Few Australians appreciate how deeply rooted the issue of tax was in the birth of their democracy.

In December 1854, gold miners in Ballarat built a wooden fort at diggings in Eureka, sparking an armed standoff with authorities, in which at least 22 miners and six soldiers died.

Under the Eureka flag, the miners fought for their “rights and liberties”.

But it was punitive taxation that inflamed their discontent. Miners began burning their gold mining licences, for which they were forced to pay a princely 30 shillings a month – irrespective of whether they struck gold.

In an Australian echo of the sentiment that helped spur the American Revolution – the notion that “taxation without representation is tyranny” – miners took to the barricades.

Defeated on the day, the Eureka miners were ultimately successful in winning both the right to vote and tax relief – in the form of a cheaper annual prospecting fee.

Australia’s first great tax debate was fought and won. And Australians have been fighting about tax ever since.

Australia’s tax landscape has been bitterly contested over the past century and a half, leading to radical changes to the taxes Australians pay. More recently, tax reform has stalled as politics has splintered and a string of budget deficits have made compensating the losers of reforms too hard.

Now the battlelines have been drawn again with tax set to dominate next May's federal election. With budget surpluses in sight, there are fresh calls for tax reform that may radically change the way Australians pay tax.

The price of democracy

While much despised, the act of paying taxes – and having a say in how they are spent – lies at the core of our democracy, says Professor Mark Evans, director of the Democracy 2025 project at Old Parliament House’s Museum of Australian Democracy in Canberra.

“If you look at the definition of fragile states, the dominant definition is those states that aren’t able to collect taxes in order to discharge their functions of state. Essentially, if you can’t collect tax you can’t carry out the functions of the nation state.”

And the modern nation state today, says Evans, is a democratic system of government.

English philosopher Thomas Hobbes wrote in his 1651 tome Leviathan of the “state of nature” and the unspoken contract individuals enter into with their governments to escape from this brutish state.

Professor Evans explains how it works: “I absolve a whole lot of freedoms – including freedom from taxation – and give them to the state in order for the state to provide me with security, and to ensure that my life is not ‘nasty, brutish and short’, as Hobbes described.”

Taxation, in short, is the price we pay for living in a democracy and enjoying the support of government through security, schools, hospitals and roads.

Australia’s taxation system has undergone massive and radical upheavals over the past century-and-a-half.

Early colonial powers relied heavily on customs duties, excises on alcohol and tobacco and stamp duties on transactions (the stamp referring to the placement of a government seal on official documents) to fund the needs of a growing colony.

At Federation in 1901, states gave up the right to impose customs duties on one another, allowing free trade between the former colonies. Uniform federal tariffs and excise duties were introduced instead.

It was not until 1915 that income taxes were introduced – first at the state level – to fund the war effort for World War I. The states handed over income taxing powers to the federal government in 1942 during World War II.

Payroll tax – one of the main levers of state-based taxation today – was initially a federal tax, introduced in 1941 to fund a child endowment scheme and later handed over to states to levy in 1971.

States also used to levy death duties on estates until Joh Bjelke-Petersen abolished them in 1977 in a move followed by other states.

By the 1980s, the tax system was in need of a reset, prompting the Hawke government to convene the 1985 tax summit at which agreement was reached to introduce a capital gains tax (excluding the family home), to end the double taxation of dividends and to abolish negative gearing (although it was reintroduced in 1987 due to political pressure).

The Summit’s infamous Option C to introduce a tax on the sale of goods and services, however, was not realised until 2000 when the Howard government introduced the GST – marking Australia’s last great structural reform of the tax system.

Since then, progress has stalled.

A bid by the Rudd government in 2010 to introduce a tax on the “rents” extracted by mining companies raised the ire of Australia's miners again – although this time it was met not with pickaxes and rifles but with an expensive publicity blitz by mining magnates such as Gina Rinehart and Andrew “Twiggy” Forrest.

The Rudd government’s other great tax initiative, to put a market price on carbon emissions – later dubbed a “carbon tax” by Julia Gillard – was introduced in 2011 but axed by Tony Abbott in 2014.

Why the stall on reform?

Deloitte Access Economics director, Chris Richardson, has been following the ins and outs of Australia’s tax debate for decades. He finds it hard to hide his frustration. “Our tax system is solid,” says Richardson. “But it’s frustrating that it could be better.”

Richardson warns against romanticising the previous tax reform era of the 1980s. “It was always difficult. But I would say that the track record of recent times proves that it’s next to impossible.”

A recent report by PricewaterhouseCoopers (PwC) found that a decade of budget deficits has made greasing the wheels of reform more difficult – reform requires having the money to compensate the noisy losers of reform.

But with Australia’s federal budget within a whisker of surplus again, the time for tax reform may be coming.

Hidden costs of taxation

Taxation does not come without a cost, though. The gold standard of tax reform is to try to minimise these harmful side-effects.

The upfront cost of taxes is clear. The federal government is set to reap $440 billion in tax revenue this year – eating up 23.1 per cent of the nation’s total annual economic output.

The tax take of the economy has risen dramatically, from around 5 per cent at Federation, as demands on government have grown.

But in addition to this direct cost, economists have long observed a hidden cost to taxation. Every dollar raised distorts the economy, destroying value by preventing transactions that might otherwise have occurred.

Taxes alter the incentives in the economy. By reducing the returns from work, income taxes discourage activity. Taxes on company profits discourage investment.

Economists call it a “deadweight loss” or “marginal welfare loss” on society.

What does a good tax system look like?

The most recent comprehensive review of Australia's tax system, led by former Treasury secretary Ken Henry, sought to quantify these side-effects and rank different taxes from worst to best, based on how much value they destroy. That review was in 2009 but the findings remain relevant today.

State-levied taxes dominate the list of worst taxes. Every dollar raised through mining royalties leads to a welfare loss of 70 cents. Payroll taxes and stamp duty destroys about 40 cents each.

At the better end, municipal rates, land tax and the GST destroy less than 10 cents each.

Just 10 taxes do all the heavy lifting … a rump of about 115 taxes deliver the rest.

The Henry review broadly concluded that taxes should be efficient, simple and fair. Australia's reality was judged far from that.

“Australia has too many taxes and too many complicated ways of delivering multiple policy objectives through the tax and transfer systems.”

Just 10 taxes do all the heavy lifting, raising 90 per cent of revenue across state and federal governments, it found. A long rump of about 115 taxes deliver the rest.

“Rationalisation of the tax and transfer architecture should now be a strategic priority,” the review recommended. More specifically, Henry wanted these changes: the abolition of stamp duty and its replacement with a broad-based land tax; a simplified personal income-tax system; the company tax rate lowered to 25 per cent; heavier taxes on economic “rents”, particularly in the mining sector; and a greater reliance on consumption taxes – code for the GST, which the review was expressly forbidden by the Rudd government to mention.

Good economics, diabolical politics

A decade on, the threats to the tax system identified by the Henry review remain, including the increasingly footloose nature of capital, the ageing of the population, new technologies, multinational tax avoidance and increasing complexity.

Such themes were echoed in the discussion paper for the Abbott government’s ill-fated tax white paper review: “The rise of the digital economy and globalisation presents significant challenges for the effectiveness of the tax system. Capital is more mobile and highlights the need for a competitive corporate tax regime to encourage investment.”

Australia relies heavily on taxes on incomes, both personal and corporate incomes, according to data from the Organisation for Economic Co-operation and Development. Other advanced countries make more use of consumption taxes, such as VAT (value-added tax) and the GST – taxes which do less to stifle the economy.

Australia's GST rate of 10 per cent is low, internationally, and applied to a shrinking base of consumption, because exempt goods and services – such as health and education – are growing as a share of spending.

There are still a bunch of things that the economists would beg you to do but the politicians would run screaming from.

Chris Richardson

Meanwhile, the high gap between the company tax rate and the top marginal tax rate – which is nearly 50 cents in the dollar after Medicare and other levies – encourages greater “tax planning” to re-characterise income as business rather than personal.

There is no shortage of radical new ideas for reshaping Australia’s tax system for the 21st century.

“Some of the easiest things that could be done have been done already,” says Richardson. “Tax reform now is a game of increments. But there are still a bunch of things that the economists would beg you to do but the politicians would run screaming from.”

Increasing the GST is one of them. Abolishing stamp duty and replacing it with land tax, as the Henry review recommended, is another.

Abolish stamp duty, introduce land tax

“If you got rid of stamp duty and introduced a broad-based land tax, you would add a little more than 1 per cent to national income,” says Richardson. Stranger things have happened. Until 1952, the federal government did have the power to tax land.

Richardson says a land tax would act much like local council rates and would be easy to administer and hard to avoid. Proceeds could be used to abolish stamp duty on property transactions, which discourage people from downsizing to homes more appropriate for them, exacerbating affordability issues.

“The economics might be wonderful but the politics are diabolical,” he concedes.

Tax economic rents instead of profits

Economist Ross Garnaut says it's time for a fresh look at corporate taxes, in the wake of the government's failure to push through reform, fuelled in part by public disquiet about the banking sector.

Garnaut wants a panel of independent experts appointed to design a way for companies to be taxed not on their profits but on the value of their economic rents.

“Economic rent,” he explained recently, “is expected profit in excess of that necessary to attract investment into an activity. It can persist because there are natural, regulatory or institutional restrictions on the flow of new investment into an activity. It can be taxed without distorting investment decisions.”

Garnaut says such a reform would echo the Henry review’s finding and help to address public concern about excessive profits in the banking sector: “It happens that an economically efficient and revenue-neutral tax reform would increase the incidence of taxation on banking income and reduce it on competitive sectors of the economy.”

Abolish the tax-free threshold

Earlier this year, partners at PwC released a paper calling for the abolition of the tax-free threshold – the amount of your annual income that isn’t taxed – which now stands at close to $20,000.

Miranda Stewart is a professor at the Australian National University’s Tax and Transfer Policy Institute. She notes that a high tax-free threshold was a recommendation of the Henry review but, while she is not convinced by the Henry review's arguments, she says the PwC idea is worth looking at.

Currently, the tax-free threshold “takes people out of the system and, in the long run, that may not be the best thing for tax compliance or understanding”.

PwC proposes taxing income from the first dollar, albeit at very low rates, with relief delivered through increased use of low-income tax offsets.

But tax offsets have their own problems, says Stewart. Withdrawn as incomes rise, tax offsets have harmful effects on women’s workforce participation as they face punitive effective marginal tax rates to return to work after childbirth.

Tax at the next election

Either way, tax is set to dominate the upcoming federal election, now set for May, as Labor and Liberal go head to head again on their established tax plans.

The Coalition will tout the benefits of its personal income-tax cuts announced in the budget – which Labor has promised to boost in the early years. Prime Minister Scott Morrison has also retained the Coalition’s promise to cut the company tax rate to 25 per cent, despite urging by some in his party to drop it.

Labor faces ferocious scare campaigns over its plans to curb tax breaks on investment properties and reform franking credits.

From the goldfields to the ballot box, tax continues to ignite passions – and to play a central role in our democracy.