Australia's Future Tax System

Architecture of Australia's tax and transfer system

Section 1: Context of the review

1.1 Introduction

The tax‑transfer system is a fundamental part of the social and economic infrastructure of Australia. Its evolution reflects the demands and expectations of Australians, especially in relation to the balance between private and public provision of goods and services, and the level of income redistribution that should occur. These roles must be financed by government revenue.

At the Australian government level, the majority of this financing is done through the tax system. At the state level, the situation is not as clear. To help fund the services their citizens expect, States rely on payments from the Australian government (largely the GST and specific purpose payments) and a wide range of non‑tax revenues (such as fees and charges) to supplement their own taxes.

Key determinants of how much tax needs to be raised are the level of income redistribution that society wants and its desired level of government provided goods and services — such as health and education services, defence and security, infrastructure and roads, appropriate forms of regulation, and support for social institutions.

The method for achieving income redistribution also has an impact on how much tax needs to be raised. For example, tax settings or tax collection mechanisms that more accurately reflect individuals' net tax‑transfer positions require less tax to be raised and distributed.

At a macroeconomic level, the tax‑transfer system also affects outcomes in the aggregate economy through its role as an 'automatic stabiliser' of fluctuations in economic growth. When the economy is growing more strongly, tax revenue will grow and transfers will tend to fall as a proportion of national income. This improves the government budget position, moderating the rate of expansion in the economy, unless a decision is taken to offset the increase in the budget through increased spending or reduced taxes. In periods of slower economic growth, the automatic stabilisers operate in the opposite direction, moderating the extent of the slowdown and the implications for unemployment and incomes.

All taxes and all transfers affect behaviour in some way. They change how much money people have and the incentives they face. For example, high levels of taxes on salary and wages reduce the disposable income of salary and wage earners, but can also make leisure (or at least doing unpaid work) more attractive. Put another way, it can dampen the incentive to work more to earn more money. In a similar way, the tax‑transfer system can dampen incentives to save and invest.

The design of the tax‑transfer system also impacts on the distribution of income and opportunity, both between different social groups and between generations. The overall level of taxation and expenditure, the level and targeting of transfers and the design of both these systems, influence the distribution of income across the Australian community.