The Politics of Taxation Reform

I remember asking Lionel Bowen in the lead up to the 1980 election what the key issues would be during the campaign.  "Tax my boy, same as the last election, same as every election!"  Lionel was exaggerating somewhat but tax or tax reform usually feature prominently at election time.  And so they will at the forthcoming election.  Tax reform is a dangerous beast, the Capital Gains Tax scare certainly played a part in Fraser's survival in 1980, and the GST scare a large part in Keating's in 1993.  Will it lead to John Howard's demise in 1998?

Major tax reform is a rare thing.  Federal income tax was levied in 1916 to finance Australia's World War 1 commitment, and then became the sole responsibility of the Commonwealth in 1942 to finance Australia's World War 11 commitment. [1]  The Fraser government sought to curtail tax avoidance and the income tax base was widened in the Hawke government to include capital gains and fringe benefits taxes, and the top marginal rate of income tax was reduced.  All governments have from time to time given tax cuts which amounted to no more than reimbursement of the ravages of inflation and bracket creep, but that is not tax reform.

Why should John Howard attempt tax reform if it is such a risk?  The truth is he has to.  He was elected in 1996 without a platform, or one so thin that it was exhausted in his first year.  Governments are not rewarded for doing nothing.  So he had to create an agenda, and that agenda was always going to include tax reform, the last great intellectual task that the Liberal party undertook with Hewson and the one great reform that Labor could not tackle (outside the waterfront labour monopoly) after Keating's 1985 Option C died.

Both 1980 and 1993 were instances where an Opposition had proposed a new tax at election time, and both were subject to the most terrible vilification by the government of the day.  What happens when a government does the proposing?  In this instance the electorate are being challenged to toss out a government on the basis of tax reform, not fail to elect an Opposition.  There is a difference, so the Howard government which is otherwise not in a terminal state, has an advantage in the contest.

What needs to be fixed in the current tax system?

1. It consists of too many different, and overlapping taxes.
2. It is complex and makes compliance difficult.
3. It is unduly focussed on business inputs and income, and reduces competitiveness.
4. It applies differently to different parts of the economy, and distorts performance.
5. It is inequitable because the wealthy can minimise tax.
6. It does little to encourage savings.

What can the government do?

There are two main choices:

1. Retain the main features of the personal, corporate and indirect tax mix, as has occurred in the changes since the 1985 Tax Summit, or
2. Replace personal and corporate income taxes with a consumption tax.

Why has option 2 not been chosen?

Commonwealth governments have been trying to eliminate the 6 problems since the McMahon government established the Asprey Taxation Review Committee. [2]  John Howard as Treasurer in 1980 wanted to change the tax mix away from income and towards a consumption tax, Paul Keating wanted a 12.5% consumption tax on all goods and services, and major personal income tax cuts.  Is it just Treasurers who want reform, not Prime Ministers?  Treasurers deal with economic truth, Prime Ministers with political truth.

For example, if the government wanted to undertake a simple tax swap, the Wholesale Sales Tax for a GST, where at present only a small number of wholesalers have to file tax returns, in the future all retailers would have to do so.  A WST can only fall on goods (you cannot wholesale a service) so a whole new sector of the economy has to become involved.  If the government wanted to go further and change the mix of taxes, say raise more in indirect taxes but less in direct taxes (income and company) it then has to try to leave everyone at the same relative after-tax income.  Then everyone becomes edgy, and everyone becomes an expert on their own position.

The best way through this is to be conservative and opt for the indirect tax replacement of corporate taxes so as to keep the debate confined, as far as possible, to industry groups.  The only tax mix change would be at the fringes.  For example, where there cannot be a clean replacement of the revenue forgone with the abolition of the old tax, and where any compensation is due to any group because of a differential impact on incomes.

But just to make sure everyone is happy you must offer a very large apparent tax cut.  Apparent because the money will have to come (in the absence of swingeing cuts to outlays) from taxes.  This must be done not by raising new or existing taxes further, which like the 1993 Budget would be too crude, but by taking them from future Budget surpluses.  Of course, those surpluses need not be available in the first place at least not for the purposes of providing a cut to the marginal rate of tax, or lifting the income level at which they bite.  Nevertheless, that is the strategy for cleaning up the indirect tax system.  Income tax relief, which may or may not be economically warranted is politically essential.

The trouble with tax reform is the economy doesn't vote.  What could otherwise be a search for the most efficient form of tax becomes a game of buying the compliance of those who will be directly involved in the change, and buying the compliance of those who will only be involved incidentally but need reassurance just the same.

What will opponents argue?  That the new tax will rise in the future.  But why is that different to any other tax, and besides a government running a surplus at a lower level of total tax take has some basis for being believed that the rate will remain steady.  That it will force more transactions into the black economy.  There is a lot of cash-in-hand income now that avoids tax, but if there is to be no greater reliance on indirect tax for raising revenue then it is a criticism misplaced.  If there is to be some greater reliance placed on indirect taxes it is at least arguable that the cash-in-hand person (usually small business, pensioners and the lower paid) will be forced to pay some of what by law they should.  As long as there are measures to ensure that the wealthy can no longer escape their obligations then equity is preserved.  Services will be taxed.  Why should they not pay, and what about the relief to export manufacturers that the new system brings?  That the new tax mix will be regressive, and cannot adequately be compensated for?  Well, if I had the brief for the poor I would embrace the change conditional on more than adequate compensation, and have a win!

Modest tax reform is one step in major tax reform.  The Labor government took the first steps, the Coalition has to take the next.  I recall when interest rates hit 18% in 1990-91.  Facing enormous political pressure the Prime Minister Bob Hawke let it be known that he was considering easing rates.  The moment he made his announcement the nervous-nellies on the backbench started ringing around seeking to meet and demonstrate against the Treasurer and his interest rate regime.  The Treasurer Paul Keating told them to hold the line.  The government did, and it survived.  If Keating had shown weakness the government would have been doomed because the electorate would have asked, and quite rightly, "why did we have to go through all this in the first place?"  The electorate do not like change but they will accept it if they are convinced that it is essential and enduring.

1. John Harrison, Total Tax Review:  Major Reform Issues.  Current Issues Brief 1996-97.  Department of Parliamentary Library, Parliament House, Canberra.
2. John Harrison, The GST Debate:  A Chronology.  Background Paper 1 1997-98.  Department of Parliamentary Library, Parliament House, Canberra.