A tax-free election

The task for the tax system is ensure that the portion of today’s income that is saved finds its way to the most productive investments

Julia Gillard will “move forward”. Tony Abbott will take “direct action”. When it comes to taxation, however, neither Labor nor the Coalition so far has put forward an election policy promising action of any kind to move the system from where it is.

And that is not a good place. Australia heavily taxes income from business, that is, from effort; and while taxing lightly spending on consumption, that is, the fruits of past effort. This is the reverse of what other rich Organisation for Economic Co-ordination and Development do, on average, and the reverse of what federal, state and local governments should be doing.

Unfortunately it reflects the general complacency of the major parties about the economy. Too often today’s politicians seem more fired up about which side of politics can claim credit for the achievements of yesterday’s politicians than about which policies will increase prosperity.

Politicians seem to be under the illusion that the liberalisation of financial, product and labour markets of the 1980s and 1990s set up the economy indefinitely.

But Bob Hawke, Paul Keating and John Howard did not discover the plans for a perpetual-motion economic machine. Instead, like any machine, the economy needs ongoing policy maintenance to address the unintended consequences of previous interventions, in response to the policies of other governments, and in recognition of broader economic, social and geopolitical trends.

Addressing the unintended consequences of previous changes to the tax system alone would give a government more than enough to do in one or even two terms in office. And it is not like Gillard and Abbott do not have plenty of well thought-out suggestions to pick from. Ken Henry, in his review of the taxation system, offers no fewer than 138 recommendations, to “ensure that the tax system supports investment, allocates resources to their most valued uses and does not inadvertently add to the cost of production through taxes on business inputs or excessive complexity and compliance costs”.

Treasurer Wayne Swan had already ruled out about 30 of Henry’s recommendations and chosen to pursue only a handful. Abbott, for his part, opposes even a watered-down version of the only substantive change Swan did pursue - the mining profits tax - and has put no new ideas of his own.

For now, Chinese demand for coal and iron ore is boosting national income and flattering the performance of the budget and non-resource sectors of the economy. This, together with the government’s inept handling of the mining tax, has weakened the resolve of politicians for tax reform at precisely the moment when it is most urgent.

The rapid industrialisation of China has decades to run but this doesn’t mean the process will run smoothly or that it can’t be derailed. In other words, the task for the tax system is ensure that the portion of today’s income that is saved finds its way to the most productive investments.

Instead, the federal government is heavily reliant on personal and company taxes - precisely those which, according to the Henry, do most damage to distort investment decisions. State governments, for their, part are too reliant on inefficient payroll taxes and stamp duties.

Worse, the federal government levies what should be an efficient tax - the GST - in a way that maximises the compliance burden for small businesses. The Henry review notes there are much better ways to tax consumption than the GST, including a cash-flow tax.

A CFT could tax the difference between an entity’s cash outflows (purchases) and cash inflows (sales). Relative to the GST, the compliance burden on small-business operators could fall dramatically, Henry explains: “By avoiding complex exemptions and special rules, a CFT could be radically simpler than existing consumption taxes, while also improving the efficiency of the tax system.

“Indeed, in a similar way to individuals being able to have personal income tax returns pre-filled and sent to them as a default a single-rate, broad-based CFT provides the opportunity for many businesses to significantly reduce their compliance costs,” the review says.

“With the CFT, companies or sole traders with very simple tax affairs might use a bank account to have their CFT liability calculated automatically.”

This is just one of many ways in which the tax system could support effort instead of indulgence. Sadly, Gillard and Abbott seem set on buying votes with the fruits of past efforts.

BRW

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