Largely because of the budgetary impact of the global financial crisis, we missed the opportunity a decade ago to fix the Australian tax and transfer systems.
The reform pathways identified in our review stand out even more clearly today. The system was not in crisis then, but urgent and comprehensive action is now required, at a national level.
Ten years ago, the tax review panel that I had the privilege to lead had finalised its two-year holistic review of Australia’s tax, transfer and retirement incomes systems.
We were grappling with a large number of challenges, arising from multiple trends: population ageing, with serious implications for workforce participation; changes in the structure of the labour market; deteriorating housing affordability; increasing urban congestion; worsening access to high quality education at all levels; increasing globalisation, most notably connected with the rise of Asia; the possibility of further international financial volatility post-GFC; transformational technological developments; and growing environmental pressures, including the accelerative impact of climate change on long term trends of land degradation, loss of ecosystems, species decline and unsustainable water use.
Most of these challenges have become even more pressing over the past decade and, in addition, today’s policy makers are struggling to find solutions to what has turned out to be a long period of poor productivity performance and many years of weak wages growth.
Ten years ago, we concluded that if we were going to be able to deal effectively with those many challenges, we would need a complete overhaul of our tax and transfer systems. Against that imperative, we observed that our systems were characterised by multiple, often conflicting, objectives; increasing complexity; very high compliance costs; base erosion; and low levels of consistency, amongst State jurisdictions and over time.
The purpose of taxation is simply to raise revenue to fund government spending on a sustainable basis. The tax system should be capable of generating sufficient revenue to meet evolving budgetary requirements, without unacceptable consequences for economic efficiency, fairness, risk and system complexity. Our tax system is not.
Notwithstanding what our politicians would have you believe, the size of government has grown since the commissioning of our review. At the Commonwealth level, payments were 23.1 per cent of GDP in 2007-08. They had risen to 23.9 per cent of GDP by 2012-13 and are estimated to be 24.6 per cent of GDP in the 2019-20 budget year. More revenue has had to be raised, and the personal income tax system has had to do most of the heavy lifting, through the stealthy operation of fiscal drag.
The most recent Commonwealth budget projects that tax receipts will rise from 21.3 per cent of GDP in 2012-13 to 23.3 per cent of GDP in 2019-20, with the proportion of the tax take contributed by personal income tax rising from 44.3 per cent in 2007-08 to 48.1 per cent in 2012-13, 49 per cent in 2019-20 and continuing to increase over the forward estimates.
Our broadest indirect tax, the GST, is suffering base erosion. It used to cover almost two-thirds of household consumption, but now applies to about half. The Howard Government’s promise of the States having access to a ‘growth tax’ has not been delivered.
So the States have had to rely, increasingly, on some of the worst tax bases in the federation. Stamp duties and resource royalties, in particular, have exposed State budgets to considerable volatility. The volatility of resource royalty revenues, especially in Western Australia, was foreseen by our review team. The failure to implement our recommendations in this area has led to quite unnecessary angst and avoidable ad hoc adjustments to the system of horizontal fiscal equalization.
And the reliance of State budgets on insurance taxes and levies is especially perverse in these times of significantly elevated risk of drought, fire and flood; with terrible consequences for human and ecosystem wellbeing.
It is time our leaders admitted that these things are unsustainable.
Had our report been implemented in full, things would be very different today. We would have a broad-based cash flow tax replacing the GST, payroll taxes and all bad State consumption taxes such as those on insurance. We would have a uniform national resource rent tax replacing all state-based resource royalties, with more predictable revenue streams to support the budgets of resource-rich states. We would have a 25 per cent company tax rate, for all companies. Stamp duties on property transfers would have been replaced by progressive land taxes. Cost based, comprehensive road user charges would have replaced fuel excises, stamp duties on motor vehicles, luxury car tax and vehicle registration taxes. We would have a comprehensive carbon emissions trading scheme instead of various renewable energy targets and a growing assortment of ad hoc measures designed to achieve greenhouse gas abatement. Capital income and expense would have symmetrical tax treatment, with a common discount applying to capital gains, interest and rent, going a long way to dealing with the distortions created by negative gearing of rental property. Scholarships, pensions, allowances and other transfer payments would be exempt from tax. And we would have a much simpler and more progressive two rate personal income tax, with no Medicare Levy, and most people facing the lower of the two marginal rates. System progressivity would be enhanced by taxing fringe benefits and employer-provided superannuation contributions at individual marginal rates, in the latter case with a flat refundable 20 per cent tax credit.
The Commonwealth’s tax system is struggling. The budget is placing increasing reliance upon fiscal drag and a set of narrowly based and economically damaging bases. And things are considerably worse at the level of State government.
Invariably, when a change is proposed to any feature of the tax system to improve its resilience, concerns are expressed about its equity implications. We have got it into our heads that tax system robustness and integrity disadvantages the less well-off. But this is the opposite of the truth. A fragile tax system undermines the ability of government to deliver to the citizens most heavily dependent upon government transfer payments and services. There is plenty of evidence of this already.
Largely because of the budgetary impact of the GFC, we missed the chance to secure generational reform a decade ago. The tax system was not in crisis then, though ominous pressures were building. Against that background, our review set out pathways for reform to guide policy development over a medium to long-term horizon. With all of the pressures we identified having intensified in the past ten years, those pathways stand out even more clearly today. Some progress has been made. But the pace of reform needs to accelerate, rapidly.
Ken Henry was Secretary to the Treasury from 2001 to 2011 and chaired the Rudd Government’s review of the tax and transfer systems published 10 years ago.