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[Note: this article presents a personal view rather than the views of ACOSS]
This article assesses the A New Tax System (“ANTS”) tax reform package[1] from the standpoint of equity, efficiency and political sustainability. It also critically discusses the processes leading up to the development of the package.
There have been three major attempts to reform Australia's tax system over the past 15 years: the previous Labor Government’s tax reform package launched in 1985, the Federal Coalition Parties “Fightback!” package[2] launched in 1991, and the recently legislated ANTS package. All of these tax packages were vigorously contested, all of them involved considerable political risk, and there is still a great deal of unfinished business especially on the income tax side. It is tempting to conclude that the political process in Australia is inherently hostile to comprehensive tax reform. This view is too simplistic. The success or otherwise of major tax reform projects depends on how the reforms are structured and the process by which they are developed and debated. One of the reasons that tax reform is so politically difficult is that it is mainly about broadening tax bases (taxing the various forms of income and consumption in a more consistent way) rather than cutting tax rates. It involves pain as well as gain.
For example, broadening the income tax base means that different forms of income (such as wages, fringe benefits, and capital gains) are taxed at the same effective rates. Income tax base broadening has much going for it. It improves equity and strengthens public revenue by plugging loopholes and leaks in the system. Economists also argue[3] that it improves economic efficiency by removing biases in the tax system that distort saving, spending and investment decisions.
This is one area of reform where equity and efficiency march to the same tune. Yet it is resisted strongly by those who benefit from the myriad loopholes and tax shelters in the system. Those who benefit are mainly high-income groups that wield power and influence well beyond their numbers. Although, the benefits of income tax base broadening are often much more thinly spread.
On the other hand, consumption tax reform is desirable from the standpoint of revenue efficiency, although its other claimed economic benefits (such as discouragement of tax evasion and encouragement of saving) have been overstated. However, it raises a different set of political risks: the living standards of large numbers of financially vulnerable households, especially low and middle income families and social security recipients, are jeopardised by any attempt to either broaden or increase taxes on consumption.
Over the past 15 years, two models of tax reform have been pursued in Australia, in various guises. One has proved successful while the other has faced strong and widespread political resistance. Labor's 1985 Draft White Paper - Reform of the Australian Taxation System named them “Option A” and “Option C”. Both involve trade offs between base broadening and reductions in tax rates. The Option A model focuses on income tax reform. This model pays for significant reductions in marginal income tax rates by closing loopholes and shelters in the income tax system. Ironically, the former Labor Government borrowed this idea from the Reagan administration in the United States. Its 1984 tax reform proposals led to the most sweeping reforms to the US income tax base in the postwar period[4]. Negative gearing was curbed, depreciation allowances were slashed, nominal tax rates on capital gains were brought into closer alignment with those applied to ordinary income, and tax breaks for retirement saving by high income earners were curtailed.
The reason these long-overdue reforms largely prevailed in the United States was that they were directly linked to reductions in income tax rates. This successful formula was followed by the Hawke Government in 1985. In spite of interest-group resistance to the proposed Capital Gains Tax (“CGT”) and Fringe Benefits Tax, these taxes were broadly accepted[5].
Aside from the success of the US formula, another contributing factor was the relatively open process of decision-making leading to these reforms. This happened almost by accident after the Prime Minister committed the Government to a tax reform summit during a radio interview. Nevertheless, both the summit and the Treasury's Draft White Paper on Tax Reform prepared the ground for change, by exposing the problems with the existing system and making it clear that all interest groups would have to make sacrifices in order to achieve their objectives.
However, Option A was incomplete. It failed to address weaknesses in the consumption tax base, especially the bias towards taxing goods rather than services. The Hawke Government's original preferred model was Option C. In addition to broadening the income tax base, Option C:
• replaced existing taxes on consumption with a broad based consumption tax or Goods and Services Tax (“GST”);
• used the GST to substantially increase taxes on consumption in order to finance much larger income tax cuts than Option A permitted (thus shifting the tax mix from income to consumption);
• compensated welfare recipients and low income families for the resulting consumer price increases.
This was a high risk strategy, both for low-income households and for the Government. A large new tax on consumption was always going to attract strong opposition. The notion that the tax mix should be shifted from income to consumption only sharpened the controversy. A shift towards taxing consumption more and income less is both regressive[6] and inflationary, and the adequacy of compensation was vigorously contested.
Many Australian tax experts supported the Option C approach in the 1980s for two reasons. First, there was a widespread view that marginal income tax rates were too high[7], and many argued that income tax base broadening on its own would not generate enough revenue to finance the tax cuts required. Secondly, many thought that a tax mix change would improve economic efficiency (by raising household saving levels) and revenue efficiency (by raising revenue from the black economy). However, these economic efficiency arguments were also contested and have since been largely discredited.[8]
Ultimately, it was not the experts who defeated Option C. Most low and middle income earners were very wary of any new tax on consumption, especially one that included essentials such as food and was levied at a high rate (12.5 per cent) to pay for income tax cuts. They were not prepared to accept the risk that compensation would be adequate and that it would last over time. Moreover, the income tax cuts would have mainly benefited high income-earners.
Given the politically risky nature of this approach to tax reform, it is surprising that the Coalition Parties' “Fightback!” package revived it in 1991 during a recession. Even though the original package was later amended to remove most food items from the proposed GST (reducing the tax mix change to virtually zero), the political damage had already been done and the package was rejected by the voters.[9]
The Tax Reform Summit jointly convened by the Australian Council of Social Service (“ACOSS”) and the Australian Chamber of Commerce and Industry (“ACCI”) in late 1996 was a unique attempt to overcome some of the hurdles to reform described above.[10]. The Business Council of Australia (“BCA”) later joined this dialogue, which was formalised through a Tax Reform Forum.
ACOSS had a long-standing interest in tax reform motivated by the following concerns:
• the public revenue base was always small in Australia and was declining in proportion to GDP;
• low-income households faced high effective marginal tax rates[11] on their incomes as well as steadily increasing levels of tax on their consumption;
• many high income-earners practically escaped paying tax altogether; and
• biases in the income tax system were a factor leading to the deep recession (and high unemployment levels) of the early 1990s.
Furthermore, ACOSS had at least two pre-conditions for its acceptance of any major tax reform package. First, there had to be a substantial effort to close off remaining loopholes in the income tax system. Strengthening this progressive tax base was the welfare sector's main tax reform agenda, not a GST. Secondly, tax reform should improve the living standards of low-income households, not require them to rely heavily on ‘compensation’ simply to maintain their existing living standards in the face of consumer price rises. This concern about any over-reliance on compensation measures was reinforced by the New Zealand experience with Option C-type reforms. Two years after New Zealand's GST was introduced in 1986, its rate was increased from 10 per cent to 12.5 per cent without compensation, and two years later welfare benefits were sharply cut by a new Government.[12]
However, ACOSS was not opposed to a GST in principle. Australia already relied on regressive consumption taxes such as excises and Wholesale Sales Tax, to raise over 30 per cent of all public revenue. These taxes were being steadily increased by both the Federal and State Governments without compensation for low-income households. The average overall rate of consumption tax imposed on the bottom 10 per cent of households rose from 14 per cent of income in 1984 to 23 per cent in 1994.[13] The status quo was therefore also putting low-income households at risk.
Although agreement on a detailed tax reform package was not contemplated or on the agenda, these discussions led to a general consensus that both the income tax and consumption tax systems should be broadened at the same time in a revenue neutral way.[14] This was a major breakthrough.
During 1998, ACOSS developed its own proposals to marry comprehensive tax reform with equity.[15] These proposals followed the broad contours of the neglected "third option" in the 1985 debate – “Option B”. Option B broadened the income tax base and used the proceeds to fund income tax reductions, and then broadened the consumption tax base in a revenue neutral way.
First, ACOSS proposed that the income tax base be substantially broadened by closing tax loopholes in the following three areas:
• the abuse of business entities such as trusts and private companies to avoid tax, including by artificial income splitting;
• the sheltering of capital incomes from taxation to exploit the generous tax treatment of capital gains;
• loopholes in the tax treatment of labour incomes, including the excessively generous Fringe Benefits Tax treatment of employer-provided cars and the rorting of work-related deductions.
This proposal would have raised over $6 billion annually to pay for improvements in family assistance for low income families together with the bulk of any modest income tax reductions.
Secondly, in regard to consumption tax reform, ACOSS proposed that a number of existing taxes on consumption would either be broadened and extended to services, or replaced by a broader consumption tax in a revenue neutral way, without significantly increasing overall levels of tax on low-income households. Modelling conducted for ACOSS suggested that this could be achieved by holding the overall level of revenue from taxes on consumption constant, and by excluding rents and food from the tax base [16].
Thirdly, ACOSS made a suggestion that was designed to help curb future increases in regressive taxes on consumption and provide the States with a more robust source of revenue than hand-outs at annual Premier's Conferences. It suggested that Federal Government collect consumption tax revenue on behalf of the States. The States would have veto rights over any change in tax rates.
This model of tax reform had the potential to address the equity concerns that had defeated previous attempts. People on low incomes would also benefit from a boost to State Government revenues to fund health, education and social welfare services, and from reform of family assistance.
Although the business leadership disagreed with an exemption for food, there was broad agreement about the desirability of not increasing taxes on consumption in overall terms. This was because existing consumption taxes such as Wholesale Sales Tax and State financial taxes fell directly on business inputs and business had an interest in abolishing as many of these taxes as possible. They also shared the welfare sector's concerns about the narrow and inadequate tax base available to the States and poverty traps, although they were wary of income tax base broadening. This image of emerging national consensus was underpinned by opinion polling indicating that a clear majority supported comprehensive tax reform in principle. However, in reality the business-welfare dialogue was not broadly representative of the Australian community, and in any event interest groups do not determine public policy. The final decisions properly rest with government and the voters.[17]
With the new Coalition Government flagging the introduction of a GST, neither the Australian Labor Party nor the union movement were willing to join a dialogue over tax reform in which this was one of the major options. Although this was understandable given the history of political conflict over a GST in Australia, this oppositional stance made the achievement of comprehensive tax reform much more difficult.[18]
The Government's response to these political risks only made matters worse. It held back the release of its tax package until less than two months prior to the 1998 Federal elections. The absence of any detailed Government proposal, Green Paper, or official inquiry seriously distorted public debate on tax reform. This absence meant that policy was largely developed in backrooms, without recourse to wider expert opinion or detailed responses from the various interests that might be affected. The community would get only one chance to accept or reject the whole package.
Once the Government's package was released in late 1998, it became clear that there was a gap between the public dialogue on tax reform and the Government's actual policies. The debate quickly polarised.
The Government's original ANTS package picked up a number of important proposals raised in the business-welfare dialogue. Family assistance was rationalised to ease poverty traps and break down the traditional distinction between family assistance provided through the social security and tax systems. As ACOSS had suggested, the States were for the first time guaranteed secure access to a viable federal revenue source (the GST). On the income tax side, the package included a major crack-down on the use of trusts to avoid tax. However, one of the most surprising and disappointing features of the package was the extent to which it adopted the twice-rejected Option C model.
In the original ANTS package, overall taxes on consumption were raised by around $6 billion per annum (1 per cent of GDP). This was roughly equivalent to the GST revenue collected on food, which was included in the tax base. This additional revenue was used to meet half the cost of the other centrepiece of the package: personal income tax cuts costing $12 billion. Other benefits in the package, including compensation and family assistance packages, and cuts in diesel excise, cost another $8 billion. Only $4 billion of the $20 billion total cost of the package was met from income tax base broadening[19]. The rest came mainly from drawing down the budget surplus by around $7 billion.
One reason that the Government took the Option C route was the high priority it placed on large personal income tax cuts for its core constituency among middle and high income-earners. These tax cuts, including a new 30 per cent tax rate for incomes from $20,000 to $50,000, delivered a $86 per week increase in disposable incomes to high income-earners. The Government was not, however, willing to antagonise elements of this constituency by paying for the tax cuts with a Reagan-style attack on tax shelters. Another likely reason was (reportedly) a concern that the Opposition would cherry-pick its income tax policies by offering similar income tax cuts without a GST.[20]
However, this time the intellectual climate was more hostile to a tax mix switch than was the case in the 1980s. More importantly, low inflation both eased pressures for large middle-income tax cuts and made it harder to fund them from the proceeds of tax bracket creep. Resistance from low-income households and middle-income families to a large new tax on consumption that included food was still as strong as it had been in the 1980s.
Once the Government released its tax package, the process of consensus-building ground to a halt. ACOSS strongly opposed the package, having clearly flagged in advance that it would not accept a package that was regressive in overall terms, left low income households to rely heavily on compensation, and did not balance the GST with a comprehensive plan to close down income tax shelters.
In 1998, the Government was returned to office with a sharply reduced majority. Following a Senate inquiry and negotiations between the Government and the Australian Democrats, the ANTS package was substantially amended to remove “basic foods” from the GST base, reduce the income tax cuts for high income-earners, and improve compensation for low-income households.
A major sticking point was how the removal of “basic foods” from the GST would be paid for. In the end, only one quarter of this ($4 billion) cost was met by reducing high-income tax cuts. The Government was unwilling to amend its very costly new 30 per cent tax rate or to close more tax shelters. The result was a game of pass the fiscal parcel in which the States were asked to absorb a loss of GST revenues, and their costs were in turn passed onto consumers of banking services through the deferred abolition of State financial taxes.[21]
ACOSS thus achieved an important goal - that taxes on the consumption of food should not increase. However, the removal of food from the GST base was not an end in itself for the welfare lobby: it was designed to protect the living standards of low-income households. With this in mind, it is worthwhile to briefly assess the revised package from this standpoint as well as its overall impact on public revenue, income inequality, and the resilience and efficiency of the overall tax base.
Distributional modelling[22] of the original and revised packages showed that the removal of basic food from the GST, together with increases in compensation payments, substantially improved the outcomes for "average" pensioners and low-income families with children, compared with the original package.
However, the revised tax package still puts at risk the living standards of people on low incomes. This is because it increases taxes on consumption by $5 billion per annum (thereby boosting inflation by an estimated 2.7 per cent in the first year[23]), and it reduces the federal budget surplus by a similar amount (thereby increasing the prospect of future expenditure cuts).
Prices will rise by significantly more than the CPI for major groups of low-income households such as age pensioners, due to their particular saving and spending patterns. [24] Even if the improved compensation package proves sufficient to compensate ‘average’ recipients of social security payments, it is inevitable that some households with non-average saving and expenditure patterns will be worse off. The low-income groups most at risk in this regard appear to be single person households - especially unemployed people, low full-time wage earners, and self employed people. This is because the compensation arrangements for these groups leave very little margin for error[25].
The revised package is regressive in overall terms. The income tax cuts are strongly regressive, delivering a 5.1 per cent boost to the disposable income of a tax-payer on $60,000, compared with 1.9 per cent for a taxpayer on $40,000 and 0.3 per cent to one on $20,000. Although the base broadening measures (such as taxing trusts as companies), compensation measures and family package are likely to be strongly progressive, their overall distributional impact will be overwhelmed by the sheer size of the income tax cuts.[26]
Broadly speaking, the end result is likely to be that high-income households and single income families (including those on low incomes) gain substantially, other middle income households gain modestly, and most other low income households more or less stand still.[27]
Another crucial objective of the welfare lobby was to strengthen the income tax base. On this score, progress in clamping down the use of trusts to shelter income was not matched by similar action in other areas such as the abuse of the concessional tax treatment of capital gains, the unfair “company car” concessions, and work related deductions by high income-earners to avoid tax. Moreover once the revised GST and income tax cuts were legislated, the Government and Labor Party negotiated a business tax reform package that took a leap in the wrong direction on capital gains.
A separate review of the business income tax system, headed by prominent business leader Mr John Ralph, was commissioned by the Government.[28] The Ralph Review paved the way for far-reaching, and broadly positive, reforms of the tax treatment of income earned by business entities (including the implementation of proposals to tax discretionary trusts as companies and curb the abuse of private company structures to avoid tax[29]). However, its proposed 50 per cent reduction in CGT rates for individual tax-payers offends fundamental equity and economic efficiency principles. Although this proposal traded off one concessional CGT tax regime[30] for another, it breached the crucial nexus between nominal tax rates on capital gains and those on ordinary income, inviting further political lobbying to widen the gap.[31] This will strengthen the hand of the tax avoidance industry, encourage speculative investment in shares and property, and deliver huge windfall gains to those on the highest incomes.
Economic reforms that increase income inequality are often justified on the grounds that they improve economic efficiency and hence the overall size of the cake. The package dramatically strengthens the consumption tax base by extending it to services. This should substantially improve the revenue efficiency of this tax base over time. However, much greater improvements in overall economic efficiency could have been achieved if the package adopted the same bold and comprehensive approach to income tax reform.[32] Equity would have also been better served. There would have been little or no “need” to erode the Federal Budget surplus. There would have been no need at all to increase taxes on consumption. This would have averted the risk to low-income households, and the economy, from a large one-off increase in inflation in the latter half of 2000.
On balance, the business-welfare dialogue and the intervention of the Senate considerably improved the final tax reform package in a number of areas:
• the family package;
• federal-state financial reform;
• the removal of basic food from the GST;
• a reduction in excessively generous income tax cuts for high income earners[33].
However, the structural flaws in the package mean that:
• income inequality will increase;
• low-income households will have to rely on the generosity of the present and future governments to sustain compensation payments so that they can sustain their living standards; and
• the Federal Budget surplus will be seriously eroded and the revenue benefits for the States will take many years to accrue.
Better and more balanced outcomes could have been achieved if greater weight had been placed on comprehensive income tax reform, taxes on consumption had not been increased, and if a more open consultative policy development process or public inquiry had been pursued from the outset.
[*] Senior Policy Officer, Australian Council of Social Service (“ACOSS”).
[1] Australia, Treasury, Tax Reform: Not a New Tax, a New Tax System, August 1998.
[2] Liberal Party of Australia, Fightback! It's your Australia : the way to rebuild and reward Australia,
Liberal and National Parties, November 1991 (“Fightback!”).
[3] See J Freebairn, "Efficiency Issues" in P Abelson (ed), The Tax Reform Debate, Allen & Unwin (1998).
[4] For a summary of the tax reform package, see C McClure, "US tax reform" in J Head (ed), Australian Tax Reform: Retrospect and Prospect, Australian Tax Research Foundation (1989). For an account of the politics of this tax reform exercise, see H Birnbaum, A Murray, Showdown at Gucci Gulch, Random House (1987).
[5] For an account of the genesis of the package, see R Krever, "Tax reform in Australia - base broadening down under" (1986) 34(2) Canadian Tax Journal.
[6] By "regressive" we mean that a tax falls more heavily on low-income households (in proportion to their incomes) than on high income households. Consumption taxes are generally regressive because low, middle and high-income households have different saving patterns. High-income households tends to save substantially while many low-income households such as retirees spend more than their current income. Taxing consumption more and income less is therefore generally regressive. See ACOSS, Making the tax package fairer, February 1999.
[7] High rates of inflation had shifted middle income earners into income tax brackets designed for people on high incomes and the top marginal rate was 60 per cent.
[8] In Australia, see N Warren, GST the long, winding road, Institute of Chartered Accountants (1997); Freebairn, note 3 supra; J Kesselman, “Evasion effects of changing the tax mix" (1993) 69(205) Economic Record. For criticism of the US approach, see American Economic Association, "Fundamental tax reform", Papers from 109th annual conference (1997) 87(2) American Economic Review; W Randoph and D Rogers, “The Implications of Tax Policy Uncertainty About Labour Supply and Savings Responses” (1995) 48(3) National Tax Journal.
[9] “Fightback!” was also rejected for other reasons. Its large income tax cuts were funded by expenditure cuts as well as the GST. This, together with the lack of serious attention to income tax reform, was the major reason for its rejection by ACOSS: J Disney, The GST in the Fightback Package, ANU (1997).
[10] It should be noted that the summit was not broadly representative. For example, the ACTU was also invited to host it, but declined.
[11] For example, families on incomes between around $20,000 and $30,000 face effective marginal tax rates of more than 80 per cent on their income, due to the interaction of income tax and Family Allowance income tests.
[12] See R Stephens, "New Zealand Tax Reform" in J Head (ed), Australian tax reform: Retrospect and Prospect, Australian Tax Research Foundation (1989).
[13] Australian Bureau of Statistics, “Effects of Taxation and Government Benefits on Australian Households”, Cat 6537 (1995).
[14] See Australian Chamber of Commerce and Industry and Australian Council of Social Service, "Joint press statement - Outcomes of National Taxation Summit", Media Release, September 1996.
[15] See Australian Council of Social Service, Agenda for Tax Reform, April 1998.
[16] This was possible for two reasons:
• the inflationary impact of tax reform would be close to zero; and
• low income households spend a relatively high proportion of their budgets on food and rent.
Although many economists argue that it is economically inefficient to exclude such a major item from the tax base, the effect of a broad food exemption on consumer behaviour is likely to be very limited since food is a necessity. The only substantial drawbacks are higher compliance costs and lower public revenues. For a discussion of the "food debate", see J Quiggin, "Equity and efficiency effects of food taxes" (unpublished); N Warren, “Food staple of life or staple of the GST”, presented at Australian Taxation Studies Program (“ATAX”) conference on The GST Law: Key Issues for Business and Administration, December 1998.
[17] This meant that business and welfare were unlikely to agree on a detailed plan since neither side could guarantee that such a package would be fully implemented by government.
[18] Significant groups within the labour movement did nevertheless attempt to develop a viable alternative approach to comprehensive tax reform. For example, see Evatt Foundation, A Fair and Adequate Tax System, May 1999.
[19] Half of this came from abolition of a savings rebate introduced by the Government a few years earlier.
[20] This was Labor's political response to the Coalition's “Fightback!” package, note 2 supra.
[21] Although the States are guaranteed that they won’t be worse off, it will take at least five years before most States actually benefit from the package in net terms. See Federal Treasurer P Costello, “The Ministerial Council for Commonwealth-State Financial relations”, Media Release, 17 March 2000.
[22] National Centre for Social and Economic Modelling, “Your hip-pocket guide to where the money goes” Weekend Australian, 19-20 June 1999.
[23] This Treasury estimate is probably on the low side, as it appears to assume that all tax savings from the abolition or reduction of existing consumption taxes will be fully passed on to consumers In New Zealand and Canada the actual inflationary impact of the introduction of a GST was significantly greater than projected by the respective governments.
[24] It should be noted, however, that age pensioners and low income families will be much better off than they would have been under the Government's original package, as they are the main beneficiaries of the food exemption.
[25] For example, the National Centre for Social and Economic Modelling estimate that the net increase in disposable income for a single wage-earner on $20,000 is just 94 cents per week or 0.3 per cent of disposable income, note 22 supra. Unfortunately, there is no reliable data on the impact on unemployed people because modelling has generally down-played or ignored important differences between their saving and spending patterns and those of similar household types on higher incomes.
[26] The tax cuts are worth $12 billion per annum, compared with $2.5 billion for the family package and $3.5 billion for the base broadening measures. Note that the temporary “Timor Levy” would have redressed this imbalance to some extent by raising tax rates for high income earners.
[27] See Australian Council of Social Service, Revised Tax Package - ACOSS Analysis, June 1999; Australian Council of Social Service, Analysis of Modelling of the Effects of the Original and Revised Tax Packages, June 1999.
[28] Australia, Review of Business Taxation, A Tax System Redesigned: More Certain, Equitable and Durable,
July 1999 (“Ralph Review”).
[29] However, at the time of writing the latter proposals have been emasculated, following lobbying by industries that make substantial use of contractors and consultants.
[30] The indexation of capital gains for inflation was abolished.
[31] This is a very abbreviated summary of a complex issue. For a detailed analysis of the likely impact of the CGT cuts, see Australian Council of Social Service, Capital Gains Tax Cuts - A Time Bomb at the Heart of our Income Tax System, November 1999.
[32] See Freebairn, note 3 supra.
[33] From a maximum of $86 per week to $62.
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