The future of tax reform in a shifting world

‘How do we design tax laws where money is more mobile?’ Joe Hockey asks. Picture: Ross Schultz

JOE Hockey is fond of recounting a story of his American friend who used Uber to travel from North Sydney to the city.

“Government misses out in three different areas: licence fees for existing participants in the regulated taxi market, company tax and probably GST too,” he says.

“How do we design tax laws where money is more mobile, goods are able to be delivered by drone from Google and there are disruptive technologies developed every day?” the Treasurer tells Inquirer, pointing to some of the challenges facing Australia’s tax system.

Tax reform in Australia has slowed to a snail’s pace. Five years on from the Henry tax review barely any of the 138 recommendations have been fully implemented (lifting tobacco excise is the most notable) and none of the hard ones, such as restructuring taxation of savings and superannuation and cutting company tax.

Release of the Intergenerational Report has refocused debate on the importance of curbing spending growth. Without reform, the budget deficit is on track to blow out to 6 per cent of gross domestic product while net debt blows out to almost 60 per cent. But even that dire outlook hinges on business-as-usual revenue growth.

Bracket creep is assumed to lift the federal government’s tax take to 23.9 per cent of national income by 2021 (the pre-GFC and post-GST average), where it will remain until 2055.

In fact revenues are bound to fall short without changes or increases in existing taxes. Already, federal receipts, about $380 billion this financial year, are sputtering, eking out annual growth of barely 3 per cent, half the average annual rate between 1993 and 2013.

Plunging export prices are only part of the explanation. Steady erosion of the tax base courtesy of demographic change and intensifying tax competition in an increasingly digital, globalised world will become more problematic.

“We keep hearing simplistic calls to expand the GST whenever someone raises tax reform, but tax reform is so much more than that,” Hockey says. He hopes the first instalment of the government’s promised tax white paper, due for release next month, will “encourage a more mature conversation”.

“Changes in the global economy and new technology will force governments here and abroad to re-examine how and what they tax,” the Treasurer says, suggesting company tax and even GST may not exist by the middle of the 21st century.

These changes are weighing most heavily on corporate tax collections, where Australia is relatively vulnerable. Almost 20 per cent of federal government tax revenue stems from companies, more than twice the OECD average. While the average company tax rate across 34 OECD nations has fallen from 29.2 per cent to 25.3 per cent across the past decade, Australia’s is still stuck at 30 per cent.

“The UK has acted aggressively on company tax and other countries will have to respond,” says Michael Devereux, a professor of business taxation at Oxford University, referring to the British government’s decision to cut its company tax rate to 21 per cent.

“Downward pressure is going to continue and we’ll see more tax rates starting with a one; I don’t see any reason why they won’t go to zero over a long period,” he adds. Even Barack Obama is proposing to lower the US’s notoriously high federal company tax rate of 35 per cent to 28 per cent.

Tax competition is powerful. In 1977 Queensland dispensed with estate duties, prompting their repeal across Australia by 1984 as people started moving to the Gold Coast to retire.

These same basic forces are intensifying internationally as global supply chains combined with the rise of intellectual property give multinationals significant scope to pick their location.

Google, Apple and even Starbucks have attracted controversy for shifting, quite legally, their intellectual property to subsidiaries in countries such as Ireland (where corporate tax is 12.5 per cent).

“It is pretty obvious when a company making cornflakes is paying exorbitant amounts for corn to a subsidiary, because of other market prices,” says Kevin Hassett, director of economic policy studies at the American Enterprise Institute. “But royalty payments for IP — how can you objectively value these?

“The economic dividend for a country that jumped to zero company tax now would be huge. But, politically, it’s very easy to lampoon proponents of cutting tax on business.”

The previous Labor government’s Henry tax review recommended Australia’s corporate rate be cut to 25 per cent, singling it out as the most damaging federal tax.

Economic theory and much of the empirical evidence suggests the company tax burden in fact falls on workers in the form of lower wages and customers in the form of higher prices.

Pascal Saint-Amans, director of tax policy at the OECD, believes the short-term pressure to cut company tax rate will peter out.

“Big countries will move to rates in the 20s, small countries to the 10s, but I expect they will learn to co-operate with each other,” he says, optimistically.

At the OECD’s instigation Britain has recently agreed to modify its 2013 “patent box” reform, which taxed at only 10 per cent corporate profits generated from intellectual property that moved to Britain.

“This is a first illustration of the sort of global regulation we are going to see develop,” Saint-Amans says.

“Even if they solve the profit shifting issue it will do nothing to solve the downward pressure on corporate tax rates,” says Devereux. Stamping out what increasingly is called “harmful tax competition” will nevertheless prove difficult as the temptation to flout rules, even by countries as large as Britain, will remain.

Tax reform debate in Australia naively revolves around expanding the base or lifting the rate of the GST. “The GST tax base is being threatened by consumers’ ability to buy and order goods and ser­vices from wherever they want in the world,” Hockey says. “This is something we should celebrate but it has major consequences for revenue.”

Calls to lower the threshold below which imported goods do not attract GST from $1000 reflect Australians’ growing appetite for online shopping at foreign retailers. While worth only $4.3 billion a year, the sum is growing at more than double the rate of traditional bricks-and-mortar sales and will erode potential collections.

According to CPA Australia the share of final private consumption the GST applies to has fallen from 53 per cent when the tax was introduced in 2000 to 47 per cent.

Saint-Amans points hopefully to an impending OECD accord that will oblige service providers to collect consumption tax at the rate levied in the country of the consumer. “VAT-type taxes are so important economically and fiscally I’m confident international agreements will be reached,” he says.

Renowned British economist John Kay reckons corporate tax is waning not so much because of competition but because it is difficult to collect. “It’s getting hard to determine where profits, incomes, even sales are actually happening,” he says.

“I expect to see a continual shift from taxes on capital income to taxes on earnings because they are easier to collect.”

Certainly the worldwide trend to lower personal income tax rates has stopped. The Gillard and Abbott governments have increased our effective top marginal rate to 49 per cent. Within a few years, Australian wage earners on an average full-time income will pay the 39 per cent marginal tax rate (which cuts in at $80,000).

Bracket creep has not been corrected since 2008; if the tax thresholds of 1981 still applied, more than half of wage earners would face the then top marginal tax rate of 60 per cent.

The US, through its 2010 Foreign Account Tax Compliance Act, has paved the way for an unprecedented crackdown on individual tax avoidance. More than 90 governments have signed up to OECD-drafted tax-sharing agreements that takes effect from 2018.

“Whether you or I have bank accounts in Norway, Switzerland or the US, the balance, interest income, transactions, dividends received and some capital gains will be recorded and shared automatically with your home tax authorities,” Saint-Amans says.

“We have systems that will identify the beneficial owners of trusts too,” he adds. The focus on bank accounts and simple cash transactions reflects an impending shift of the tax focus to transactions that are easily observable.

“Unless maybe you live in Luxembourg people tend not to be especially mobile or responsive to changes in personal income tax rates,” says Hassett, predicting the overall tax burden in rich countries will continue to rise and more of it will be collected in the form of personal income tax.

While technology chips away at corporate tax bases, demography is also doing its bit to thwart income and consumption tax bases.

The proportion of working-age people in the population is in long-term decline. The dependency ratio — the number of people aged 15 to 64 to everyone else — will fall from about 4.5 today to 2.7 by 2055. The working-age population as a share of the total population peaked in 2010 at 67.4 per cent and is projected to sink below 60 per cent in coming decades.

Ageing means relatively more income will flow through concessionally taxed superannuation funds. The over-60s pay no tax on earnings in their superannuation fund, while super funds also pay only 10 per cent capital gains tax on assets held more than one year. And ageing will also put further pressure on the GST, as more consumption expenditure is directed toward GST-exempt healthcare and medical supplies.

While governments will be discomfited by sluggish revenues and the exigency of tax reform, technological change is actually forcing them to introduce more efficient tax systems.

Taxes on corporate income, among the most damaging in ­theory, will shrink, which should boost welfare.

“It’s not clear reductions in company tax rates need to be offset by increases in other taxes, if the lower company tax generates additional economic activity,” says John Piggott, professor of economics at the University of NSW and a panellist on the Henry tax review.