FEDERAL-STATE RELATIONS COMMITTEE
Inquiry into overlap and duplication of
roles and responsibilities
Minutes of evidence
Melbourne - 23 February 1998
Members
| Mr A. Andrianopoulos | Mr M. John |
| Mr G. B. Ashman | Ms L. J. Kosky |
| Ms L. T. Burke | Mr B. T. Pullen |
| Mr D. Dollis | Ms W. I. Smith |
| Mr K. S. Jasper |
Chairman: Mr M. John
Deputy Chairman: Mr B. T. Pullen
Staff
Executive Officer: Ms L. Topic
Office Manager: Ms N. Papal
Research Officer: Mr P. Emerton
Witness
Professor J. Freebairn, University of Melbourne (affirmed)
I am pleased to now welcome Professor John Freebairn from the University of Melbourne and the Melbourne Institute of Applied and Economic Social Research. Would you like to address the meeting, Professor?
Prof. FREEBAIRN - I agree with most of what Mr Paterson said. I will try to shorten my presentation and pick up other issues. I will address three topics: a reiteration of the need for tax reform; what are some of the reform options; and what are likely to be the consequences of some of these reform options for federal-state financial relations. The need for tax reform is now clearly on the political agenda of the commonwealth and the states, and the various parties. However, more fundamentally, as Mr Paterson said, the current tax system is not sustainable. Federal Treasurer Costello has said it might just about get us through for a year or two, but it will not work into the next century.
The basic reasons for that are that it will not generate the necessary revenue. Every day people are managing to get around the income tax system with new tricks. The expenditure tax system is tied to goods but not to services. The part of the economy that is growing fastest is services. The state's payroll tax falls largely on big and not small business. Which part of the economy grows fastest? Small business, not big business. Some of that growth is driven by the absurdities of the tax system; there is a bit of push and shove both ways. There is a growing consensus in the community that we want a tax system that secures revenue for the future.
It is interesting to recognise who is in favour of that. On one hand there are those who really depend on government for social security, and on the other hand business now realises that if the tax revenue falls governments will be out to do something - they will put on another bandaid or another brand of tax. Because that creates uncertainty for businesses, they have an interest in having a sustainable tax system so they can concentrate on sorting out relationships with their employees and how to beat the Americans, the Japanese and whoever else they compete with. Let us not waste their energies on trying to second guess what those in Spring Street or neighbouring Lake Burley Griffin will do to the tax system.
The second reason why the tax system is not sustainable is that it is inefficient. Different items are taxed differently. When we think of income tax most people, including those in this room today, think how terrible is the top tax rate of 48.5 per cent, including the Medicare levy. But that is actually low. Many low and middle-income earners who may move from $20 000 to $25 000 a year not only pay extra income tax but also lose some of their family allowances, Austudy, rental assistance and so forth. The effective tax rate they face is often above 80 per cent - and sometimes above 100 per cent. Why would such a person want to go out to work? Why would he or she seek to work overtime, or to encourage the kids to be properly educated? They are crippling deficiencies. Fundamental reforms must examine the social security system as well as the tax system.
We put our savings into housing at a concessional rate relative to putting our savings into business investments. We have a country full of beautiful, big houses, but we are doing that partly because of the tax concessions. We talk about stamp duties. That locks in a lot of existing decisions, because if I have a block of land and do not sell it, I do not pay stamp duty. If I sell it to somebody who can use it more productively, I must pay stamp duty. That is a disincentive for some people to sell. We are locking up part of the economy in atrophied, inefficient activities relative to what we should be doing. You can get over that easily with a comprehensive wealth or land tax imposed every time regardless of for what the property is used - it will be pushed around to those areas where it will have the best use for the country. So the story goes on. We do not know the magnitude of those deficiencies. A number of estimates put it at more than 5 per cent of national income. We could probably halve that with a decent system. Tax reform in micro-economic reform terms could do more for us than cutting tariffs or getting the wharves and our railways and transport systems to work. There are big opportunities that we could use to improve our income.
The tax system is not all that fair. We often think the income tax system is progressive. Somebody who earns more than $50 000 a year pays 48 cents in the dollar thereafter, but the rich can exploit the income tax system better than can the poor. They can establish trusts and hide money under companies. It is progressive but not nearly as progressive as we think. We should recognise that 40 per cent of our taxes are collected on expenditure - on cigarettes, alcohol, washing machines, toothpaste, televisions and so on. Those taxes are regressive. The lower income earners pay a bigger share of their income on such indirect taxes than do the rich. The overall distribution is rather U-shaped. Those in the bottom two deciles pay more tax than the middle-income earners and the rich ultimately pay more. If you look at horizontal inequities, wage earners paying PAYE can hardly escape tax. A lot of small non-PAYE salary earners can avoid tax. Those who buy goods are taxed heavily, but those who buy services do not pay much tax.
The final deficiency is that the tax system is highly complicated and has huge compliance costs. Estimates are that we probably spend two to three times as much as an average business or average taxpayer on compliance costs relative to taxpayers in New Zealand, the USA or the UK. About 70 per cent of Australians, who really only have wage incomes, decide they need tax agents to fill in their tax forms because it is so complicated. We are unsure what we are doing and we have a guilty until proven innocent philosophy. It is money down the drain; it could have been spent more productively in looking after the environment, looking after the elderly and disadvantaged or even having a good holiday.
All taxes are in a mess. It is a commonwealth and a state issue. It is about income taxes, expenditure and asset taxes. One of the attractive things about the current environment is we have a chance to look at the whole issue.
What are some of the reform options? I reiterate the context in which this debate can be run. Firstly, tax reform is long-term structural change; it is something to be set for decades. It is not about a quick fix or a story to solve tomorrow's unemployment problems. It is all about the structure or how we organise our businesses and our activities.
Secondly, I think it ought to be couched in an aggregate revenue-neutral package. Let us fight the debate somewhere else about whether governments should be bigger or smaller. Let us decide: we want to collect the current $150 billion a year; what is the best way to collect it? If one group wants to expand government, that is another issue and it can push up the tax rates. If another group wants to have less government, it can just lower the tax rates. We will fight that at another time; let us not get diverted by that problem.
The third constraint is on what we would hope to achieve in terms of equity. There is a pretty good consensus that we do not want tax reform to make the bottom 20 or 30 per cent worse off. People on social security and those on low wages should not be seen as losers out of this game. We also do not want tax reform that makes the top 10 per cent look as if they are big winners. To have Kerry Packer and friends appearing as winners again is the quickest way to kill a tax package.
To me it seems we should focus on trying to get a more neutral tax system; one that secures the revenue and reduces compliance costs. What, then, are some of the tax reforms we might look at? Firstly, there is income taxation, the commonwealth bailiwick, which collects 55 per cent of the revenue. Surprisingly, it is only 55 per cent and not 100 per cent. Most of the problems in our income tax system are caused by its not really being an income tax system; it is partly a nominal income tax system; it is partly a real income tax system; it is partly an expenditure or consumption tax system; and, when you come to one wonderful mess called superannuation, God knows what that is. It is taxed differently, depending on whether I put the money in or the employer puts the money in, and whether I take it out as an annuity or as a lump sum. And of course it is changed about every three years, and nobody in this room would have the faintest idea about taxation of their superannuation: it is just a systematic mess.
There are two ideal academic solutions to the problem of the present hybrid income tax system. One would be to have a comprehensive income tax system. That is pretty much what the Kiwis adopted. Alternatively, we could have what is called a comprehensive direct expenditure tax system, which essentially exempts savings from taxation. That is what is done with housing. Essentially, with the income you earn on your investment in your own home, neither the imputed rent or the capital gains are taxed. That is also what business does when it invests in people. It spends the money now on training people and they earn lower salaries; then when the people earn higher salaries or there is greater productivity for the business down the track, that extra output or productivity is taxed. Interestingly, we are about halfway between a pure income tax system and a pure expenditure tax system, with what is often called a mongrel hybrid bastardised tax system. Whatever term you want to use, we've got it. We could go to one or other of those extremes. Interestingly, nobody has tried the expenditure tax system in full. I guess, getting off my academic high horse, we will not expect either of those options to be implemented, but they are benchmarks to look at.
What I think will happen is we will look at ways of broadening the income tax base and closing some of the current loopholes and exemptions. We could go through quite an extensive list, but perhaps I will talk about labour income. We ought to tax everything like wages, lump sums and fringe benefits. Also, it could be done as well the same way with superannuation. You could pay tax at your personal rate on every dollar of wages you get, and then you could spend it on super, your house, cars, whatever you like. That would expand the tax base. As Mark said, we really need a common tax system for different business structures. It should not matter whether you are in a trust, a partnership or a company; the tax rate system ought to be the same. It demonstrably is not.
We could tighten up the capital gains tax, we could bring in pre-1985 assets, and we could take in the family home, deemed realisation at death, and so on. We could certainly get rid of the Liberal government's savings concession, which many of us will spend a lot of money on trying to understand next year but which will achieve very little. Superannuation is up for reform as is tightening-up on income splitting. Fairly conservatively, you could increase the income tax take by at least $10 billion a year by using some of those measures. That would fund reductions of, say, the top rate of 47 per cent to 42 per cent and a 34 per cent rate to 30 per cent. The pay-off of broadening the tax base and closing off lots of loopholes, exemptions and deductions is that you can use that to fund lower tax rates.
What are the benefits of that? You will secure the revenue because you have closed loopholes; and because you have moved to taxing different things similarly you will get a more neutral and efficient tax system which will turn out in general to be distributionally more satisfactory. The winners out of this will of course be PAYE people, because they are the ones who generally have been screwed by the current system and cannot escape it. It is non-PAYE employees and the wealthy who are genuinely and legitimately able to exploit existing tax loopholes, and they of course will scream a bit. That is the political pain that has to be worn. My suggestion is there are more PAYE wage earners than there are others, and the Australian sense of fair play and justice might give that a chance of being put through. Let's face it, base broadening will create some losers as well as winners. We just have to paint the losers as being the nasty ones who deserve it. That is a challenge for politicians, not for academics.
Let us move to the expenditure taxes. I would break up the expenditure taxes into two types. One type is what I call the general revenue-raising expenditure taxes. Here I include the commonwealth wholesale sales tax, the state payroll tax, state stamp duties and the state FID and BAD taxes. Altogether they collect about 20 per cent of the revenue. This is the area where most people are proposing a broad-based consumption tax as a replacement. In general, the New Zealand goods and services tax is the best working model that we know of in the world.
A tax rate of about 11 per cent on everything would replace wholesale sales tax, payroll, FID, BAD and the stamp duties. If, say, food, health services and education were exempted, the rate would need to be pushed up to about 16 per cent. One of the things about exemptions is that they make you push the tax rate up to collect the same revenue. This is another example of how base broadening is the key to keeping the rate down and keeping everything in the net.
What would be the pay-offs of doing that? There would be revenue security, and services as well as goods would be captured in the net. And as we shift our expenditure around from holidays to movies and whatever, this tax follows us; we cannot escape it. It would substantially improve economic efficiency. One of the problems with those taxes we will replace is that the bulk of them fall on business inputs - some inputs, but not others. This would level the playing field for the business sector, and it would go about producing products much more efficiently than it does now. Secondly, it would remove distortions to the mix of what you and I buy. In general, it would bring up the tax rate on services and bring down the tax rate on mostgoods.
Then there are the equity effects. It would give us a major improvement in horizontal equity. In terms of vertical equity we are still working on the numbers, but it looks like a broad-based consumption tax, a la GST, would have similar vertical equity effects to those taxes it would replace. Interestingly, a lot of us think that food is not taxed under the current indirect tax system. Except for soft drinks and snack foods, that is true. But farmers use cars, and trucks are used to transport food to supermarkets; those trucks are subject to the 22 per cent wholesale sales tax. The supermarkets employ people who are subject to payroll tax. That is passed on. The farmers, the processors and the retailers pay stamp duties, FIDs and BADs. They are passed on. So food, indirectly, carries these expenditure taxes. It is hidden. One of the things we want to do is make taxes transparent.
What I think is important about this GST proposal is that it is a commonwealth tax. I think it is fairly clear that the High Court decision of August last year means the GST will have to be imposed at the commonwealth level. We are getting rid of State payroll tax, stamp duties, FIDS and BADs so it will aggravate the current vertical fiscal imbalance. If that happens, the reason for your committee's inquiries will be even stronger.
What about some of the other special purpose taxes such as excise taxes and state franchise fees on petroleum, alcohol, tobacco, and gambling taxes? In a sense the petroleum one is very interesting. Part of the heavy taxes on petroleum and motor vehicles is a crude user-pays fee for road infrastructure. Governments provide us with all roads and bridges essentially scot-free. What is interesting is that with electricity and telecommunications the user is charged for access to the infrastructure. Petroleum and motor vehicles should not be taxed; there should be a user fee - you pay an annual charge for access to the road, which is essentially your registration fee, and you pay your usage fees of, say, so much per kilometre. You might argue that the petrol excise is a reasonable trade-off for that. It is not ideal, but it is close. It would be interesting to look at getting these taxes out of the so-called tax net and regarding them as user-pays fees for road construction and maintenance.
That still leaves a little bit of money left over. There is still money to tax for the congestion costs of road transport and particularly for pollution. We only have to think back to the Kyoto conference in December last year to realise that Australia is a little recalcitrant in doing something about greenhouse gases. This is an opportunity to take some of the revenue now collected by petrol excise and franchise fees and have a comprehensive greenhouse tax. You would want to capture the use of petroleum products off road as well as on road, the burning of fossil fuels for electricity, and so on. Of course you would hear a few screams from the aluminium industry and so on. But do we want to be the leper of the world on greenhouse? Rather than be pushed kicking and screaming, why do we not do something pro-active? It is a great opportunity. I do not see why we do not take it that way. Again, we have taxes on alcohol and tobacco - I will not worry about those.
I turn to asset taxes. It strikes me that this state, among others, has a wonderful tax base at its feet called taxes on land. It is very attractive to states because you cannot take land interstate. Labour and capital can walk; land cannot. Land is also one of those things which has very few efficiency costs. We all laugh at Henry George, but really land is one of those things which ought to be taxed much more. There is a compelling case for expanding the land tax so it applies not only to people in the central business district where it is now but also to residences and primary producers.
You can put a little bit of carrot with this package. One of the things we want to get rid of is stamp duties on land transfers. We would be much better off having an annual land tax rather than these infrequent stamp duties that block transactions. Even if it were made revenue neutral, we would be some steps ahead. I would suggest you could go quite a bit further. Australia, together with Canada, is one of those unusual countries that does not have a wealth tax - either an annual wealth tax or a death and gift tax. My guess is that if we were to have a comprehensive income tax - and that is an important 'if' - there is an arguable case that a wealth tax would be double taxation. There are people who argue that wealth gives people satisfaction per se and that therefore it is a form of expenditure tax. There are arguments pro and con that notion.
In terms of changes in the tax mix - that is, Keating's option C or Hewson's Fightback! - where you would use this new broad-based GST to fund reductions in income tax. You are going to need probably another 5 percentage points on your GST. Essentially for the reasons that Mark mentioned, I think that is not a goer, even though it appears to be favourably treated by the Liberal Party in Canberra. The reason I think it is not a goer is that income tax is progressive and a consumption tax is regressive, so you are replacing a progressive tax with a regressive tax. That is going to make the people at the bottom of the income scale worse off and the rich better off. You can fiddle the tax schedules; you can go in for compensation to offset a lot of it, but it is messy and costly and there will be some people who will still look like losers, and that makes it a political difficult sell.
Unlike Mark, I am not confident the change in the tax mix is much good at catching the black economy. Let us think of the black economy as dealing in drugs, sex or home repairs. At the moment those people do not declare those activities for income tax. I would suggest that if I buy drugs, sex or home repairs I am not going to declare them for consumption tax either; we are both going avoid it. Again you might say that when people get their illicit money from the black economy they will spend it on the white economy and that they will pay tax then. That is true. But suppose I am a baby-sitter in the black economy and I earn, for instance, $5 a day looking after somebody's kids. What if I then find out that I have to spend 20 per cent on indirect taxes through an increase in a GST. I am probably going to ask for $6 a day instead of $5 so I can buy the same amount of beer, cigarettes and food with my day's baby-sitting. When the economy adjusts and reacts this is not going to make a big difference. The only way to get into the black economy is by having very comprehensive tax bases and spending a lot of money on tax administration. To the extent that we have comprehensive tax bases, we might feel that it is valuable to pay tax.
What does all this mean for federal-state relations? I think there is a lot the states can do in their own backyards. It seems to me you could expand the land tax, and you could, if you wish, expand the payroll tax - and there are some proposals for sorting out the FIDs and the BADs. A more extreme tax regime that would be interesting to have a look at is whether you would want to directly charge a fee for the use of road infrastructure and in that way get around the constitution - but not to offend the August 1997 High Court decision. If the GST comes in, it will aggravate vertical and fiscal imbalance. However, let me just throw a fly in the ointment: I personally am not all that hung up by vertical fiscal imbalance.
My argument is essentially the following: for the most part the dollars you get from the commonwealth you spend first. Then you decide whether you are going to spend another $100 million on education, health or transport? How are you going to fund that? By raising another $100 million yourself from your own taxes. If that is true, the last $100 million you spend is also the last $100 million you raise from your own tax revenue. At the margin you are making a decision: will I get as much of a kick for a dollar as it will cost me to collect it? I think we tend to think too much about averages - that you collect 50 cents for each dollar you spend. My guess is you are really making decisions on the margin, so I am not all that hung up about vertical fiscal imbalance.
Suppose you are worried about this vertical fiscal imbalance. I think there are three options, and they are as Mark suggested. Firstly, you could be given a fixed share of commonwealth income revenue or a fixed share of the new GST, or both, and you would want something a lot better than the horse trading that goes on with COAG and premiers' conferences. Secondly, you could ask the commonwealth to withdraw in part from the income tax, and a state income tax could be levied on exactly the same base. That, I think, would be levied only on individuals; the commonwealth would collect income tax on businesses. Thirdly, you could perhaps pray for a referendum and a constitutional change and get some rights to collect some broad-based consumption taxes of your own. But I guess we are going to pray for a change in the Governor-General's role - or a president - before we go to that stage! Thank you.
The CHAIRMAN - Thank you, Professor.
Witness withdrew.
23/2
Public Hearing