Tax reform: Why and how?
Achieving successful tax reform in Australia
Published 1 December 2015
Tax reform was a central focus of the 2015 Melbourne Institute / The Australian Outlook Conference, held in the Grand Hyatt Melbourne 5 – 6 November. With the potential to raise national productivity and living standards, there is general consensus on the need for tax reform but the form it should take has been much debated.
Why tax reform?
Taxation involves more than a dollar for dollar transfer of income from households and businesses to government. Most taxes change relative prices faced by the private sector.
As prices change households and businesses alter their decisions and the result is lower household welfare and business profits greater than the dollar tax transfer.
For example, labour income tax reduces the take-home pay for paid employment, but it does not alter the value of time allocated to leisure and home production. So, some people decide not to work or to work less hours.
Other taxes result in altered decisions about investment and saving, the purchase and sale of goods and services and the form of business organisation. According to the government’s 2015 discussion paper, Re:think, the national productivity loss of a tax is, in general, greater the more sensitive, or elastic, decisions are to price changes, and the larger the tax rate.
I propose three categories of tax reform packages to improve national productivity, but collecting about the same revenue and with similar equity effects.
Broader base and lower rate reform packages
Reform opportunities include more comprehensive tax bases for labour income, for the GST, for payroll tax and for land tax.
A comprehensive labour income tax base would see superannuation and fringe benefits taxed exactly the same as wages and salaries. Such a comprehensive labour remuneration tax base would fund a reduction of the average personal income tax rate by about 10 per cent, according to data from the Treasury Tax Expenditure Statement 2014. The package would provide efficiency gains from the lower tax burden on decisions to work, and it would remove artificial distortions to the way in which remuneration is received.
Losers are those with greater than average use of the concessions, and winners are those with smaller than average use – arguably an improvement in horizontal equity.
If Australia was to adopt a comprehensive GST tax base along the lines of New Zealand, the current 10% rate could be reduced to around 7% to collect the same revenue. Data in the Australian Government paper, Re:think, indicates such a package would have negligible redistribution effects for the majority of households.
State governments could more than double their land tax and payroll tax bases and lower the rates without significantly reducing their revenue.
Tax mix change reform packages
A larger land tax to replace conveyance duty reform package would have a minimal effect on house asset prices.
In terms of tax payments, relative to the status quo distribution, those who buy and sell property more often than the average would win, and those who maintain the same property for longer than average would lose. Then, horizontal equity of the change becomes debatable. As illustrated by the ACT reform package, an extended transition period may be required for such a reform package.
To maintain distributional equity for those on lower incomes, such a reform package should involve recycling some of the extra GST revenue to higher social security rates and to larger income tax rate reductions at the bottom of the scale. This would compensate for the higher cost of living associated with a larger GST.
Correct market failures
Reform of special taxes on motor vehicles, including the commonwealth fuel excise, and state stamp duty and registration fees, was proposed in the Henry Review, and is supported by the Productivity Commission, the Competition Review and others. The current taxes would be replaced by an approximate aggregate revenue neutral package with; a user fee for vehicle use of roads, a congestion fee by time of use in cities, and charges for pollution.
Should Australia settle on its proposed greenhouse gas emissions reduction target of 26 to 28% below the 2006 level by 2030, we will need to again consider a more efficient pricing instrument, either a carbon tax or an emissions trading scheme. The Gillard government’s Clean Energy Future model, but with a comprehensive base to cover all electricity, other stationary energy, all petroleum products, and large manufacturers and mining emitters, provides a good starting base. Equity at the lower end can be preserved by recycling some of the revenue windfall to lower income households.
Tax reform is one of several key government policy options to raise national productivity, which is necessary to support Australians’ entrenched aspirations for higher living standards.
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