Opportunities and Challenges in Tax Reform

Taxes are the principal way in which governments gain control over limited resources to provide defence, education and other government funded goods and services, and to redistribute income to the less fortunate members of society. In 2003-04, governments in Australia collected $257 billion, which represents 31.5 per cent of national income. Taxes are levied by the commonwealth, state and local governments. They include taxes on income, consumption expenditure, other expenditures, and asset stocks. Arguments for tax reform seek changes which will simplify an already complex and costly system, which will reduce the differences in effective tax burdens on related decision choice options and so improve national productivity, and which will better meet society objectives for an equitable sharing of the tax burden.

Credible arguments can be made to reform all Australian taxes. The easiest case is to consider reforms under the restriction that the aggregate revenue collected remains unchanged and that there are a limited number of winners and losers. A fundamental reform option is to remove most to all of the special tax exemptions and deductions, in order to broaden the taxable sums or tax bases for income, GST, payroll and land. It is time to apply logic to the choice of tax base and tax rates to internalize externalities associated with the consumption of petroleum products (or more generally fossil fuels), tobacco, alcohol and gambling. The remaining stamp duties, including those on property, motor vehicles and insurance, should be eliminated.

Broad and comprehensive tax bases
A broad and comprehensive tax base with a minimum number of special exemptions and deductions in which every unit is taxable generally provides a good tax design. This maxim applies to the taxation of income, consumption expenditure, payroll, or asset wealth. When everything is taxable, simplicity is achieved and the incentives and rewards for clever tax avoidance schemes are removed. With a broad tax base, similar forms of income, expenditure, etc face the same tax burden resulting in a level playing field. This minimises distortions to decisions on related choice options. Horizontal tax equity, or similar tax burdens for people in similar circumstances, is achieved the more comprehensive the tax base. To gain political support for a broad and comprehensive tax base, such reforms can be sold as a revenue neutral package of a removing the special exemptions and deductions (the sticks) to fund lower tax rates (the carrots).

Income base broadening measures were important in the Australian personal income tax reform of 1985, which included the introduction of capital gains taxes (CGT) and fringe benefits taxes (FBT), and a cut in the top 60 per cent rate to 49 per cent; and in the business income tax reforms of 2001, which brought an end to accelerated depreciation and other concessions to fund the lower 30 per cent corporate tax rate. Today there are opportunities to broaden the personal income tax base by at least 10 per cent and by as much as 20 per cent. Potential special exemptions and deductions to be eliminated include a range of work related expenses, concessional FBT treatment of motor vehicles, concessional tax rates on many forms of lump sum remuneration, exemptions and concessional tax rates on capital gains, remote area concessions, and income averaging. Since these special exemptions and deductions from taxable income are used more by, and are of relatively more value to, those on higher incomes, a revenue neutral and an approximately distributionally neutral income tax reform package would have a flatter, and lower, tax rate structure.

A comprehensive broad based New Zealand type goods and services tax (GST) with no exemptions would simplify the Australian GST. We could also learn from the Kiwis about a simpler administration system.

The tax bases for the state government payroll taxes differ from state to state and they are about half their potential comprehensive size. The principal exemptions to be removed are for small businesses, and then for various decentralization and tax holidays to attract new businesses reasons. Further simplification, and an answer to small business special pleading about compliance costs, could be achieved by tagging payroll tax onto either of the existing workers’ compensation or PAYG tax bases.

Land taxes levied by the states are narrow based, and to a large extent they are restricted to businesses in the city business districts. Political reality probably means that land used for owner occupied homes will remain sacred and free of land tax. For the rest, there are good efficiency and equity arguments for dispensing with conveyance duties, which act as a deterrent to innovation and productivity enhancing reallocations of property to higher valued uses, and imposing a broad based and flat rate tax on all land used for non-residential purposes.

Simplicity
By any measure, including pages of tax acts, numbers seeking professional tax advice and expenditures on tax compliance, taxation in Australia is complicated, and the level of complexity is growing. Recent attempts to rewrite tax legislation in simpler English have achieved very little. Real progress requires joint attention to both tax design, in particular the minimisation of the number of special exemptions and deductions, and rewriting.

Special purpose indirect taxes
Special taxes on activities resulting in external costs on third parties are one way of correcting for market failures and improving the allocation of scarce national resources. However, to reap an efficiency improvement requires both that the tax base reflects the externality causing activity and that the rate reflects the marginal external cost. The commonwealth excise taxes on petroleum, alcohol and tobacco products, and the state taxes on motor vehicles and gambling, are more ad hoc revenue raisers than they are genuine externality correction taxes.

Stamp duties
With the GST, and to a lesser extent the payroll taxes, in place, Australia has the elements of comprehensive taxes on consumption: but as noted above they could be improved. The remaining stamp duties represent double taxation of expenditures on insurance, leases, motor vehicles and property, which is not applied to other consumption expenditures, and they should therefore be high on the reform list for removal.

Tags: