political terms. It is the kind of idea that is circulated on social media by people who wish that the public sector, and the tax base funding it, were smaller.

That’s a legitimate wish, but anyone spreading around Mr Hockey’s “six months working for the government” meme is also veering away from reality – in the most recent budget papers, federal tax receipts, including GST revenue, were 23.6 per cent of GDP.

Where the small-government brigade have more of a point, however, is when state and local taxes are added into the equation. When that is done, the total tax paid by Australians is around 30 per cent of GDP – higher than the US (27 per cent) and lower than Canada (32 per cent).

Needless to say, the Abbott government wants to see the total tax paid in Australia move towards the US level, and there are three ways to do that.

Firstly, the government can do less, or at least pay for less – and current attempts to scale back Medicare and tertiary education funding fit into this category. The political problems that come with these sorts of cuts are obvious.

Secondly, the federal and state governments can get together and eliminate duplication of services. For example, the Abbott government wants state environment departments to approve major projects rather than both state and federal departments.

Finally, the type of taxes raised can be made more efficient – that is to say, raise the taxes that have a small distorting effect on economic activity, and reduce the taxes that create bigger distortions.

Joe Hockey feels the heat on budget night, 2014. Photo: AAP

And this is where Mr Hockey’s income-tax bogey-man routine comes in. He wants voters to be worried about income tax, because economists generally agree that it is a distorting tax. It really does create a disincentive to work, especially for some of the more highly skilled (and therefore highly paid) employees, and for women re-entering the workforce.

Oh, and by cutting marginal tax rates Mr Hockey would drum up badly-needed votes at the next election.

What was largely missed by Mr Hockey’s critics earlier this week is what the “six months working for the government” brain-snap was designed to do.

It is laying the groundwork for the government’s tax reform white paper later in the year, and building support for the idea that taxes other than income tax should do more of the revenue-raising work.

But what other taxes will there be? Economists usually rank a broad-based land tax as the most efficient way to raise money, but that is difficult in a nation addicted to housing-boom speculation.

Second on their list of efficient taxes is a value-added tax – in Australia’s case the 10 per cent GST, which is low by global standards.

As the Commission of Audit pointed out last year: “Australia rates 29th lowest out of 33 OECD countries in terms of rate of value-added-tax levied. In the period since Australia introduced its GST in 2000, 20 OECD countries have increased their value-added-tax rate.”

And yet the Coalition continues to play down the idea of a GST hike – or even broadening it to take in things such as basic foods and educational supplies.

What then, is Mr Hockey softening us up for?

A major clue is to be found in the “$80 billion” in cuts to health and education sprung upon the nation in last May’s budget.

That $80 billion figure, which Labor says has been “ripped” from budgets over the next 10 years, is highly debatable (as the ABC’s Factcheck showed). However, it is certainly true that the Abbott government is reducing the projected levels of funding it will provide to states to deliver these services.

But if it won’t raise more GST to give back to the states to address this shortfall, how will they raise the money? Existing state taxes such as payroll tax and stamp duty are grossly inefficient, and would be very difficult politically to increase.

Audit Commission Chairman Tony Shepherd. Photo: AAP

As it happens, the Commission of Audit made one recommendation that may just explain Mr Hockey’s outburst.

It recommended giving a chunk of income tax revenue back to each state that raised it.

The Commission of Audit dubbed this chunk of money the “state surcharge”, and the idea is that by giving each state the money it needs to cover the costs of education and health, voters will know who to blame when services are not delivered well.

Under the present system, various Commonwealth grants can be misspent by the states, resulting in slanging matches between the federal and state governments – the well-known ‘blame game’.

Besides eliminating the blame game, the idea is supposed to give state governments the scope to raise or lower the “state surcharge” as economic conditions dictate.

For example, a few years ago Western Australia was raking in large volumes of royalties on iron ore. During those years, if it had been given a 10 per cent slice of the WA income tax receipts collected by Canberra, the state government could have cut the state surcharge to nine percentage points.

Conversely, the current WA government, which has watched royalty revenues plummet, could increase the state surcharge back to 10 per cent to balance the books.

While that might sound like political suicide, it at least shifts the state’s revenue/expenditure arguments to where they really belong – in WA.

Back in Canberra, Mr Hockey would achieve a number of goals all at once.

• The funding shortfalls set in motion at the May budget would be at least partially addressed

• Federal marginal tax rates would be cut (by re-labelling a chunk of income tax as ‘state surcharge’)

• The blame game would be somewhat diminished

• Some duplication would be removed from federal/state relations

The only thing it would not achieve is replacing an inefficient tax (income tax) with a more efficient one (a higher GST).

The latter is the kind of reform that a Howard-Costello or even a Hawke-Keating government might have attempted.

For the Abbott-Hockey government, shifting income tax around a bit might be all its diminished political capital will allow.