How do we judge whether one tax is better than another? That question will lie at the heart of the tax reform agenda at the economic reform roundtable on Thursday.
Four principles have guided tax reform over the decades: efficiency, equity, simplicity and sustainability (or revenue adequacy).
All are important. But with productivity growth the name of the game, let’s focus on the first: efficiency.
Stephen Bartos, a professor of economics at the University of Canberra and a former deputy secretary at the Department of Finance, says taxes inevitably affect behaviour – but “some taxes are a lot better for the economy than others”.
When it comes to efficiency, a core concept is to design a tax system as simple as possible to not discourage productive activities such as work and investing.
Chris Murphy, an honorary senior lecturer at the Australian National University, has for decades been a central figure in modelling the impact of tax reform, including the introduction of the GST and the landmark Henry tax review.
Calculating the burden of a tax
Murphy has updated his estimates of various taxes’ “marginal excess burden” – the additional economic cost of a tax beyond the revenue raised.
His modelling suggests raising the rate of the GST imposes an additional 30c cost to the economy for every dollar raised. Broadening it, he says, comes with a marginal excess burden of 13c.
That makes the GST more efficient than personal income taxes (a 48c loss of economic welfare for every $1 of revenue raised) and company taxes (65c).
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Speaking at the National Press Club this week, Danielle Wood, the chair of the Productivity Commission, explained that “generally, anything that switches out higher cost, higher economic-drag taxes for lower cost, more efficient taxes will give you a productivity dividend”.
“Equally, anything that broadens the base of a tax, which winds back concessions but then reduces the rate, will give you an economic kicker.”
The ‘worst’ taxes
Four of the five least efficient taxes are at state and territory level. This makes it difficult to coordinate shifts away from more damaging but highly lucrative taxes.
The “worst” taxes on Murphy’s measure are the land tax on investment properties (92c of economic damage for every $1 in revenue raised), followed by stamp duties on the purchase of homes (74c) and taxes on insurance (69c).
Wood said it was “very clear” from modelling that “stamp duties stand out as kind of exceptionally economically damaging taxes”.
When experts talk about switching from inefficient stamp duties to a land tax, they are talking about a broad land tax that applies to all homeowners.
Murphy says a broad land tax is equivalent to municipal rates – which, as the analysis shows, is a very efficient tax (a 4c offset in extra economic welfare per dollar of revenue raised).
State pain for national gain
Efforts to transition to a more stable and less distortionary land tax have proved a step too far for even the most willing of state leaders.
That’s why any commonwealth-led discussion on tax reform has to include the states and territories, Bartos says.
“The only way to get the states on side is if you compensate them,” he says.
“Probably the only way to do that is to increase the GST rate or broaden its base” to include excluded items such as fresh food, education and health services.
“Broadening the GST would have the added benefit of simplifying the system.”
Luke Yeaman, the Commonwealth Bank’s chief economist and a former Treasury deputy secretary, says there is theoretically a strong case for using increased GST revenue to pay for income tax relief – a switch that has wide support among many experts.
But cash-strapped states were unlikely to want to make this deal with the commonwealth.
“If you want lower income taxes, you’d have to do some other broader deal with the states, for example, around health funding or education funding, where you agree to provide less on the health and education side, and they claim the extra GST revenue,” he says.
“I think that proves very difficult at the moment in a world where the states are cash-constrained.”
Yeaman agrees there could, however, be scope to use any increase in GST revenue to pay for states to get rid of inefficient taxes such as stamp duties.
Royalties v rents
While state-level mining royalties schemes are lucrative for governments such as Queensland, Murphy’s analysis shows they are much more inefficient than federal mining “rent” taxes, which target excess profits.
The petroleum resource rent tax, for example, has an offsetting 8c for the economy for every dollar raised. That’s in part because foreign owners of the gas companies pay the tax, Murphy says.
Bartos explains that “the problem with royalties is basically you are taxing production, and so that acts as a direct disincentive”.
“A rent tax taxes super profits over and above normal profits, and in that sense they don’t distort production at all. That makes them a much better form of tax.”
Tax income less and wealth more
Bartos’ high level verdict on Australia’s broad tax settings echoes the expert consensus: “Australia’s tax system is weighted too heavily to taxing income and not wealth.
“That encourages people to salt away wealth in unproductive things.”
Labor is already chipping away at overly generous tax concessions for Australians with more than $3m in superannuation.
But it has balked, at least so far, at suggestions for trimming tax breaks for residential property investors, which also overwhelmingly favour the rich.
“Sadly, the least likely to be on the agenda is inheritance taxes,” Bartos says.
“That doesn’t distort behaviour – people are not going to put off dying because they have to pay tax.
“And it actually is a very efficient tax to levy and Australia is really unusual to be one of the few countries to not have some form of inheritance tax. It is very much a political no-no in Australia.”
Patrick Commins is Guardian Australia’s economics editor
