Date posted: 3/08/2020 10 min read

Time for another go at tax reform in Australia

As the COVID-19 pandemic threatens to push Australia’s net debt to A$677 billion by 2021, is tax reform an ambition too far?

In Brief

  • If there is one thing all tax experts agree on, it is that Australia’s tax system needs reform.
  • Treasurer Josh Frydenberg has indicated he won’t touch the 10% GST rate but has encouraged states to carry out tax reform without federal help.
  • Recent significant tax reforms have occurred in the years after – not in the midst of – fiscal downturns.

By Katie Walsh

Ask tax experts about reform and there is a good chance they will reach for the wisdom of 17th-century French finance minister Jean-Baptiste Colbert: “the art of taxation”, the famed saying goes, “consists in so plucking the goose as to procure the largest quantity of feathers with the least possible amount of hissing”.

If there is one thing all tax experts agree on, it is that Australia’s system generates an awful lot of hissing for an increasingly inadequate haul of feathers. Understanding this, and watching as so little changes, is their great lament.

Now, they seek hope in an unsavoury place: the COVID-19 global pandemic which threatens to push net debt to A$677 billion by 2021. And they’re looking to federal Treasurer Josh Frydenberg to lead the way, even if the man himself appears cautious.

“As the prime minister has indicated, we are not about to announce a shopping list of reforms,” Frydenberg says.

“We are in the ‘harvesting phase’, during which we will look at new and old reform proposals with fresh eyes.

“In sifting through reform options, our focus will be on practical solutions to the most significant challenges that will be front and centre in the post-crisis world, including tax and industrial relations reform as a means of increasing our competitiveness.”

The difficulty he faces is Australia’s proverbial goose makes a lot of noise at the mere whiff of change, even if it might loosen the tax system’s chokehold on productivity.

Lobby groups are already circling. Frydenberg has indicated he has no interest in touching the nation’s 10% goods and services tax and has encouraged states to carry their ambitious agendas for tax reform without federal help.

Treasurer Josh FrydenbergPicture: Treasurer Josh Frydenberg. Image credit: Nic Walker.

But even before the pandemic hit our sea-girt home, former Treasury secretary Ken Henry had a warning.

“People are going to lose out big time if we don’t have tax reform. Really big time,” Henry said in December last year. “Everybody’s going to lose.”

An Australian flag hangs beside Frydenberg as he checks his phone. On the wall is a near life-sized portrait of the late Sir Zelman Cowen, a former governor-general and Frydenberg’s mentor.

Sir Zelman, a devoted Melburnian like Frydenberg, was described in an obituary by former High Court judge Michael Kirby as the “tallest of poppies”; a “scholar of sparkling brilliance” who “lived in the real world, engaged with its problems”.

Today, Frydenberg is similarly engaged with problems of a magnitude that few, if any, could have foreseen when the former lawyer and banker was sworn in as treasurer in August 2018.

Far from the anticipated return to budget surplus that Frydenberg’s Liberal Party had trumpeted in April 2019 (remember the Back in Black mugs?), the Treasury estimates COVID-19 could wipe A$63.9 billion off tax receipts in 2020-21. It's already sliced A$33 billion off tax receipts in 2019-20.

Nobody wants this. Yet it could provide political cover for critical tax reform.

Treasurer Josh FrydenbergPicture: Treasurer Josh Frydenberg. Image credit: Nic Walker.

Mind the timeline

“People are cognisant it’s a very significant event, [and that] we’re going to need substantial change to the economy,” says Melbourne-based PwC partner Paul Abbey CA, who led the firm’s tax reform project.

But landing tax reform while supply and demand are both low is hard. The unemployment rate in Australia rose to an almost 20-year high of 7.1% in May and 835,000 jobs have been lost since March.

In his 23 July update, Frydenberg shared Treasury predictions that the unemployment rate will peak at 9.25% in December – almost one in 10 workers.

The most significant tax reforms of recent decades have occurred in the years after – not in the midst of – fiscal downturns. The Hawke-Keating tax reforms came in 1985-87, when the economy had shifted into recovery mode after the early 1980s recession. The Howard-Costello 1998 GST policy launch took impetus after the early 1990s recession “we had to have”.

“If you have the same parallel in two to three years, people won’t forget,” says Abbey. “Well-structured tax reform can continue to instigate growth and development when you’re trying to rebuild and strengthen the economy.”

The Ken Henry playbook

Tax experts insist now is the time to start laying the groundwork for structural change. And the truth, says Abbey, is that we know what we need to do. The Henry Tax Review, penned by the previously mentioned Ken Henry, shows the way.

When its final report was released in May 2010, the 1000-plus page Henry Tax Review – officially Australia’s Future Tax System Review – was heralded by some as the greatest tome on tax the nation had seen.

Among its 138 recommendations was a shift away from productivity-hindering and inefficient state imposts on transactions, insurance and staffing. To encourage savings, Henry flagged a 40% discount on passive income, bringing down the capital gains discount rate to match.

Simplification measures included ditching personal tax rebates, standardising work-related deductions and quarantining property investment losses.

Barred from even considering changes to the GST, Henry found a way around it: an even simpler, broad-based cash-flow tax.

A decade on, Henry has been vocal in his disappointment over the low uptake of his recommendations. The one key measure adopted on the review’s release – a resources super profits tax – was neutered by the mining industry and eventually killed off by the Abbott government in 2014.

But there have been some changes. Company tax will fall to 25% in the 2021-22 financial year for small to medium companies. Personal income tax changes will pull back on bracket creep and slot taxpayers into three categories by 2024-25; the highest individual rate will be 45% for earnings above A$200,000 per annum.

Government revenue has made some gains through efforts to tax multinational companies, including via strengthened transfer pricing rules, and an anti-avoidance law is predicted to bring in an extra A$7billion in taxable sales and a consequent boost to tax revenue.

Still, Henry has called the tax system “unambiguously worse” in terms of revenue sustainability.

Consumption patterns mean the GST is not the growth tax intended. While Australians have grown their consumption, it’s in areas such as fresh food, education and health – none of which attract GST.

former Treasury secretary Ken HenryPicture: former Treasury secretary Ken Henry.

Reforms can take decades

Some find hope in comparisons with the nation’s previous comprehensive tax review: released in 1975 and led by another Kenneth – Kenneth Asprey, a highly respected judge with tax experience.

Respected tax academic Cynthia Coleman says there were “high hopes” for Asprey, yet the Whitlam and Fraser governments passed it by.

It was the Hawke-Keating government that picked up Asprey’s key recommendations from 1985 to 1987: introducing capital gains tax and fringe benefits tax (FBT) to level the playing field, dividend imputation to encourage investment and cutting personal and business income tax rates (notwithstanding that, today, the FBT is among nuisance taxes in dire need of an overhaul).

Yet another 15 years would pass before the Howard-Costello government would implement Asprey’s broad-based consumption tax; albeit one heavily negotiated and narrowed in scope when it finally began operating in July 2000.

It’s now a decade since the Henry Review, which predicted its recommended tax measures could add 2-3% – A$25billion to A$40 billion – to Australia’s GDP over time.

But can a country combating an unprecedented health and financial crisis pause to consider ambitious productivity goals?

Fresh thinking on tax reform

Chartered Accountants Australia and New Zealand senior tax advocate Susan Franks says any change will necessarily lead to some people being worse off – and “we don’t have money in the tin” to compensate them.

“There will be a lot of noise,” she says.

Franks says today’s environment is different to that during the Henry Review. The problem today is not one of lack of access to adequate capital – particularly given record low interest rates. Rather, it is one of business confidence.

“We need a fresh debate on tax reform,” says Franks. “Environmental taxes and sustainability issues will have to be taken into account. It’s getting the tax settings to support the right business environment rather than necessarily picking an industry.”

CA ANZ’s Australia tax leader Michael Croker CA says the significant expertise within Treasury can provide guidance removed from politics. Less controversial change could include building on technology to ease the administrative burden and improve compliance including single touch payroll, real-time business software and better tax infrastructure.

BDO tax partner Mark Molesworth FCA says we need to get over some of our preconceptions, including that we can’t possibly tax capital gains on the sale of a person’s main residence (that exemption could cost A$20.5 billion by 2022-23) or roll back tax concessions on superannuation (possible revenue gains on super entity earnings were A$17.4 billion in 2019-20).

“For people like me who can afford to pay it, we’re shifting the tax system overall which will benefit me because an efficient tax system means the economy grows faster,” he says.

Ultimately, Molesworth argues a full tax redesign is warranted. “Australia always makes the mistake of starting from what we’ve got, and we’ll add or tweak. We really do need to think, if we’re starting with a blank sheet of paper, what would we do? What should we do?

“We really do need to think, if we’re starting with a blank sheet of paper, what would we do? What should we do?”
Mark Molesworth FCA, BDO

“That would be a great conversation to have, rather than interest groups saying ‘rule this out or rule this in or we’ll wedge you on this’.”

How can we boost investment

EY Oceania tax policy leader Alf Capito CA says one priority must be reducing tax on investment. It may cost revenue in the short term but ultimately it’s about “growing the pie” and attracting foreign investors.

“There’s nothing better than actually lowering the corporate tax rate,” he says.

The government’s A$259 billion stimulus measures during COVID-19 include an expansion of the instant asset write-off and investment allowance. Frydenberg says the government is “focused on economic support which is temporary and economy wide”.

Whatever changes are sought, the key will be bipartisanship, says Capito. The government will need an accord.

“They can’t reform mid-term; they have to take it to the people, and it has to be bipartisan – it has to be done as part of a broader deal with unions, welfare and business, small and big. And even then, you’re not guaranteed.”

Grant Wardell-Johnson, lead tax partner at KPMG’s Economics and Tax Centre, says he would like to see the government bring forward the planned personal income tax cuts, consider changing the childcare subsidy to reduce disincentives to work, expand employee share schemes to give more staff a productivity incentive, and apply incentives ordinarily given to capital gains to income from work.

“Traditionally, people have thought the other way –you should not tax capital and it leads to investment, but at the moment there’s excess capital and there has been for years, so I think it should be the other way.”

While some productivity-boosting measures would appear as a cost to the federal budget, Wardell-Johnson says an austerity approach would be “very, very dangerous”. “I’m in the camp where you have to make society as productive as possible and that will pay back the debt eventually.”

“I’m in the camp where you have to make society as productive as possible and that will pay back the debt eventually.”
Grant Wardell-Johnson, KPMG

Coaxing the goose

All these approaches require a degree of comfort with big budget deficits, which runs contrary to the popular surplus-seeking mantra of recent years. That’s an unprecedented weight for one treasurer to bear.

On the morning of the Frydenberg photo shoot, the nation awoke to news of the draft report of the Federal Financial Relations Review Committee, chaired by former Telstra chief David Thodey. Commissioned by NSW treasurer Dominic Perrottet last year, the esteemed panel had fast-tracked its efforts to look into the interaction of federal funding with the NSW state tax system.

NSW treasurer Dominic PerrottetPicture: NSW treasurer Dominic Perrottet.

Some of the Thodey recommendations sound familiar: governments should consult on how to increase the GST rate and/or broaden the base. The state should swap stamp duty with a broad-based land tax via an opt-in process and consider abolishing insurance taxes for a property levy. A strategic national approach to addressing payroll tax is needed. Road user charges could fix falling revenue from fuel excise.

But boldly, Thodey also suggests an opt-in model allowing a share of personal income tax for states.

Wardell-Johnson is confident the stamp duty for land tax swap can happen, but he is pessimistic about the chances of GST being used to fund a switch away from other more inefficient taxes that put a brake on productivity. Once a tax base is established it’s almost “locked in” apart from tinkering at the edges.

The Thodey report contains a stark warning. State and territory governments “confront a significant decline in their tax revenues at the same time as they inject all of their fiscal firepower into the economy to avoid serious economic collapse.

“It will involve changing the tax mix in a way that is neutral to the overall burden on the taxpayer, while extracting the best value.”

In other words, how to pluck feathers with the least amount of hissing.

Politicians must step up

Treasurer Josh FrydenbergPicture: Treasurer Josh Frydenberg. Image credit: Nic Walker.

Frydenberg says the national cabinet has tasked the Council on Federal Financial Relations “to look at issues of tax reform where the Commonwealth, state and territory governments can work together”.

“These discussions are underway,” he adds. “The government will continue to look for opportunities to drive a fairer and simpler tax system. We will continue to look for opportunities to cut taxes where it aligns with our values and principles of encouraging personal responsibility, maximising personal choice and rewarding effort.”

Ahead of retiring last year, former Greenwoods & Herbert Smith Freehills managing director Tony Frost CA shared his view on successful tax reform.

“Our political leaders need conviction, capital, courage, clarity, commitment, charm, consultation, community support and the outcome should be competitive,” he told the audience of tax accountants and lawyers.

Speaking with Acuity, Frost says the most important of those is conviction.

“What you really need is conviction – politicians who preferably want to make a difference. They’ve got political capital and they’re prepared to spend it.”

“What you really need is conviction – politicians who preferably want to make a difference: they’ve got political capital and they’re prepared to spend it.” –
Tony Frost CA

How politics puts the brake on tax reform

Former Liberal Party leader John Hewson has said it before, but it’s a point worth repeating. He should have told A Current Affair interviewer Mike Willesee to “piss off” in 1993.

Instead, Hewson’s answer to Willesee’s question about the tax on a birthday cake has become a tired anecdote on the dangers of honesty and ambition in policy platforms.

“The idea was to broaden the base as recommended by Asprey,” Hewson tells Acuity of his party’s ambitious 1993 election policy to bring in a consumption tax.

“The answer was accurate, but I should have either told him to piss off or said it’s an incredibly complicated system we’re replacing with a simple one.”

Reflecting on the GST that eventually did happen under Prime Minister John Howard, Hewson says the involvement of the states and procurement of support from stakeholders via compromises was clever but ultimately neutered the tax.

“We’ve made the GST almost as complicated,” he says.

Court cases crunch questions such as whether a crisp dry bread is a biscuit and therefore subject to GST. We now spend so much on the exempt categories of fresh food, health and education that the tax only covers half of consumption, down from two-thirds at its inception.

That’s hardly the simple, broad-based growth tax envisaged by Asprey.

Hewson sees the lighter and the darker side of it all.

“Keating said he tried for the GST for the rest of his career, except for when he had to do Hewson slowly,” he laughs. “This is the world we’re in.”

Today, Hewson insists there is a path beyond politics despite his experience, and points to the COVID challenge.

“If you’d said to people back in January, ‘you’re not going to be able to travel’, they’d say ‘go jump’. And then circumstances changed.

“You just have to explain yourself – say why you’re doing it, that there’ll be winners and losers – but you have to admit it. You have to tell the truth.”

“You just have to explain yourself – say why you’re doing it, that there’ll be winners and losers – but you have to admit it. You have to tell the truth.”
John Hewson

As for what it might involve, Hewson says people should be “marching in the street” about multinationals paying little tax. He wants corporations taxed on revenue or cash flows, not profit which can be “fudged”.

Former Labor treasurer Wayne Swan expresses similar views. He says the “race to the bottom in corporate tax rates” and “rampant multinational corporate tax avoidance” are clobbering the developed world.

Swan wants to see a discussion beyond the “standard tax reform mantra about increasing profit share”. He wants a community consensus around a progressive tax system.

“I think what a lot of the debate misses is, how you raise tax is just as important as what you raise,” he says. “We need a tax system that drives incentives for people to work hard and investors to invest.”

Swan was the treasurer in receipt of the Henry Tax Review. He calls it an important piece of work that could have triggered good discussions – “if it wasn’t for the politics and belligerence”.

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