As Joe Hockey prepares to release the MYEFO, we should move away from short-term political promises and look to how the restructuring of Federation and our tax system can really "fix the budget", writes John Hewson.

As Joe Hockey promises to release the Mid-Year Economic and Fiscal Outlook (MYEFO) this week it is imperative to face some basic realities.

The discussion needs to be elevated above the facile and futile games played by both sides of politics in recent years that concentrated on undeliverable, short-term, political promises about when the budget would be returned to surplus.

This is especially so given the weakness of our economy, as it struggles to make a transition from a resources boom to whatever, against a very difficult global environment that promises a particularly volatile 2015, as both challenging economic and geo-political forces play out.

The origins of the current and prospective budget challenges go back to the Howard years, and were compounded by both expenditure and tax commitments made by both sides of politics in the run-up to the last election. These have been compounded further by poor economic forecasting, and the hostilities in the Senate.

Howard/Costello enjoyed several years of unexpectedly strong revenue growth that (as Treasury data has confirmed), essentially, they spent. For example, the bulk of the recent deficits would disappear if Howard/Costello (confirmed by Rudd) hadn't given the tax cuts.

Both sides of politics made huge, mostly unfunded, expenditure commitments in the run-up to the last election, which will compound over the next 10 years, in areas such as school reform, disability care and infrastructure, while also promising to avoid serious cuts in health, education and pensions.

They also foreshadowed lower personal and business taxes, all while also promising to "fix the budget - deficits and debt".

Clearly, this simply doesn't add up!

Treasury has also struggled to forecast our economy, with revenue estimates, in particular, under shooting in the Howard years, and then over shooting in more recent years.

All this is now compounded by the fact that Joe Hockey and the Abbott Government burnt a considerable amount of political capital with its first budget that, despite pre-budget assurances to the contrary, was particularly inequitable, and poorly explained.

The explanations failed at two levels. First, individual decisions, such as the Medicare co-payment and uni fees, were announced without an overarching health or education policy, against which the electorate could hope to understand and assess them.

Second, and importantly, the Government failed to provide an overarching narrative that could explain their budget strategy, and how it fitted into their overall policy framework.

In large measure, they don't have such a framework. They got away at the last election with mere "dot points" that they called policies - stop the boats, fix the budget, create two million jobs etc - enmeshed in a host of ad hoc "promises" or "commitments", mostly delivered to various audiences, interest groups, or in response to media questions, as they were confronted during the campaign.

It should not be surprising that it doesn't add up or hang together.

So, where to from here? I would suggest that they need to start with the overarching strategy. Say, commit to a 10-year target to double national productivity, and then seek to pull together the economic, industry and social policy reforms that will be required to get there. The restructuring of our Federation and tax, the reforms to education and training, industrial relations, industry policy, our financial system and infrastructure, along with strategies to develop technology, innovation and science, all against the challenge and opportunities of an adequate response to climate change, and so on.

In this context, the structure of the budget remains very important. In the near term, our economy can't withstand further negative growth from the public sector. In the medium term, a realistic restructuring of our Federation should see substantial expenditure savings by eliminating duplication between the Commonwealth and the states.

This will call for a decisive shift in the allocation of responsibilities, and a willingness to scale down, if not close, departments at one level of government.

For example, as with Canada, perhaps we could pass responsibility for all education to the states, thereby effectively closing the federal department except, perhaps, for setting and monitoring national standards. We could also do away with a federal minister for education.

Similarly, there are some functions that are truly national, such as the environment and industrial relations, and a host of transport and other regulations.

The basic point is that, ultimately, any reform will need to be a deal between the Commonwealth and the states, with both sides willing to compromise in the national interest.

Once the expenditure side is agreed, the emphasis will turn to the most effective way to fund the agreed division of responsibilities and service delivery. Hence, on the nature and detail of essential tax reform.

The basic reality here is that, with the existing revenue base likely to remain subdued for many years to come, and given the commitments made by both sides in relation to new spending programs, and certain taxes, spanning over the next 10 years or so, the overall burden of taxation will need to be increased in the medium term.

This should see a very detailed stocktake and assessment of taxation at all levels of government, again calling for some quite decisive shifts in taxing powers and in the structure of our overall tax system.

While some state taxes, such as stamp and insurance duties, should be scrapped as part of any reform, other state taxes, such as land and payroll, where the states have worked, by competing, to reduce their effectiveness, could be quite effective if set and administered nationally.

However, given political commitments by both sides to further lower business and personal tax, most attention will need to be on the main tax expenditures - in housing, superannuation and the GST - where the big tax concessions lie, and where the inequities are most pronounced.

Consider superannuation tax concessions as an example. In total, they cost the budget some $40 billion annually, not too different from the cost of the aged pension, but rising faster. They are also distributed extremely unfairly as revealed here.

Share of total superannuation tax concessions by income decile. ( Source: Treasury, based on an analysis of 2011–12 Australian Taxation Office data )

Those at the bottom of the income scales actually have to pay to get a superannuation benefit, while those at the top enjoy almost obscene benefits. For example, somebody earning $20,000 has to pay about $118 to get a $100 benefit, while somebody earning $250,000 pays only about $62.50.

The GST is presently only applied to about 60 per cent of expenditure and at 10 per cent raises about $55 billion. To apply it across the board to all expenditure would probably raise about $80-90 billion (allowing for behavioural responses), and about twice that if (say) doubled. I am not advocating such a shift, simply wishing to provide some orders of magnitude.

Clearly, all options should be identified and debated publicly. The GST offers the capacity to compensate those most disadvantaged from any changes, as well as fund some of the desired/committed spending programs, abolish some ineffective/distortionary taxes, lower others, and address distribution issues between the states.

Finally, it would be desirable to consider splitting infrastructure spending and financing from the annual budget, both state and federal. The Commonwealth could beef up Infrastructure Australia, making it responsible for analysing and ranking all significant national infrastructure projects much more transparently than it does at present, against well established, accepted and published financial assessment principles.

The financing could be by way of a new, government-guaranteed, 30-50 year infrastructure bond at an attractive coupon rate. These funds would need to be collected and managed outside government, probably by way of a Future Fund type structure, with an independent board and management, on a fully transparent and accountable basis.

This fund could then work to provide debt and/or equity funding to projects of national significance, co-financing in both equity and debt terms with the private sector and banks, wherever possible.

These bonds would be most attractive, given our national AAA rated safe haven status, to sovereign wealth funds, central banks and governments, pension and superannuation funds, both globally and domestically.

Of course, our political leaders would have rise above their simplistic political notions that "all debt is bad", but it would allow them to make their infrastructure preferences publicly known, to be addressed by Infrastructure Australia and the proposed fund.

It seems to me that with so much of our social, transport and economic infrastructure deficient or in decline, this sort of approach is the most effective and constructive way to meet our infrastructure needs, and to give somebody a real hope of being "The Infrastructure Prime Minister".

Overall, given the likely magnitude and significance of the required changes to the structure of our Federation and taxation it may be preferable to have the Government break the total reform package into "bite sized chunks" by way of a series of propositions to be placed before the electorate, at successive elections over, say, the next 10 years.

John Hewson is Professor in the Crawford School ANU and former leader of the Liberal Party and the federal opposition. View his full profile here.