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
Ms A. McClelland, Brotherhood of St Laurence (sworn)
Ms McClelland - Thank you, Mr Chairman. The presentation I give today is from the perspective of the Australian Council of Social Service rather than from that of the Brotherhood of St Laurence. While the brotherhood pays my salary, much of my time, due to the generosity of the brotherhood, goes to working with ACOSS in my position as deputy president and principal coordinator for economics and tax. As Mark Paterson said, ACOSS has been an active participant in tax reform with the business community. Of course, that relates to a long-term interest both ACOSS and the Brotherhood have in tax reform. I will outline the objectives and problems we see with the tax system and the objectives for tax reform, including how not to achieve tax reform and how to achieve it. I will then give some detail about an ACOSS framework for tax reform, including some comments on federal-state financial relations.
Turning first to the problems and objectives for tax reform, we endorse the criteria developed by ACOSS and ACCI at the tax summit, and I will highlight some but not all of those today. As Mark Paterson said, a very important point at that tax summit held 18 months ago was the agreement by all parties that adequacy was an issue in taxation. That was a very significant agreement. From that perspective one of the key concerns of ACOSS has been the decline in the revenue capacity of our federal-state system. That has been apparent at federal level where we have seen a decline in federal revenue as a proportion of GDP over the past 10 years to the extent that if we raised the same proportion now as we did 10 years ago we would raise at least $10 billion per annum in additional revenue.
It would be fair to say that in the late 1980s and early 1990s in particular the impact of that decline in revenue was in part cushioned by the additional revenues the state raised from state-owned taxes - and Mark has mentioned the percentage increase in that revenue in all states apart from Tasmania. As has been said, the states have only narrow, relatively inefficient and regressive taxes on which to rely, so there are limits to their capacity to make up for any problems with the federal revenue base. We also know that those problems with the revenue base have not been confined to the past 10 years. Economic growth is not going to make them magically go away. There are structural problems there that will continue and will worsen as time goes on. Those problems include, first of all, some loopholes and distortions in the income tax base, and they were mentioned by John. They also include changes in the work force, the trend to casual and part-time work and also, importantly, the trend to contract work, which will create pressures on our PAYE tax system into the future. They also include a low-inflationary environment, which I hope we will maintain, getting less revenue from bracket creep into the future.
On the indirect tax side, as John Freebairn said, they importantly include the lack of taxation of services. That means that as we become a more service-based economy, as services take up more and more of our GDP, our indirect tax base is increasingly going to be inadequate. What is the overall solution to that problem? As John Freebairn said, it is to take action to improve both the income and the indirect tax bases - and I will talk more about that later on. That action may enable us to reduce rates, because part of the problem on the indirect tax side was the response in the Dawkins budget. That contained substantial increases in the rates of indirect taxes, which hurt low-income people and about which we were concerned.
That brings me to the second problem we have identified with the tax system, which is that it has major inequities. There are different tax systems for different Australians, depending on how you get your income and the loopholes in the income tax system that you are able to take advantage of. Therefore, we can see the effective tax rates that different people pay varying differently. For example, if you are able to engage in negative gearing - that is, if you are able to borrow and offset the cost of that borrowing against your labour income and pay little in capital gains tax - you can actually have an effective negative tax rate. Your effective tax rate can be lower if you are in a family trust. As John Freebairn said, the ones who actually face the highest effective tax rates are people on pensions and benefits, people who are in receipt of family payments and low-wage earners with incomes between $20 000 and $30 000, who in many cases pay effective tax rates higher than 80 per cent.
The upshot was that if a low-income family with two children, earning somewhere between $20 000 and $30 000, increased its income by a significant amount it may receive only an additional $1000 disposable income - that is, if by working harder you increase your income by $10 000 your disposable income may increase by only $1000. It is inequitable that certain members of the population receive only a small increase in disposable income as a result of their efforts in the work force. That inequity has caused a fair amount of anger amongst the battlers.
It is not commonly recognised that our indirect tax system has become increasingly inequitable over the past 10 years. In 1984 the bottom 10 per cent of the population spent 14 per cent of their income in indirect taxes; by 1994 that had increased to 23 per cent. Although that is a result of the changes in both income and indirect taxes over that 10-year period, there is no doubt that indirect taxes have become more unfair. In 1994 the top 20 per cent of the population paid 6 per cent of their income in indirect taxes, compared with 23 per cent for the bottom 10 per cent. Those figures illustrate how regressive the indirect tax system is.
We would stress that the solution to the problems of inequity is to remove the loopholes and distortions in the income tax base. Income tax, together with other taxes such as land tax, is the cornerstone of fairness in our tax system. It is the tax levied according to capacity to pay. The tax system must be kept strong and the pressures upon that tax system removed in order to maintain a basis of fairness in our tax system. We must also consider improving the indirect tax system, as previously mentioned. Another problem is economic inefficiency. Mark Paterson has mentioned some of those problems already, particularly those on the indirect tax side, and I will not repeat them.
I will mention several inefficiencies on the income tax side. The first is that there is an incentive to borrow and invest in capital-appreciating assets because debt on nominal returns can be deducted as it is incurred, yet payment of tax on capital can be delayed until it is sold on an inflation-indexed basis. The combination of those factors means that there are distortions, and decisions about what asset to invest in and what investment to make are made not on the basis on how efficient the investment is but on the basis of what yields the best after-tax return. That distortion of investment patterns is a major concern. Because of the way different entities such as trusts are taxed there is also an incentive for businesses to take part in complex business structures rather than the business structure that might be the most efficient and simple. Finally, the system is too complex. Mark Paterson has referred to that in some detail and I will not reiterate it. Simplicity is obviously an objective.
I will focus now on how not to achieve tax reform. We know there is a concern that tax reform should have personal income tax cuts. To some extent that concern is justifiable. We have an unsustainable gap between the top marginal tax and the company tax rates, but that is not to say it should be completely closed. We also have very high effective marginal tax rates for people on low incomes and average tax earners in striking distance of the top marginal tax rate. That is as much a result of having cut marginal tax rates and not having adjusted tax thresholds as anything else. If we concentrate merely on cutting the top marginal tax rate we will still have that problem a few years down the track. We have to be clear about the long-term solution to that problem. It is difficult.
We know there is a need for some tax cuts in a new tax reform package, but one of the issues is how to pay for them. The first thing we must not do is to fund tax cuts from the budget surplus, apart from funding to remove any bracket creep that has occurred. The surplus at a federal level, and possibly also at state level, has been achieved by big spending cuts which have affected the living standards of many low-income earners and have made some services unavailable to them. How should we fund tax cuts? It would be both unfair and economically irresponsible to fund them through that hard-earned surplus. We have achieved that surplus because of economic responsibility, because we want to be economically responsible.
The second thing we must not do is to fund tax cuts from an increase in taxes in consumption. John Freebairn gave the reasons for that - that is, because taxes on consumption are regressive, they take more of the income of a low-income earner than a high-income earner, whereas taxes on income are by and large progressive. Liability increases as capacity to pay increases. Therefore, financing tax cuts from increasing consumption would change the tax mix towards a more unfair tax system. It is important to understand that that change in tax mix was the reason for the staunch opposition by the welfare sector to option C when it was put forward in 1985, and it was responsible for much of the concern by the welfare sector to Fightback.
There is no reason to believe that if a package that included those changes was reintroduced, those concerns would not recur. It was said in 1985 that one reason why we should not worry about these concerns too much, or try to overcome them, was that a change in the tax mix towards consumption would make us more economically efficient and would solve the problems of the tax economy. Nowadays, there are few economists who are saying we will be more efficient if we move from income to consumption, and there is dispute - I believe that is a fair way to put it - about the impact on the cash economy from a change in the tax mix. It is an area that is highly contested.
One of the reasons we believe you should not try and achieve tax reform by changing the tax mix towards consumption is that it is hard to solve it through a big compensation package. John Freebairn dealt with some of those issues, but it is important to reiterate them because they do not seem to be believed in many cases. We are not saying that you will not need some kind of compensation package. You probably will. Some people will probably need to be compensated in some way. We are trying to avoid a solution to big equity problems through a big compensation package. We do not want to rely on a big compensation package for several reasons.
Firstly, there is concern that over time it is risky. The New Zealand experience showed that in the early 1990s welfare increases associated with a compensation package were eroded. Secondly, it costs a lot of money - money that could be better and more efficiently used elsewhere for tax reform. Thirdly, it is likely to be inflationary and increase prices that otherwise would not occur. Fourthly, it artificially inflates the welfare bill. Australia does not have a history of being a high welfare nation. The welfare community is concerned that it will see a large increase in social security payments. The community is saying, 'We are spending more on social security. Why should we improve the position of people on social security when really it is just an artificial increase to help them stand still?'. We want to avoid big compensation packages.
How should we achieve tax reform? Firstly, we would emphasise that we need a bold approach that addresses the problems comprehensively. The problems are, as Mark and John have said, the key deficiencies in income tax and consumption tax and in the way assets are taxed. We must consider much more than just tax cuts and a GST. That would be a minimalist tax reform package, not a bold and comprehensive package that addressed and overcame the main deficiencies. We must build fairness into the tax reform package, not just add it on as compensation. We must consider the high rates of taxation facing low-income earners. To do that, ACOSS has developed a framework which accepts that in the first instance tax reform needs to be revenue neutral. Although it would be no surprise to the committee that we would wish to have more revenue, we also understand that the politics of tax reform over the past 15 years has never seen a political party taking a tax reform package to the community which was not revenue neutral.
ACOSS is saying that within the framework of a revenue neutral package there would be three revenue neutral subsections, particularly a revenue neutral reform of the income tax base achieved by income tax base broadening. That issue has been dealt with by John Freebairn and Mark Paterson. I reiterate that the priorities for income tax base broadening relate to improvements in the way we tax capital and debt by overcoming some of the deficiencies in our capital gains tax and quarantining capacity to negatively gear. If negative gearing is not quarantined, we will see an erosion of the PAYE tax system in this country in the same way that the absence of fringe benefits taxation was eroding the tax system in the 1980s. It is a serious problem.
I reinforce the comments of John Freebairn about the importance of strengthening land tax. It is unlikely that wealth taxation will be introduced into this country. Some assets are taxed, but as with income and consumption they are not taxed comprehensively. A wealth tax would achieve that, but the politics make it unlikely. A more comprehensive system of land tax that, as John Freebairn said, could be offset by eliminating taxes on land transactions would be a more economically efficient and fair way of taxing land, and that should be addressed in the same way capital and debt are taxed.
The whole area of work-related deductions requires tightening up. Fringe benefits tax is a central armoury in keeping the PAYE system robust and should not be completely abolished. It requires changes to reduce the compliance cost to business, such as changes in the way entertainment is taxed. A third area requiring attention is that of saving and superannuation. Finally, there is the area of business entities. I do not have time to go into those now
As the committee would know, at this stage ACOSS has an open mind on GST. It is looking at all proposals in terms of their impact on the living standards of low-income earners. However, it believes there is a strong case for broadening the consumption tax base. We cannot continue with the current narrow base. ACOSS will be considering options to broaden that base in much more detail over the next month.
In conclusion, I would like to stress a couple of points on the reform of federal-state tax. Our key concern in the reform of federal-state taxes is not so much with federal-state fiscal imbalance as it is with the lack of certainty that the states have about the amount of revenue they can expect, not just for next year but over time, and the impact that lack of certainty is having on the state's capacity to deliver critical services affecting the living standards of Australians and their future opportunities, particularly in the education and health areas.
So we have that major concern. We also approach the issue with the view that in any reform we must ensure some consistency across Australia in terms of the adequacy of the delivery of health and education services. We would be concerned about changes that had wide variation in providing access to basic services depending on the state in which one lived.
We agree with earlier comments that there are key inadequacies in state government tax bases: they are too narrow, too restrictive and economically inefficient. Therefore, the reform direction that we would see would be one that gives the states some fixed share of either commonwealth revenue or a particular tax - perhaps a broader consumption tax might be the one.
In return for that fixed share, however, the states would guarantee to deliver a basic standard of services to their people and would also consider strengthening some of the taxes they have, such as a land tax, which is one of the important taxes. We would be concerned about going down the track where the states were given the capacity to vary their rates of, say, consumption tax or indirect taxes particularly which meant the commonwealth would be reducing its rates in that area because we believe they would be inefficient or it would lead to confusion about the different rates that services have in different areas. It is certainly likely to lead to different amounts of service provision in different areas. The main concern is that it is a recipe for erosion.
One of the biggest concerns about states having control over a substantial base is that some of the big bases they have had have been eroded over time. One would not want to see the reform go in the direction that it strengthened the bases that were non-distorting.
In conclusion, I would like to thank the committee for inviting me. I believe this is an important exercise. Although tax reform is a difficult exercise for governments, it is a very important and critical one. You will never get a package that pleases every member of the Australian community; therefore, governments have to be prepared to be bold and to offend someone. It is unrealistic to suggest that you will have a totally consensus package but it is also important to develop a package with open community dialogue, and your seminar today is part of that dialogue. Thank you.
The CHAIRMAN - Thank you, Alison, for your valuable contribution.
Witness withdrew.
23/2 Public Hearing