Australia's Future Tax System

Consultation Paper Summary

2. Principles and features of a new system

Submissions identify a range of fundamental features that Australia's future tax-transfer system needs, in order to respond effectively to future challenges and opportunities. These are either principles to guide the design and operation of the system or structural features that a well designed system should have.

Design principles for the tax-transfer system

Five design principles can be broadly identified in submissions — equity, efficiency, simplicity, sustainability, and policy consistency. Economic inefficiency and excessive complexity both increase the costs of the tax‑transfer system and are dealt with together below.

Equity

Equity is generally agreed to be an important principle for the system, but there is no consensus about exactly what equity is or how to measure it.

One perspective on equity 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.

Another common perspective is that those with greater economic means should pay more, though there is less agreement about how means should be measured and how steeply progressive the system should be. Several submissions place primary emphasis on the need for a 'fair' and progressive tax‑transfer system with minimal opportunity for high income earners to minimise their tax obligations.

There is also a general view that individuals or families with the same capacity should face the same tax burden, although this is often not stated explicitly.

Other issues relating to the equity of the system include:

  • the impact of complexity, which tends to fall most heavily on those with the least capacity to deal with it;
  • the role of the beneficiary principle — that people should pay tax broadly in accordance with the benefits they receive from government spending, regardless of their income;
  • the importance of inter‑temporal equity — which considers how the system affects individuals over their entire lifecycle, not just in a particular year; and
  • what account to take of intergenerational equity, which is concerned with how tax‑transfer decisions taken now will affect the wellbeing of future generations.

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.

Submissions consistently argue 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 individuals and businesses devote to understanding and complying with the requirements of the system, are diverted from more productive or satisfying activities. Therefore, they 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 right 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 reduce 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 sense 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‑transfer 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.

Some submissions express a view that the tax system should deliver a stable revenue base by minimising reliance on more volatile taxes. A related theme is that the tax‑transfer system should support flexibility in the economy to respond to changing circumstances.

Access to broad revenue bases such as household consumption or income (broadly defined) means governments can 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‑transfer system needs to provide governments with a stable revenue stream that allows them to meet their spending responsibilities consistently and reliably over time.

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 — may be useful for smoothing demand in the economy without requiring policy action by government. However, they detract from revenue stability to some degree.

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

Many submissions, particularly from business, highlight the need for tax‑transfer policy settings to be consistent internally and with governments' broader policy objectives. Consistency with environmental objectives, particularly in relation to climate change, is a key area of concern.

In general, consistency in policy settings within the tax‑transfer system can help people to understand the system and helps to reduce complexity, cost and uncertainty for taxpayers and transfer recipients. This can reduce the costs of the system and increase equity by improving levels of voluntary compliance.

However, the extent to which particular features of the tax‑transfer system pursue policy objectives other than raising and re‑distributing revenue 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.

Structural features

Submissions contain a diversity of views on the structural features a well designed tax‑transfer system should have.

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

Reform of state taxation, policy and administration, and improved federal fiscal arrangements are identified as key areas for reform in many submissions. Reform proposals ranged from removing the more inefficient state taxes through to revenue sharing arrangements.

Submissions point to the need for sustainable policies for an ageing population experiencing increased longevity. 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 or the fact that people are living longer.

Some 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 to be 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 measures to improve neutrality, for example, 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 a dual income tax approach.

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