A revamped personal tax system could provide Australia with a broader, simpler and more sustainable regime.
Article by Michael Laurence.
During the Howard government's 11 years in office, the ageing of Australia's population has become a much more significant issue, and will put the tax system under increasing pressure.
The government's Intergenerational Report 2007, released in early April, forecasts that the number of people aged 65 and over will almost double to a quarter of the population by 2047. And those over 85 will triple to 5.6 per cent of the population during this time.
One of the government's major initiatives to help Australia cope with the ageing of the population the simplification of the superannuation system and introduction of tax-free superannuation benefits has brought mixed responses.
The Business Coalition for Tax Reform (BCTR), for example, says the superannuation changes have 'dramatically' simplified superannuation and increased incentives to save for retirement.
And Garry Addison, senior tax counsel for CPA Australia, says the new superannuation system will encourage us to remain longer in the workforce before retiring a crucial development given the ageing of the population and near-full employment.
But economist Geoff Carmody, a commentator on tax reform and a former director of Access Economics, argues that superannuation members who have average balances would not have paid tax on their superannuation savings under the system being abolished.
Michael Rice, a director of Rice Warner Actuaries and a specialist in superannuation fund research, strongly agrees with Carmody that the introduction of tax-free superannuation benefits unfairly favours members who have high super balances.
Imagine the possible shape of Australia's personal tax system if the regime had a truly significant redesign.
Say the number of tax rates was cut from five to three, and the top marginal and the corporate rates are moved much closer together.
And, in what would inevitably prove highly controversial measures, the tax-free threshold is eliminated along with the capital gains tax (CGT) discount and most work-related expenses.
Such a revamped personal tax system, according to its creators, would provide Australia with a broader, simpler, and more sustainable regime while removing much of the motivation for extensive tax planning.
This image of a possible new-generation personal tax regime was developed in research projected by the Australian school of taxation (Atax) at the University of NSW and recently presented in a paper, 'Towards Systematic Reform of the Australian Personal Income Tax: Developing a Sustainable Model for the Future'.
And, say the paper's authors, Professor Chris Evans and Associate Professor Binh Tran-Nam of Atax, would produce, in their opinion, 'no adverse equity implications'.
Funded and assisted by the Australian Research Council and CPA Australia, the Atax project set itself the seemingly elusive task of developing a personal taxation model that would command widespread expert and community support yet meet expectations for tax revenue and tax policy.
Further, the researchers worked within the constraints of developing a tax model broadly based on the existing system. In other words, the researchers didn't have the luxury of starting with a clean sheet of paper.
The project's preferred personal tax model was built around the three marginal tax rates of: 0$24,599, 13 per cent; $24,600$69,999, 26 per cent; and $70,000 upwards, 38 per cent.
Although the current tax-free threshold would be removed, the low-income tax offset would be increased to $900. (The project was completed before the recent federal budget, which in fact, lifted the low-income tax offset from $600 in 200607 to $750 for 200708.)
The model allows for a degree of compensation to some taxpayers who appear to lose out. While discount CGT would be abolished, the first $5000 of capital gains each year would be exempt from tax. Taxpayers who claim work-related deductions would receive a $300 refundable tax credit.
The researchers had thought about quarantining interest-rate deductions on negatively geared investments but could not accurately calculate the financial impact. This will be the subject of a future study.
As a fundamental part of the project, researchers surveyed 3900 personal taxpayers and more than 3000 tax practitioners. These surveys found strong support for personal tax reform but some resistance among tax practitioners surveyed about the removal of deductions for work-related expenses.
Paul Drum, policy and research director of CPA Australia, can understand the caution of these practitioners.
'Many tax agents will naturally feel threatened if their bread-and-butter work were to disappear as a result of tax simplification,' Drum says. 'It is important that we recognise these concerns and ensure they are properly addressed in any reform package that may emerge.'
A growing debate
Despite the finding in the Atax surveys of widespread support for personal tax reform among taxpayers and tax practitioners surveyed, measures in recent federal budgets appear to be opening up more debate among some well-known tax commentators and economists about the direction and extent of reform needed. (The Atax surveys were completed in the first few months of this year.)
As usual, nothing is clear-cut when discussing the possible future direction of taxation.
Before last year's federal budget, many leading tax commentators and economists appeared to share a view that reform of Australia's personal tax system was the missing plank in the Howard government's tax-reform agenda.
But in subsequent budgets, the government announced the simplified superannuation system with tax-free superannuation benefits for those over 60 from July and further rounds of personal tax cuts. (In total, Australia has had six rounds of tax cuts in seven years, five announced in successive budgets.)
And a widening diversity of opinions is emerging among some commentators about the extent to which these cuts and superannuation changes are achieving true tax reform.
For instance, in April last year, national tax partner for Ernst & Young Tony Stolarek described personal tax reform as the 'major unresolved issue for tax reform in Australia'. Today, Stolarek says personal tax reform is 'now not such a compelling issue'.
Stolarek says successive tax cuts are giving greater incentives to higher-income earners, including entrepreneurs, while managing to draw more people from welfare into work. However, he adds: 'There's still more to be done in personal tax.'
Shortly before last year's budget, CPA Australia's Drum told this reporter that calls for personal tax reform were the loudest he had heard since the Howard government came to office.
But today Drum says the overall impact of the successive personal tax cuts and other personal tax measures has been 'quite dramatic' and provided valuable tax reforms.
In short, Drum believes the adjustments to tax thresholds have lifted the incentive to work. 'The government has taken an incremental rather than a big-bang approach to reforming the personal tax system,' he says.
Treasury secretary Ken Henry describes the increase in the income threshold for entering the 30 per cent marginal rate up from $21,600 to $30,000 over the past two budgets as a 'very big deal'.
Treasury calculates that this alone will expand the workforce by 90,000, easing wage pressures at a time when unemployment is at a 32-year low.
But some outspoken advocates remain committed to extensive personal tax reform. Evans and Binh Tran-Nam of Atax, for instance, are adamant that the personal tax system is still in need of extensive reform.
Evans says the government has been snipping away at the edges of tax reform, yet its big surpluses (10 in the past 11 years) provide excellent opportunities to make more far-reaching personal tax reforms.
And Chris Richardson, a director of Access Economics and long-time commentator on how the tax system interacts with the economy, says some fundamental characteristics of the Australian personal tax regime are still in need of reform.
Richardson says these characteristics include when opportunities to move from welfare to work are rejected because of the combined cost of lost benefits and income taxes (often tagged as the 'effective marginal tax rate').
Other characteristics are when companies are formed to exploit the gap between personal and corporate rates, and when people in engage in investment speculation rather than joining the workforce because capital gains are taxed at a much lower rate than income.
Seeds of debate
The triggers for part of the debate about the need for personal tax reform can, perhaps ironically, be traced back to the Howard government's earliest tax-reform initiatives.
In September 1999, the government outlined its program to fix the business tax regime, A Tax System Redesigned, mostly based on the government-commissioned Review of Business Tax, chaired by businessman John Ralph.
Despite the Ralph review's main focus on business taxes, several of its recommendations accepted by the government were to have a monumental effect on personal taxes.
The Ralph review recommended the introduction of discount CGT (individuals pay tax on capital gains at half of their marginal rates).
Economist Geoff Carmody argues that the taxing of capital gains at half the rate of income has led to a significant increase in tax-planning activities by both individual and business taxpayers. And the Ralph review recommended the reduction of the corporate tax rate from 36 per cent to 30 per cent.
Although this was a big win for companies, the gap with the top marginal rate was widened even further. Evans and Binh Tran-Nam of Atax say in their paper on a possible new personal tax model that the widening of the gap increased the incentive for 'wasteful' tax-planning by top marginal taxpayers.
Advocates of tax reform generally believe that the government should have significantly cut the top personal rate at the same time that it cut the corporate rate in order to get a much closer alignment of the two rates.
The introduction of GST in July 2000 (which wasn't one of the Ralph recommendations) improved the robustness of Australia's indirect tax system, and led to states and territories getting rid of several inefficient taxes.
But the dispute between the federal government and the states rages over the remaining state taxes in the Commonwealth/state agreement that are yet to be abolished.
Federal versus state
Consider this tax shocker: governments impose 56 taxes on businesses: 21 federal taxes, 33 state and territory taxes, and two local government taxes.
A recent report by PricewaterhouseCoopers for the Business Council of Australia (BCA) and the Corporate Tax Association tallied this list of imposts when measuring the tax burden on nearly 100 of Australia's largest companies.
BCA president Michael Chaney asks whether such a sum of taxes is sustainable given that Australian companies are competing against foreign opposition that operate under much more streamlined tax systems.
'The next level of tax reform will occur only as a result of reforming all levels of tax state and federal,' Chaney says.
The introduction of the GST in July 2000 was meant to lead to the removal of inefficient or nuisance state taxes. But senior tax counsel for CPA Australia Garry Addison says the 'process has now stalled'.
Addison calls for a 'more appropriate timetable' for the abolition of the remaining nuisance taxes (some of which are not scheduled to be abolished until 2012/13).
Also, no state has specified when it will abolish stamp duty on business real property transfers as requested under the GST Agreement. He says this matter needs to be resolved as soon as possible.
'Once this is done more wide-ranging reform of the remaining state taxes should be addressed,' he says.
Business wish list
Few tax professionals and interest groups would argue with the widely held belief that the Howard government has had a heavy focus on business tax reform for much of its time in office. But now business is calling for whatever party wins the next election to finish the job.
The business world's remaining wish list for tax reform includes:
Ease the double taxation of foreign income
CPA Australia, the Business Coalition for Tax Reform (BCTR) and accounting firms such as Ernst & Young are among those seeking a 20 per cent tax credit to shareholders receiving unfranked dividends from foreign-source income.
Currently, the profits of foreign subsidiaries and branches of Australian companies are taxed on distribution to shareholders even if already taxed by a foreign jurisdiction.
The Ralph Review of Business Tax in 1999 and the Board of Taxation in 2003 both identified the need for more equitable treatment for Australian investors in this situation.
A fairer tax treatment for foreign income is crucial for Australia to remain an attractive location for companies growing offshore, according to the advocates for this change.
Keep reforming Australian tax law to remain internationally competitive
The BCTR notes that other countries are 'continually fine-tuning their business and personal tax rules as the international tax landscape evolves'. And Australia should continually review its taxation arrangements 'in order to avoid losing ground'.
The government-commissioned International Review of Australia's Taxes, released in April last year, notes that Australia's corporate tax rate is broadly in line with its key competitors.
However, Australia's corporate tax burden is the highest of the 10 OECD countries chosen by the review panel as being most comparable to Australia.
Improve consultation
The BCTR calls for improved consultation in the development of tax policy and tax laws at the stage between policy announcements and drafting of legislation.
