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The mixed fortunes of tax reform in Australia, part 2

This article is based on edited extracts from Paul Tilley’s book, Mixed Fortunes: A History of Tax Reform in Australia, published by MUP https://www.mup.com.au/books/mixed-fortunes-paperback-softback. Part 1 can be read here.

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Part 2: Tax reform episodes

Australia’s tax reform efforts since Federation have been mixed. Part one of this two-part series looked at the history of the Australian tax system and the issues it now confronts. Part two will look at Australia’s main tax reviews and examine the key ingredients that make a tax reform exercise work, or not.

Tax reform efforts at the Commonwealth level can be viewed in three main phases. The first covers the early decades of the 20th Century with governments establishing their roles in the new Federation. The second covers the post-war period leading into the major tax reforms of the 1980s and 1990s. The third covers the 21st Century to date. State tax reform efforts overlap these phases.

Early Federation reviews and the 1942 Income Tax Unification

At Federation in 1901, the Constitution gave the Commonwealth exclusive access to customs and excise duties, but with other taxes open to both levels of government they were soon competing, and efforts to resolve these overlaps were a focus of early Commonwealth-State finance negotiations and tax reviews.

After the Commonwealth introduced income tax in 1915, the overlap with state income taxes was problematic for taxpayers. Two Royal Commissions considered ways to achieve greater uniformity. The 1923 commission recommended that income tax be raised exclusively by the Commonwealth, but this was not actioned by governments. The 1934 commission recommended a compromise with separate income tax acts containing a uniform set of core provisions defining those elements of the tax base that could be agreed on. This was implemented by governments, as the Income Tax Assessment Act 1936 at the Commonwealth level, but over time ongoing changes across jurisdictions eroded the uniformity.

Financing Australia’s involvement in World War Two required large revenue increases and the Commonwealth asked the states to suspend their income taxes to allow it unfettered access. The states refused, so the Commonwealth appointed a committee which duly recommended that it be the sole collector of income tax. The Commonwealth then acted unilaterally in 1942 to force the states out of income tax, making it a Commonwealth monopoly.

This episode showed that a crisis, even a war, can provide the opportunity for reform. In this case, the royal commissions had established the foundational case for income tax unification, and a new government needing war finance provided the determinative opportunity.

Asprey tax blueprint and reforms of the 1980s and 1990s

In the post-war period in Australia through the ‘golden years’ of the 1950s and 1960s there wasn’t an imperative to tackle basic economic reform, and structural problems in the tax system went largely unactioned. High inflation in the 1970s, though, pushed taxpayers onto higher tax rates and exposed Australia’s flawed income tax base. Dissatisfaction with the tax system was acute as tax avoidance and evasion became pervasive.

A comprehensive external tax review was commissioned – the 1975 Asprey review – which laid out a blueprint for the Commonwealth tax system, entailing broadening of both the income and consumption tax bases. With the review reporting in the final tumultuous year of the Whitlam government, though, its recommendations were not implemented.

In 1985, the Hawke government conducted an internal tax review that sought to implement the Asprey blueprint, with structural broadening of the income and consumption tax bases. Support for the consumption tax proposal could not be established at the 1985 tax summit but income tax base broadening was implemented, with a capital gains tax, a fringe benefits tax, a foreign tax credit system, and a dividend imputation system.

In 1998, the Howard government conducted an internal tax review that focused on reform of Australia’s indirect taxes. The Commonwealth then used its constitutional power to introduce a 10 per cent GST to replace the WST and a raft of the state transaction taxes, with all the GST revenue going to the states. While practical and political considerations resulted in health, education and basic food being excluded from the GST base, the package was a major consumption tax reform that complemented the 1985 income tax reform and went a substantial way to completing the Asprey blueprint.

Associated with A New Tax System Act (ANTS) was the 1999 Ralph Review of Business Taxation, which set up a cut in the company tax rate funded by the removal of accelerated depreciation, along with a raft of other more modest reforms.

These tax reviews can be seen as a group. The external Asprey review was the foundational review that established a blueprint for the Australian tax system, while the 1985 and 1998 internal reviews were the determinative reviews that sought to implement that.

21st century tax reform

At the beginning of this century, Australia’s emerging resources boom drove economic growth and revenues. The 2008 GFC and the COVID-19 crisis, however, interrupted that momentum, pushing budgets deep into deficit. A fraught political situation further obviated reform opportunities.

The 2009 Henry report outlined a comprehensive reform agenda addressing long-term directions for the Australian tax system. In the context of the GFC and a difficult political environment, however, those reforms were largely not implemented. The main initial reform, a resource rent tax, was short lived. The review report has provided a useful ongoing role, though, with over a third of its recommendations actioned since.

The 21st Century has also seen greater efforts at the international level to tackle profit-shifting by multinationals to minimise their tax liabilities. Domestically, advances in computer programming and information technology have revolutionised aspects of business accounting and tax administration.

State tax bases generally suffer from poor design and erosion due to interstate competition. State and territory tax reviews have established some broadly consistent reform themes, in particular reductions in transaction taxes such as stamp duties and broadening the bases of land tax and payroll tax. While there have been some tax policy measures of note, including the replacement of transaction taxes by the GST and efforts to harmonise payroll taxes, many problems remain.

Why is tax reform so hard?

With the tax system establishing a community’s sharing of the burden of funding government, any rearrangement will inevitably be contentious. The economic and social benefits of tax reform can be substantial, but the ‘winners’ are often dispersed through the community, while the ‘losers’ tend to be more concentrated and politically vocal. Aspects of tax policy are also inherently subjective, requiring a balancing of objectives, making the establishment of unambiguous arguments unrealistic.

Tax reform is part of a change-management process, and several stars need to align. The arguments for the nature of the reform need to have been established and broadly understood and accepted. A reformist government then needs political capital that it is willing to spend on tax reform, and most likely a fiscal position capable of accommodating a budget-negative reform package. A political window, perhaps early in a government’s tenure or during a crisis, then needs to present as a catalyst for reform.

What history shows us is that where reforms have been achieved, there have been certain prerequisites. First there needs to be a burning platform, that is the arguments need to be made that there is a major problem that needs solving. Second, a government needs political capital to manage the inevitable short-term difficulties. Third, fiscal room is desirable to accommodate a reform that is budget negative in the short term to enable compensation of ‘losers’ in certain socio-economic groups. Finally, skilled politicians are needed to effectively advocate the reforms, in particular Prime Minister/Treasurer partnerships of the ilk of Curtin/Chifley, Hawke/Keating and Howard/Costello.

Prospects for tax reform

Flaws in the Australian tax system provide numerous opportunities for a reformist government. At the Commonwealth level, an obvious starting point is the inconsistent approach to the taxation of savings, as well as the taxation of companies in an increasingly global economy and the taxation of Australia’s natural resources. At the state level, the most obvious reform is to continue the transition away from transaction taxes such as housing conveyance duties to broad-based land taxes.

Overlaying these generally microeconomic tax reform concerns is the more macroeconomic consideration of the size of government in Australia. Budgets face large spending pressures but also significant structural deficits. This has spawned a debate about whether Australia’s tax burden will need to rise and, if so, how that should be done to avoid transferring the burden to future generations.

What is the role of tax reviews?

A formal review is one tool available to governments considering reform. History shows us that a well-constructed review can provide an effective vehicle for community consultation and expert advice, away from the political hothouse of government. It can be helpful in making the case for, and designing the nature of, a tax reform package and can lend credibility to the reform proposals.

Formal reviews, though, need to be seen as just one part of a government’s broader change-management process. The complexity and contentiousness of major tax policy changes means that the arguments need to be made over a longer period and reinforced by governments and ongoing academic and community debate. A review provides a tool but not a solution.

Life wasn’t meant to be easy

Given how difficult the achievement of tax reform has proven to be, one may well ponder whether it is worth the effort. But what is at stake in terms of the broad social contract between government and citizens, and the pervasive effect a tax system has on the economy, means that it is too important to leave in the too-hard basket. To paraphrase George Bernard Shaw, the lesson for potential tax reformers is, perhaps, that tax reform is hard, but take courage, for the benefits can be great.

 

This article is based on edited extracts from Paul Tilley’s book, Mixed Fortunes: A History of Tax Reform in Australia, published by MUP https://www.mup.com.au/books/mixed-fortunes-paperback-softback.

Paul Tilley was an economic policy adviser to governments for thirty years, working mainly in Treasury but also the Department of the Prime Minister and Cabinet, the Treasurer’s Office, and the Organisation for Economic Co-operation and Development. He is a Visiting Fellow at the Australian National University’s Tax and Transfer Policy Institute, and a Senior Fellow at the Melbourne Law School.

 

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