Australia's Future Tax System

Consultation Paper

Executive summary

Challenges and opportunities for reform

The terms of reference set an objective for the review of creating a tax-transfer structure that will position Australia to deal with its demographic, social, economic and environmental challenges, and enhance Australia's economic, social and environmental wellbeing.

The Panel's four consultation questions, issued in August, were intended to elicit community perspectives about the way in which Australia's tax-transfer system should be structured to better position Australia to respond to developments over the next few decades and address the perceived major short-comings in the system as it operates today.

Submissions have responded to these issues and identify several key challenges and opportunities of importance in considering Australia's future tax-transfer system:

  • the type of society in which Australians might choose to live, including considerations about the role and size of government in Australia;
  • increasing globalisation and the changing pattern of world economic activity;
  • demographic change, including changing patterns of workforce participation;
  • climate change, the environment and sustainable economic growth;
  • intergovernmental relationships within the Australian federation;
  • the process of policy formation and its administration; and
  • the role of technological progress.

Consultation questions

Q1.1 In considering the community's aspirations for the type of society that Australia should become over the next two decades and beyond, which key features should inform or drive the future design of the Australian tax-transfer system?

Q1.2 Assuming that the absolute size of government will not fall, should (and can) Australia nonetheless aim to reduce the burden of taxation over time by promoting faster economic growth than public spending growth? Can it be demonstrated that alternative tax policies could help deliver that outcome?

Key questions about the design of the tax-transfer system

Design principles identified in submissions can be broadly categorised as equity, efficiency, simplicity, sustainability (including revenue adequacy) and policy consistency. Consistent themes emerging from submissions are that the tax-transfer system should be equitable, impose low costs on society in terms of economic efficiency and operating costs, provide sustainable revenue to fund government and be consistent with broader policy objectives, including environmental sustainability.

These broad principles may at times be in conflict. Inevitably, it will be necessary to make judgments about the balances to be made between the principles where this is the case. The Panel recognises that not everyone will make the same judgments when faced with these conflicts. The Panel will strive to be open and explicit where judgments are made.

The structure of the tax-transfer system

Australia's tax-transfer system spans three levels of government. In legal form it is comprised of the many different taxes and transfers designed and administered by government. It can be considered a single economic system that, through the complex interactions between its elements, impacts on a broad range of choices made by individuals and business. While the various elements affect economic decisions in similar ways, key differences exist between, and within, taxes and transfers in terms of their underpinning structural elements.

The revenue mix

The revenue mix can be considered at several levels: the balance between the underlying sources of government revenue; the balance between taxes faced by individuals; and the balance of approaches taken to raising revenue.

The short-term balance between government revenue from the three tax bases — labour, capital and consumption — is sensitive to economic conditions and government policy decisions. There has been a marked change in the balance of taxes from labour to capital since 2000-01. It is unclear how this balance will be influenced over the long-term by pressures such as the ageing of the population. However, it is possible there will be a continuation of existing pressures on capital and labour taxes as a revenue source, suggesting an increased reliance on consumption taxes.

The relative taxation of the return to work compared with the return to saving can affect individuals' choices about working, saving and consuming. These choices can have important implications for the efficiency and equity of the tax-transfer system. There are strong and conflicting views about the relative reliance on these bases.

Alternative arrangements, such as user charges, have the potential to play an important role in improving efficiency through the pricing of public resources and to provide an alternative source of revenue to more conventional taxes.

Consultation questions

Q3.1 What problems, if any, are generated by the overall mix of taxes in Australia on business and labour income, consumption, transactions and assets, and what changes, if any, should be made?

Q3.2 Does Australia's tax system penalise (or favour) the returns to savings relative to other activities and should this lead to changes in the structure of taxes and means tests?

Q3.3 Does Australia's tax-transfer system appropriately deal with property and wealth, or should new approaches be introduced? What, if any, implications would any changes have for the taxation (or means testing) of capital income flowing from property and wealth?

Q3.4 Assuming no increase in the rate or base of the GST, what principles should guide the future development of other consumption taxes in Australia, and is there a need to change the role and structure of such taxes?

Q3.5 Could greater application of user charges, rather than general taxes, in the funding of government services or infrastructure bring social, environmental or economic benefits?

Personal tax and transfers

The personal income tax and transfer systems have far-reaching implications for the wellbeing of Australians and their choices to work, save and acquire skills.

Tax and transfer policies involve trade-offs between the adequacy of payment rates, incentives to work, and the complexity individuals and families face. Higher payment rates can lessen individuals' incentives to work and to invest in skills. The application of means tests for transfers leads to a more targeted but more complex system. Most critically, incremental reforms generally involve a trade-off between equity objectives on the one hand and efficiency and simplicity on the other.

With the ageing of the population and increasing global competitiveness, the structure and settings of the tax-transfer system and resulting incentives are key components in meeting these challenges.

Reforms which reduce complexity and deliver adequate incentives will improve resource allocation, productivity and participation. However, there are significant tensions between such objectives, and with targeting, equity and fiscal sustainability.

Consultation questions

Q4.1 How might the personal tax system be changed to better achieve the goals of greater simplicity, transparency, equity and efficiency?

Q4.2 What is the appropriate distribution of income tax across income levels and how should it differ from the current distribution? Should governments seek to maintain a similar distribution over time, or should they fix the value of current tax thresholds through indexation?

Q4.3 Is the personal income tax base appropriately defined? Should reforms such as changes to the scope of deductions or other measures be considered?

Q4.4 Should the tax treatment of transfer payments be reconsidered? Should transfer payments be taxed at the same rate or a lower rate than earned income?

Q4.5 Should people in different circumstances be taxed differently (for example, by age, occupation, location), and what might be the implications of such arrangements? Are tax offsets the best way to achieve differential taxation?

Q4.6 How can fringe benefits tax be simplified while maintaining tax integrity? Would it be better to adopt the general OECD practice of taxing fringe benefits in the hands of employees, rather than employers?

Q4.7 Are the current categorical distinctions for income support, including rates of payment and income tests, still relevant? If not, would other categories be better? What goals or principles should guide categorical distinctions and associated payment rates?

Q4.8 What priority should be given to the different objectives associated with family assistance, such as poverty alleviation, recognising the social value of child rearing, facilitating workforce participation of parents, and early childhood education? Would it be better to provide less family assistance to higher income earners?

Q4.9 What are the key factors that should affect rates of transfer payments? What should be the relative importance of duration on income support, costs of work and job search, costs of children, value of home production and the level of the federal minimum wage?

Q4.10 Should transfer payments have a common benchmark? If so, should it be a proportion of a wage measure, and if so, which one? Or is there a better benchmark? Should there be a common indexation arrangement?

Q4.11 Should payments for retired people remain linked to payments for people of working age?

Q4.12 In a targeted system there is a trade-off between the level of income support and workforce incentives. Given this, what priority should be given to reducing the disincentives to work?

Q4.13 What structure of income tests and taxes would best support the increasing diversity of work and the need to increase workforce participation, and where should improved incentives be targeted?

Q4.14 Does the tax-transfer system create disincentives for individuals seeking to acquire new skills or upgrade existing skills? If so, what sort of tax or transfer changes would provide better incentives?

Q4.15 Given the competing demands of targeting assistance to people when they need it and minimising unnecessary transactions, what changes could be made to existing tax and transfer policies?

Q4.16 Should the different bases of assessment for tax and transfers be reconsidered (including the unit of assessment, income definitions, period of assessment and assets treatment)?

The retirement income system

Australia has a three pillar retirement income system:

  • a government provided Age Pension;
  • compulsory savings enforced through the superannuation guarantee system (SG); and
  • voluntary savings (both through superannuation and other sources).

The Age Pension provides a guaranteed income based on means, while the income generated from the second and third pillars depends on the amount invested and returns on these investments.

The retirement income system has developed over time. The SG pillar will not mature until 2037 when employees retire after a full working life (35 years) of compulsory superannuation contributions of 9 per cent.

Submissions to the Panel support the structure of the retirement income system. Common themes in the submissions concern the current rate of the SG and the level of concessions provided to encourage additional saving. Other themes relate to how the system should deal with individuals outliving their savings and the way the system treats individuals with different circumstances.

Key considerations about the retirement income system are whether it is broad and adequate, acceptable, robust, simple and approachable, and sustainable.

Another aspect to be considered is the role of the retirement income system in providing health and aged care services.

Consultation questions

Q5.1 In considering the future of Australia's retirement income system, which objectives are relevant in setting retirement income policy? Does the current system of the Age Pension and compulsory and voluntary savings meet these objectives? If not, how should the system be changed to meet these objectives?

Q5.2 As the SG system matures, it will become a greater part of an employee's retirement income. What are the implications for individuals partially or fully excluded from the mature SG system (the self-employed, individuals with broken work patterns such as carers, women and migrants), and how can the retirement income system best accommodate these groups?

Q5.3 Noting that the adequacy of the Age Pension is being considered by the Pension Review, what is an appropriate concept of adequacy for the retirement income system? Should it be to ensure there is a minimum level of income in retirement, to replace a proportion of income earned prior to retirement, or some other alternative?

Q5.4 What should the role of the government be in assisting individuals to meet their retirement income expectations in relation to the support provided by the Age Pension, the level of compulsory savings and incentives to make additional savings? Should the role of government change as an individual's income increases over their working life?

Q5.5 Do the settings of the retirement income system, such as the level of SG and access to concessions, adequately consider the needs and preferences of individuals both before and after retirement?

Q5.6 Is the current level of superannuation income tax concessions appropriate and sustainable into the future? Are the current concessions properly targeted and, if not, how should they be reformed?

Q5.7 At what age should an individual be able to access their superannuation and at what age should they become eligible for the Age Pension?

Q5.8 What is the role of individuals in dealing with investment and longevity risk in accumulating and drawing down their retirement income? Do financial markets provide the means to deal with these risks? If not, is there a role for government to address these shortcomings?

Q5.9 In what ways does the retirement income system impose undue complexity and cost on retirees and workers? How could this complexity be reduced?

Q5.10 The Age Pension serves two roles, as a safety-net for individuals who are unable to sufficiently save for their retirement and as an income supplement for many individuals who do save. What should be the role for the Age Pension and means testing in a future retirement income system and what impact does this have on its sustainability into the future?

Q5.11 In what ways does retirement income policy affect workforce participation decisions and what, if any, changes might reduce disincentives to work? Does the sustainability and cost of the retirement income system affect the workforce decisions of younger generations of workers?

Q5.12 What impact could financial intermediation have on the effectiveness of retirement income policy?

Q5.13 The cost of providing health and aged care to older Australians is currently met by government through the health sector. Should retirement income policy take into account projected increases in health costs for older Australians? If so, what would be the most effective mechanism and how might the transition to such a system be achieved?

Taxing business and investment

The tax system needs to evolve to respond to the opportunities, as well as challenges, arising from globalisation. Attracting investment to Australia, directed to activities with the greatest national return, will improve the returns to Australians from working and saving.

An internationally competitive business environment is necessary to attract investment and international businesses, consistent with an objective of increasing national income. Achieving an internationally competitive business environment depends, in part, on getting the right balance of tax bases and rates.

The quality of investment is equally important. Improving the allocation of resources and investments, not discouraging risk taking, and removing tax biases that negatively affect business and household investment decisions, offers the potential to increase productivity and Australia's long-term prospects for economic growth.

Consultation questions

Q6.1 Can the tax system be structured to better attract investment to Australia in a way that increases national income, and if so how? For any given revenue outcome, what are the relative merits of broader base/lower rate (comprehensive income tax) or narrower base/higher rate (a narrow income tax or an expenditure tax) approaches?

Q6.2 What changes, if any, to the tax system would improve the ability of Australian companies to operate internationally orientated businesses? How should the tax treatment of companies and shareholders be integrated in an open economy?

Q6.3 Can the tax system be restructured to improve resource allocation within the economy and minimise operating costs, and if so, how? What changes would reduce distortions to risk taking and encourage entrepreneurial activity?

Q6.4 What principal goals should inform the taxation of capital gains in Australia, and what, if any, changes should be made to capital gains tax as a result?

Q6.5 Should the tax system provide a more neutral treatment of different financing arrangements (debt, equity and retained earnings), and if so, how? What principles should inform approaches to entity taxation?

Q6.6 Should the tax system be structured to cater for the specific circumstances of small business, and if so, how?

Q6.7 Should the tax system be restructured to deliver a more neutral tax treatment for the different forms of return on household savings and investments, and if so, how?

Not-for-profit organisations

Not-for-profit (NFP) organisations perform a valuable role in Australian society. They are eligible for a range of tax concessions and receive direct government funding in support of their philanthropic and community-based activities.

The tax concessions for the NFP sector are complex and applied unevenly.

Gifts are an important source of funding for NFP organisations. The current gift deductibility arrangements impose compliance costs on individuals and provide higher income donors with a greater taxation benefit than lower income donors.

Consultation questions

Q7.1 What is the appropriate tax treatment for NFP organisations, including compliance obligations?

Q7.2 Given the impact of the tax concessions for NFP organisations on competition, compliance costs and equity, would alternative arrangements (such as the provision of direct funding) be a more efficient way of assisting these organisations to further their philanthropic and community-based activities?

Complexity — cost, risk and transparency

The tax-transfer system is very complex. To a degree this reflects the reality of the modern world. Some complexity is unavoidable in a system that also has equity and efficiency objectives. However, complexity adds cost and risk to day-to-day business and personal activities. It affects the choices individuals make to work, save and consume. The time and resources individuals and businesses spend understanding and complying with the tax-transfer system could be devoted to more productive or satisfying activities. Complexity also makes the system more costly to administer. These costs impact on Australia's international competitiveness and the efficient allocation of society's resources.

Complexity also reduces transparency — that is, the extent to which people understand how the system works and what it is trying to achieve. This can impact on people's attitudes to the system, including its perceived legitimacy and people's willingness to voluntarily comply.

Sources of complexity include the large number of taxes and transfers, detailed rules associated with each, the interaction between them, different jurisdictions applying similar taxes or transfers in different ways, and the way taxes and transfers are administered.

Accordingly, reducing complexity may demand: reconsideration of the range of complex policies and objectives embodied in the system; integration and streamlining its currently fragmented administration; and greater certainty, transparency and public engagement in the overall management of the system.

Consultation questions

Q8.1 Which taxes or transfers are the most complex and impose the greatest costs? How should these costs be reduced (by abolishing the taxes or transfers or by making the rules applying to them simpler)?

Q8.2 In what ways might the administration of Australia's tax-transfer system be changed to better meet the needs of individuals and businesses? How might the process of personal income tax returns be simplified, including by removing the requirement for some taxpayers to lodge returns? Should the administration of the system be more integrated (across taxes and transfers and between jurisdictions)? How might advances in technology assist?

Q8.3 To what extent might policy objectives be traded off to achieve a simpler system? In what areas should efficiency, equity or choice be traded off for simplicity?

Q8.4 How could the governance of the tax-transfer system be reformed to reduce complexity, uncertainty and cost, and to improve transparency, understanding and support for the system?

State and local taxes and transfers

A well functioning federal tax-transfer system is necessary if Australia is to meet the challenges of the coming century and make the most of future opportunities. Through a lack of coordination in policy and administration, the federation's tax-transfer system has become disjointed and complex, imposing unnecessary costs on all Australians.

Reforms which enhance the accountabilities, integration and efficiency of the federation's tax-transfer system can improve the functioning of the federation by reducing costs, removing complexity and improving resource allocation.

There are many issues that need to be taken into account when considering possible reforms to the way the tax-transfer system operates across the federation. Central to this is the trade-off that may occur in relation to the accountability (and other benefits) of State governments for raising their own revenue and the complexity and efficiency of the federal system. In addition, having different transfer policies in different States as well as multiple administering agencies for both taxes and transfers is a source of further complexity and possible inequities.

Consultation questions

Q9.1 Noting the overall structure of Australia's federal financial arrangements, what changes, if any, should be made to the assignment of revenue raising powers and intergovernmental transfers in Australia?

Q9.2 Given the widely held view in submissions that the current state tax arrangements need to be reformed, what changes should be made to state and local government own source revenue instruments? What scope is there for greater use of user charging to bring social, environmental or economic benefits?

Q9.3 What is the appropriate allocation of the roles of the Australian and state governments in income redistribution?

Q9.4 What opportunities could be pursued to deliver more seamless administrative arrangements of the tax-transfer system across the federation?

Tax and transfer impacts on housing

Housing plays an integral role in Australian society. It provides a source of shelter and a base for people to participate in communities and the workforce. It is the largest store of the nation's wealth and a major source of retirement savings for home-owners.

The tax-transfer system affects the housing market through a range of taxes, concessions and transfers, which in some cases are targeted at certain housing tenures or income levels. These aspects of the system influence the type of homes people live in, the way they save and invest, including for their retirement, and the affordability of housing. Through its treatment of housing, the tax-transfer system also delivers significant assistance to particular groups of Australians, which affects the overall equity of the tax-transfer system.

Consultation questions

Q10.1 What should be the objective of the tax-transfer system in respect of housing? Should there be assistance for housing over other assets or services? Should assistance be based on housing tenures? Should assistance be focused on people on low incomes? Should assistance differ between public and private tenants?

Q10.2 What role, if any, should the tax-transfer system play in respect of housing affordability? Should the tax-transfer system be used to influence housing supply and/or demand to improve housing affordability? What changes, if any, should be made to housing-related transfers that assist disadvantaged households to find housing?

Q10.3 Recognising the influence that some taxes and transfers have on the use of housing and residential land, what changes, if any, should be made to ensure the housing stock and residential land are used efficiently?

Taxes on specific goods and services

In addition to the broad-based GST, there is also a range of consumption or other indirect taxes levied on narrow bases, including excise collected by the Australian Government and other taxes collected by the States. Products subject to these narrow base taxes, are taxed relatively more heavily than other consumption goods.

The decision whether to tax some consumption goods more highly than others, and the optimal design of a particular tax, depend on the policy objective it is trying to achieve.

The current tax arrangements for beer, wine, spirits, tobacco and luxury cars reflect a range of competing policy goals. They exist in the context of other forms of regulation and the broader tax-transfer system.

Consultation questions

Q11.1 Is it appropriate to use taxes on specific goods or services to influence individual consumption choices, and if so, what principles can be applied in designing the structure and rates of such taxes?

Q11.2 Can the competing potential objectives of alcohol taxation, including revenue raising, health policy and industry assistance, be resolved? What does this mean for the decision to tax alcohol more than other commodities?

Q11.3 What is the appropriate specific goal of taxing tobacco? Is it necessary to change the structure or rate of tobacco taxes?

Q11.4 If health and other social costs represent the principal rationale for specific taxes on alcohol and tobacco, is any purpose served in retaining duty free concessions for passenger importation of these items?

Q11.5 Are taxes on specific 'luxury' goods an effective way of making the tax system more progressive? If so, what principles should apply to the design and coverage of these taxes?

Q11.6 Should the tax system have a role in influencing the relative prices of different types of cars, including luxury cars and higher polluting cars, and if so, on what basis? What does this mean for taxes on the purchase price of motor vehicles?

Fuel, roads and transport

The efficient movement of people and goods is an important contributor to productivity and wellbeing. Improving the structure of taxes and charges related to transport can improve efficiency.

Taxes on motor vehicle fuels provide a considerable share of revenue, but contribute little to reducing the location and time specific costs of motoring. Different tax treatments of alternative fuels may also further reduce the efficiency of fuel taxes. Different types of transport are also taxed in different ways, potentially altering economic behaviour.

There may be opportunities to replace existing taxes with more targeted taxes and charges that promote the efficient use of transport networks. In particular, emerging technologies may have a role in targeting the social costs of motoring such as air pollution, greenhouse gas emissions and damage to publicly funded roads.

Consultation questions

Q12.1 How can motor vehicle related taxes and road funding arrangements be designed to improve the efficiency of transport of people and goods in Australia?

Q12.2 What should be the role, if any, of fuel taxes? What does this mean for how fuels and their uses are taxed and the rates of tax applied?

Q12.3 Do the existing tax arrangements lead people to make economically inefficient transport choices, and if so, how might they be improved?

Tax-transfer impacts on the environment

Australia faces significant environmental challenges in the 21st century, ranging from global issues, such as climate change, to local issues, such as water scarcity, land degradation and species loss. Economic development must be undertaken in an environmentally sustainable way, while also recognising that the environment itself has value.

Taxes may provide one means of improving environmental amenity. The tax-transfer system can also detract from environmental outcomes through the incentives it creates. Such incentives need to be carefully evaluated against other policy objectives.

Consultation questions

Q13.1 Bearing in mind that tax is one of several possible instruments that can address environmental externalities, what opportunities exist to use specific environmental taxes to address Australia's environmental challenges?

Q13.2 Noting that many submissions raise concerns over unintended environmental consequences of taxes and transfers, such as the fringe benefits tax concession for cars, are there features of the tax-transfer system which encourage poor environmental outcomes and how might such outcomes be addressed?

Q13.3 Given the environmental challenges confronting Australian society, are there opportunities to shape tax-transfer policies which do not currently affect the environment in ways which could deliver better environmental outcomes?

Natural resource charging

Natural resources are an essential input to Australia's productive capacity. The way in which Australia uses its natural resources is an important determinant of the level of economic growth. It also affects the environment now and into the future.

Ensuring the community obtains maximum value from the appropriate use of its natural resources is an important part of an efficient tax system. The tax system can influence the rate at which resources are extracted and the capacity of future generations to enjoy the benefits of natural resources. Issues which need to be taken into account in considering the taxation of natural resources include the size of the recoverable stock of the resource and how quickly (if at all) it is able to renew, the effect of taxes on investment decisions, which level of government taxes the resource, and the alternative uses of resources outside commodity markets.

Consultation questions

Q14.1 When considering the appropriate return to the Australian community for the use of its non-renewable resources, what relative weight should be given to the determinants of that return?

Q14.2 What is the most appropriate method of charging for Australia's non-renewable resources, given they are immobile but that Australia needs to compete globally for mining investment?

Q14.3 What is the role of the tax system in ensuring that renewable resources are used both sustainably and efficiently?