Howard has put Taxation reform back at the top of the political agenda. Some say courageously but, whether he regrets putting it there or not, he cannot now take it off without being identified as a wimp not worth electing. We will, therefore, have the Coalition's tax plans to accept or reject at the coming poll and in the probably short meantime we have an opportunity to influence the package. The ideal tax system, even if tax experts could agree, would be beyond political achievement; it is, nevertheless, nice to know when one is heading in more or less the right direction.
Total tax receipts reached 31.8% of GDP in 1997 -- the highest level ever and some 4.6% of GDP above that of the early 1980s. How the three arms of government tax the nearly $200 billion that they raise annually is less important than the fact that they do raise it. Reform of the method of collection is not a first league issue but neither is it trivial and it is currently one that can be influenced. Our tax system's shortcomings can be grouped under four heads -- economic inefficiency, unfairness, compliance costs and its tendency to negate the federal division of political power.
An activity taxed is an activity reduced -- tax savings and people save less, tax employment and entrepreneurs substitute machines for people, tax tobacco and some give up smoking, tax the realisation of capital gains and people sit on their assets, and so on. These are only first round effects. More unemployed people require higher taxes, taxed smokers spend less on food or leisure, employers pass some pay-roll tax costs on in higher prices and so on but we don't need an economic model to know that when people are caused to adopt their second or third preferences they are worse off.
The so called "sin taxes" levied on tobacco, alcohol and gambling might be a exception. Although I believe their attitude is mite high handed, many people see these imposts as saving ignorant folk from themselves. Even though, tobacco taxation is by far the most regressive tax and is therefore by one popular criterion the most unfair, these are off the current agenda. Mr Costello says we are against sin!
Only a poll tax does not discriminate between activities or between paid activity and leisure. It, however, would attempt to gather far too much from poor people and is not on anybody's agenda. We should, however, attempt to tax at least close substitutes at the same rate. At least wholesale sales tax, pay-roll taxes, stamp duties, and the financial taxes (FID and BAD) and most petrol taxes should be abolished in favour of some form of tax that does not discriminate. A GST or similar tax at 14% would do this.
Are income and leisure close substitutes? For some people: yes. Moreover, the income tax has other serious problems caused by its high marginal rates and a tax base that defies precise definition even in volumes of law that, when bound, are 12 inches thick so far and getting thicker. Effort devoted to avoiding income tax is, therefore, likely to be well rewarded. It is so well rewarded for those with high enough incomes to justify accountants, lawyers, residences in the Bahamas or wherever, the Australian income tax is well on the way to being discretionary for them. Since not everybody has the same capacity or inclination to avoid it, income tax is damned unfair.
Naturally (or is it unnaturally?) foot-thick legislation is associated with huge compliance and enforcement costs. Further, as we should expect, the high marginal rates and the manifest opportunities for avoidance encourage even more economic distortions than do most taxes. One of the more serious of these is encouragement to invest in untaxed housing rather than assets that produce taxed rewards. It has been estimated that to raise an extra dollar of income tax costs between $1.23 and $1.65. This seems unbelievably inefficient, but it is about right in my own case.
Income taxation hits savings both prior to investment and upon the investment's earnings. This is not smart in a country that has a big and growing savings and balance of payments problem. Mark Latham, the Opposition Education spokesman, proposed to avoid this with an expenditure tax. Although theoretically attractive, no country has one and the implementation problems are daunting. Income tax also taxes the effect of inflation upon the value of bank deposits sometimes causing the least sophisticate investors to suffer negative post-tax real returns.
It is an election year and the domestic economy is still strong, therefore, Howard will almost certainly use some of his budget surplus to reduce income tax. Because a biggish budget surplus would be appropriate at this stage of the economic cycle, we would be better served by a 20% GST -- enough to subsume the above indirect taxes, affect a tax switch and compensate the least wealthy losers. However, that would require a braver government than we have.
Finally there are the problem visited upon our federation in which the central government raises over half the States' revenues. The reason that federations are favoured is that they allow diversity which in turn allows choice and by comparison identifies waste, inefficiency and all forms of bad government. Of course, not everyone wants these things identified. Nevertheless, genuine autonomy and responsibility should be returned to the States by replacing most States-grants with what some have called a "piggy back" income tax. That is, one in which the Commonwealth sets the tax base and does the collecting but the States compete with each other to offer the best combination of tax rates and services. Prime Minister Fraser proposed such a measure only to back off when Premier Wran fibbed about "double taxation".
Thus, much good could come from tax-reform. Howard's central political difficulty is that he will be replacing relatively invisible taxes with a new tax. For that he deserves our sympathy but not our willingness to settle for reforms that are too modest.
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