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Taxing Times – Federal Priorities


Lachlan Hotchin

By

October 15th, 2020


In this article, join Lachlan Hotchin as he investigates the underlying issues in Australia’s taxation system and analyses the reforms proposed by the Federal Government in this year’s budget.


‘If you look at what’s happened to the Australian tax system over the past decade…you’d have to say things have gotten very much worse, not better.’ [1] – Dr Ken Henry.

This is the epitaph on the 2010s apropos of tax reform. The 2010s were a lost decade for Australia in the politico-economic arena, with 6 Prime Ministers and the implementation and repeal of the world-leading Carbon Pricing Scheme. That was it. No real, lasting, structural reforms to the economy or the tax system.

But hanging on the precipice as Australia emerges into the third decade of the 21st Century, the words of Lee Kuan Yew loom large. Unless Australia adopts radical and politically difficult reform, we are set to become the ‘white trash of Asia’. As former Secretary of the Commonwealth Treasury and doyen of tax reform, Dr Ken Henry opined, ‘The burning platform [for reform] is here’ [2]

As is well established in economics, all forms of taxation creating distortion. In microeconomics 101, this is referred to as ‘deadweight loss’. However, we also know that not all taxes have equal effect with some being more distortionary than others. What is becoming increasingly clear in Australia, and what we should be increasingly concerned about, is that the proportion of taxes Australia collects comes mainly from the most distortionary forms of taxation. This is born out in high marginal income and corporate tax rates. The marginal income tax rates in Australia have not materially changed since 1989, with the exception of the abolition of the 37% rate in the financial year 1994-95 by the Keating Government [3].

Indeed, OECD analysis shows that Australians pay amongst the highest income tax rates in the world as a proportion of the total tax take. Australia ranked second only behind the Scandinavian welfare state Denmark, which has high rates on individual taxation but unlike Australia has a 25% consumption tax [4]. Despite the Coalition’s promised tax cuts and the advertised reduction of tax rates, modelling indicates that the vast majority of workers will actually be worse off over the medium term under the so-called reforms. This is due to ‘bracket creep’, whereby nominal wages growth (CPI + real wages growth) pushes taxpayers into higher tax brackets. The result is that people pay a higher proportion of their income as taxation over time. Regardless of the proposition of 3 stages of tax cuts, modelling by ANU’s Ben Phillips shows that ‘all household income groups except for the top 20% will pay more tax in real terms under the Coalition…’ [5]. Phillips notes that “For the top 20 per cent the tax cuts are large enough under the Coalition to more than compensate for bracket creep.” This would seem to indicate that the reductions in real tax rates for top quintile are funded by real increases in tax paid by low- and middle-income earners. In effect, a net wealth transfer from low-middle income earners to high-income earners.

However, due to COVID, Deloitte Access Economics partner Chris Richardson stated that ‘bracket creep is much less ‘creepy’ than it used to be’. [6] There does still remain important questions about Australia’s tax reform and setting us up for a strong and sustained recovery on the other side of the COVID recession – how do we decrease income tax in a manner that is fiscally responsible given record budget deficits?

The answer is, as always, something’s got to give. There’s no free lunches and no magic puddings. There are, however, much better ways of taxing. Reforms to Australia’s chronically low GST would be the best place to start, given consumption taxes are amongst the least distortionary. This brings up another set of problems, because Australia’s system of GST distribution is as unique as the echidna. When the GST was introduced in July 2000, it replaced its precursor (the wholesale sales tax) and 8 other state-based taxes. In order to combat the crisis of the day in state funding and to securitise the GST against repeal from a future Labor Government, a system was developed called ‘horizontal fiscal equalisation’. This being that GST is remitted from businesses to the government quarterly via the ‘Business Activity Statement’ (BAS). In essence, you can imagine this remittance as being ‘vertical’ and then these funds are distributed outwards from the federal government, to the state governments, ‘horizontally’.  Subsequently, Australia never made the switch from taxing income to taxing consumption as our main revenue base. There is a large degree of unfinished business here. Although due to political difficulties and the perception of the GST being ‘regressive’, this hasn’t occurred. There are a number of propositions to make more of a switch from taxing income to consumption.

Source: OECD

There are other problems with the GST, that being in order to get it passed the Senate in 2000, fresh food was exempted from tax and so too were health and education. The consequence being it covered only around 62% of all goods and services at its advent. This has since shrunk considerably to around 56% given a higher proportion of household expenditure now falls on GST exempt items.

Source: Grattan Institute, NSW Government

The most politically palatable proposition for GST is made by Professor Richard Holden from UNSW. He proposes a GST where the base is increased to cover all expenditure and the rate is moved from 10% to 15% (to put it in perspective, the average rate of consumption taxes in the OECD are 19.3%) [5]. His proposition is for a ‘progressive GST’ [6] where the first $7500 of consumption paid electronically would be exempt. This would be modulated by an opt-in system which would be connected to Australia’s single touch payroll. Holden notes ‘those on lower incomes tend to spend a larger proportion of their income on consumption…’ The $7500 consumption free threshold would not be means-tested – in other words, it would apply to everyone. He cites PwC research showing this base broadening and rate increase would raise $60 billion, of which $20 billion would be forfeited via the $7500 per person exemption. This leaves $40 billion for personal income tax reductions.

Although, this wouldn’t fix Australia’s tax system entirely. There would still be more work to do to set us up for another 3 decades of uninterrupted growth. Reforming the taxation of income and consumption would only make Australia’s tax system more analogous to New Zealand’s. Their GST covers 96% of all goods and services and is levied at a rate of 15%, while their income tax rates start at 10.5% and their top rate is 33%. Australia would still need to reform its system of corporate tax and this, of all the reforms, hitherto discussed, is the most important.

Despite the obscurantism, there is clear evidence that corporate income tax reductions do yield benefits to workers which Martin Parkinson explained to Ged Kearney [7]. Indeed, he explained that Treasury research showed half of the benefits of corporate tax cuts flow through to workers via higher wages. In addition to this, corporate tax levels need to be viewed through the lens of Australia as a capital importing nation. In other words, one which has almost completely been dependent on foreign capital in order to fund domestic investment. This means that the level of tax on corporate profits has a significant effect on the level of overseas investment and Australia’s current level of 30% on large firms – many of those listed on the ASX – which attract foreign investment. This is problematic as Australia, which is ensconced in the Asian region, is competing against an average corporate tax rate in our region of 21% [8]. Additionally, there are other issues with our system of corporate taxation. Australia’s use of dividend imputation, whereby citizens and permanent residents can offset corporate tax paid on a dividend against their personal income tax liability, is viewed as a ‘tariff’ on international investment [9]. This means that Australia can maintain an internationally uncompetitive tax rate whilst making it attractive for Australians to invest in equities. The best way to reform this would not be a reduction in corporate taxation, which simply engages in a race to the bottom with other countries. Rather, Australia should adopt a system where it replaces profit taxation with taxation of corporations’ cash flow.

How would this work?

The proposition was put forth by Dr Craig Emerson and Professor Ross Garnaut. This would work by taxing the net cash flow position of businesses, that is inflows minus outflows, except for outflows servicing debt and dividend payments [10]. This would not only avoid the race to the bottom with other countries, but it would also deduct all capital expenditures. That being, expenditures which improve business productivity or expand businesses physical presence in some way. It would, in fact, make this kind of investment more attractive as a negative cash flow would constitute no tax liability. This also mitigates the current system which favours debt over equity. By this, businesses with large amounts of debt can under the current system rack up a large quantum of debt and use the interest repayments to decrease their net profit position. The implementation of a cash flow tax would remove that disparity in their treatment. Likewise, another significant advantage would be that this tax switch would make it fruitless for multinational corporations and tech companies to move profits around and gerrymander their financial statements to avoid tax, as it deducts expenditures made in Australia. This would make it more attractive for them to invest in Australia.

Of all the reforms to be made, the switch from taxing corporate profits to tax flow is the most exigent for the aforementioned reasons and the sooner both sides of politics come to the party, the better. In the last recession in 1991, Paul Keating proceeded to cut corporate tax from 39% to 33%. Now, we need to make positive changes by moving to a system which will support the recovery.

[1] Kehoe, J., 2020. The $20B Losers Of The ‘Dumber’ Tax System. [online] Australian Financial Review. Available at: <https://www.afr.com/policy/tax-and-super/the-20b-losers-of-the-dumber-system-20200218p541sc#:~:text=Tax%20experts%20backed%20former%20Treasury,income%20and%20state%20stamp%20duty.>.

[2] Kehoe, J., “‘Burning platform’ is here for GST reform: Ken Henry”, Australian Financial Review, 2020. [Online]. Available: https://www.afr.com/politics/federal/burning-platform-is-here-for-gst-reform-ken-henry-20200626-p556j5.

[3] Wright, S., “First abolition of a tax scale in three decades as system simplified”, Sydney Morning Herald, 2019. [Online]. Available: https://www.smh.com.au/politics/federal/first-abolition-of-a-tax-scale-in-three-decades-as-system-simplified-20190704-p5244m.html#:~:text=The%20government’s%20abolition%20of%20the,people%20earning%20more%20than%20%2435%2C788.

[4] Kehoe, J., “Australia’s tax take is second-highest in world”, Australian Financial Review, 2019. [Online]. Available: https://www.afr.com/policy/economy/tax-slug-on-income-and-profits-second-highest-in-world-20191205-p53h32.

[5] Kehoe, J., “Tax cuts fail to return bracket creep”, Australian Financial Review, 2019. [Online]. Available: https://www.afr.com/politics/federal/tax-cuts-fail-to-return-bracket-creep-20190408-p51bwq.

[6] K. Nassim, “A $355 billion Federal Budget hole shouldn’t stop spending on welfare, tax cuts: Deloitte”, ABC, 2020. [Online]. Available: https://www.abc.net.au/news/2020-09-28/covid-19-crisis-355b-hole-budget-but-government-should-spend/12703868

[7] R. Holden, “The GST can be progressive: here’s how”, Australian Financial Review, 2020. [Online]. Available: https://www.afr.com/wealth/tax/the-gst-can-be-progressive-here-s-how-20200707-p559ph.

[8] S. Michael, “It’s not ‘right-wing’. It’s just rational to reform now”, Australian Financial Review, 2020. [Online]. Available: https://www.afr.com/politics/federal/it-s-not-right-wing-it-s-just-rational-to-reform-now-20200423-p54mku.

[9] D. Moskowitz, “Countries with the Highest and Lowest Corporate Tax Rates”, Investopedia, 2020. [Online]. Available: https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=&ved=2ahUKEwjpuO-_7bHsAhXQzTgGHZZ3ADkQFjADegQIAhAC&url=https%3A%2F%2Fwww.investopedia.com%2Farticles%2Fpersonal-finance%2F051915%2Fcorporate-tax-rates-highs-and-lows.asp&usg=AOvVaw3Xb1wZNWavkisG4nV5hhVc.

[10] R. Garnaut and C. Emerson, “Here’s a long-term budget fix that would boost investment: replace company tax with cashflow tax”, The Conversation, 2018. [Online]. Available: https://theconversation.com/heres-a-long-term-budget-fix-that-would-boost-investment-replace-company-tax-with-cashflow-tax-108347.

The views expressed within this article are those of the author and do not represent the views of the ESSA Committee or the Society's sponsors. Use of any content from this article should clearly attribute the work to the author and not to ESSA or its sponsors.

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