Incoming Productivity Commission Danielle Wood head says tax system needs urgent overhaul

Ms Wood, who will start as commission chair on November 13, told a forum at Melbourne University that tax revenue was failing to keep pace with the rise in government spending and needed to increase.

The shortfall has been estimated at around $12 billion a year, but Ms Wood said this was an underestimate given "persistently optimistic assumptions around containing spending growth".

The economist, who currently leads the Grattan Institute think tank, said part of the solution was to grow the economy, which was something "I look forward to pursuing ... in a big way when I join the Productivity Commission".

But she said this alone would not be enough to close the budget gap, which would also require cutting spending and boosting revenue.

Ms Wood's warning coincided with the release of a Parliamentary Budget Office assessment showing that federal and state budget balances have improved in the past year.

But net national debt (which includes by federal and state government debt) remains "on an upward trajectory" and will reach 37 per cent of gross domestic product by 2026-27. Higher interest rates, meanwhile, have increased the size of repayments on that debt from $35.5 billion this financial year to $48.1 billion in 2026-27.

On a per capita basis, net debt is lowest in the ACT (at less than $7000) and highest in the Northern Territory (close to $30,000).

In almost all scenarios modelled by the PBO, the national debt to GDP ratio trends downwards, suggesting the country's fiscal position is likely to be sustainable.

However, Ms Wood is urging tax reform and has criticised calls to improve the Commonwealth's financial position by cutting the public service or cracking down on so-called welfare cheats, describing both as "largely illusory" solutions that would not deliver anywhere near enough savings.

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She also attacked the idea that taxes should not increase, which could "only be regarded as credible and intellectually honest if it comes with a complementary list of very sizeable cuts to major spending programs".

The economist said the current tax system was complex and riddled with inefficiencies and inequities that tended to favour the older and better off.

Ms Woods warning followed a call by former top public servant Mike Keating for a "full-scale" revenue review amid estimates the tax take is on track to be at least $90 billion short of what will be needed in the next decade.

Dr Keating said taxes needed to increase to pay for the government services the public expects.

But the federal government has repeatedly rebuffed calls to scale back the stage three tax cuts and has shown little interest in tax reform beyond the tweaks it has made to reduce tax breaks for high value superannuation accounts, boost the Petroleum Resource Rent Tax take and tighten rules for multinational corporations.

Dr Wood said major reform was needed.

She said reform packages that included compensation for those hit hardest by tax changes were important and suggested a range of improvements including broadening the income tax base, replacing stamp duty with land tax, getting more revenue from resources, aligning the tax treatment of savings and introducing road user charges.

The task of tax reform should not be left solely to politicians and "need a diverse cheer squad" involving community groups, public policy institutions, academics and premiers", Ms Wood added.

The economist said leaving things as they were was not an option, warning that "over the coming decade the gap between our spending needs and our tax system's capacity to meet them without ever higher taxes on employment income will be stretched to breaking point".

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