Now is the Time for Tax Reform
In the last two issues of National Observer articles by Professor Geoffrey Walker have been published which discuss the disturbing state of the Australian taxation system. The tax legislation is virtually incomprehensible, with more than 13,500 pages. And very high marginal rates apply to relatively low incomes.
In the recent Federal election Mr. John Howard's government was returned with an increased majority, but what is of particular significance is that the Coalition will from 1 July 2005 have control of the Senate. The Labor Party and the Greens will no longer be able to prevent the enactment of legislation.
This position will be of extraordinary importance. Whereas for many years the Howard government has been unable to implement various important policies – and in view of its lack of control has not attempted to develop appropriate policies in a number of areas – it will now have an opportunity to carry out important basic reforms.
One of the first areas that should be turned to is taxation. The objective should be to simplify the legislative position – the existing legislation should be discarded entirely, and a more satisfactory foreign model should be adopted instead – and the rates of tax should be lowered in association with a removal of various tax preferences.
Tax Reform Blueprint
In these circumstances the recent issue of Tax Reform Blueprint1 by the Australian Chamber of Commerce and Industry is particularly auspicious. The Chamber assembled an impression group of experts for this purpose, and the Blueprint is persuasive and sensible.
Personal Tax Rates
In regard to income tax, the authors recommend the elimination of bracket creep via the introduction of tax indexation. This is a simple and clearly appropriate reform, so far as it goes, and there can be no justification for failing to implement it. Bracket creep has been allowed to distort the tax system for too long, and it has caused more injustice than any other single factor.
The authors recommend further that the maximum rate of personal income tax should be gradually reduced to the same level as the corporate rate (which is thirty per cent). Over a longer period the number of tax thresholds should be reduced, preferably to no more than two. These recommendations also should be adopted. High personal rates are not desirable economically. And as a matter of equity also they are unsatisfactory, since although they are nominally directed against the wealthy, they prevent those with smaller means from improving themselves by a proper application of after-tax income. High tax rates have had a locking-in effect. They create great difficulties for those who wish to improve their financial positions. With a prevalence of lower taxes it will become possible for many who currently bear a heavy burden of taxation to set aside and invest a significant part of their incomes.
A lowering of personal tax rates will also enable many taxpayers to provide for their retirement, rather than being compelled to rely upon a government pension. Indeed, this is a matter that the Blueprint addresses specifically. The authors recommend the re-introduction of the 15 per cent tax rebate on savings income which was introduced in 1997 but subsequently discontinued. This rebate applied only to the first $3000 of savings income, and it appears that a more general incentive to save is required. The Household Saving Ratio has fallen from around 10 per cent in 1989 to -1.9 per cent, and not only must there be financial (and specifically, in taxation) incentives to save, but also there must be a thorough educational campaign to make Australians aware how important savings are for those who wish to maintain reasonable standards of living.
Social mobility must not be impeded. Those who wish to work hard and increase their incomes and assets should not be prevented from doing so. The present obstacle of a 48.5 per cent marginal rate goes far to ensure that those who have modest assets will have difficulties in ever being reasonably well off.
For these and other related reasons the Blueprint proposals for a rationalisation of income tax rates are to be commended.
Company Tax Rates
The Blueprint notes that the rate of company tax has been reduced to thirty per cent, and that although there may be scope for future reductions, in the short term priority should be given to reductions in the rates of personal tax, so that the maximum marginal rate also becomes thirty per cent.
This allocation of priorities is reasonable, but in a world of competing tax jurisdictions (where businesses often deliberately select countries with favourable tax environments), there is much to be said in favour of reducing the company tax rate to twenty per cent. Revenue losses would be off-set by increasing company tax incomes and by decreasing franking credit amounts.
Capital Gains Tax
Capital gains taxes have been one of the most controversial categories of taxation. On the one hand there is a perceived equity argument – unfortunately often buttressed by envy – but on the other hand incentives to invest in a particular country are much reduced if a capital gains tax (and especially a capital gains tax at a high rate) applies. The matter is complicated by inflation: a large part of general gains is illusory, and reflects merely the steadily diminishing value of money.
It would be much to Australia's advantage not to have a capital gains tax. But the Blueprint recommends a medium course. It suggests a series of steps, whereby the proportion of a gain that is taxable is 100 per cent for a gain realised during the first year of holding, 50 per cent for the second year of holding, 25 per cent for the third, fourth and fifth years of holding, 10 per cent for the sixth to the tenth years of holding, and thereafter nil. This structure would certainly be markedly superior to the current structure,whereby after the first year of holding a permanent proportion of 50 per cent is taxed.
Fringe Benefits Tax
The Australian fringe benefits tax is contrary to all notions of tax equity. It requires the tax to be paid by the employer, not by the employee who derives the relevant benefit. Accordingly some taxpayers obtain substantial untaxed increments to their incomes.
The Blueprint correctly recommends that the relevant tax should be borne by the employees who receive the benefits in question. Indeed, on this basis there is no need for a separate fringe benefits tax at all. The benefits to be taxed may be simply added to the employees’ taxable incomes, in accordance with a specified method of calculation.
Research and Development
As the Blueprint notes, it is generally recognised that research and development (R.& D.) is an important driver of economic growth. Government intervention to promote R. & D. is justified to the extent that this promotes efficiency, productivity and growth. The O.E.C.D. has estimated that in-novation accounts for 50 per cent of long term economic growth in advanced industrial countries.
In 1996 the rate in Australia of the tax deduction for R. & D. was reduced from 150 per cent to 125 per cent, and the Blueprint notes that this reduction "together with the reduction in the company tax rate" has seen the value of the tax benefit decline considerably and had a significant impact on business R. & D. expenditure. It therefore recommends that the higher rate be restored.
It may indeed be questioned whether the Blueprint goes far enough in this regard. Where the company tax rate is 30 per cent, a deduction of at least 200 per cent (giving a net benefit of 60 per cent) is required. Indeed, for companies a rate of 250 per cent would be preferable. Until the personal tax rate of 48.5 per cent is reduced, the special R. & D. deduction for individuals should be kept at its present level.
The Blueprint also addresses the issue of compliance costs. It correctly notes: "Taxation complexity and compliance represent a drain on the time and finances of all businesses, particularly small business. Any long-term solution is to not only simplify the current system but also to recognise that new legislation must be carefully assessed for its compliance impact."
The principal reason why the Australian taxation system is one of the most complex in the world, and compliance has become an inordinate burden, is that successive governments have disregarded these matters. They have permitted Treasury and Australian Tax Office draftsmen to introduce long and complicated legislation many times each year, and have not concerned themselves with the legislation save to find out what government revenue is to be gained or lost by it.
For these reasons talk of greater care and responsibility is futile. Complexity will continue to compound complexity. Unfortunately the only course now is to commence entirely afresh, with an entirely new taxing statute based upon a successful overseas model.
The Howard Government and Tax Reform
As has been noted here, having obtained a majority in both Houses of Parliament the Howard government has an unexpected opportunity to introduce a new, simpler and more modern taxation system.
It would be extremely unforunate if this opportunity were not taken. A similar opportunity might not arise for twenty or thirty years.
Unfortunately Mr. John Howard has shown little recent interest in tax reform, and has left this matter in the hands of his Treasurer, Mr. Peter Costello. Mr. Costello has never revealed any interest in genuine tax reform. For example he succeeded in introducing a G.S.T. in order to boost Commonwealth revenue without proper reciprocal reductions in income tax rates. His brother, the Reverend Tim Costello, is very much of the Left, and there is reason to believe that this is also where Mr. Peter Costello's heart lies. (On social issues he tends to be on the same side as the Labor Party, in regard to such matters as re-publicanism, "reconciliation", and so on. In so far as the Australian economy has held up reasonably well during his Treasurership, this has been due to an extravagant influx of borrowings from abroad, with the overseas deficit increasing at an alarming rate.)
Unfortunately there is no reason to believe that the Howard government will do other than tinker somewhat uselessly with the current tax system, outmoded and counter-productive as it is. So long as Mr. Costello is the Treasurer there will be a continual significant worsening of the Australian taxation system.
1. Tax Reform Blueprint: A Strategy for the Australian Taxation System 2004-2014 (The Australian Chamber of Commerce and Industry, 2004). The Taskforce that was assembled in the production of this document included Mr. Richard Buchanan (former Managing Partner, K.P.M.G.), Mr. Peter Hendy (Chief Exective, A.C.C.I.), Mr. Michael Griffith (General Manager Taxation, Linfox Australia), Mr. Tony Merlo (Tax Adviser, Shell Australia), Mr. Curt Rendall (Managing Partner, Rendall Kelly), Mr. Peter Morris (Chief Economist, Minerals Council of Australia), Mr. Jeff Schubert (Chief Economist, Australian Business Limited), Mr. Todd Ritchie (Chief Economist, Master Builders Australia), Mr. Michael Potter (Policy Manager, Economics, National Farmers Federation), Mr. Rob Janes (Partner, Deloittes), Mr. Michael Selth (Partner, Horwath Accounting), Mr. Tony Carroll (Partner, Price Waterhouse Coopers), Mr Michael Evans (Partner K.P.M.G.), Mr. Matthew Hayes (Partner K.P.M.G.) and Mr. Steve Kates (Chief Economist, A.C.C.I.).
National Observer No. 63 - Summer 2005