Australia's Future Tax System

Consultation Paper

Section 1: Challenges and opportunities for reform

The Panel's four consultation questions from August were intended to elicit community perspectives about the way in which Australia's tax-transfer system should be structured. The first two questions focus on how to better position Australia to respond to developments over the next few decades, while the second two questions focus on problems evident in the existing arrangements.

Future developments are likely to have wide ranging effects on tax-transfer policy choices. This section provides an overview of these issues. The questions were:

Q1. What major challenges facing Australia need to be addressed through the tax-transfer system?

Q2. What features should the system have in order to respond to these challenges?

The key themes from submissions in response to these questions are presented in this section as part of a broader discussion of the influences that are relevant to the design of Australia's future tax-transfer system.

1.1 Challenges and opportunities facing Australia and what they mean for the tax-transfer system

Policy choices arising from this review will influence the shape of Australia's tax-transfer system for many years into the future. Accordingly, appreciating the factors that might shape Australian society over at least the next few decades is important when considering how Australia's tax-transfer system might be structured.

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 (see Appendix A).

Submissions identify the following broad challenges and opportunities:

  • 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.

Section 1.2 discusses submission responses relating to the Panel's second question about the features a future tax-transfer system might have to best respond to these challenges and opportunities.

What type of society do Australians want?

The tax-transfer system is a fundamental part of Australia's social and economic infrastructure. It will both shape, and be shaped by, the evolution of society more broadly.

Several submissions explicitly talk about the type of society in which Australians might aspire to live, while in others it is implicit in the identified challenges and desired features of the tax-transfer system.

Summary of key messages from submissions

Many submissions see a role for the tax-transfer system in fostering improved living standards through stronger economic growth, as well as promoting opportunities for those experiencing entrenched disadvantage and transitioning from welfare. For example, one submission echoes the contributions of the 2020 Summit by setting an objective of Australia being the 'best place to live, work and do business with GDP per capita in the top five countries by 2012'.

Other submissions believe a fairer and more equal society is the main priority for reform of the tax-transfer system, with economic and market considerations supporting this goal. One submission along these lines states that the tax-transfer system should embody the values and expectations held by society and sets an objective of building 'a competent and compassionate Australia'.

Several submissions comment on the need to provide a more appropriate level of income support for the disadvantaged and facilitate transitions into employment and retirement.

Strengthening economic growth is the implicit starting point in many submissions. Equity is also seen as an explicit part of the design framework, along with maximising efficiency and minimising complexity.

A number of submissions see a general need to shift to a more environmentally sustainable society, while many others emphasise various environmental goals.

One of the inputs to the Australian Government's decision to establish the review was the report of the 2020 Summit, held in April 2008. The summit report illustrates how reform of the tax-transfer system can fit into a broader perspective on the future of Australia. It emphasises that taxation is one of many government functions that impact on the economy and can be considered alongside Australia's regulatory regimes and direct economic interventions by government.

The summit report saw the role of government as one means of '[creating] a truly national, efficient, sustainable and inclusive economy supported by seamless regulation.'

As noted above, many submissions are explicitly or implicitly framed by an objective of increasing economic growth. Economic growth is a key factor influencing the wellbeing of Australians, through its impact on incomes and living standards.

The 2007 Intergenerational Report (Australian Government 2007) projects that, on the basis of established demographic and economic trends, Australia's rate of per capita economic growth will average around 1.6 per cent over the next 40 years, compared with a rate of 2.1 per cent over the past 40 years, due primarily to a decline in the proportion of the population of working age.

The tax-transfer system can have an important influence on the rate of economic growth. The system impacts on economic decision making, particularly on decisions about workforce participation and decisions that affect productivity, as well as through the economic costs of administration, compliance, avoidance, complexity and uncertainty.

Improving the efficiency of the tax-transfer system could help to ease the projected expenditure burden of our ageing population on working-age Australians.

The appropriateness of the existing income support arrangements is considered in Section 4. The adequacy of pensions and issues surrounding the transition to retirement are the subject of the separate Pension Review and retirement incomes consultation process due to report in early 2009.

The size of government in Australia

The size of government in Australia, including the transfer system, determines how much revenue the tax system needs to raise. It has implications for the way the system is designed and how it affects the community. The terms of reference require the review not to presume a smaller general government sector or a sustained increase in the tax to GDP ratio relative to its level in 2007-08. However, revenue neutrality will not be a rigid constraint on the Panel's recommendations for tax-transfer reform.

Most submissions do not comment on the size of government or the level of tax or total revenue as a proportion of GDP. Those that do, express differing views about the size of government. A range of submissions note the need for some revenue flexibility to avoid ruling out potentially important reforms with significant revenue implications.

Summary of key messages from submissions

Several submissions from community groups say the existing level of tax revenue is inadequate to fund Australia's social programs and economic infrastructure needs. One states that tax reform should strengthen, not diminish, future revenue to equitably support the costs of our ageing population and necessary investment in economic and social infrastructure.

Business submissions generally express or imply a view that the overall tax burden is too high and government spending should be reduced, noting all taxes impose costs to economic efficiency.

A number of business submissions argue that unilateral reductions in taxes on capital will provide a stronger economy and a lower per capita tax burden.

At around 31 per cent of GDP, Australia's tax to GDP ratio is reasonably typical of developed countries, though there is a considerable range across developed and developing countries.

A key issue for the review is how the role and size of government in Australia might change in the future. One possibility is that Australia could pursue a strategy of maintaining the size of government but with a higher rate of economic growth than government expenditure. This would allow some reduction in tax rates without reducing the absolute size of government. Whether this is possible in the face of strongly growing demands on government — particularly demands generated by demographic change — is difficult to say. On the other hand, Australians may choose to have a larger government sector as real incomes increase.

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?

Increasing globalisation and changing world economic activity

Australia is a small, open economy operating in an increasingly globalised world with freer flows of ideas, investment and labour. Increasing globalisation, particularly among more developed economies means social systems and economic infrastructure are becoming more uniform and tax settings may become relatively more important in decisions about where to invest and work.

The current crisis in financial markets shows the extent to which world economic systems are interlinked. It also shows the need for policy flexibility in responding to developments overseas.

The shifting pattern of world economic growth is also important. China and India now account for around 15 per cent of world GDP. The growth of these two economies has been a major factor in the strength in Australia's terms of trade recently, through mineral and agricultural commodity prices. Despite the current economic difficulties, these economies, and others in our region, are likely to continue to be an important influence on Australia's future prospects.

Globalisation and tax competitiveness

Many submissions, particularly those from business groups, identify global competition as a key challenge for Australia and a key determinant of tax-transfer design. This is particularly important for taxing investment income, especially corporate income, because investment can be switched with relative ease between alternative activities and locations and because profit can be shifted between jurisdictions. There are also concerns about the need to have personal taxes that competitively attract and retain skilled workers and promote entrepreneurial activity.

Summary of key messages from submissions

Several submissions point to the role of investment and cross-border capital flows in promoting economic growth and the living standards of Australians.

Global integration is generally seen as desirable. Several submissions highlight the need to foster entrepreneurship, new business activity and diversity in markets.

A key theme of business submissions is the need to promote increased tax competitiveness for the business sector. Reducing the corporate tax rate is seen as a key reform. Submissions cite the steady decline in OECD company tax rates in arguing for an Australian company rate of 25 per cent, with further reductions over the medium term. Business submissions also point to a range of other (base narrowing) reforms to promote tax competitiveness.

However, not all business groups support lowering the company tax rate in the near term. At least one would like to see the top personal rate aligned with the existing company rate rather than a reduction in the company rate.

Non-business organisations contest claims about the need to cut the rate of tax on capital income to maintain competitiveness. Equity considerations are seen to be more important, in one case reflecting a view that any benefit from cutting tax on capital income will go to shareholders only.

The need to attain an appropriately skilled workforce and the mobility of skilled labour is mentioned in several submissions, but does not feature as prominently as the taxing of capital income in terms of international tax competitiveness.

Several submissions refer to the recent instability in global financial markets, arguing that tax settings should be flexible enough to accommodate changing circumstances in international and domestic markets.

Taxation of capital income

A focal point of business concerns about taxation of investment income is Australia's 30 per cent corporate tax rate. Many submissions point to Australia's declining ranking relative to other OECD countries. The unweighted average company tax rate among OECD countries is steadily declining at a rate of about one percentage point per year, with a smaller decline in the GDP weighted average rate (Chart 1.1). Since 2001, when Australia's company rate was reduced to 30 per cent, Australia's company tax rate has moved from ninth lowest in the OECD to twenty-second lowest on 1 April 2008 (KPMG 2008).

Chart 1.1: Statutory company income tax rates of OECD countries (1985 to 2008)

Chart 1.1: Statutory company income tax rates of OECD countries (1985 to 2008)

Note: Rates are top national statutory company tax rates until 2000 (they exclude local and state company taxes imposed in some countries) and full company tax rates thereafter (they include company taxes from all levels of government). Averages are both GDP weighted and unweighted.

Source: Australian Treasury estimates; OECD Tax Database; KPMG (various years); Deloitte (2006); national governments.

To date, much of the impact of reducing company tax rates on revenue in OECD countries has been offset by legislative and economic broadening of the corporate tax base, though overall effective tax rates have declined. The company income tax rates of smaller economies have declined to a lower level than those of the major economies.

The scope for further base broadening is, arguably, now more limited among many OECD countries. This means that revenue and other constraints may weigh more heavily on decisions about company tax rates. However, the trend toward lower company tax rates may continue as countries compete to attract mobile capital and highly profitable firms.

Other submissions point to Australia's relatively high reliance on tax revenues from capital income, of which corporate tax revenue is a primary contributor, and Australia's high corporate tax to GDP ratio relative to other OECD countries. Section 3 examines this issue, noting that recent high corporate tax revenues are mainly due to strong growth in the corporate tax base.

One reason for the differences of view in submissions about the importance of reducing corporate tax is that they reflect different assumptions about who bears the economic burden of taxes on capital income. However, as discussed in Section 6, while shareholders may benefit from a reduction in company tax in the short term, it is likely that in the long-term, labour will receive at least part of the benefit in the form of higher wages. This is due to increased investment, and a larger capital stock, leading to higher labour productivity.

In particular, increased foreign direct investment can lead to higher labour productivity. This happens through improvements in the way labour and capital are used through the introduction of new production techniques, knowledge, products, organisational synergies and process technologies. These can generate 'spillover' benefits for the rest of the economy, thereby increasing economic growth.

Labour mobility

Several submissions also highlight the increasing international mobility of individuals, particularly of more highly skilled individuals. Tight labour market conditions in recent years have led to high demand for skilled workers across a broad range of occupational groups. Permanent and temporary skilled migration has responded to this demand. The inflow of skilled workers has generally exceeded the outflow of skilled workers in recent years. While there will be strong cyclical elements in the demand for skilled labour, population ageing in Australia and many other countries could lead to increased international competition for skilled labour.

Electronic commerce

A further dimension of globalisation that receives relatively little attention in submissions is the evolution of the internet and e-commerce. This has reduced the connection between a person's residence and their place of business and the consumption of some goods and services, such as those available over the internet. These developments represent a potential challenge to taxing some commercial activities and private consumption.

The changing pattern of world economic growth

If the economies of China and India follow similar growth paths to those of the newly industrialised Asian economies, the pattern of world GDP will be substantially altered over the next few decades (Chart 1.2). While this will not substantially improve Australia's economic isolation in an absolute sense, as the distances from Australia's main capital cities to these locations are considerable, a relative improvement in Australia's trade competitiveness, compared with many other OECD countries, may result in an increasing share of Australian trade in the Asian region.

Summary of key messages from submissions

A number of submissions see sustained economic growth in China and India — and other developing countries more generally — as an opportunity for Australia's resource industries.

Other business submissions anticipate that as these countries accumulate human capital and sophisticated economic infrastructure, they will begin to compete with Australia for internationally mobile capital.

Chart 1.2: Distance in kilometres to world GDP (2005 and 2025)

Australia

Chart 1.2: Distance in kilometres to world GDP (2005 and 2025) - Australia

United Kingdom

Chart 1.2: Distance in kilometres to world GDP (2005 and 2025) - United Kingdom

Note: The chart shows the percentage of world GDP generated in countries within the distances in kilometres from each of Australia and the United Kingdom respectively.

Source: The Conference Board and Groningen Growth and Development Centre Total Economy Database, January (2008); Australian Treasury estimates.

The implications of an absolute and relative increase in economic activity in the Asian region are uncertain but could be significant for Australia, as has been the case with the rise in commodity prices in recent years. Possible implications of the projected growth in these economies include increased: competition for internationally mobile investment; employment opportunities for skilled Australians; and opportunities for two-way trade in commodity, product and service industries.

Demographic change in Australia

The 2007 Intergenerational Report (Australian Government 2007) highlights the profound demographic changes Australia is likely to experience over the period to 2047. Australia's total population is projected to increase by close to 40 per cent, from 20.6 million in 2006 to 28.5 million people. Under the report's assumptions, migration is projected to account for around half of this increase.

The projected ageing of Australia's population is particularly significant, with a quarter of the population expected to be aged 65 years or over by 2047, almost double that of today. The fastest rate of population growth is projected to be among Australians aged 85 years or over. By 2047 there will be only 2.4 people of traditional working age (16 to 64 years) supporting each person aged 65 years or older, down from five working-age people in 2007. The increase in age dependency is only slightly offset by a projected reduction in child dependency.

The proportion of the population of traditional working age is projected to decline by around 8 percentage points, to less than 60 per cent of the population. Within the group of Australians of traditional working age, the fastest growing group will be 55 to 64 year olds, rising by nearly 50 per cent over the next 40 years.

The ageing of the population is projected to slow economic growth and lead to increased spending in areas such as health, age pensions, and aged care.

Many submissions recognise the significance of this demographic change. There is also an awareness that the higher the growth in real incomes for the population, the lower the proportion of income that will need to be taken in tax to provide government services to older Australians.

Summary of key messages from submissions

Many submissions identify an ageing population as a key challenge facing Australia. Many recognise the role that higher rates of workforce participation and economic productivity can play in reducing the impacts of an ageing population on the working population.

Income adequacy in retirement and its potential implications for government spending is identified as a key issue. A range of submissions say current policy does not ensure adequate incomes in retirement, with a particular focus on the adequacy of the 9 per cent superannuation guarantee and its scope.

Several submissions from the financial industry point to the prospect of increasing life expectancy and argue that greater reliance on income stream products will be required to address the income risks surrounding increasing longevity.

Given the significance of the tax-transfer system, both as a mechanism for funding government spending and a conduit for much demographically dependent spending, the efficient design of the system will be a critical element of Australia's response to its demographic challenge.

The design of the tax-transfer system can either contribute to, or hinder, Australia's economic performance over the next few decades. Minimising the effect of the tax-transfer system on individuals' incentives to work and on the productive use of our scarce resources can help sustain our economic growth. Similarly, tax-transfer policy has the potential to significantly affect the delivery and cost of achieving intended social policy outcomes.

The demographic challenges faced by Australia are also faced by many other OECD countries, as well as China and India. Australia has some advantages over many other countries in dealing with these challenges. For example, Australia's strong fiscal stance has enabled the elimination of government net debt and the accumulation of reserves to assist in meeting some of the anticipated future costs of our ageing population. However, the scale of the demographic challenge will require further major adjustments in Australia.

A changing pattern of workforce engagement

Changes in the structure of the Australian economy, following a long period of economic reform, and changing patterns of engagement in the workforce have resulted in structural changes to the labour market. In particular, we have seen: a fall in the predominance of male full-time jobs; an increase in female participation; and an increase in the number of older workers. Life-time work careers are also changing. More young, single people have short-term jobs and the increased workforce participation of women has increased their average job durations.

These changes have resulted in a more flexible labour market. But they have also increased the complexity in individuals' lives as they balance work with education, caring responsibilities and preparation for retirement.

Submissions note the need for the tax-transfer system to support both increased workforce participation and higher rates of skills formation.

Summary of key messages from submissions

A range of submissions argue that the tax-transfer system should do more to promote workforce participation and be better adapted to the greater diversity of working patterns.

Several submissions propose introducing tax-advantaged saving accounts to provide for education and lifelong learning.

The tax-transfer system can affect incentives to work and invest in education and training. For example, for welfare recipients, the combination of high rates of benefit withdrawal and marginal tax rates can reduce the incentive for them to find a job. It can also influence decisions about investing in education and skills formation. In addition to their impact on investment decisions, the treatment of superannuation income and the application of income tests and assets tests to the pension incomes of older Australians influence the workforce decisions they make in their transition to, and during, retirement.

Environmental sustainability

The environment is of value to Australians. It also provides natural resources essential to Australia's productive capacity, and ecosystems that absorb and assimilate the waste generated by people and industry. While it may be possible to extract higher levels of economic growth in the short term at the cost of a degraded environment, over the long term these choices may not be sustainable. Economic growth is strongly linked to environmental sustainability.

A broad range of submissions identify climate change as an important challenge facing the Australian community. Business submissions express concern about the potential impact of the tax arrangements associated with the Carbon Pollution Reduction Scheme.

Some submissions address the broader issue of environmental sustainability.

Summary of key messages from submissions

An important theme in submissions from environmental groups is that, given its central importance to economic decision making, the tax-transfer system needs to be consistent with achieving sustainable economic growth. Some submissions see sustainable growth as requiring reductions in net consumption and the production of wastes.

Many submissions argue that tax-transfer settings should be consistent with the objective of reducing carbon emissions. The potential costs of environmental protection are also a focus of attention, with a number of submissions arguing taxes relating to the Carbon Pollution Reduction Scheme should be designed to minimise the costs imposed on business.

Submissions propose a range of tax concessions aimed at enhancing the development and adoption of carbon-reducing technology. Some suggest that environmental taxes and charges provide a potentially significant alternative revenue source to conventional taxes.

Another theme in submissions is concern for the urban environment of our cities, including road congestion and air pollution, and whether these problems are exacerbated by a privileged tax treatment of motor vehicles.

Within the community and government, there is increasing awareness of the importance of Australia's natural environment and the environmental pressures emerging in areas such as land degradation, soil erosion and salinity, water use and climate change (Chart 1.3).

Chart 1.3: Indicators of Australian environmental pressures

1951-2006 (Index 1961 = 100)

Chart 1.3: Indicators of Australian environmental pressures - 1951-2006 (Index 1961 = 100)

Source: Commonwealth Scientific and Industrial Research Organisation, Australian Stocks and Flows Framework (unpublished); ABS (2004), ABS (2006d) and Australian Greenhouse Office (2006).

A greater understanding of environmental problems, arising from improved knowledge of environmental systems and their interactions, has led to a greater capacity to address environmental problems. As people's incomes and wealth have increased so too has their demand for environmental action. These factors will be an ongoing (and possibly greater) influence in the future.

Sustainable policy addresses the underlying incentives causing environmental degradation. Historically, governments have relied on regulation to achieve environmental outcomes. However, in some circumstances, corrective taxes, user charges and other market-based approaches provide alternative mechanisms for addressing environmental amenity.

Emerging technology may enhance the capacity to use these mechanisms. For example, it can enable direct charging for congestion and noise pollution from road transport (see Section 12).

Improving the Australian federation

A well functioning system of government can enhance economic performance and the broader wellbeing of Australians. There is general agreement, both within government and in the broader community, that the effectiveness of government in Australia could be enhanced. Improving the effectiveness of government has been a focus of the Council of Australian Governments in recent years.

The tax-transfer system spans the three levels of government, in terms of both the revenue raising and transfer functions. There is currently a relatively low degree of policy integration across levels of government and between the States. In recent years there have been repeated calls to improve the structure of the tax-transfer system of the federation. Reflecting the cost on business from differing regimes, the States have been working to harmonise payroll tax arrangements (other than rates and thresholds).

Improving federal fiscal relations and the federal structure of the tax-transfer system are seen as key issues for this review. There is broad consensus across submissions that the structure of taxation, and to a lesser extent transfers, needs to be improved. These concerns arise in respect of both the underlying structure of the tax-transfer system and its administration.

Summary of key messages from submissions

Submissions call for federal funding arrangements that adequately recognise the responsibilities of each level of government, including local government. There is an imbalance between the amount of revenue that state governments raise and the amount they spend. The revenue powers and expenditure responsibilities of government need to be addressed to make them more transparent. These submissions also call for more revenue certainty for each level of government.

Some submissions argue that federal arrangements should be designed in such a way as to create incentives for States to improve efficiency in tax collection and service delivery.

While there is a range of views about the merits of specific state taxes, a common theme is that many of the states' taxes need to be abolished or reformed.

Some submissions call for a single Australian government tax collection agency, in place of the nine existing tax administrations, to reduce administration and compliance costs.

Some submissions note the interactions between transfers provided by the Australian government and state and local government concessions, as well as the implications that these may have for reforms.

Section 2 provides an overview of the federal structure of the tax-transfer system. The issues arising from this structure and from the broader financial relationship between governments in Australia are discussed in Section 9.

Improving policy formation and administration

A key message in the Architecture paper and the Pension paper is that our tax-transfer system is very complex and imposes high costs on the community. This is highlighted by the number of taxes and transfers, the lack of coordination and harmonisation across jurisdictions of essentially similar taxes and transfers, and the complexity in the administration of the tax-transfer system.

The existing tax-transfer system is largely a product of Australia's history. However, it also reflects an incremental approach to policy development based on partial assessments of trade-offs between complexity, efficiency and equity, often made with limited information. This incremental approach has reduced policy coherence, with costs to both equity and efficiency. It has also contributed to higher levels of complexity and operating costs in the tax-transfer system.

Submissions reflect a general concern about the process of policy development and the ongoing maintenance of the tax system. Fewer concerns were expressed in respect of the transfer system.

Summary of key messages from submissions

A common theme in submissions is the need for the tax policy process to be more open and transparent, particularly around the trade-offs between efficiency, equity and simplicity. In expressing these views, submissions welcome the recent government announcement to engage with the private sector earlier in the policy and legislative design process.

Several submissions from peak organisations comment that there is a 'governance gap' in the tax system. The concerns underlying these comments vary across submissions and include limitations on competitiveness, opportunities for tax minimisation, missed technological opportunities and policy inconsistency. However, there is a degree of consensus that there should be a regular review process to complement less frequent tax reform exercises. Some submissions specify that an independent oversighting body should be established to undertake this review process.

Some submissions point to the need to build a stronger culture of tax compliance. A regular process of review and repair, aimed at addressing tax minimisation strategies that undermine the integrity of the tax system, would be an important step in this process.

Submissions from larger businesses express some concern about the negative impact on business decisions of changes in the interpretation of the law and delays in processing requests for rulings. Representatives of small business note that engagement with the Australian Taxation Office has improved over recent years.

An important design challenge is to lessen the influences that gradually erode the benefits of reform. To an extent these influences are cultural and difficult to change. A more coherent policy framework, enhanced governance arrangements and increased community awareness about the costs and benefits of alternative tax-transfer settings may assist.

The Architecture paper drew attention to several areas where knowledge is deficient, including the incidence and efficiency impacts of individual taxes and transfers and their operating costs. Addressing these information gaps is a major task and will take some time. To initiate this process the Panel is commissioning research into the efficiency and operating costs of Australia's tax-transfer system.

The role of technology

Advances in technology have had a profound impact on the way we live. Over the past 50 years, technological improvements have dramatically increased the productive capacity of the economy — in particular through the evolution of computer technology. Technological progress is accelerating as our ability to assimilate and build upon information improves.

Summary of key messages from submissions

A range of submissions identify investment in technology as an important part of Australia's future growth. Several mention that global integration and technological advances will be key factors affecting Australia's international competitiveness.

A range of submissions call for incentives for innovation and research and development.

A number of submissions state that technology should be used as a means to reduce compliance costs for individuals and business.

Submissions also note the important relationship between technology and the environment. One submission mentions that it will play a particularly important role in the future of transport and alternative energy.

One submission claims that technology is changing the nature of work, allowing greater flexibility in how and where work is performed and by whom.

In a competitive global environment, technology creates opportunities and challenges for our society. Our standard of living is determined as much by relative changes in our productive capacity as it is by absolute changes. The tax-transfer system can influence the rate of technological progress by affecting the incentives for entrepreneurs to be creative and the incentives to invest in research and development or to adopt new technology.

Emerging technology has the potential to redefine the way we design and administer the tax-transfer system, both in terms of feasibility and operating costs. For example, new technologies such as 'etag' and the global positioning system allow more economically efficient direct charging for road use. Improved information technology enables administrators and clients to process tax and transfer information more efficiently, potentially reducing administration and compliance costs. The evolution of tax software to assist small businesses, electronic filing and pre-filling of individuals' tax returns illustrates how technology can change the way users interact with the system. The Government's Standard Business Reporting project aims to streamline interaction with government by allowing businesses to provide information through a single internet portal.

The extent to which technology can streamline community interaction with government is influenced, in part, by the design of the tax-transfer system. Taking full advantage of past and future technological developments may require a different perspective on the design and administration of the system.

1.2 Tax-transfer features to respond to these challenges and opportunities

Submissions identify a range of features that Australia's future tax-transfer system should have. These can be broadly categorised according to whether they represent the principles that might guide the design and operation of the tax-transfer system or the structural features that a well designed system might exhibit.

Design principles for 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.

Summary of key messages from submissions

The traditional tax design principles of equity, efficiency and simplicity are endorsed in a broad range of submissions.

Several submissions place primary emphasis on the need for a fair tax-transfer system. Behind this view is a progressive tax-transfer system with minimal opportunity for higher income earners to minimise their tax obligations. There is also a view that the system needs to support those experiencing entrenched disadvantage and help them move on to better outcomes.

Submissions acknowledge that the tax-transfer system should be efficient. It should support economic growth through minimal impediments to investment, entrepreneurship, innovation and workforce participation.

There is wide recognition that complexity and operating costs should be minimised. Submissions note that the tax-transfer system should be transparent and provide certainty to taxpayers and transfer recipients. Some express concern about the current balance between operating costs and ensuring integrity in the system.

A range of submissions identify the need for the tax system to deliver adequate revenue in a sustainable manner. Some express a view that the tax system should deliver a stable revenue base by minimising reliance on more volatile taxes.

A related theme, motivated by the recent financial market instability, is that the tax-transfer system should support flexibility in the economy to respond to changing circumstances.

Business submissions highlight the need for tax-transfer policy settings to be internally consistent and consistent with broader policy objectives. Consistency with environmental objectives, particularly in relation to climate change, is identified in a range of submissions as an area of concern.

An equitable tax-transfer system

There is no generally accepted benchmark for measuring how equitable the tax-transfer system is, or the extent to which equity is altered under different policy designs. Such assessments depend on individuals' value judgments. A diversity of views is reflected in the different perspectives presented in submissions.

One perspective on equity in submissions is that all individuals should have the opportunity to participate in society and achieve the things they value. Tax-transfer settings that enable people to escape poverty and improve their lifetime opportunities through education and workforce participation are consistent with this view of equity.

A more common perspective is that taxes should be levied according to individuals' or families' ability to pay, with those who are more capable of bearing the burden of taxes paying more. Implicit in submissions is a general view that individuals or families with the same capacity should face the same tax burden. There is less agreement about the degree to which those with greater capacity should pay more, as reflected in different statements about whether the tax system is currently, or should be, progressive, proportional or regressive. There is also less agreement about exactly what 'capacity to pay' means. That is, whether it should include all income, treated on a consistent basis regardless of how it is derived, the significance of family circumstances, the role of assets, including owner-occupied housing, and choices about work and leisure.

In some cases the different perspectives about the merits of alternative policies reflect differences of view about who bears the burden of a tax, or benefits from a transfer. For example, the different perspectives about whether taxes on capital should be reduced, in part, reflect differences of view about whether the economic burden of taxes on capital is borne by the owners of capital or by Australian workers through lower real wages. Some perspectives on transfers also reflect views about who enjoys the economic benefit of transfers, for example, the extent to which transfers to the aged benefit the aged themselves or are transferred to the next generation through larger bequests. Section 2.2 discusses the economic incidence of taxes and transfers.

The equity of the tax-transfer system can also be affected in several other ways.

  • Equity is influenced by the level of compliance with tax and transfer obligations and the ability of individuals to avoid paying tax or receive increased transfers through income planning arrangements. Some submissions point to the existence of significant opportunities for high income earners to reduce their effective tax liability through tax concessions, such as the 50 per cent discount for capital gains and salary sacrifice arrangements for superannuation, and through tax planning arrangements.
  • The impact of complexity in the tax-transfer system tends to be regressive, falling most heavily on those with the least capacity to deal with it and the least means to get professional help. These people may make less advantageous decisions or be unaware of the transfers to which they are entitled.
  • The allocation of operating costs between the administration and individuals also influences the overall equity of the tax-transfer system. All taxpayers share the cost of tax administration but compliance costs are borne by individuals based on their circumstances and choices.

Other perspectives on equity are:

  • the beneficiary principle, which states that people should pay tax broadly in accordance with the benefits they receive from government spending, regardless of their income. This principle provides a rationale for user charging and is described in Section 3.4;
  • inter-temporal or period equity, which is concerned with how the tax-transfer system affects individuals over time, particularly their decisions about work, saving, family and education;
  • intergenerational equity, which is concerned with how the wellbeing of individuals alive today compares with that of future generations; and
  • spatial equity, which is concerned with how the tax-transfer system affects individuals in different geographic areas with similar consumption opportunities. The geographic distribution of the people is changing with the ageing of Australia's population.

The costs of the tax-transfer system

The costs imposed by the tax-transfer system include efficiency and operating costs (administration costs and compliance costs), as well as the broader costs on individuals and businesses resulting from uncertainty and complexity.

Unlike perspectives on equity, submissions are in broad agreement that the tax-transfer system should raise and redistribute revenue with the least possible cost to economic efficiency and with minimal operating costs. There is also agreement that the broader costs of complexity should be minimised.

All taxes and transfers affect the choices individuals and businesses make by altering incentives to work, save, invest or consume things that are of value to them. These changes in behaviour can ultimately leave the economy and society as a whole worse off than if the revenue were raised (or distributed) without affecting behaviour. The size of these efficiency costs varies across different taxes and transfers, reflecting, in part, the extent to which they affect behaviour. The resources devoted to tax-transfer administration and the time and resources that individuals and businesses devote to understanding and complying with the requirements of the system, are diverted from more productive or satisfying activities and therefore also represent a significant efficiency cost to the economy.

Complexity in the tax-transfer system makes it difficult for people to understand their obligations and entitlements. This increases the risk of non-compliance and can make it harder for individuals to make the most beneficial decisions. Complexity can also give rise to tax-transfer planning opportunities that divert resources from productive uses.

Together with instability in tax-transfer settings, complexity may also reduce economic efficiency by increasing the level of uncertainty about the expected payoffs to long-term investment decisions, such as: investment in education; retirement products; long-lived productive assets; or the choice of business structure. Submissions also express concern about uncertainty in the interpretation and administration of the law.

The existence of these costs does not automatically imply that taxing and spending by governments reduces GDP or social wellbeing. Provided the goods and services supplied by government are of sufficient value to society to offset these costs, the overall wellbeing of society is enhanced. However, the tax-transfer system should operate at the lowest cost to society for a given set of outcomes. There is a clear message from submissions that current costs are excessive and need to be reduced.

Sustainability

The Panel views the design principle of sustainability from three perspectives. First, environmental sustainability is of such importance to Australia's future that the Panel regards it as a principle against which the current system and potential reforms ought to be tested.

Second, the Panel regards institutional sustainability as important. This includes whether the legal and administrative frameworks are robust and whether community attitudes to the system maintain its legitimacy.

Third, several submissions point to the need for a tax system that meets the revenue needs of Australian, state and local governments without recourse to inefficient taxes. Others point to the need for policies that contribute to a fair and equitable society and are affordable over the longer term, in light of the demographic changes facing Australia.

The Panel notes that a principal objective of the tax system is to raise revenue to fund the government programs, including transfer payments that Australians want. Access to broad revenue bases such as household consumption or income (broadly defined) gives governments the capacity to meet their spending responsibilities by imposing relatively low rates of tax on a broad range of economic activities.

Since many government functions, such as infrastructure projects and major defence acquisitions, require large expenditures over many years, the tax system needs to provide governments with a stable revenue stream that allows them to meet their spending responsibilities consistently and reliably over time. If the revenue stream from the tax-transfer system is too volatile from year to year, long-term government planning can be jeopardised and borrowing costs may be higher, diverting revenue from more productive uses. Short-term fiscal pressures created by unanticipated shortfalls in revenue may also force governments to resort to easily accessible but inefficient means of raising revenue, imposing higher costs on the economy.

Revenue stability is not, however, a goal that could reasonably be pursued at any cost. Features of the tax-transfer system that function as automatic stabilisers — injecting resources into the private sector in macroeconomic downturns and withdrawing them in times of economic expansion — help smooth demand in the economy without requiring policy action by government. However, taxes and transfers with these features may be more appropriate for the Australian government than for state and local governments.

In some cases, there may be a trade-off between revenue stability and economic efficiency. For example, a resource rent tax is a more efficient revenue raising mechanism than a flat, production based royalty. However, it produces a more volatile revenue stream than the royalty because revenue collections from a rent tax are more closely related to volatile world commodity prices.

Policy consistency within and beyond the tax-transfer system

The issue of policy consistency is mentioned in a range of submissions. For example, the policy impact of climate change is a focal point for this issue in many submissions, while others comment in terms of how well the tax-transfer system integrates with broader government policies and objectives and in terms of the settings within the tax‑transfer system.

Internal consistency in policy settings within the tax-transfer system can help people to understand the system and may assist in reducing complexity and uncertainty for taxpayers and transfer recipients. This can reduce the costs of the system and also increase equity by improving levels of voluntary compliance. If taxpayers cannot understand the system, or if the system is clearly inconsistent in the way it treats different taxpayers, transactions or activities, then taxpayers are less likely to comply with their obligations.

Consistency with the broader policy objectives of government can further improve understanding and transparency. Tax-transfer policy should not directly contradict policy in other areas of government activity. The extent to which particular features of the tax-transfer system can be designed to pursue policy objectives other than raising revenue is a matter that must be considered case by case. In some instances, attempting to use the tax-transfer system to pursue other goals may jeopardise the system's revenue raising capacity or increase the efficiency costs of raising revenue. It will often be necessary to compare the costs and benefits of different tax and non-tax policies available to pursue a given policy objective.

Structural features

While there is general agreement about the design principles of a tax-transfer system, there is less consistency in terms of what they mean for its design and how apparent conflicts between these objectives should be reconciled. Some of the key structural views raised in submissions are presented below.

Summary of key messages from submissions

There are mixed perspectives on whether the tax and transfer functions should remain largely separate, reflecting different roles and objectives, or more fully integrated, in order to reduce complexity and disincentives for individuals and families.

There is some consensus about the need to improve administration of the system. While there is broad concern about federal fiscal arrangements there is less consensus about how the problems should be resolved.

Submissions point to the need for sustainable policies for an ageing population. Proposals include increases in the level of self-provision through an increase in the superannuation guarantee, broadening its application to currently uncovered groups and adopting measures to reduce income risk due to poor financial planning.

Many submissions call for a reduction in the effective rate of tax on companies, either through a reduction in the company tax rate or a narrowing of the corporate tax base. Other submissions consider this a second order priority or regard it as inappropriate on equity grounds.

A range of submissions highlight the distortions in the treatment of different forms of capital income. Many call for the rate of tax on interest income to be reduced to bring it closer into line with other forms of capital income. Some call for improved neutrality by removing the concessional treatment of capital gains.

There is some interest in alternative capital tax structures, such as an allowance for corporate equity, flow-through taxation and the dual income tax approach.

Reform of state taxation, both policy and administration, and improved federal fiscal arrangements are identified as key issues in many submissions. Reform proposals range from removing less efficient state taxes through to revenue sharing arrangements.

Several submissions call for policy settings that are consistent with achieving environmental sustainability.

These issues are discussed in the following sections.