Australia: What does real tax reform look like?

Last Updated: 19 September 2013

The Federal election is behind us and a new Prime Minister and Treasurer are about to be sworn in. The new Government is intent on "living within its means". But how to do that when election promises need to be paid for out of declining tax receipts is a big question.

Currently, there are 5 Australians of working age for every Australian aged 65 or older. By 2047 this "dependency ratio" is projected to more than halve to just 2.4. 1 There will be far fewer taxpayers to support a population that is living longer. A fiscal crisis is looming and it raises questions about intergenerational equity.

The Coalition Government plans to produce a white paper on tax reform within its first two years and then seek a mandate for reform at the next election. Sooner would be better but it's a start.

So what does real tax reform look like? Here are a few thoughts.

A shift from direct to indirect taxation is necessary. Australia's direct (ie income) tax rates are high and indirect tax rates are low in a comparative sense. This means that the GST must be on the tax reform table in terms of both the rate and the base. Broadening the base may result in GST on health, education and fresh food.

Whilst on the topic of GST, the argument that the GST cannot be changed without the agreement of the States should be dropped. It is based on section 11 of the A New Tax System (Managing the GST Rate and Base) Act 1999 which states that, "The rate of the GST, and the GST base, are not to be changed unless each State agrees to the change." But this is merely an Act of the Federal Parliament capable of being repealed in the same way the Coalition Government proposes to repeal the carbon price and the minerals resource rent tax (MRRT). The Senate may prove an obstacle but that is a political issue, not a legal issue.

Putting the legal issues surrounding the GST rate and base to one side, the States do need to be included in the reform process. State tax reform cannot continue to be left in the "too hard" basket. State taxes are too numerous, too complex and raise too little. 2 The MRRT illustrates the problem. The 2009 Review of Australia's future tax system (the Henry Review) recommended that a Federal resource rent tax be introduced and that State resource royalties be repealed. Instead, the Labor Government of the day sidestepped the States by giving a credit for royalties against the MRRT. This left both taxes running in tandem and needing to be complied with. The Federal and State Governments must negotiate in good faith and reach agreement.

Coalition policy is to repeal the MRRT (if the Senate lets it). But, like the GST, the MRRT should be on the table. It is hard to argue against the idea that all Australians should benefit from exploitation of the nation's non-renewable resources (not just coal and iron ore). The offshore oil and gas industry has coped with a Federal resource rent tax since 1987. Resource rich States will say the resources belong to them and not the nation but, under current arrangements, royalties reduce a State's share of the GST which is also unsatisfactory.

The dividend imputation system should be examined. Australia is unusual in giving shareholders a credit for tax paid by the company. Shareholders, especially superannuation funds and retirees, would oppose any change but the current system works against lowering company and individual income tax rates.

The taxation of income in retirement also requires attention. Specifically, whether or not the tax exemption for superannuation funds in the pension phase is sustainable, which it probably is not. Also, the pension age has increased from 65 to 67. Given increasing life expectancy and good health, perhaps it should be higher still. On the flip side, expecting working age Australians to work and pay tax for longer to finance the services demanded by all Australians demonstrates the difficult intergenerational equity issues in play.

Land tax is another indirect tax that needs to be looked at. Being immovable, land is an obvious asset to tax. Within reason, higher land tax rates partially offset by lower income tax rates should not put off investors, including foreign investors. Alternatively, higher land taxes may contribute to the prevention of real estate price bubbles.

Finally, real tax reform is unlikely to include significant tax concessions for the development of northern Australia. Such concessions may cannibalise investment in other parts of the country, and attract mobile capital that will exit the country when the next, better opportunity presents itself. Ireland did better when it reduced the company tax rate on trading income to 12.5% throughout the country than it did when it applied a special 10% rate to income derived in the International Financial Services Centre or the Shannon Free Zone.

An issue closely related to tax reform is public sector debt. The political rhetoric on both sides stresses the need to balance the budget or, even better, produce a surplus. Running a deficit is considered to be irresponsible. But is that really the case? Most households have debt but still manage to live within their means. The real issues are: is the debt put to a productive use (ie much needed quality infrastructure); and can it be serviced? A responsible level of debt also contributes to intergenerational equity because it means the successive generations that use debt financed infrastructure pay for it. Of course debt can blow out to irresponsible levels but Australia is a long way from that, and the productivity gains to be made from better infrastructure increase the tax take and contribute to keeping debt under control and paying it down.

If the "grown ups are back in charge" then it's time for a mature debate about substantive tax and public sector finance reform. Australia faces tough decisions it can't keep putting off.

Footnotes

1Source: Australian Government (2007).

2The States and Territories collect 15% of total tax revenue, the Federal Government collects 82% and Local Governments collect 3%.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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