Reforming Australia’s tax and transfer system

Relative to the income tax and social security payments systems, exemptions from the GST and payroll taxes are far less direct and effective ways of meeting society equity objectives.

An important area of the taxation reform debate facing the Henry Review Committee concerns the mix of income and consumption taxes. Australia is relatively more reliant on income taxation than most other countries.

A key reform option is whether there should be a lower effective tax rate on capital income, and not just a lower corporate tax rate, than on labour income. The analytical supporting argument for such a tax mix change rests on the observations that Australia is a small and open economy with the result that the supply of capital to Australia, including borrowing from overseas, is much more elastic or price responsive than is the supply of labour. In this context, most of the final economic incidence of taxation of capital, and of labour, falls on the relatively fixed supply input labour, and that in the longer run the size of the economy and real wage rates can be increased with a relatively low tax rate on the more mobile factor capital.

In principle there are compelling arguments for special and additional taxes on particular expenditure items to correct market failures. However, the current Australian special purpose indirect taxes on petroleum products, alcohol, tobacco, gambling and motor vehicles are poorly designed.

A special tax to increase the price of products whose consumption or production results in external or spill over costs on third parties internalises these external costs, reduces production and consumption, and brings gains in economic efficiency. For example, an appropriate tax on the external costs of criminal activity, road accidents and extra health costs associated with excessive alcohol consumption is a common rate per unit of alcohol by volume on all alcohol beverages, not the current ad hoc set of different rates on different beverages and even different rates by form of beverage container.

Special taxation of the use of motor vehicles is justified on efficiency grounds as a user charge for government provided road infrastructure, as a charge on the external costs of local and global pollution, and as a way of internalising the costs of congestion in the big cities during peak hour travel.

With no general annual wealth tax or a set of taxes on bequests and gifts, Australia differs from many other OECD countries, although such taxes are not large revenue raisers.

The current land tax base is far from comprehensive and its current progressive rate schedule is more a means of tax avoidance and unnecessary complication than an effective vertical equity instrument.

Replacement of the state royalties per tone or dollar of product on mining with a profit-based resource rent tax would achieve significant gains in economic efficiency with no revenue loss. Further, one reform option is to increase the relative importance of resource rent taxes on energy and minerals, and perhaps to extend its application to water and other natural resources, and then to use the revenue gains to fund reductions in other more distorting taxes on labour and capital incomes.

Stamp duties on the transfer of commercial and residential property and stamp duties on insurance are old fashioned revenue raising turnover taxes imposed by the states. They should be high on the list for replacement with less distorting taxes. The transfer duties restrict the transfer of property from less valued to more valued uses, and they hinder productivity growth and adjustment to changing household and business circumstances. Their replacement with annual taxes, such as an augmented land tax or an annual wealth tax, would have similar long run economic tax incidence effects, but with a gain in efficiency. Stamp duties on insurance, in addition to the GST, do not correct any market failure, but rather they increase the cost of desirable risk management strategies.

The extensive set of social security payments for the aged, the disabled, the unemployed and families is an important component of the Australian income transfer system to be considered by the Henry Review Committee. Rates of payment and their indexation, the means testing of these benefits, and their inter-relationships with the tax system are all important topics for reform evaluation.

For example, the current set of multiple supports for families, including the baby bonus, Family Tax Benefit (A), Family Tax Benefit (B), and subsidies and tax concessions for child care, is complex and their interaction with the income tax system results in effective marginal tax rates exceeding 50 per cent falling mainly on women who have relatively high elasticities of labour supply. Reform options include a single family support measure justified to achieve horizontal equity and to recognise the external benefits of children to society, and making the support measure a universal non-means tested payment.

Commonwealth-State financial relations, both on the expenditure side as well as on the revenue side, continue as a lively area of policy reform debate. On the revenue side, policy options under discussion include reductions in the extent of vertical fiscal imbalance whereby the commonwealth collects about 80 per cent of the revenue but the states account for nearly a half of government expenditure, the appropriate levels of horizontal fiscal equalisation under which the smaller states receive larger commonwealth tax transfers per capita than the larger states, and greater harmonisation of tax bases across the states to improve simplicity and to reduce costs.

A summary theme of my proposals for reform of the Australian tax system is to have broad and comprehensive tax bases, with bases for income and consumption and with the more controversial option of a base for wealth or assets, by removing the many current special tax exemptions and deductions. The revenue gains would be used to fund lower tax rates and removal of the transaction taxes. Special taxes designed to correct market failures would complement the broad based general taxes.