Tax Reforms Have Drawbacks

Two major proposals for tax reform are soon to be put on the table:  the Government's and the BCA lead business/welfare consortium's.

Enough has been said to get good idea about basic structure of these options though, the BCA group appears now to be having second thoughts.

Both options included a GST with a rate of around 10%.  They differ mainly in their use of GST revenue and approach to reform of income tax.

Under the Government option revenue from the GST will be used to replace wholesale sales taxes and reduce marginal tax rates for middle income earners.  State taxes will be left untouched.

The political logic of this approach is clear.  It proposes a tried and tested model -- the one that worked in Canada and New Zealand.  It keeps things as simple and tangible as possible.  It ensures that the median voter comes-out ahead and in a unambiguous manner.  And it ensures that Commonwealth gets full credit for all the goodies -- the tax cut.

The problem with the Costello option are two fold.

First it will likely result in higher expenditure and ultimately higher taxes.  The proposal entails a shift in the tax system from income tax to a GST.  This will result in a less progressive overall tax system with the lowest income groups being worse off.  The government, therefore, will come under immense pressure to provide a compensation package which, if made, will necessitate a higher expenditure and overall tax take.

Second, it would leave in place state taxes which together collect more and impose far more damage than the wholesales sales tax.  In other words it would leave the job half done.

The option being put together by BCA lead group appears to overcomes the problems of the Government's option, but it has a major problem of its own.

Under the BCA option, the proceeds from a GST would be used solely to reform the indirect tax system including the elimination of wholesales sales, payroll tax, financial taxes and stamp duties.  This should require no compensation package, as the GST would be no more regressive than the indirect taxes it replaces.  Moreover it will thoroughly reform the indirect tax system.

The weakness of the consortium's option -- and the thing that is making its members waver -- is its approach to reform of income tax.

It proposes that cuts in income tax rates be financed solely from within the income tax system via the elimination of deductions and loopholes.

The trouble is that there are very few large loopholes in the Australian income tax system.  The system has been continuously scrutinised by revenue hunger tax collectors over the last ten years leaving.  Most deduction and tax structures has a strong rationale.

Moreover most so-called loopholes benefit small-to-medium business -- which make up the bulk of the consortium's membership.  In effect therefore this option is based on its proponents agreeing to higher effective income tax rates.  This is causing the concern in the consortium's ranks.

The sticking point in tax debate to date then is no GST but income tax.  The real task is for the BCA lead group to come up with a saleable income tax reform package, that will work not increase the complexity of the system and require some self inflicted pain.

Otherwise simpler, more modest and inferior Costello option will rule the day.

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