GST is not the only option for federal tax reform

The Prime Minister has launched a taxation debate centred on repairing the financial problems of the Australian Federation.

They are problems begging to be fixed but will need maximum skills to achieve. I fully support the push for reform. Obviously all state premiers will need to be on board for wholesale reform to occur.

The Government is in the process of producing two parallel white papers (ie government policy positions) on reform of the Federation and on tax reform. In that context the Prime Minister said in a speech at Tenterfield on 25 October that "the Commonwealth would be ready to work with states on a range of tax reforms that could permanently improve the states' tax base – including changes to the indirect tax base with compensating reductions in income tax". It is assumed that when he spoke about an indirect tax option he was clearly referring to GST. But what is also clear is that the Prime Minister talked of considering "a range of tax reforms".

I have previously written and spoken in Parliament about the prospects of raising the GST and the difficulties that will be confronted in such an endeavour.

This article explores a different option for reform that has been considered before but in recent times (too readily) discarded. Many commentators dismiss it out of hand. However it is an option that has in the past had substantial support in both economic and political terms. I think it should be given serious consideration in the preparation of the Government's Taxation White paper.

I am speaking about an income tax sharing agreement between the Federal and state governments.

The basic problem that needs to be addressed is clearly stated in the Government's September issues paper on Federation Reform that notes that the States revenue base is inadequate to fund their spending growth responsibilities in areas such as health and education. Demand is outstripping supply.

A brief history of income tax is relevant. Up until 1942 States levied income taxes. Then due to World War II's funding demands it was mutually agreed to hand the tax to the Federal Government. After the emergency passed it refused to hand it back.

That is until 1977 when Prime Minister Malcolm Fraser proposed a "New Federalism" policy and passed legislation to allow state income tax surcharges (or rebates for that matter) to help states meet their funding needs. Unfortunately NSW Premier Wran waged a short-sighted scare campaign on the issue alleging this would lead to "double taxation" and the option was never taken up.

However, 14 years later Prime Minister Bob Hawke was inching towards reintroducing such a policy through a series of Special Premier's Conferences when he lost a leadership ballot to Paul Keating in 1991. Hawke had set up a "Working Party on Tax Powers" that reported on 4 October 1991 and noted one option for reform was the introduction of a State Income Tax Surcharge. In response, all State and Territory leaders at the time signed a communique on 8 November 1991 calling for its implementation. They sought a 6 per cent surcharge in a broadly revenue neutral package of reforms, whereby the federal government would reduce income tax and also payments to the states. So it was recommended by experts and was politically doable. However the new Prime Minister Keating was personally against the proposal and it died there and then.

Importantly, an income tax surcharge was recently recommended by the National Commission of Audit it its February 2014 report.

Many so-called experts will complain that reordering the intergovernmental share of income tax revenue would do nothing to fix the relative balance between direct (eg income) taxes and indirect (eg GST) taxes. The argument they are referring to, recently repeated by the departing Treasury Department head Martin Parkinson, is that less reliance on income taxes is more efficient as it reduces the negative impact of high marginal rates on people's incentive to work. There is truth to this.

However when you think about it basically all taxes including GST are paid out of your earned income so it is not apparent that this is an overwhelmingly decisive argument. And to make it clear, the income tax sharing option I believe should be debated is not designed to raise more total revenue but to substitute federal taxes with state taxes, thus not increasing the reliance on income taxes. Indeed, in my opinion any possible economic efficiency benefits from reform would be lost if all that we are doing is locking in the deleterious effects of further increases in the overall tax burden.

The other economic benefit claimed for what is often called a tax mix switch is that GST as a consumption tax on balance encourages further saving. Again, Australia does not at present suffer from a household savings problem – with indexes at historical highs.

In conclusion, I have put forward the income tax sharing proposal as yet another option. It would not be a perfect solution but as with other options should be at least considered in the white paper process.