There is no more important issue in Australian taxation reform than replacing current arrangements by efficient mineral rent taxation. That requires large analytic effort and effective political leadership. Success would bring high rewards to the Australian polity, and I expect electoral rewards to the Government that is seen as being responsible for a good outcome.
Editors’ note: The following is an extract from the 132nd Henry George Address by Prof. Ross Garnaut, delivered at the Kelvin Club Melbourne, 7 September 2023. The full transcript, including comments by Professor Garnaut that, if it had not been cancelled under a coalition government, “the Commonwealth government could today be collecting over $70 billion a year from an Emission Trading Scheme” is available to read in full here.
The Henry Review proposals and carbon pricing were both defeated by massive campaigns by vested interests, harnessed by the Commonwealth Opposition of the day led by Tony Abbott. When Abbott won government in 2013, it encouraged vested interests to see investment in the political process as a rewarding path to defeat of proposals for reform in the public interest that challenge their own interests. I myself do not see this as a sound interpretation of what happened in 2013. And if it were, I think that Australians’ commitment to the integrity of our democracy would allow that perspective to be challenged politically.
Mineral rents [account for] more than half the rents in the Australian economy over the past year, and are growing rapidly. I will run through more quickly the other main sources of rents. These others are the main sources of the rise in rents in other countries, and they have been causing the rent share of income outside mining to rise in Australia—more strongly in Australia than in other developed countries.
The network and intellectual property rents of information technology
The new information technology industries draw rents form two sources—networks with characteristics of natural monopolies; and intellectual property protected by patent. They are the source of much of the increase in global rents in the twenty first century. Once established, they are well protected from new competitors by the usual network economies. Once established, they serve new customers at very low marginal costs and with little incremental fixed expenditure. Their sales account for a large and rapidly growing share of expenditure everywhere. They contribute to the low share of investment in expenditure, and through the high rents incomes to the high savings shares of incomes that are contributing to low real interest rates on low-risk debt in competitive markets.
Australia cannot expect to establish a competitive supply of information technology services. The ACCC has identified some measures that can improve the competitive environment, without fundamentally changing the oligopolistic structures, We should do what we can. And Australia can ensure that the public revenue receives a reasonable proportion of the rent generated by sales within Australia. This is best achieved by denying deductions against corporate income as assessed for corporate income or cash flow tax purposes, of payments for imported services that are not associated directly with supply to the Australian taxpayer.
Urban land rents
The increases in land and housing costs in Australia over the past couple of decades have transformed unfavourably the lifetime economic prospects of younger Australians who do not have the support of wealthy relatives. That’s a tragedy. There are two sources of higher house prices. One is the increased rent value of land, that is capitalised in the asset price. The other is the fall in the discount rate—that increases the capital value of a stream of rents. I have already mentioned that interest rates on low-risk debt have fallen to near zero in real terms in the twenty first century, and won’t go further on that in this lecture.
Taxing the rent would reduce the capital value of the asset. It’s worth discussing why the rent value of land has increased, as well as how it should be taxed. The value of land in a good urban location is the difference between the cost of the land on the frontiers of the city—the open fields being subdivided on the way to Ballarat–and the value of the land in good locations.
That differential, which sets the value of land in the attractive areas, is very much affected by the quality of transport and communications. We haven’t invested in transport infrastructure in line with the growth of our population. We are starting to catch up in recent years, but have a long way to go. The new transport infrastructure increases the value of some urban land, while reducing the scarcity or rent value of other property. Taxation on the increases in land values resulting from improvement in transport infrastructure is an important source of public revenue in some of the countries and cities that have managed the transport infrastructure problem best. Changes in urban planning that allow denser housing near the centres of urban employment and the transport nodes will also reduce land scarcity and rents throughout the city.
High population growth from immigration increases the scarcity and rent value of land—especially if it has not been carefully calibrated to expansion of supply of transport and other urban infrastructure. Australia (and New Zealand, Tim, our Chair, reminds me) currently stand out with immigration rates that are extremely high by international and our own historical standards. Immigration brings many benefits for Australians. But the rates since its resumption after COVID have been beyond the capacity of our infrastructure to absorb. It is much of the reason for the extraordinary shortage of housing and increases in land values and rents. Let’s make sure we tax land rents in the public interest, but let’s also think more strategically about the contributions of immigration and underinvestment in transport infrastructure to the increases in land prices.
Standard monopoly and oligopoly is more serious here than elsewhere
So the larger role of mining and higher population growth are two large reasons why the rent share of income has risen more in Australia than elsewhere. A third is that standard monopoly and oligopoly are more serious and have deteriorated more in Australia than elsewhere. The Qantas story that’s become news over the last few weeks is one manifestation of a much more general problem. Increased concentration of banking business is a large problem. Four big banks all putting up their interest rates or putting them down on adjacent days by the same amount. No effective competition. They know how to work together.
I worked with Hawke on the liberalisation of the financial system in the mid-1980s. That was meant to increase competition. It did for a while. The older participants in this meeting will remember the state banks, the building societies, the credit unions that played a large role in accumulating household savings and providing housing loans 40 years ago. The increased concentration in banking has its parallels in many sectors—although not all as extreme as in banking.
Australians have been in denial about increasing oligopoly and the rise of rents. A very good book has just come out by an American academic Phillippon an American academic, discussing how much less effective competition is in the US today than in Europe. Europe has done much better than the US. Amongst other things, the EU has had stronger antitrust laws and enforcement. He says that one of the reasons is that many countries becoming part of the one market disrupted the organisation and effectiveness of national business lobbies that place pressure on the policy-making and enforcement process.
The problem is much greater in Australia than the US, and has probably deteriorated more in recent times. And in America there has at least been much serious analysis and discussion of the problem in recent years. We haven’t done as well in Australia. There have been lonely minds and contributors in discussion in the Henry George Society, in and around the ACCC including through its past senior executives, our few genuinely independent think tanks. But discussion has been at the fringes of policy-making.
There are signs that this is changing. There have been two splendid speeches on the issues over the past month. One was by Andrew Leigh, Minister Assisting The Treasurer on Competition Policy.—a highly reputed Professor of Economics at the ANU before entering Parliament and still a highly productive contributor to Australian economic analysis beyond his official responsibilities. He spoke about the Australian oligopoly problem at the Conference of Economists in Brisbane in July. Drawing on the international literature, amongst other things he draws attention to the ways in which more powerful oligopoly has increased profit margins and placed downward pressure on wages. The second was by Rod Sims, former Chair of the ACCC, a few days ago. He presents data in awful detail on the reduction in numbers of suppliers in many Australian industries, to levels that are inconsistent with effective competition. It is more good news that the Treasurer has just established a review of competition policy, to which Leigh and Sims will contribute in different ways. I made my own contribution to the discussion in the ACCC’s 2023 Bannerman lecture a few months ago.
So while the problem of increasing rents is growing, we are starting to focus on it. Now is the time to focused on the rise of rents, policy to slow or reverse the increase, and taxation reform to secure for the public revenue part of the rents that cannot be removed by sound policy.
Add up all the opportunities for economic reform to reduce economic rents or to tax them efficiently and equitably and you have a transformational economic reform programme to increase productivity and equity. Resource rent taxation. Tax on carbon externalities, Tax on land and housing rent—and urban infrastructure and planning and immigration adjustments to reduce urban land rents. Increased competition.
And to provide an overarching framework for raising revenue from business rents, the replacement of standard corporate income tax with a tax with cash flow as a base.
Cash flow tax
Craig Emerson, Reuben Finighan, Stephen Anthony and I proposed the replacement of the standard corporate income tax by a cash flow tax in a paper in the Australian Economic Review in December 2020. The Cash Flow Tax would be a tax on economic rent. The paper focussed on replacement of the corporate tax, but it actually could be a tax on all business income.
The Cash Flow Tax, or Business Rent Tax, would
–allow immediate deduction of any capital expenditure
–provide a cash credit at the tax rate for negative cash flows.
–deny any deductions for interest or any other payments for financing, and
–deny a deduction for imports of services, unless those imports of services related directly to provision of the service within Australia.
The paper proposes various practical details and costings, and suggests transitional arrangements.
The cash flow tax is a tax on economic rent. On average, firms in competitive businesses would pay little or no tax. The successful would pay tax at the designated rate; the unsuccessful would be reimbursed their losses at the tax rate. Competitive businesses include the marvellous restaurants of Melbourne, most of whom struggle to survive, many without surviving. Those who are actually making losses would get a bit of a payment, and those who are making profits would pay a bit at the tax rate.
Companies that are innovating would find this tax system very much more congenial, than the corporate income tax. The current tax system systematically discriminates against any company that takes a risk and cannot rely on deductions against a secure flow of established income. For the innovator with limited secure cash flows, there is asymmetry between treatment of success and failure. Success is taxed, and failure is not compensated. This is different from the company with a secure flow of rents. Think Rio Tinto or Qantas or Westpac. And if they make some investment, they know that if it is unsuccessful, they will be able to deduct the cost against income for standard income tax purposes. So the cash flow tax supports innovation. It also supports the firm that is investing and expanding.
We calculated, based on public information, that at a 30% tax rate the cash flow would be roughly revenue neutral over time, even if the expected positive effect on investment, innovation and output did not materialise. The suggested transitional arrangements may make it revenue negative in the early years and revenue positive in later years. Any decision on application would require analysis of revenue impacts based on information available only to the tax office.
Companies that are innovating and investing at high rates would pay less tax than under current arrangements. Companies that are receiving high rents and not investing much would pay more. The tax is less vulnerable to international tax avoidance than the corporate income tax in its current form.
Now is the time for the cash flow tax and for other reform measures to make Australia a more prosperous and equitable economy and society and successful democratic polity. There is a lot of work in turning these broad thoughts into a programme for effective reform, in explaining and in building support for the programme. That is a task for this venerable society in its 133rd year, Prosper Australia. There is a large challenge of political leadership in making at happen.
Some of the policy disappointments of the twenty first century so far may discourage ambition for Australia. The lesson of our history is that our democratic polity is capable of productive change when some Australians are prepared to put the necessary effort into development of ideas, public education and political leadership.
I have pointed to a few indications this evening that after a dark decade, the prospects of reform to increase prosperity and equity in Australia might be turning a little bit. Let’s, we who have been thinking about these problems for a long time, let’s help things turn.
Read the full transcript of Professor Garnaut’s speech here.