What needs to be done to fix the tax system?

Some of Australia’s top economists and policy experts are calling for higher taxes on capital gains, the introduction of death duties and a hike in GST as part of a major reform to help the federal budget, strengthen the economy and cut taxes on ordinary workers.

The unequal treatment of taxes and over-reliance on income tax are two major features of the system the majority of experts interviewed by The Sydney Morning Herald and The Age want changed, though there are varied opinions on how to get the treatment of income, earnings and wealth right overall.

In the past month, both the Organisation for Economic Co-operation and Development and the International Monetary Fund joined the chorus urging wide-ranging reform of the tax system.

According to the OECD, tax reform could deliver a sustainable financial base that boosts economic growth, promotes some of the government’s own priorities and prevents income and inter-generational inequality.

“Tax reform is needed. Australia’s heavy reliance on taxation of personal incomes adds to the vulnerability of public finances to an ageing population,” it found in its most recent economic survey of Australia.

The IMF said reducing company tax rates, overhauling our tax arrangements around property and moving to more indirect taxes would also deliver major economic benefits.

“Tax reforms can help strengthen investment and promote efficiency,” it argued.

They follow the Henry tax paper of 2010 that made more than 130 recommendations around the tax and welfare system, from a super profits tax on the resources sector to a discounted rate of tax on bank deposit interest.

The aborted Re: Think tax white paper of then-treasurer Joe Hockey in 2015 had as its opening claim that the country needed a “better tax system that delivers taxes that are lower, simpler, fairer”.

But what sort of proposals should be on the agenda?

Increasing the GST

A common view among tax experts is the need to shift towards indirect taxes and away from direct taxes. GST, an indirect tax, currently accounts for about 15 per cent of the federal government’s total tax revenue compared to about half from personal income tax. In New Zealand – where the goods and services tax was increased to 15 per cent in 2010 – about a third of tax is from GST.

The complexity and breadth of Australia’s 10 per cent GST is also an ongoing issue.

It is charged on food eaten on-premises and hot items for takeaway but not on fresh food depending on the way it is packaged, marketed and eaten. An 82-page document provided by the Tax Office explains the complexities. For example, edible chocolate body paint is a taxable item but chocolate spread won’t attract GST.

Former Treasurer Peter Costello says most people now push for a hike in the GST he steered into place in 2000 or for more items and services to be included. Costello is also chairman of Nine Entertainment Co, owner of this masthead.

When the GST was originally proposed it also applied to fresh food, but not to health or education, which Costello said would lead to bad competition outcomes as private providers would be taxed while public institutions wouldn’t.

But University of Melbourne Law School Professor Miranda Stewart, director of the university’s Tax Group, says charging the tax on private education and health care could help redistribute wealth. In New Zealand, where the GST rate is 15 per cent, it is charged on these services.

“We would be taxing higher-income and higher-wealth families through that GST. And so even though people think of the GST as a regressive tax, it actually could be made much more equitable by broadening the base,” Stewart says.

Neither side of politics is proposing a GST expansion. Prime Minister Scott Morrison considered raising the rate or including more products in 2016 when he was treasurer but has since scrapped the idea. Opposition Leader Anthony Albanese has also ruled out any changes.

Regardless, former Treasury secretary Ken Henry warns tax from GST as a share of total revenues is declining. Experts are concerned about the nation’s ability to pay for services like aged care and health care without leaning too heavily on workers’ income into the future due to a decline in the tax take from sources other than income tax. Increasing the GST could provide an option to cut income taxes and assist the states and territories, who receive this tax from the federal government, to replace inefficient taxes like stamp duties on housing with land taxes.

“We’d be in a much worse place had we not [introduced GST]. But after all that work the best you can say about it is we’re no worse off than we were 20 years ago in terms of the relative reliance on personal income taxes,” Henry says.

He proposes a Commonwealth-State agreement to roll GST and payroll tax into one “Business Cash Flow Tax” and remove other taxes in the process, including taxes on insurance that act as a perverse disincentive.

”It would dramatically simplify the system and take a lot of compliance costs out of the system.”

Rolling the GST into a new tax provides more opportunities to take a closer look at what is and isn’t taxed. This could include broadening the base of what is captured by GST but also removing inefficient taxes.

Former Liberal Party leader John Hewson also says GST isn’t the growth tax it was expected to be, with spending on what it is levied on not growing as quickly as spending on the areas where it isn’t charged.

“If you doubled the rate and increased its coverage you can at least get $100 billion net additional revenue, which you can use to restructure the other elements of tax and abolish some of them,” Hewson says.

“It’s the key to tax reform.”

Outside the reticence of the major parties towards any GST change, the other problem is a feature inserted by Howard and Costello.

All money raised by the GST flows to the states and territories. But the cost of reducing personal income tax would be borne by the federal government.

Scott Morrison has already partly punctured this “walled garden” approach to the GST, topping up the GST pool with federal taxpayers’ money as part of a deal to blunt Western Australia’s complaints about the current system.

Any change to the rate or the breadth of the GST would require a major change to how the tax is shared between the Commonwealth and the states.

Poverty traps and road rules

Some issues are getting traction among both experts and politicians. Miranda Stewart says the interaction between the tax system and the welfare system, as well as other support such as childcare, needs particular scrutiny.

“It’s families with children, in particular mothers in families with children, who are bearing by far the highest tax rates in the system on their work ... because they’re paying taxes and the income tax,” she says. Given childcare subsidies are scaled back in line with income increases, the effective tax rate can in some cases reach above 90 per cent of wages for a second earner.

“In some ways the best tax reform would actually be … to deliver free childcare because that would relieve the economic burden on the majority of Australian families very significantly.”

Hewson is also concerned about the way the tax and welfare systems are interacting. It also makes the wish list of the top changes Costello has in mind. Costello says many of the options recommended by experts are tinkering at the edges and not the “big ideas” needed to justify the title of reform but says this would be one of his first places to look for improvement.

“Reducing marginal tax rates, simplifying the tax system, ironing out poverty traps and disincentives,” Costello lists.

A poverty trap is created where a person can be left worse off by losing access to welfare payments even as they gain income from employment.

Another issue on Ken Henry’s radar is the fuel excise, currently 43 cents on a litre of petrol or diesel and worth about $12 billion a year in federal revenue. With more fuel efficient cars on the roads and electric vehicles forecast to be more than half the nation’s passenger vehicles by 2040, revenue from this tax will ultimately collapse.

One option he recommended in 2010, backed by a 2020 report for NSW Treasury chaired by CSIRO chairman David Thodey, is the replacement of the fuel excise with a road user charge.

“The failure to implement that set of recommendations has led to some states now considering imposing special taxes on electric vehicles because they don’t pay fuel excise. It’s just bizarre,” Henry says.

The NSW government is currently looking at a road user charge of 2.5 cents per kilometre from either July 2027 or when electric vehicles make up 30 per cent of new vehicle sales. Victoria this year put in place a road user charge on EVs, citing the impending drop in excise on petrol and diesel.

Taxing wealth more

Ken Henry has a swathe of improvements he wants to see implemented quickly but near the top is a total overhaul of how tax is charged on returns from rent, interest and capital gains.

He proposes a dual income tax system, also known as a Nordic tax system or Schedular system, which not only taxes earned income at progressive rates as it does currently but also levies a consistent tax on other earnings. This would help capture lightly taxed property gains and other forms of wealth currently contributing to rising inequality.

“I think that there is considerable appetite [for] that now,” he says.

ANU Professor Bob Breunig says reducing the reliance on direct taxation, scrapping inefficient taxes like stamp duty and, in line with Henry, considering a Dual Income Tax system are the most necessary changes.

The Tax and Transfer Policy Institute last year proposed a version of the Nordic system taxing all income generated from savings and wealth at a flat rate of 7 to 10 per cent. This would include earnings from housing, shares and distributions from trusts.

Under this system, a homeowner who had made $1 million on the sale of their primary residence would pay $100,000 under this proposal if the rate was 10 per cent, while someone who made $100,000 in capital gains would pay $10,000.

“The idea is that you want to incentivise savings, but you want to make sure you’re taxing all of that and … rather than having a wealth tax you can just tax income from wealth,” he says.

This change in the tax system would help with the inequality concerns many of the experts have warned about and provide a new source of revenue for the government as well as provide an opportunity to lower taxes in other areas such as income.

“The big area that we really don’t want to tackle, but I think is just the elephant in the room is basically [that] our income tax system is set up to tax income ... but we don’t really tax wealth at all,” he says.

“We’re going to have to [tax the family home]. Most other countries do it ... and if you’re taxing it at a low rate, then I’m not sure what people could reasonably object to.”

This could help redistribute earnings among younger generations, helping fix what Corinna Economic Advisory founder and independent economist Saul Eslake describes as progressive tax rates for income but not progressive taxes overall.

“In particular we tax income from working much too severely,” he says. While the top income tax rate is in the middle of the pack for OECD countries, the multiple of average weekly earnings at which the top tax rate kicks in is among the lowest, he says.

“In addition ... our tax system is so riddled with loopholes that many people who should be paying the top tax rate don’t actually pay it,” he says. “And in my view, almost all these loopholes should be cut out.”

This includes negative gearing, capital gains tax discounts, franking credits and what he considers to be the excessively generous tax treatment of superannuation assets, all of which can allow the legal minimisation of tax.

Stewart also says removing tax breaks and increasing taxes on some groups that have benefited from the system over the past 20 years is a crucial first step. Part of this would be redistributing wealth to those who need it.

“The big issue is that we are under taxing, and unevenly taxing, capital and wealth in Australia relative to… work,” she says. “Our tax rate on most salaries of most workers is still lower than many other countries, for example in Europe, but relative to the way we tax capital and wealth it’s pretty high. So we get this increased inequality in the system.”

Experts further recommend changing and potentially decreasing company taxes. There is currently a differential tax rate, where small companies whose annual turnover is under $50 million pay only 25 per cent – worth more than $30 billion over 10 years – and larger companies pay the full rate of 30 per cent (and large banks pay a levy worth $1.6 billion a year). Malcolm Turnbull tried to change this, but the then-prime minister’s 2018 package was defeated in the Senate.

Committee for Economic Development Australia chief economist Jarrod Ball says there is now a “stand-off” over the company tax rate. He says it’s time to take a look at the incentives for long-term investment and how to avoid profit shifting offshore. This could be through a “cash flow” tax, or revenue minus operating expenses, rather than the current tax on profits, which can be distorted by multinationals able to strike deals with overseas offices in lower tax jurisdictions.

Breunig warns the corporate tax rate is narrow, with half of the nation’s revenue from this tax coming from a handful of large companies concentrated in a small group of sectors like banking and mining, making a case for lowering the tax rate but capturing more of them.

“I think that’s something people don’t realise - that corporate tax base is so fragile,” he says. “If you had a lower rate and a broader base, and a wider range of industries ... we’d be much more secure.”

This is the second part of a special series on tax reform. Read part one here.