Why are we discussing tax reform again, and what really are the priority issues?
The Federal Government has released a wide-ranging discussion paper on the Australian tax system, yet Australia has been reforming its tax system for the past 35 years.
The last major reform in 2000 – then called the New Tax System – included the introduction of the Goods and Services Tax (GST). For several years afterwards, the tax system looked efficient, robust, and fair, and met the Government’s wider policy objectives.
So what gets us to this point of reassessment again?
Australia’s tax reforms have had one key theme. They have broadened tax bases so as to lower tax rates. This is true for taxes both on income and expenditure
This theme has three main purposes.
First, maintaining tax revenues often requires base broadening because economic activity shifts over time from higher to lower taxed activity, reducing the revenue robustness of the system.
Second, broader bases and lower rates reduce economic distortions and so are more economically efficient.
Third, without adjustment the fairness of taxes declines over time as some taxpayers learn to exploit any rate and base margins in the system.
Over the past 15 years, while the new tax system largely stood still, social and economic change has continued. This has meant that pressure for tax reform has rebuilt for each of its three main purposes.
The most significant developments have been:
- Overall revenue robustness has fallen. As a share of national economic output, the tax system is collecting less now than in the several years after 2000.
- The consumption tax share of revenues has fallen. The GST share has fallen because households save more than previously and because consumption patterns have shifted towards exempt items like education, health and overseas purchases. Fuel taxes have not been maintained in real terms, consumption shares of excised products has fallen and import taxes have been reduced as part of trade reform.
- Fairness of saving and investment taxes has been challenged as more taxpayers exploit the margins. Concerns regarding the cost and distribution of the concessions for capital gains and superannuation, and to some extent the interface between company and personal tax systems, has increased.
These developments are already entrenched and have very little to do with broader fears about the future. They are not much about the globalising economy or about the future intergenerational health and ageing agenda.
The fact is that there has been little change in the openness of the Australian economy over the last 15 years and there will be relatively little impact of intergenerational change over the next 15.
The main issues we face now are really more basic ones of getting the right calibration of policy to stay on our generally good economic track.
The aggregate revenue task and the decline in consumption taxes point to much the same response.
The decline in Commonwealth indirect tax collections as a share of gross domestic product (GDP) translates to around $20 billion per year. If we do nothing, this gap eventually will be met by increasing personal income tax mainly on wages, through ongoing bracket creep.
Key issue number one, then, is whether to restore indirect taxes instead, through base broadening and perhaps some rate increases.
There is also within this an issue of timing and the relationship with fiscal policy – should restoring indirect tax revenues contribute to budget repair or should it wait and be applied only to future personal tax cuts? The answer to this goes beyond considerations of tax reform alone.
The third emerging problem, addressing increased exploitation of the tax margins, provides both challenges and opportunities in the crafting of tax reform packages. Many of the key margins relate to the taxation of different forms of saving and investment.
The challenge in this area is that saving and investment are vital to Australia’s long term social and economic future.
Australia has built a very strong society and economy, often with innovative policy in areas like occupational superannuation, means testing of age pensions and dividend imputation. Policies have also supported home ownership and competitive business and markets.
At the same time, the exploitation of tax features in these areas mainly benefits those on higher incomes who have the greatest capacity for saving and investment.
So key issue number two, then, is whether and how to adjust the tax margins in areas related to savings and investment to preserve growth while reducing undue exploitation. In essence, while the fundamental provisions should continue, some adjustments could contribute to maintaining revenue, increasing investment efficiency and fairness.
Particular issues have already been canvassed in studies like the Henry Tax Review, including:
- Whether the capital gains tax discount should be reduced, or perhaps abolished in the case of superannuation funds already taxed at concessional rates.
- Whether superannuation concessions should be scaled back especially for those on high incomes and superannuation access better targeted to retirement purposes.
- Whether any reductions in company tax rates should be funded by other or broader business or investment tax bases.
Australia has a broadly effective tax system, and it was calibrated to closely match fiscal and other public policy objectives in the several years after 2000.
It is not now quite as closely matching those objectives and if we could agree on that, we could reasonably proceed to make the updates necessary to restore key performance levels.
Of course, some will want to pursue other objectives, and that will bring greater controversy and risk. But I suggest the priority now is just to get back onto the previously established performance track.
To do that the priorities are: first, to steadily restore aggregate revenues as a share of GDP; second, to do this mainly through restoring the post-2000 indirect tax share; and third to maintain both fairness and ongoing revenues by moderately scaling back tax concessions to capital gains and superannuation.
Greg Smith was a member of the Henry Future Tax System Review Panel. He has also been head of the Treasury Tax Policy and Financial Institution Divisions and of Treasury Budget and Revenue Groups. This article was first published by CEDA.