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Tax opportunities for state governments
Dr Paul Kenny
FLINDERS UNIVERSITY
Introduction
The potential tax opportunities for Australian state governments to broaden their tax bases can be illustrated by comparing the revenue raised by the current tax system with that of a sensible tax system (the tax gap). A number of tax enquiries have set out the general outline of a sensible tax structure. For examples, see the Asprey Report1and the Draft White Paper,2and more recently, the UK’s Mirrlees Review3 and Australia’s Henry Review.4Such a sensible tax system allows the government to raise revenue and redistribute in the most efficient, fair and simple way.
Under a sensible tax system it is necessary to spread the revenue base over a number of taxes, because the higher the tax rate on a particular tax, the higher the incentive to get around the tax rules. Also, there are limited ways you can redistribute if there is only one tax (eg, only a GST), so income and wealth taxes are needed. However, having 125 different Australian Government taxes produces excessive complexity and costs to the community. It is apparent from the above reviews that a sensible tax structure consists of far fewer and broader taxes that need to work in harmony together (as well as integrate with the social security benefit). A sensible tax structure should be generally aligned with comprehensive tax bases and the following package of seven taxes.
A sensible tax system
Broad progressive income tax
There is a plethora of complex tax concessions in the current progressive income tax system that allows exces-sive tax minimisation and tax avoidance, and appears to encourage tax evasion. This is unfair and favours certain types of economic activity over others. Such conces-sions also undermine fiscal adequacy. As Richard Edmonds J noted, the trade-off for Australia’s high tax-free thresh-old and the steep increase in rates after the tax-free threshold is that Australia’s effective marginal tax rates are comparatively high vis-à-vis other countries with similar tax systems.5The judge considers that the calls for broadening the base of the GST without broadening the base of the income tax and reduction of its high marginal tax rates “is not only politically flawed and
unlikely to succeed, but is inconsistent with the gener-ally accepted criteria or design principles which should drive the structure of the tax system”.6
A broad-based income tax is preferred. Such a tax system treats similar economic activities in similar ways for tax purposes, it is simpler and helps to minimise economic distortions. All expenses incurred in produc-ing the income would be deductible. Taxable income from all sources would be taxed according to the same tax rate structure.
A fair tax system should also feature a progressive tax rate structure.7Progressivity carries out a vital redistri-bution role but also involves a loss of efficiency, as the behaviour of both poor and rich is affected. It is important to design a progressive tax rate structure to minimise the loss of efficiency.
A single rate of company income tax should also be employed. There should be equal treatment of income derived from employment and self-employment and from operating a small company. However, there is an international shift away from dividend imputation,8with Australia and New Zealand being the only two Organisa-tion for Economic Co-operaOrganisa-tion and Development (OECD) economies using imputation. As the Australian economy has become more open, the benefits of dividend impu-tation have declined. Consequently, alternatives to divi-dend imputation should be considered.
There are only a few exceptions from a broad income tax base.9Since people tend not to save adequately for their retirement, and with an ageing population, it is important to offer limited encouragement for individuals to provide for their retirement so as to prevent reliance on expensive government age pensions.10
A broad single rate GST
The current GST system provides: • concessional GST-free rates;
• input taxes supplies and exempts large amounts of consumption;
• promotes complexity;
• distorts consumption decisions; and
• unfairly impacts on consumers with different pat-terns of consumption.
Exemptions prevent businesses from claiming GST paid on their inputs; this distorts production decisions. As the Henry Review notes:
… the GST is an efficient tax relative to most other taxes levied in Australia, it is less efficient than it could be because of its failure to tax consumption on a truly comprehensive basis[.]11
A GST should be applied to all final consumption expenditure by households. Expenditure on business inputs, though, should be untaxed, with businesses able to be refunded GST charged on their inputs. This involves a single GST rate with minimal exemptions (a GST on financial services is unpractical). However, an economically equivalent tax to the GST should be applied to financial services.12
Removing the exemptions on basic necessities of life would greatly increase tax revenue but be very regres-sive on low income earners. This impact though must be offset by a combination of income tax cuts and perma-nent increases in means-tested social security benefits that are indexed for inflation to ensure a revenue-neutral outcome.
Additional taxes on illegal drugs, tobacco,
carbon and gambling
Additional taxes are economically justifiable on cer-tain harmful activities such as:
• illegal drugs;
• tobacco and junk food consumption; • gambling; and
• activities that damage the environment.
Gambling taxes should recoup the economic rent generated by government restrictions on the supply of gambling services or be used efficiently to impose such restrictions.13 The regressive impact of environmental taxes on power costs must be recognised through adjust-ments to the means-tested social security benefits that are adjusted for inflation and income tax rates.
Land tax
There are great efficiency benefits of a broad land tax, and thus, such a tax should replace all existing stamp duties and other transactional taxes on land and build-ings.14To aid equity, an increasing marginal rate sched-ule should be applied according to the per-square-metre value. The Henry Review found:
Stamp duties on conveyances are inconsistent with the needs of a modern tax system. While a significant source of State tax revenue, they are volatile and highly inefficient and should be replaced with a more efficient means of raising revenue.
Conveyance stamp duty is highly inefficient and inequi-table. It discourages transactions of commercial and resi-dential property and, through this, its allocation to its most
valuable use. Conveyance stamp duty can also discourage people from changing their place of residence as their personal circumstances change or discourage people from making lifestyle changes that involve a change in resi-dence. It is also inequitable, as people who need to move more frequently bear more tax, irrespective of their income or wealth.15
Transfer of wealth tax
Taxing the transfer of wealth from one generation to the next has the potential to lessen the inequality of life chances between children, due to the accident of their birth. Efficiency and equity are enhanced through a tax on such transfers.16 All assets transferred on death or during the donor’s lifetime should be subject to tax.
Uniform resource rent tax
The resource taxes on royalties distort investment and production decisions, and this reduces the community’s return from its abundant resources.17Additionally, they do not collect an adequate return for the community, because they are unresponsive to changes in profits. Such taxes collected a declining share of the return to resources over the recent period of increasing profitabil-ity in the resource sector.
The Henry Review recommended a uniform resource rent tax that should be applied on taxable profit associ-ated with a resource project equal to net income less an allowance for undeducted expenses or unused losses.18 The allowance rate would be set by the long-term government bond rate, as the government would share in the risks of projects by providing a loss refund if the tax value of expenditure is otherwise unable to be used.19
Road congestion tax
The heavily congested parts of the road network impose high costs on the community.20As the Henry Review recommended, transparent congestion charges should apply to all registered vehicles using congested roads.21 The regressive impact of such taxes must be recognised through adjustments to the means-tested social security benefits that are adjusted for inflation and income tax rates.
Setting tax rates
The current income tax rate structure on salary and wage earners reduces employment and earnings more than necessary. A broader tax base can deliver appropri-ate tax rappropri-ates for the above taxes and the degrees of income tax, wealth tax and land tax progressivity.
Quantifying the tax gap
The tax gap can be estimated by comparing the taxes raised by all Australian governments with the tax pro-duced by a sensible tax system. In the absence of any known estimates of this tax gap, the following two-part estimate is made for 2014–15.
Commonwealth’s annual tax expenditures
The Commonwealth estimated the annual tax expen-ditures for 2014–15 for a limited range of tax conces-sions as follows:22
Commonwealth tax expenditures 2014–15 $ billion
Taxing all capital gains of residents 61 Concession of non-superannuation termination benefits
2 Capping the superannuation concession to $5 billion
25 Research and development tax offset 1
Capital works deductions 1
Family tax benefit exemptions 23
Child care assistance 1.4
Interest withholding tax exemption 1.7
Broaden GST to include: 21.4
• food; • education; • health;
• financial supplies; • child care; and • water.
Total 116.8
As set out above the Commonwealth finds that this broader definition of income tax and GST could raise an additional $117 billion.
Additional revenue from a broader sensible tax
system
A sensible tax system, however, would further extend the tax base to include other free riders as follows:
Additional revenue from a broader sensible tax system 2014-15
$ billion
Income and wealth taxes
Estimated capital gains tax on realisations on a total of $3 billion of foreign investments in Australia23
14
Capping negative gearing at $10,00024 1.5 Broader company tax on multinationals25 6 Wealth tax at 2.5% of tax base26 11
Tax on externalities
GST of 30% on sugary drinks and fast food27 4 Carbon tax set at former 2014 tax rate of $24.15 per tonne of carbon28
12
Road transport congestion tax 2
Doubling gambling taxes29 7.6
100% GST on illegal drugs30 17
Additional revenue from a broader sensible tax system 2014-15
$ billion
Taxes on use of community resources
Alberta, Canada style royalty scheme on oil and gas31
11 Resource super profits tax on minerals32 9
Bank liability taxes33 2
Total 97.1
Conclusion
Including the governments’ stated tax expenditures of $117 billion, it is estimated that taxing free riders in 2014–15 provides a potential state government revenue opportunity of an estimated $214 billion in 2014–15, or about 50% of the total revenue raised by all Australian state and territory governments. While the states are subject to the constraint in s 90 of the Commonwealth of Australia Constitution Act 1900 (prohibiting states from imposing duties of customs and excise) and s 109 (Commonwealth law prevails over an inconsistent state law), the states nevertheless have a significant concur-rent ability to tax (along with the Commonwealth) under the Constitution. The Commonwealth’s dithering on addressing the tax gap offers the prospect for states to adopt a leadership position in Australian taxation as well as better meet their community needs. The recent move by the South Australian Government to introduce a tax on banks to take advantage of the tax gap in bank liability taxes indicates that states are looking at these tax opportunities.
Dr Paul Kenny Associate Professor
Taxation Law, Flinders Business School Flinders University
paul.kenny@flinders.com.au www.flinders.com.au
Footnotes
1. K W Asprey and R W ParsonsTaxation Review Committee: Full Report(31 January 1975) http://adc.library.usyd.edu.au/ data-2/p00087.pdf.
2. The TreasuryReform of the Australian Taxation System: Draft White PaperAustralian Government Publishing Service, Aus-tralia 1985.
3. J Mirrlees, S Adam, T Besley, R Blundell, S Bond, R Chote, M Gammie, P Johnson, G Myles and J Poterba Mirrlees Review: Tax by DesignOxford University Press, Oxford 2011 www.ifs.org.uk/publications/5353. The Institute for Fiscal Stud-ies’s (which financed the Mirrlees Review) goal is to promote effective economic and social policies by understanding better their impact on individuals, families, businesses and the
government’s finances. Our findings are based on rigorous analysis, detailed empirical evidence and in-depth institutional knowledge. It is Britain’s leading independent microeconomic research institute and an authoritative commentator on the public finances, tax and welfare policy, tax law, education, inequality and poverty, pensions, productivity and innovation, consumer behaviour and the evaluation of policies designed to promote development in poorer countries. See p 478, Table 20.1.
4. Commonwealth of Australia Australia’s Future Tax System: Final Report(December 2009) https://taxreview.treasury.gov.au/ content/FinalReport.aspx?doc=html/publications/papers/ Final_Report_Part_1/index.htm.
5. R Edmonds JStructural Tax Reform: What Should be Brought to the Table? (20 January 2015) https://cdn.tspace.gov.au/ uploads/sites/52/2015/06/Federal-Court-of-Australia-Submission-2.pdf.
6. Above n 5, p 397. 7. Above n 4, p 21.
8. Dividend imputation provides a tax offset called a “franking credit” to company members who receive dividends. 9. Notably, the Henry Review and Mirrlees Review were
influ-enced by optimal tax theory, and both sought income tax concessions for savings and investment in addition to super-annuation concessions. However, insufficient economic or other evidence was provided to warrant such departures from a comprehensive income tax base. The theory does not accord to the real world.
10. Above n 4, Ch 4. 11. Above n 4, Ch 7. 12. Above n 3, p 486.
13. Above n 4, Recommendation 76:
Gambling taxes should be reviewed to ensure that they are focused on recouping economic rent generated by govern-ment restrictions on the supply of gambling services or are being used efficiently to impose such restrictions. 14. Above n 4, Ch 6 and Recommendation 52:
Given the efficiency benefits of a broad land tax, it should be levied on as broad a base as possible. In order to tax more valuable land at higher rates, consideration should be given to levying land tax using an increasing marginal rate schedule, with the lowest rate being zero, with thresholds determined by the per-square-metre value.
Recommendation 53:
In the long run, the land tax base should be broadened to eventually include all land. If this occurs, low-value land such as most agricultural land would not face a land tax liability where its value per square metre is below the lowest rate threshold.
15. Above n 4, para 6.2. 16. Above n 3, p 486.
17. Above n 4, Ch 6. 18. Above n 4, Ch 6. 19. Above n 4, Ch 6.
20. Above n 3. In respect of the UK, note in p 487:
The economic costs of not having a coherent system of motoring taxation are large. The government estimates that annual welfare benefits of up to 1% of national income are available from a road pricing scheme that varies charges by place and time of day to accurately reflect actual congestion levels and costs.
21. Above n 4, Ch 8 and Recommendation 61:
Governments should analyse the potential network-wide benefits and costs of introducing variable congestion pric-ing on existpric-ing tolled roads (or lanes), and consider extending existing technology across heavily congested parts of the road network. Beyond that, new technologies may further enable wider application of road pricing if proven cost-effective.
22. Commonwealth of AustraliaTax Expenditures Statement 2015
(January 2016) https://static.treasury.gov.au/uploads/sites/1/ 2017/06/2015_TES.pdf.
23. Australian Bureau of StatisticsInternational Investment Posi-tion, Australia: Supplementary Statistics(2016) www.abs.gov.au/ ausstats/abs@.nsf/mf/5352.0.
24. J Mather “Here’s what happens if negative gearing is capped” (27 April 2017) www.afr.com/news/policy/tax/heres-what-happens-if-negative-gearing-is-capped-20170425-gvsg1w. 25. Oxfam Australia “Tax promises offer progress on big
compa-nies avoiding their fair share” (3 May 2017) www.oxfam.org.au/ media/2017/05/tax-promises-offer-progress-on-big-companies-avoiding-their-fair-share.
26. N Chatalova and C Evans “Too rich to rein in? The under-utilised wealth tax base”eJournal of Tax Research434, notes countries have raised up to 2.5% of tax revenue by wealth taxation www.austlii.edu.au/au/journals/eJlTaxR/2013/ 21.html.
27. Extra GST based on the estimated fast food industry revenue of $19.3 billion: Ibis World Fast Food Services in Australia: Market Research Report(February 2017) www.ibisworld.com.au/ industry-trends/market-research-reports/accommodation-food-services/fast-food-services.html.
28. Australian Greenhouse Emissions Information System http:// ageis.climatechange.gov.au.
29. Queensland Government Statistician’s OfficeAustralian Gam-bling Statistics: 1989–90 to 2014–15(32nd edn) (August 2016) www.qgso.qld.gov.au/products/reports/aus-gambling-stats/aus-gambling-stats-32nd-edn.pdf.
30. J JiggensEstimating the Size and Value of Australia’s Market for Illegal Drugs and its Potential for Taxation under a Regulated Market(14 June 2013) p 4 www.ffdlr.org.au/forums/ docs/howmanyconesb+w-3.pdf. Estimates the value of illegal drugs at $17 billion per annum.
31. R Lanis, B Govendir and R McClure “Chevron is just the start: modelling shows how many billions in revenue the government is missing out on” (26 April 2017) https://theconversation.com/ chevron-is-just-the-start-modelling-shows-how-many-billions-in-revenue-the-government-is-missing-out-on-76525. Estimates over the period from 2010 to 2015, the additional revenue would have been A$11.3 billion per year from an Alberta, Canada style royalty scheme on oil and gas.
32. Commonwealth of AustraliaBudget Measures Budget Paper No 2: 2010–11(11 May 2010) p 45 www.budget.gov.au/2010-11/content/bp2/download/bp2_v2.pdf.
33. Commonwealth of AustraliaBudget Measures Budget Paper No 2: 2017–18 (9 May 2017) http://budget.gov.au/2017-18 /content/bp2/download/bp2.pdf.
