Australia's Future Tax System

Consultation Paper

Section 3: The revenue mix

Overview

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 that 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 returns to work compared with the returns 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?

A key issue for tax design is the mix of revenue from taxes on labour income, capital income, consumption and accumulated wealth, taking into account interactions with the transfer system. Decisions about the mix of taxes need to reflect the way in which a particular combination will affect the choices that individuals make and their disposable incomes. This requires balancing the equity, efficiency, simplicity and sustainability implications inherent in using any particular tax base. In general, government seeks a mix that raises the required revenue in a sustainable manner while best meeting society's equity objectives at least cost to the economy.

The Architecture paper highlights that, as a share of total tax revenue, Australia has a relatively low reliance on tax revenue from labour income and consumption compared with other OECD countries, and a correspondingly high share of tax revenue derived from capital income (the highest in the OECD in 2005). It left open the question of whether Australia's high reliance on capital tax revenue is an issue in terms of Australia's ability to attract foreign investment and maintain economic growth.

The Architecture paper also noted that the findings of a recent OECD study (Johansson et al 2008) suggest that taxes on capital income are more likely to have a detrimental impact on growth than taxes on property, labour income or consumption.

Australia's relatively low reliance on taxes on labour income partly arises because Australia, unlike most OECD jurisdictions, does not levy social security contributions on wage and salary income. If the superannuation guarantee were treated as a social security contribution, for the purpose of this comparison, taxes on labour income in 2007‑08 would have accounted for around 46 per cent of total tax revenue (compared to 39 per cent). The shares from capital and consumption would have been around 30 per cent and 24 per cent, respectively (compared to 34 per cent and 27 per cent). Even after making such an adjustment, Australia would still have a relatively high reliance on capital taxes and a relatively low reliance on labour taxes compared to other OECD countries.

This section further examines Australia's tax mix and discusses the appropriate balance of taxes on the returns to work and saving by Australian residents. It also discusses the taxation of consumption, including instances where particular types of consumption might receive a different tax treatment. Finally it considers the potential role for user charging and beneficiary taxation as a revenue source.

3.1 The mix of conventional taxes

Summary of key messages from submissions

A number of submissions argue for a reduction in taxes on income and an increase in taxes on consumption. Some submissions propose an increase in the rate of the GST, although they generally acknowledge that increasing the base or rate of the GST are outside the terms of reference of the review. However, some also oppose a shift toward taxes on consumption, or advocate reducing existing taxes on consumption, citing equity concerns.

Many submissions, mostly from business, call for a reduction in taxes on capital, particularly corporate taxes. Australia's relatively greater reliance on revenue from corporate taxes is seen as a key issue, with submissions highlighting concerns around capital mobility and international competitiveness.

Other submissions comment on the equity implications of the concessional treatment of some forms of capital income, noting that these arrangements tend to favour high income taxpayers.

Some submissions suggest more radical changes to the basis of tax, such as proposing a tax on financial transactions to fund reductions in taxes on income.

The composition of tax revenue in 2007-08

Chart 3.1 details the composition of Australia's tax revenue collected across all levels of government in 2007-08.

Taxes on labour provided an estimated 39 per cent of total tax revenue. The largest component, personal income tax on labour income, contributed around 31 per cent of total tax revenue. Payroll tax contributed 5 per cent of tax revenue, with a further 3 per cent arising from taxes on fringe benefits and superannuation contributions.

Taxes on capital accounted for around 34 per cent of total tax revenue, of which around 20 percentage points was from corporate tax (including petroleum resource rent tax, crude oil excise and taxes on the earnings of superannuation funds) and 9 percentage points was from annual taxes on real property and conveyancing and other stamp duties, in roughly equal proportions. Taxes on individuals' capital income, such as interest, net rental and business income, capital gains and dividends, and some state government taxes on financial and capital transactions accounted for the remaining 5 percentage points of capital tax revenue.

Chart 3.1: Contributions to Australia's tax mix

All Australian governments (2007-08)

Chart 3.1: Contributions to Australia's tax mix - All Australian governments (2007-08)

  1. Includes petroleum resource rent tax and crude oil excise and tax on earnings of superannuation funds.

Source: Australian Treasury estimates.

Taxes on consumption contributed around 27 per cent to total tax revenue. The largest single item was the GST, contributing around half of total consumption tax revenue. Excises contributed around 7 per cent of total tax revenue, while a range of state taxes — including on motor vehicles, gambling, and insurance — accounted for a further 7 per cent.

Recent changes in Australia's tax mix

Over recent years Australia has been relying less on tax revenue from labour income and more on tax revenue from capital income. The revenue projections in the 2008-09 Mid-Year Economic and Fiscal Outlook (Australian Government 2008d) imply that this trend will stabilise over the next few years, partly reflecting the influence of developments in world financial markets and their likely impact on economic growth (Chart 3.2).

Chart 3.2: Tax revenue from labour, capital and consumption

All Australian governments (1983-84 to 2011-12)

Chart 3.2: Tax revenue from labour, capital and consumption - All Australian governments (1983-84 to 2011-12)

Source: Australian Treasury estimates.

Chart 3.2 indicates that capital tax revenue has exceeded 30 per cent of total tax revenue on previous occasions. During 1988-89, the peak of the last economic cycle, the capital tax share was around 31 per cent and the labour tax share around 41 per cent. During the early 1990s recession, the capital tax share fell to around 27 per cent, with the labour tax share rising to around 45 per cent. This suggests a cyclical element, which is not surprising given that capital tax revenue is driven largely by receipts from corporate taxes, personal taxes on capital income, and property taxes, all of which tend to rise during periods of strong or sustained economic growth.

However, the dominant feature in Chart 3.2 is the persistent upward trend in the share of capital tax revenue since 2001-02 and the downward trend in the shares of labour and consumption tax revenue. Up to that point, nominal revenue collections from the three bases had grown at approximately equal rates. Since 2001-02, nominal revenue from capital income has grown faster than revenue from labour and consumption.

Changes in labour tax revenue

As a share of GDP, revenue from personal taxes on labour income has declined from over 11 per cent in the late 1990s to an estimated 9.7 per cent in 2007-08. Two key factors have contributed to this decline. The first is a reduction in the wages share of total factor income, from over 55 per cent in the late 1990s to an estimated 53.4 per cent in 2007-08, reflecting a bias in national income growth toward corporate profits. The second is successive personal income tax reductions.

Starting in 2000, personal taxes have been reduced seven times, most recently in the 2008-09 Budget, with further reductions scheduled to take effect from 1 July 2009 and 1 July 2010. In addition the low income tax offset (LITO) increased from $150 in 1998-99 to $1,200 in 2008-09 and the senior Australians' tax offset (SATO) was introduced. As a result, average personal income tax rates are currently at their lowest point since 1983-84 (Chart 3.3).

Chart 3.3: Change in average personal income tax rate at
selected multiples of average weekly earnings(a)

1983-84 to 2011-12 (Index 1983-84 = 100)

Chart 3.3: Change in average personal income tax rate at 
selected multiples of average weekly earnings - 1983-84 to 2011-12 (Index 1983-84 = 100)

  1. Includes low income tax offset but does not include Medicare levy or other tax offsets based on personal circumstances.

Source: Australian Treasury estimates.

Changes in capital tax revenue

The more rapid increase in capital tax revenue since 2001-02 is due largely to strong growth in corporate tax revenue (from 3.7 per cent of GDP in 2001-02 to around 5.7 per cent in 2007-08) and increased stamp duty revenue from property conveyancing.

Corporate tax revenue

Corporate tax revenue has increased from around 11 per cent to 20 per cent of total tax revenue in the past 10 years or so, accounting for the vast majority of the increase in the capital tax share of revenue.

Corporate tax revenues are a product of the level of corporate economic activity, the rate of company tax, and the breadth of the statutory corporate tax base. Growth in corporate profits has been very strong in recent years, underpinned by the expansion of the Australian economy and the rising terms of trade. Profits as a share of total factor income have risen from around 23 per cent in the late 1990s to just over 27 per cent in 2007-08.

The resources sector has been an important contributor to the recent profit growth in the economy, owing to increased bulk commodity prices. Profit growth has also been strong in the financial sector and property services sector (Chart 3.4).

Chart 3.4: Change in industry gross value added

1989-90 to 2007-08 (Index 1989-90 = 100)

Chart 3.4: Change in industry gross value added - 1989-90 to 2007-08 (Index 1989-90 = 100)

Source: ABS (2008b).

To the extent that the increase in revenue reflects an expansion in corporate profits, the change in the tax mix toward capital should not be of particular concern. However, this does not imply that the present corporate tax system is appropriate in terms of maximising the wellbeing of Australians. Issues concerning company tax and resources are discussed in Sections 6 and 14.

The statutory company tax rate has remained at 30 per cent since 1 July 2001, after being reduced from 36 per cent in the previous two years as part of a reform package involving the removal of accelerated depreciation and other base broadening measures. Since then changes to the statutory company tax base have been limited. Reflecting this, the effective average corporate tax rate has remained relatively stable (Chart 3.5) and below the statutory company tax rate.

Chart 3.5: Measures of the company tax rate in Australia (1985-86 to 2007-08)

Chart 3.5: Measures of the company tax rate in Australia (1985-86 to 2007-08)

  1. Economic profit is defined as corporate gross operating surplus as measured by the national accounts, less depreciation. An adjustment has been made for conceptual differences between national accounts and standard accounting definitions of net income. The income of government enterprises not subject to tax has been excluded from economic profit. CGT has not been included on the basis that realised capital gains have no direct relationship with current economic activity.
  1. Estimate.

Source: Australian Treasury estimates.

Revenue from stamp duty on property conveyances

Revenue from stamp duties on property conveyances increased between 2001-02 and 2007-08 from around 3.4 to 4.2 per cent of total tax revenue. These taxes have been an increasingly important source of revenue for the States.

The increase in this stamp duty revenue is mainly the result of higher property prices feeding through to a higher value of taxable transactions. For example, in Queensland, the value of taxable transactions increased by over 200 per cent between 1999-00 and 2007-08, with an even larger increase in revenues from stamp duties on these transactions (Chart 3.6). Recent economic developments appear likely to dampen property conveyance revenues. For example, the NSW Government's November 2008 Mini‑Budget (NSW Government 2008) included a downward revision of more than 20 per cent to 2008-09 conveyancing duty revenue.

Chart 3.6: Taxable transactions and revenue from land transfer duty

Queensland (1999-00 to 2006-07)

A: Taxable transactions

Chart 3.6: Taxable transactions and revenue from land transfer duty - Queensland (1999-00 to 2006-07) - A: Taxable transactions

Source: Queensland Government estimates.

B: Revenue

Chart 3.6: Taxable transactions and revenue from land transfer duty - Queensland (1999-00 to 2006-07) - B: Revenue

Source: Queensland Government estimates.

Changes in consumption tax revenue

In 2007-08, taxes on consumption contributed around 27 per cent to total tax revenue. This has been broadly constant over the past 25 years. The slight downward trend in evidence over the past five years largely reflects the relatively stronger growth in capital tax revenue. Represented as a proportion of GDP, taxes on consumption have declined from around 9 per cent in 2001-02 to around 8 per cent in 2007-08.

The most notable policy change affecting the composition of consumption tax revenue in the past 25 years was the introduction of the GST in 2000, accompanied by the abolition of the wholesale sales tax and a range of state taxes. The abolition of fuel excise indexation in 2001 was a further significant policy change, from which the cumulative revenue loss by 2007-08 is estimated to be in the order of $14 billion.

Longer term influences on the tax mix

The longer term prospects for the tax mix are difficult to discern. The change in the forward estimates of revenue between the 2008-09 Budget (Australian Government 2008a) and the 2008-09 Mid-Year Economic and Fiscal Outlook (Australian Government 2008d) indicate the sensitivity of the tax mix to economic conditions. Over the short to medium term a key influence on the tax mix will be movements in the terms of trade. Declining asset prices will reduce capital gains tax revenue for individuals, companies and superannuation funds. In addition, revenue from consumption taxes may grow more slowly.

A key question is to what extent the projected changes in the Australian population might influence the tax mix. Implicit in the economic growth projections in the 2007 Intergenerational report (Australian Government 2007) is an assumption that the capital to labour ratio in the economy will remain unchanged. Such an assumption reflects the profound difficulties in defining an alternative scenario. It is also difficult to project how the relative contribution to revenue from taxes on capital and labour might be affected by demographic change.

For example, if the relatively smaller working age population were to result in a relative scarcity of labour compared to capital, the effect would be to bid up real wages, implying a shift in relative factor shares toward labour income. If the larger proportion of the population moving into retirement and drawing down accumulated assets were to result in a relative scarcity of capital, the price of capital could increase relative to labour, implying a shift in relative factor incomes toward capital. These types of effects would not be confined to Australia. Similar demographic shifts are expected to play out in many developed countries over the next 40 years.

It is unclear how this might affect the global supply and demand for capital and labour, and how it might affect the relative price of capital and labour in Australia. International changes in capital and labour may have additional implications through international tax competition in either market. These pressures may point to an increasing future role for consumption taxes, but these too are incident on individuals and can affect competitiveness accordingly.

Consultation question

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?

3.2 Taxing the returns to work and saving

The tax burden on the returns to work and saving of Australian residents potentially has important implications for economic efficiency and the perceived fairness of the tax‑transfer system. In considering the tax burden on capital income, the focus in this section is on the way in which tax affects the choice between consumption and saving. The impact of the tax system upon the form in which saving occurs and the decision about how savings are to be invested is examined in Section 6 (which also argues that Australia's total investment level is determined by broader factors than domestic saving).

Choices that Australians make about working and saving affect their lifetime level of consumption and how that consumption is distributed through their lifetime. Tax-transfer arrangements, particularly the balance of taxes on earnings from work and from saving, affect these choices and can have important equity and efficiency implications.

Summary of key messages from submissions

A number of submissions, including from welfare groups, argue for greater taxation of the returns to saving. Some of these submissions suggest taxing returns to saving more heavily than returns to work.

A number of other submissions, including from individuals, business groups, and business advisory organisations, argue in favour of reduced taxation of the returns to saving. Some of these submissions argue that taxing savings penalises people who exhibit thrift.

Submissions also identify the treatment of inflation as an issue. Some call for the exclusion of inflation from the taxation of interest income, while others call inflation to be excluded for all savings income.

A number of submissions support consideration of a direct, recurrent tax on household net wealth. These submissions generally support a low rate and a broad base, including all assets and deducting all liabilities. Proposals often feature a threshold high enough to ensure that only high wealth individuals would have a tax liability. Most submissions proposing a wealth tax envisage it as a supplement to taxes on capital income.

Some submissions also canvass the possibility of wealth transfer taxes, again with a threshold to ensure that only large estates, or inheritances or gifts are affected. In some cases, proposals include concessional treatment for particular classes of recipients, especially spouses and children.

The relative taxation of the returns to work and saving

Many transfer payments are calculated with reference to an individual's income from work, savings and their holdings of assets. Section 2.2 discussed how income and asset tests have effects that are economically equivalent to taxes. In this section, the term 'taxes on the returns to work' refers to both traditional taxes as well as reductions in transfer payments due to income tests. Similarly, the term 'taxes on the returns to saving' refers to both traditional taxes and to reductions in transfer payments under income and asset tests that are due to income from savings and holdings of wealth.

Equity implications

It was noted in Section 1.2 that there is no universally agreed view as to what constitutes an equitable tax-transfer system. As noted above, there is a range of views in submissions as well as more broadly, about how the returns to saving should be taxed relative to the returns to work. These differences of view reflect different conceptual benchmarks and perspectives on horizontal and vertical equity.

The 'nominal income tax' benchmark reflects a view that all income represents an addition to the resources at the taxpayer's disposal. Under this view, individuals who have the same increment to their resources should pay the same amount of tax, irrespective of whether this income is compensation for work or for deferring consumption through saving. Those that have a greater increment to their resources should pay more tax.

A 'real income tax' benchmark reflects a view that a portion of the return to saving merely maintains the purchasing power of the saved income in the presence of inflation. As such, it does not add to the resources of the taxpayer as measured by what they are able to consume. Under this view it is considered appropriate to only tax the real return to saving, but to do so in an equivalent manner to other sources of income, such as the return to work.

An 'expenditure tax' benchmark reflects a view that the portion of the return to saving that is compensation for the taxpayer deferring consumption (the minimum required rate of return of the taxpayer) does not reflect an addition to the value of lifetime consumption experienced by the taxpayer. Thus, under this view, it is considered appropriate to levy tax only on the excess of the taxpayer's required return on deferred consumption. The Meade Report (1978) described this approach as one that taxes an individual based on the resources they take out of the economy (through consumption), rather than the resources they contribute to the economy.

The Architecture paper (see Box 6.1) includes a more detailed discussion of the characteristics of the expenditure and income tax bases.

An additional dimension to some people's views about taxing the returns to saving is that saving, and the wealth that it can create, tends to be biased toward those who are better off in society. A lower rate of tax on income from wealth, or deferral of taxation until the point of consumption, might be seen as undermining vertical equity. Two perceptions that might underlie these concerns are that holders of wealth receive benefits from holding wealth, such as financial security, power and influence, and that deferred taxation might not be recovered for an extended period of time.

Some proponents of an expenditure tax base argue that taxes on wealth transfers or on wealth holdings could be an important mechanism for ensuring equitable outcomes if taxation of saving were reduced or removed. Box 3.1 discusses taxes on wealth transfers and recurrent wealth taxes.

Taxes on wealth transfers may help to promote equality of economic opportunity by taxing large fortunes handed down from generation to generation and by limiting the acquisition of wealth without personal effort. On the other hand, bequest taxes may fall disproportionately on families where a death is unexpected relative to those that have had time to plan the management of the estate, although this would depend on the design of the tax. Also, bequest taxes would have to be designed to provide the appropriate treatment of intergenerational transfer of some particular asset types, such as business assets within a family.

Taxes on wealth holdings have similar properties to taxes on the income generated by asset holdings. Therefore a wealth tax is not entirely consistent with an expenditure tax approach, but could reflect a decision to tax savings at a different rate compared to the returns to work.

Analogous issues arise in relation to the transfer system. An additional consideration is that, irrespective of the application of an income test, some people consider that private wealth (and hence savings) should be called upon before any entitlement to transfer payments.

Box 3.1 Wealth taxes

Taxes on wealth transfers

Australia is one of only three OECD countries that do not levy taxes on transfers of wealth, such as estate, inheritance and gift taxes. While the majority of OECD countries raise some revenue from such taxes, in no case are they a major source of revenue. The OECD average is 0.4 per cent of total tax revenue. Only Japan, France and Belgium raise more than 1 per cent of tax revenue from such taxes. Australia has had no such taxes since the early 1980s when all States and the Australian government abolished their death and gift duties.

Recurrent taxes on wealth holdings

In Australia, council rates and state land taxes are the only significant recurrent taxes on asset stocks. In the transfer system, assets tests and the deemed rate of return on financial assets are examples where tax liability (or transfer reduction) is determined with reference to the stock of wealth, rather than the flows from it.

As the value of an asset generally reflects the flow of future benefits that it is expected to generate, recurrent wealth taxes are economically similar to taxes on capital income. There are several arguments for and against a greater use of wealth taxes compared to taxes on capital income.

Wealth taxes may improve equity, as they effectively tax non-monetary returns to holding assets (for instance power, security and prestige). Taxes on capital income flows generally exempt these non-monetary returns. If it is easier to measure asset values rather than capital income flows, wealth taxes may be able to provide more neutral treatment of particular assets.

However, wealth taxes may create cash flow difficulties for people who are relatively well off in terms of assets but live on relatively low incomes. In contrast, levying tax on income flows generally imposes tax liabilities in the same period that cash flows arise.

Efficiency implications

Taxes on the returns to work and taxes on the returns to saving create efficiency costs.

Taxes on the returns to work change the relative price to an individual of market consumption compared to non-market consumption and production. These taxes discourage individuals from working as much as they otherwise might in the absence of tax and encourage them to devote more time to activities such as leisure and home production.

Taxes on the returns to saving also create efficiency costs by discouraging people from deferring consumption and by discouraging people from working, as the tax on the returns to saving creates an additional wedge between the pre-tax returns to work and the amount of consumption that work generates.

An efficiency argument for taxing the returns to work and saving on an equivalent basis is that a broad income tax base with uniform rates of tax will result in fewer distortions to individuals' behaviour. Within this paradigm it has generally been acknowledged that applying such a treatment to the real return to saving (as opposed to the nominal return) is appropriate.

However, taxing savings results in a higher tax burden on deferred consumption relative to immediate consumption (see Box 3.2). This discourages saving and results in efficiency costs. It can be shown that under a range of assumptions the efficiency benefit from removing taxes on savings (which impact on choices to work and save) outweighs the additional inefficiency that would be created by increasing taxes on work.

More recent literature has questioned the relative efficiency of exempting savings through an expenditure tax approach, suggesting a range of reasons why it may be efficient to tax the returns to saving under an income tax. However, that literature also tends to suggest that the tax rate on the returns to saving should be lower than that applied to the returns to work. These issues have been examined in detail in the Mirrlees Review (see Diamond and Banks 2008, Hall 2008, Kay 2008 and Pestieau 2008).

Table 3.1 summarises the various efficiency and equity arguments for the different tax treatments of the returns to saving.

Table 3.1: Efficiency and equity arguments for different approaches to taxing saving

Tax treatment of savings

'Nominal income tax base': Tax all nominal returns

'Real income tax base': Exclude inflation

'Expenditure tax base': Exclude inflation and the returns for deferring consumption

Efficiency arguments

Efficiency arguments for taxing the returns to saving

Uncertainty about future wage prospects can mean it is efficient to levy some tax on the returns to saving.

Working decisions vary with age, which means taxes that vary with age can be more efficient. Taxing savings can be a proxy for age-based taxation.

Saving rates may vary with earning capacity, which can make some taxation of saving efficient.

Large accumulations of savings in the hands of a few individuals may cause detrimental concentrations of power.

Tax system integrity is easier to safeguard for unincorporated businesses and closely held companies.

Efficiency arguments for not taxing the returns to saving

The double taxation of deferred consumption means that replacing taxes on savings with higher taxes on labour is often efficient.

The presence of intergenerational transfers mean the cumulative distortion from savings taxes becomes very large in the long term, implying a zero rate of tax on savings (although the same arguments suggest a very high rate of tax on savings in the short term).

Individuals are myopic and don't save enough (although the pension and superannuation guarantee are retirement savings policies to address this, and government intervention on this basis risks detracting from wellbeing by encouraging too much saving).

 

Efficiency argument for not taxing inflation returns

Taxing inflation returns reduces savings and increases the variance of real after-tax rates of return between projects and through time.

Equity arguments

All income constitutes additional resources and should be taxed.

Taxes on savings are taxes on the wealthy.

All real income is additional resources and should be taxed. Returns reflecting inflation are not increases to the real quantity of goods and services the individual can buy and should not be taxed.

Taxes on savings are taxes on the wealthy.

All increases to a person's lifetime consumption possibilities, as valued today, should be taxed. Returns to saving do not reflect increases in lifetime consumption possibilities; instead they are compensation for consumption that has been deferred in the past.

Taxes on savings are taxes that fall on people who have saved in the past and benefit people who consume their income as soon as they earn it.

People should be taxed on what they take out of the economy (consumption) rather than what they contribute (income).

Box 3.2: The cumulative impact of taxes on the returns to saving

Taxing the returns to saving, as well as the returns to work results in higher tax rates on consumption that is deferred through saving than it does for immediate consumption. The additional effective tax rate depends on how long the consumption is deferred. Chart 3.7 shows how imposing a 30 per cent tax on the returns to both work and saving results in a greater tax liability (in net present value terms) the longer the taxpayer defers their consumption. In this example the individual faces an effective tax rate of 30 per cent on immediate consumption and of about 50 per cent on consumption that is deferred for 20 years.

Chart 3.7: Effective tax rates on consumption with a 30 per cent income tax

Chart 3.7: Effective tax rates on consumption with a 30 per cent income tax

Note: Calculated for an individual taxpayer on a 30 per cent personal tax rate and a 6 per cent nominal rate of return on savings with no inflation.

Source: Australian Treasury estimates.

Mechanisms for taxing the returns to work and saving differently

If considered appropriate, differential taxation of the returns to work and saving could be achieved in a number of ways depending in part upon the rationale for doing so. All potentially involve issues in identifying the capital and labour components of the return to unincorporated businesses and closely held companies.

Excluding the inflation component

There are several means by which the inflation component of the returns to saving can be excluded from tax.

The most accurate method is to provide a deduction equal to the inflation that occurs during the saving period. In the case of assets generating capital gains, this is typically done by indexing the cost of the asset. Australia used this method for capital gains tax between 1985 and 1999. However, it is difficult to apply this method to some assets.

An alternative to providing a specific allowance for inflation is to provide a proportionate reduction in tax as a proxy for inflation. There are two approaches to achieving this: exempt a proportion of the returns to saving; or provide a proportional reduction in the tax rate that applies to the returns to saving.

These two approaches have largely equivalent effects. The main difference is that exempting a proportion of the return results in slightly less progressivity compared to a proportional rate reduction. However, the base reduction method may involve less complexity in the context of a progressive personal tax scale.

Under these two approaches, real effective tax rates would continue to vary with changes in inflation, although the impacts would be reduced. In an environment of inflation targeting this may not be a major concern. More importantly, a proportional adjustment provides a disproportionate benefit to assets with high real returns, compared to assets with low real returns.

Excluding inflation and the return for deferring consumption

There are a range of approaches for achieving a policy objective of excluding both inflation and that part of the return that is compensation for deferring consumption. These approaches generally only tax the return to risk and unexpected variations in returns.

One approach is to extend the first method for excluding inflation such that the indexation/deduction equals the risk‑free return on capital (such as the government bond rate) rather than the current period inflation rate. Here the risk‑free rate is used as a market proxy for the individual's required compensation for deferring consumption. This approach allows for a progressive tax rate structure. This method is conceptually similar to the allowance for corporate equity, which is discussed in the context of investment in Section 6.

Another approach is to use a 'post-paid' expenditure tax, which involves taxing the returns to saving at the time it is withdrawn to undertake consumption. A cash-flow tax is one example of such an approach. Under a cash-flow tax, all incomings from work and savings are taxed but there is an immediate deduction for net additions to savings. The deduction means that tax only applies to income in the period it is consumed. Similar to the first approach discussed above, a cash-flow tax effectively excludes the risk‑free returns to saving. However, unlike the approach discussed above, a cash-flow tax does not need to explicitly exempt a deemed rate of return to achieve this. A cash‑flow tax can be implemented to incorporate either a progressive rate structure or a flat rate structure.

Another broadly equivalent approach is a consumption tax, such as the GST. A consumption tax (considered alone) has similar properties to a cash-flow tax. Returns to saving up to the risk-free rate are effectively untaxed while both labour income and any returns to saving in excess of the risk-free return to capital are effectively taxed. Unlike the two approaches discussed above, it is not possible to impose a consumption tax at progressive rates on an individual basis. Shifts toward consumption taxes or cash-flow taxes can effectively impose an additional tax on past savings.

Yet another approach is to use a 'pre-paid' expenditure tax. This involves taxing income from work in the period when it is earned, and exempting the returns to saving from any further tax. This approach excludes both the inflation and risk-free returns to saving from tax, but also excludes any return to risk and unexpected variations in returns.

Providing an arbitrary reduction in the tax applied to savings

Another approach is to provide an arbitrary reduction in the tax applied to savings, relative to that applied to work. In addition to excluding a proportion of the returns to saving from tax or providing a proportional reduction in the tax rate on the returns to saving, an arbitrary reduction could be provided by rebalancing the overall tax mix toward taxes that only target the returns to work or consumption. Such taxes include payroll tax, which is generally thought to only apply to labour income (although its incidence might be different in some circumstances), social security contributions, as implemented in many European countries, or taxes on consumption.

Taxing savings at a flat rate

There are some efficiency and equity issues with levying progressive taxes on the returns to saving. Many assets generate significantly different returns from year to year. Progressive capital taxes mean that these variations may be taxed at different rates. This can create period inequity, where two savings projects that generate the same overall return are taxed differently due to the pattern of those returns.

Some countries have adopted systems that impose flat taxes on savings, while retaining progressive taxation of work and benefit income. An example of this approach is the Netherlands' dual income tax system, which taxes personal income from savings at a lower (flat) rate than income from work. It should be noted that even systems with flat rates of tax on the returns to saving are typically redistributive (though less so than under a progressive rate structure), as taxpayers with more income from savings contribute more to government.

A flat rate of tax on savings would facilitate final tax withholding, which may expand opportunities to streamline personal tax administration. For example, banks could withhold tax on deposits and companies could withhold tax on dividend distributions, without the need for further individual-level tax calculations.

The existing tax system in aggregate

Given the mix of taxes in Australia, and the existing concessional tax treatment of some forms of saving, it is possible to characterise the aggregate tax system as providing a mixture of the income and expenditure tax concepts. The issue then is whether to shift this mix further in one direction or the other, if at all.

Consultation questions

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?

3.3 Taxing consumption

Taxes on consumption are generally considered to impose lower economic efficiency costs than taxes on labour and capital income, particularly where they are applied broadly at a uniform rate. A recent OECD study (Johansson et al 2008) of the impact of different taxes on economic growth ranked taxes on consumption ahead of taxes on labour and capital, in terms of imposing the least detriment to economic growth. The introduction of the GST was underpinned in part by such considerations.

By contrast, taxes on transactions, particularly on a narrow base, are generally thought to be relatively inefficient in economic terms. These taxes both discourage production and consumption of goods and services, but also discourage the reallocation of assets to their most valued use.

The operating efficiency of taxes can often be quite different from their economic efficiency (resource allocation). The GST has relatively high operating costs, while many transaction taxes are simple and low cost to operate.

Summary of key messages from submissions

A number of submissions note that increasing the rate and broadening the base of the GST is beyond the scope of this review, but either suggest that the review be expanded or note that the GST's role will need to be considered at some time. Some suggest abolition of the GST, while others call for the replacement of all existing taxes with an extended GST (technically, reducing or abolishing the GST is within the scope of the terms of reference).

Submissions raise a range of issues with secondary taxes on consumption (such as alcohol and tobacco). Some submissions support these taxes on various grounds, such as health impacts. Others suggest these taxes are overly complex.

Submissions present different views regarding other taxes on transactions. Some argue that existing taxes on transactions, such as stamp duty on property conveyance, are inefficient and should be reduced or abolished. Others argue in favour of more extensive use of taxes on transactions, for example, by replacing all other taxes with a broad-based financial transactions tax.

The GST

The GST is a broad-based tax on goods and services. The breadth of the GST makes it a relatively efficient tax, with limited distortions to consumption choices. Estimates from the national accounts suggest that the GST covers around three quarters of household consumption (see Chart 3.8). A number of household consumption items are GST-free (basic food, health and education) or input taxed (residential rent and financial services).

Chart 3.8: GST revenue relative to household consumption expenditure (2007-08)

Chart 3.8: GST revenue relative to household consumption expenditure (2007-08)

Note: Taxable consumption is derived from actual GST revenue, and subtracted from total household final consumption expenditure to give the residual untaxed amount. It does not include GST paid by businesses making supplies that are input taxed.

Source: ABS (2008b), GST revenue from Australian Government (2008d).

Secondary taxes on consumption

More narrowly based taxes may also have a role to play in the revenue mix on efficiency, equity and simplicity grounds.

Like most countries, Australia raises significant revenue, in addition to the GST, from specific commodities including fuel, alcohol and tobacco products, and motor vehicles. The States also impose a range of taxes on specific commodities or activities (see Section 9), although the Constitution does not allow them to impose excise taxes.

Narrow-based consumption taxes can have very different distributional outcomes to a broad tax like the GST.

Looking at international practice, Cnossen (2005) has identified five potential objectives for product-specific taxes.

  1. To raise revenue for general purposes. The consumption of some goods may be particularly unresponsive to price. This means that additional taxes may not significantly alter individual consumption choices, and therefore impose low efficiency costs.
  2. To reflect external costs. In some cases, taxes provide a price signal to the user of a good. For example, where the private use of a particular good is closely related to quantifiable social harm (for example, sulphur dioxide pollution), a specific tax may be employed to reflect the true social cost in the price, and therefore induce a reduction in demand.
  3. To discourage consumption. A tax may be imposed to counter perceived information failure, possibly in relation to harmful or addictive products. This may be driven by public health objectives.
  4. To charge for government-provided services. Specific taxes may be viewed as a mechanism to charge for the cost of providing a good or service.
  5. Other objectives. Governments may apply specific taxes to achieve specific objectives, such as to make the tax system more progressive.

To achieve many of these objectives, tax is used as an instrument to affect market prices and, therefore, to deliberately change the behaviour of producers and consumers. However, while taxing particular products can be used as a tool to regulate the market, it may be a 'blunt instrument' for meeting some policy goals.

In many cases the ability to target taxes is constrained by the cost of gathering the information upon which to calculate the tax, as well as ensuring compliance with the tax law. This is why, historically, excises have been levied on goods that are produced at a few, easily controlled sources.

Section 11 discusses specific taxes on alcohol and tobacco and luxury cars. Section 9 discusses gambling and insurance taxes levied by the States. Section 13 discusses environmental taxes and Section 12 considers fuel and motor vehicle taxes.

Transfers are also sometimes linked to consumption of particular goods and services. For example, rent assistance and child care subsidies can be considered in a similar way to differential taxation of consumption. They are typically imposed in pursuit of one or more of the five objectives identified above, such as encouraging (rather than discouraging) consumption of a particular good or service, or targeting assistance at particular groups. Section 4.8 discusses these issues in further detail.

Transactions taxes

Taxes on financial transactions and asset transfers are generally considered to be highly inefficient. Transaction taxes create an efficiency cost by discouraging transactions, which are the means by which resources are allocated to their most valued use.

Transactions taxes are also often considered particularly inequitable. They change the prices of goods and services in an arbitrary way, depending on the frequency of transactions. Thus higher taxes are imposed on people who undertake more frequent transactions, such as frequently moving house in the case of stamp duty on property conveyance.

Currency transaction taxes

A number of submissions propose the introduction of a tax on foreign currency transactions, commonly known as a 'Tobin tax'. The primary reason given in submissions for such a tax is to reduce exchange rate volatility, though other rationales have been raised in other contexts (such as funding foreign aid).

The Panel notes that this proposal has been widely criticised and has serious shortcomings. Tobin taxes are also virtually impossible to implement unilaterally. Any unilateral tax would be expected to result in substantial avoidance through trading outside of Australia's jurisdiction.

Consultation question

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?

3.4 User charges and beneficiary taxation

In addition to conventional taxes, government raises revenue from a number of different sources, including user charges and beneficiary taxes. The relative merits of these different instruments and their potential use is an issue for consideration as part of this Review.

User charging involves the government charging a fee in return for providing a good or service to a person or business. Examples include bus and train tickets, stamps, national park entrance fees, royalties from natural resource use, motor vehicle licences and the sale of rights to electromagnetic spectrum. User charges can improve pricing, reducing the over-use of such resources, while also providing governments with revenue. However, they can also reduce efficiency if they are set inappropriately.

Beneficiary taxation involves the government imposing a fee on an activity for the benefit of the general community. In contrast to user charging, beneficiary taxation may involve little or no provision by government of goods or services to the taxpayer. Examples include the noise levy on plane arrivals at prescribed airports, where the airline owners 'benefit' from being allowed to land their planes. Another example is agricultural levies where fee-payers benefit indirectly from the spending of the money raised. Beneficiary taxation can improve equity by allocating the cost of public goods and services to the people who benefit from them.

This section considers the role that might be played by these sources of revenue. The issues of environmental taxation and resource charges are considered in Sections 13 and 14, respectively.

Summary of key messages from submissions

A range of submissions comment on particular user charges, claiming they are set at the wrong rate or that the administrative costs of collecting them make them inefficient. There are various views about different beneficiary taxes. Some argue that these taxes can be both equitable and efficient. Others argue that these charges are inefficient and the relevant services should be funded out of general revenue.

Some of the submissions that argue for the replacement of most existing taxes with a single tax — on land, financial transactions or household consumption — also argue for the retention of non-tax user charges for cost recovery purposes.

Public transport advocates argue for recovery of the costs of the road system from road users. Some suggest that fixed or periodical charges be restructured so they vary according to the level of motor vehicle use. Other submissions argue that public transport should be free to users on the grounds that this would put public transport on an equal footing with private road transport, which does not pay (at least directly) for access to most roads.

Some motorist groups recommend a two-part charging regime for road users: a small access charge to cover the costs of vehicle registration and other fixed costs; and a variable user charge to cover the external costs of road use such as pavement damage, air and noise pollution and congestion. Giving motorists the option of converting existing fixed charges into distance-based variable charges is also suggested.

Some submissions argue that the Australian government imposes a number of small taxes in the telecommunications sector that have various cost recovery rationales but which impose high collection costs relative to the amount of revenue they raise. For example, the National Relay Service (NRS) is a telephone access service for people who are deaf or who have a hearing or speech impairment. The NRS is funded by the NRS levy, which in 2007-08 was paid by 32 telecommunications carriers and raised $12 million.

Airlines argue that the quarantine services funded through the Passenger Movement Charge are not directly related to the aviation industry and that the community as a whole is the principal beneficiary. On this basis they argue that the services should be funded out of general tax revenue.

Infrastructure charges are a concern for housing developers who argue that the costs of infrastructure should be borne by the community as a whole, rather than by landholders or the buyers of dwellings in new developments.

User charges

User charging tends to improve efficiency where governments provide services that are inherently 'private' in nature. Private in this case does not mean provided by the private sector. Instead, it is a technical term meaning 'rivalrous' in consumption — that is, one person consuming the good or service stops another person from doing so, such as occupying a seat on a crowded train.

The types of commodities that could potentially be subject to improved user charging include (rivalrous) natural resources (including water), electricity and transport services (including roads and rail), and even health and education services.

Efficient user charging improves resource allocation by providing a price signal. When faced with a price that reflects the cost of the service, potential users will not consume a good or service if they value it less than the cost of supplying it. User charges also provide direct feedback on the value of services to producers. Moving toward efficient user charging, as an alternative to conventional taxation, can have a 'double benefit' in the form of improved efficiency from the pricing of the rivalrous commodity, as well as a reduction in the efficiency costs associated with conventional taxation.

Even where user charging is practical and efficient, there may be equity or other social reasons for not applying it. Efficient user charging may impose high costs on particular groups of people or restrict access to goods and services deemed important to social inclusion. Rationing may be more socially acceptable in these circumstances.

In order to apply user charging efficiently, the government needs to determine the social marginal cost of the good or service. In the absence of a market, government agencies may find this difficult. User charges that are too high act like a tax (see Box 3.3). For example, some submissions suggest the Passenger Movement Charge over‑charges for the cost of providing the services it funds.

Beneficiary taxation

A beneficiary tax, like a user charge, attempts to recover the cost of providing a good or service from those who benefit. However, where a good or service is a 'public' rather than a 'private' good, the marginal cost of providing the good to an extra person is zero, that is, a person could benefit from the good or service, without imposing any additional costs on others. Charging for these goods or services tends to be inefficient, because it means that some people are excluded even though the marginal cost of providing the good or service to them is zero or close to zero. However, in some cases beneficiary taxes are seen as an equitable way to recover the cost of public goods where only a sub-set of the community benefits, for example for the large up-front costs of public infrastructure.

One example of beneficiary taxation is the set of Australian Government agricultural levies. There are a range of levies for different products that apply at low rates. The revenue collected is used to fund marketing and research and development (R&D) for the respective agricultural sectors. Industry participants do not receive a direct benefit in exchange for the levy, but receive indirect benefits through the marketing and R&D conducted on behalf of the industry. Submissions support agricultural levies as an equitable and efficient way of raising funds for collective action by particular industries.

Beneficiary taxes are often applied to goods that are related to the provision of a particular service. For example, fuel taxes are sometimes justified as a form of beneficiary taxation for the capital cost of building public roads. The rationale is that those who use public roads the most (indicated by their fuel use) get the greatest benefit, and should therefore compensate the budget for the expense of providing them.

Opportunities for beneficiary taxation may exist in relation to pricing some road and transport services (Section 12), environmental goods (Section 13), and pricing of (non‑rivalrous) natural resources (Section 14).

The role of technology

Improvements in technology may extend the range of activities for which it is practicable to apply user charging and beneficiary taxation. User charging can be applied only if the amount of the good or service provided to the fee payer is able to be measured. Improved technology can allow better measurement. For example, electronic tolling systems can measure exactly how far and at what times a particular vehicle travels on a road system.

Box 3.3: User charging and taxation

The ABS Government Financial Statistics (GFS) defines a tax as a compulsory levy imposed by government, usually with no clear and direct link between the payment of the tax and the provision of goods and services (ABS 2005). By contrast, user charges refer to levies imposed to cover the costs of providing a particular good or service to an individual or business.

Chart 3.9 illustrates the distinction between taxes and user charges for a government provided commodity (Q) which imposes a cost on others when consumed.

Chart 3.9: Charging for government-provided services

Chart 3.9: Charging for government-provided services

When government provides the commodity free of charge, demand equals Qfree and the government must find revenue of A+B+C+D to meet the cost of providing the good. Moving from free provision to market pricing (Pp) would see revenues of A+B flowing to government, which would cover the cost of provision, and a social gain (D) in terms of improved resource allocation.

If there were no social cost associated with the consumption of the commodity, but the government chose to charge PS, area E would be considered a tax, while A would be a user charge. Government fees can therefore have both tax and user charge components.

However, where there is a social cost associated with the use of the good, the market price (Pp) would allow too much consumption. In this case consumers do not take sufficient account of the cost they impose on others. The government could therefore charge a higher and more efficient price (Ps), at which there is a further social gain.

If this revenue was used to meet the cost of providing the commodity to consumers (for example, if revenue E was spent regulating the application of the fee), this would be an efficient user charge. If, instead, government did not need to spend any resources in providing the commodity, area E would be considered tax revenue.

Further, whether a government fee is a user charge or a tax does not depend on the form or intent of the legislation. For example, certain types of licence revenues are, at least in part, taxes, including taxi licences and motor vehicle registration fees.

Consultation question

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?