Budget Review 1996-97

Contents

Introduction

Macro-economic Policy Perspectives

Statistical Overview

Public Policy Context and Outlays Overview

Charter of Budget Honesty

Taxation Issues

Superannuation

Detailed Portfolio Reviews

INTRODUCTION

John Kain

This is the first attempt by the Parliamentary Research Service to produce a detailed review of major Budget initiatives. It is designed to provide Parliamentarians with timely background, analysis and commentary which may be of assistance in their preparation for Budget debates. It has necessarily been prepared in some haste but every effort has been made to ensure its accuracy in the time available.

The main emphasis of the Review is on noteworthy changes flowing from the Budget at the program or sub-program level. It does not aim to provide a comprehensive treatment of every program-specific initiative, nor does it examine in detail the economy-wide, macroeconomic strategies and implications of the Budget.

The Review identifies, on a portfolio basis, those programs most affected from a financial perspective. It also highlights those which will be subject to significant changes in policy direction, even if the financial implications of the Budget are relatively minor.

Where there have been significant changes to program structures reflecting major policy changes since the last Budget, these are explained in the Review. Such changes may involve the creation of new programs or the elimination or merging of other programs; the Review offers some explanation of the nature and rationale for such changes. However, it is not intended that this document should provide an exhaustive guide to all revisions to program and sub-program structures which have accompanied the Budget.

For each selected program or sub-program, the Review summarises the major outlay and revenue variations proposed in the Budget. It also addresses the apparent policy rationale and implications of the Budget initiatives for each of the selected programs. However, it is not the intention of this document to make value judgements about Budget initiatives or to be prescriptive about preferred outcomes.

Thus, in addressing the policy context of Budget initiatives at the program level, the focus of this Review is on:

• the rationale for the Commonwealth's past activities in each particular program area;
• the direction in which the 1996-97 Budget will lead each program area;
• the policy strategies underlying the program directions proposed in the Budget; and
• the possible implications of the Budget proposals including downstream effects on relevant stakeholders.

Although the emphasis of the Review is on Program-level initiatives, its opening sections provide overview perspectives of the Budget strategy. It includes a macroeconomic policy assessment and a statistical review which summarises changes in broad Budget aggregates and portfolio outlays. This is followed by a more detailed precis of outlay changes and a commentary on the Budget from a broader public policy perspective. An accompanying commentary addresses the Charter of Budget Honesty, followed by two overview sections which examine aspects of the Budget which have wide ranging fiscal implications across most activities of Government and of prime concern to households and firms-specifically the Budget's taxation and superannuation policy initiatives.

MACRO-ECONOMIC POLICY PERSPECTIVES

Phil Hanratty

1. Main Aggregate Features of the Budget

This Budget implements a strategy of fiscal contraction (i.e. reduced, and eventually eliminated, budget deficits) based much more upon reductions of public spending than on increases in public revenue raised.

The main policy focus is upon the "underlying" budget deficit (which excludes loan transactions and asset sales) as a better measure of the economic impact of fiscal policy than the "headline" budget deficit. The principal goal of current fiscal policy is to eliminate the underlying Commonwealth budget deficit by 1998-99 and to maintain an underlying budget balance (equality of outlays and revenue in underlying terms), on average, over the course of the economic cycle.

This implies that future Budgets will not, on average, generate any increase to net Commonwealth debt. The level of such public debt has increased substantially in recent years but still remains low compared to most other advanced countries.

Underlying Commonwealth outlays are estimated to increase by 2.9% in nominal (current dollar) terms in 1996-97 and by just 0.1% in real (inflation adjusted) terms. Commonwealth revenue is also estimated to increase by 7.8% in nominal terms and by 4.0% in real terms in 1996-97. Underlying outlays are projected to actually fall by 0.7% in real terms in 1997-98. In comparison, in 1995-96 underlying Commonwealth outlays increased by 3.9% in real terms (and by at least 3.5% real growth in each of the previous four financial years).

The underlying budget deficit is now estimated to be about $5.6 billion, or 1.1% of GDP, in 1996-97 compared to 10.3 billion, or 2.1% of GDP, in 1995-96 and 2.9% in 1994-95. Without any fiscal policy change, the Budget Papers estimate that the underlying budget deficit for 1996-97 would be about $9.6 billion.

This "policy-induced" reduction in the budget deficit for 1996-97 from $9.6 billion to $5.6 billion can be disaggregated into reductions due to spending measures and those due to revenue measures. The Budget Papers estimate that about 75% of the deficit reduction is due to spending reductions while only about 25% is due to revenue enhancement measures. Both spending on goods and services and on transfer payments have been subject to significant reductions.

2. Main Macroeconomic Aims of the Budget

The official economic aims of the Budget are:

• to reduce the growth of public debt and public debt interest payments;
• to raise public sector saving and national saving; and thus
• to help reduce the current account deficit (CAD) and the rate of foreign debt accumulation.

Some definitions should be noted here. Public sector saving equals public revenue minus recurrent public spending (capital spending is excluded) while national saving equals the sum of public sector saving and private sector saving (which in turn equals the sum of household saving and company saving). The CAD is, by definition, equal to the level of national investment (public plus private) minus the level of national saving.

The Government's medium term fiscal goal of underlying budget balance, on average over the cycle, will thus make a small, ongoing, positive contribution (in and of itself) to higher national saving; this contrasts with recent experience where the Commonwealth Government has had negative saving (i.e. dissaving).

This turnaround comes about because Commonwealth General Government saving (in gross terms, excluding depreciation provisions for existing capital assets) will now be equal to the level of underlying Commonwealth capital spending since such spending will now be, on average, financed by tax and non-tax revenue rather than by borrowing. For example, in 1996-97 underlying gross Commonwealth General Government capital spending is estimated to be about $3.8 billion, or 0.73% of GDP. This gives an indication of the order of magnitude of the direct contribution to gross national saving which the Government's fiscal strategy implies. In net saving terms this contribution will be reduced somewhat by the subtraction of depreciation on existing Commonwealth General Government assets.

The Budget Papers argue that this reduction in external deficits and debt will allow, over the medium to long term, a higher rate of sustainable economic growth by loosening the "external constraint" (the limit imposed by the external accounts) on economic growth and thus, in the medium to longer term, allow a substantial reduction in unemployment through higher growth.

The Government also clearly believes that the smaller Commonwealth Government sector generated by the spending cuts will, over the medium to longer term, encourage the private sector to grow more strongly and thus to increase total employment and community living standards more quickly. This view underpins this Budget's reliance upon spending cuts rather than revenue increases to reduce the budget deficit.

3. Comparisons with a Previous Episode of Fiscal Contraction

This Budget strategy is reminiscent of the Labor Government's fiscal strategy of the second half of the 1980s. The Budgets of 1987-88 and 1988-89, for example, made even greater use of spending cuts than the current Budget in their efforts to turn around the Commonwealth public sector from deficit to surplus.

Those Budgets generated a substantial fall in Commonwealth net public debt and net interest payments (relative to GDP in both cases), a significant increase in public saving and a smaller but still noteworthy rise in national saving. Output and employment growth remained quite strong throughout the fiscal contraction and until the onset of recession in the early 1990s.

However, the CAD and foreign debt accumulation did not fall much at all. This lack of effect on the CAD and foreign debt accumulation posed a considerable challenge to various formulations of the "twin deficits" theory which predicted a strong link between fiscal policy and the external accounts.

The absence of such a strong link was due to the strong rate of growth of private investment (in both the residential and business sectors), falling private sector saving and the rising exchange rate experienced in this period.

4. Effects of this Budget on Output, Employment and Inflation

The effects of fiscal contraction on output and employment, especially in the first couple of years after implementation, have been the subject of extensive debate in recent times in Australia. One side argues that this Budget strategy might substantially reduce output and employment growth (and probably, in turn, dampen inflationary pressures), at least in the short term, because of its negative effects on aggregate demand (for goods and services, and labour).

Others argue that there will be countervailing effects which might actually mean that this Budget's fiscal contraction encourages aggregate demand and stimulates output and employment growth (and possibly, depending on the magnitude of these effects on output and employment, generate some extra inflationary pressures).

The first set of arguments relies largely upon traditional Keynesian analyses of fiscal policy. Fiscal contraction reduces aggregate household employment and income; public employment levels fall as public spending falls while higher public revenue raising directly reduces disposable household incomes levels. This net reduction in household income will, it is argued, generate a reduction in household spending (especially where households view the fiscal contraction as permanent or relatively long-lasting). This will generate further, second-round, reductions in private output and employment and household income which will in turn generate further reductions in household spending, so that the process continues on iteratively, round after round, in the fashion of a downward spiral.

This process will be accentuated, it is argued, by a related fall in private investment spending which is viewed as quite responsive to changes in household and public spending.

The aggregate fall in output and employment will be determined both by how responsive household spending is to changes in household income and how responsive private investment is to changes in other types of spending. Aggregate national saving and investment levels will both be lower as a result of these Keynesian processes.

The other side of the debate focuses upon a range of countervailing considerations neglected by the above arguments. First, the rise in public and national saving generated by the fiscal contraction immediately after its implementation will tend to reduce long term interest rates (in both nominal and real, inflation adjusted, terms). The supply of new public debt will fall as the budget deficit falls, and this will tend to increase the price of government securities and thus reduce the interest yield offered on them (price and yield have an inverse relationship).

Since most public debt is of a longer term (fixed interest) nature this reduction in public debt interest rates will tend to reduce interest rates for private sector longer term debt (the former provides a risk-free benchmark for the latter). This reduction in real long term interest rates might stimulate that portion of business and household (residential) investment dependent upon such (fixed interest) rates.

Second, there is also the option of relaxing monetary policy (by reducing official short term interest rates) so that the variable interest rates for home and business lending which are dependent upon such rates can fall, in both nominal and real terms.

This would stimulate that substantial portion of business and residential investment dependent upon such lending.

Fortunately, the Budget Papers already forecast that underlying inflation will fall back into its target 2-3% range during 1996-97 so that monetary policy would seem to be relatively free to be used to bolster output and employment growth if needed. Indeed, monetary policy has already been relaxed in July 1996 in order to encourage higher growth.

Third, reduced interest rates at both the short term and long term ends of the financial spectrum can tend to put downward pressure on the exchange rate (because finance capital will tend to flow out of Australia in search of higher returns overseas). This lower nominal and real (inflation adjusted) exchange rate will help to encourage exports and discourage imports, in real (volume) terms, and the positive effect of both on the balance of trade (exports minus imports) will help to bolster private demand and activity.

Fourth, reduced budget deficits might directly encourage higher household (and possibly business) spending. "Ricardian equivalence" arguments posit that the private sector (both households and businesses) will ratchet down their estimates of future taxation burdens in response to lower current and planned budget deficits (since the resort to future tax rate increases will now seem far less likely and expectations about levels of future public debt and public debt interest payments will also be ratcheted down).

This optimism about lower future taxation, it is argued, may be converted into higher spending by households, and possibly businesses, in the current period.

The Budget Papers forecast a relatively strong outcome for output and employment in 1996-97. These optimistic forecasts seem to imply that the countervailing effects discussed above will substantially negate and offset the contractionary Keynesian effects of the Budget. Private demand growth (through the year) is forecast to accelerate from 4.0% in 1995-96 to 4.5% in 1996-97, while total employment growth (through the year) is forecast to accelerate from 0.9% in 1995-96 to 2% in 1996-97. We must wait and see whether such optimism is fulfilled by economic outcomes.

In contrast, the unemployment rate is forecast to fall hardly at all (to just 8.25% by June 1997), since employment growth is expected to only just cover the growth in labour supply.

The long term effects of fiscal contraction (and fiscal expansion) on output and employment will be largely determined by what happens to national investment over the longer term. Under some of the above scenarios it will be higher than otherwise but under others it will be lower, or could even remain unchanged.

5. Effects of this Budget on the Current Account Deficit and Foreign Debt

It is important to note, especially since it is not widely recognised, that many of the arguments discussed above about fiscal contraction imply some significant tradeoff, in the short to medium term at least, between the maintenance of steady output and employment growth on the one hand, and reductions in the CAD and foreign debt growth on the other. In only one case is it possible to achieve both goals.

First, consider the case of households and businesses reacting to lower current and expected future budget deficits by increasing their spending in the current period. This reaction will clearly tend to reduce private sector saving so that the fall in the latter will tend to negate the rise in public saving. In the extreme, national saving may not rise at all and there will be thus no tendency for higher national saving to reduce the CAD and foreign debt accumulation.

Second, consider the case of fiscal contraction reducing long term and/or short term real interest rates and thus stimulating business and household (residential) investment. Here, national saving may rise but, in the extreme, national investment may rise by a similar amount and the CAD (which equals national investment minus national saving) will be largely unchanged.

It is really only in the case of a lower nominal and real exchange rate arising from fiscal contraction that steady output and employment growth and a lower CAD are both possible. Here, any contraction in domestic spending on Australian goods and services (e.g. where investment is not very responsive to lower real interest rates) is counterbalanced by higher net exports and an improved balance of trade so that steady aggregate output and employment growth can be maintained while the improved balance of trade (made possible by the lower real exchange rate) will strongly contribute to a lower CAD.

On the other hand, it should be noted that a lower nominal exchange rate will tend to increase the interest costs of servicing some existing foreign debt (because a substantial portion of this debt is contracted in foreign currencies) and this will negate some of the effects on the CAD of the better balance of trade. As well, a lower nominal exchange rate will also raise the Australian-dollar value of that existing foreign debt which has been contracted in foreign currencies.

The Budget Papers forecast that the CAD will remain at about $20 billion in 1996-97, as it was in 1995-96, but that this will constitute about 4% of GDP in 1996-97 compared to about 4.2% in 1995-96.

This lack of change in the CAD despite substantial fiscal contraction seems to be due to expectations of quite strong business investment growth, recovery in residential investment, some small fall in private sector saving and an ongoing rise in the exchange rate. It will be recalled that these factors were also present in the economic and fiscal experience of Australia in the latter 1980s.

It is forecast that business investment will increase by 13% (through the year) this financial year and that the Trade Weighted Index of the Australian dollar will rise to an average of 58 in 1996-97 compared to an average of 54.8 in 1995-96.

This expected appreciation of the exchange rate seems to be bound up with the upward trajectory of world commodity prices, and possibly with ongoing international interest rate differentials and general "confidence" effects of the Budget. Net exports (the balance of trade) are expected to fall in real terms.

Even if the Budget does not produce much reduction in the CAD or foreign debt accumulation, it is not clear how much of a concern this will really be to the Government and its economic advisers. There is an influential point of view, amongst both academic and bureaucratic economists, which argues that if the "economic fundamentals" are properly in place (such as the tight control of budget deficits and public debt and the maintenance of low inflation) then any CAD and foreign debt accumulation occurring in this context is not of any great concern.

That is, on this view, there are "good" and "bad" forms of the CAD and foreign debt. The occurrence of "good" forms does not threaten our national economic interests.

STATISTICAL OVERVIEW

Stephen Barber

This statistical overview is, in keeping with the purpose of this document, not meant to be a comprehensive coverage of the statistical information that is available from the Budget. Rather, it provides a quick reference to Portfolio outlays and the major Budget aggregates of revenue, outlays and balance.

Portfolio Outlays

Portfolio outlays are the aggregation of outlays according to the Ministry which has the administrative responsibility for them. Table 1 shows the actual outlays for each portfolio for 1995-96 along with estimates for 1996-97 and the ensuing three years. Each estimate is expressed in the expected price levels of the year to which it refers - also known as current prices. The percentage changes in outlays between 1995-96 and 1996-97 are also shown. In some cases a percentage change is not able to be calculated or is not meaningful and where this occurs "na" (not applicable) is substituted. Care should be exercised when assessing some of the percentage changes between 1995-96 and 1996-97 as the portfolio outlays figures may be significantly smaller than the corresponding total appropriations because of adjustments. Adjustments can comprise three categories of receipts: Section 35 receipts, repayments of advances (loans and equity) and proceeds from the sale of assets.

Table 1: Outlays by Portfolio, current prices

In Table 2 the data from Table 1 are converted to constant 1995-96 prices, also known as expressing the data in real terms, using the gross non-farm product deflator. The gross non-farm product deflator is estimated by the Treasurer to increase by 2.75% in 1996-97 and 1997-98 and 3% in each of the later years. Calculating values in real terms means that the effect of rising prices, or inflation, is removed from them. For example, if outlays are increased by 2% but inflation is greater than 2% then the real movement in outlays is a decrease.

Table 2: Outlays by Portfolio, constant 1995-96 prices

Budget Aggregates

The Budget aggregates are revenue, outlays and balance, however, in this Budget there has been a change in definition of outlays and balance. The 'headline' balance, as used in previous years, which is revenue less outlays has been superseded by the 'underlying' balance which is revenue less outlays excluding net advances. (Net advances include such items as asset sales and repayment of State debt.) The reason for the change in focus is that the underlying balance aligns with the national accounts concept of net lending and therefore gives a measure of the contribution of the Budget sector to the current account deficit (through its contribution to national savings).

Table 3 presents a time series of the Budget aggregates from 1960-61 to 1995-96 and estimates and projections for future years. Both measures of outlays and balance have been included to show the differences and the data are expressed as percentages of GDP to allow meaningful comparisons to be made over time.

Table 3: Budget Aggregates, 1960-61 to 1999-2000

The information in Table 3 is also displayed graphically in Charts 1 and 2. From these charts the differences between the two measures of outlays and between the two balances can more easily be seen.

Chart 1: Budget Revenue and Outlays

Chart 2: Budget Balances

PUBLIC POLICY CONTEXT AND OUTLAYS OVERVIEW

John Kain

This section is primarily descriptive and draws heavily on the various Budget statements contained within Budget Paper Number 1. Its purpose is to provide a broad overview of the Budget from a public policy standpoint and to highlight some of its key directions.

Public Policy Objectives

The Government considers that there are two important structural weaknesses in the Australian economy which limit its ability to sustain strong economic growth. These are a high structural current account deficit and impediments in the labour market which, it argues, are responsible for the high structural unemployment which has been evident in Australia since the mid 1970s.

The Government believes that the policies announced in the Budget and in the Workplace Relations and Other Legislation Amendment Bill 1996, once they are implemented, will address these structural weaknesses. In particular, the Government argues that its fiscal consolidation program combined with its labour market policies and broad ranging microeconomic reform strategies should contribute significantly to its core economic policy goal of creating a competitive, dynamic and flexible economy which will provide higher living standards and greater employment opportunities.

The Budget in Context

The 1996-97 Budget is seen as a step towards addressing the first of these weaknesses. The Government maintains that remedying these structural concerns within a comprehensive policy framework will provide the basis for stronger and sustainable economic growth and lower unemployment over the medium term.

The decline in the rate of national saving is seen as the essential cause of the structural deterioration in the current account deficit. While there has been a marked decline in the rate of private savings in Australia and many comparable western economies over the past 2 decades, the extent of the decline has been particularly significant in Australia. Likewise, over the past 20 years, the Commonwealth budget has exerted a leakage from national saving although by international standards, Australian Government indebtedness relative to GDP is relatively modest.

Nevertheless, the Commonwealth has chosen to use its direct control over public fiscal policy (particularly on the outlays side) as the primary tool for raising the level of national savings. It stresses that its objective of keeping the Commonwealth budget in underlying balance, on average, over the economic cycle is underpinned by the expectation that such budget outcomes will make a significant contribution to addressing the structural weakness in the current account deficit. The Charter of Budget Honesty is seen as a means of providing legislative backing to prudent fiscal principles and ensuring that fiscal strategies are set and assessed against those principles.

The Government has emphasised that its Budget strategy alone will not resolve the structural weaknesses of the economy. It maintains that broad ranging microeconomic reform, including its proposed labour market changes, are also essential and are now the immediate priority. Such reforms are seen as offering the prospect of lowering structural unemployment and providing the basis for faster economic growth and lower inflation over the medium term as well as improvement in the current account deficit.

Although the Budget papers appropriately do not address the microeconomic reform agenda in detail, they identify a range of shortcomings with the current industrial relations system including impediments to enterprise bargaining, restrictions on workplace flexibility attributable to awards, inhibitions on labour market competition and inappropriate employment protection provisions.¹ They also describe the Government's proposed industrial relations system and its plans for revamping labour market assistance and case management arrangements. As is evident in the discussion below, the latter are expected to contribute significantly to reductions in Government outlays.

Overview of Outlays Initiatives

As noted in the Macroeconomic Policy Perspectives section of this review, approximately three quarters of the fiscal policy tightening in the Budget is attributable to reductions in prospective outlays with the remainder stemming from revenue initiatives. The Budget strategy has been formulated against the Government's announced intention to achieve an underlying budget balance with a fiscal consolidation program over 1996-97 and 1997-98.

In aggregate terms for 1996-97:

• underlying outlays (ie outlays excluding net advances) are expected to increase by 2.9 per cent in nominal terms and not to change in real terms;
• measures taken between the 1995-96 Budget and the March 1996 Federal Election increased estimated underlying outlays by about a net $550 million; and
• measures taken between the Federal Election and the 1996-97 Budget decreased estimated underlying outlays by around a net $2810 million.

In aggregate, over the forward years (1997-98 to 1999-2000 inclusive):

• underlying outlays are expected to rise by 6.2 per cent in nominal terms and 1.5 per cent in real terms;
• the major sources of real growth in underlying outlays are expected to be in the Social Security and Welfare and Health functions; and
• increases in these functions are partially offset by real declines in some other functions, most notably Public Debt Interest and Labour and Employment Affairs.

The ratio of underlying outlays to GDP is estimated to decline by 2.0 percentage points over the period to 1999-2000; which brings it to 24.3 per cent, well below the average ratio of 26.6 per cent for the ten years to 1995-96.

The following table summarises the outlays side of the Budget and includes estimated aggregated outlays for the Commonwealth budget sector through to the year 1999-2000.

Table 1: Summary of Outlays

Underlying Outlays are Outlays less Net Advances. Net Advances predominantly consists of equity asset sales (returns from the sale of government enterprises) and the repayment of public policy loans to the Commonwealth from various sources including State Governments.

Major outlay initiatives (entailing positive or negative outlay changes in excess of $50 million for 1996-97) are as follows:

• Rationalisation of DAS commercial businesses $53 million
• Implementation of the National Firearms Program $500 million
• Reduction in Labour Market Programs funding -$578 million
• Reduction in discretionary funding for universities -$85 million
• Foreign Aid Program savings -$65 million
• Abolition of DIFF -$94 million
• Hospital Funding Grants to States -$74 million
• Diesel Fuel Rebate Scheme Revamp -$60 million
• Rural adjustment Scheme: Additional Funding $89 million
• ATSIC Programs savings -$77 million
• Tightening Job Search/Newstart & Pensions Advances Schemes -$56 million
• Family Tax Initiative $248 million
• Labour market funds adjustments $185 million
• Reduction in National Highway System funding -$113 million
• Abolition of Regional Development Program -$53 million
• Additional savings from Building Better Cities Program Part II -$65 million
• State fiscal contributions (payments to and from the States) -$619 million
• Across the board 2% portfolio funding reduction -$187 million (see discussion below)
• Savings from cash balances held by Statutory Bodies -$301 million
• Application of efficiency dividend to Commonwealth own purpose outlays and specific purpose payments of a running cost nature -$75 million

Commonwealth Departments and Agencies: Running Cost Changes

Running costs are the recurrent and minor capital costs incurred by a budget department or agency in providing the government services for which it is responsible. They include salary costs, administrative expenses and property operating expenses, as well as payments to ComSuper to reflect the employer cost of Commonwealth public sector superannuation schemes. They are formulated on the basis of existing policy and do not include any provision for new programmes or expansion of existing programs that have not been agreed by the Government or for programs that are not expected to continue.

The Budget provides for running costs for departments and agencies to be reduced by 2 per cent from 1996-97. This reduction is in addition to the existing annual 1 per cent efficiency dividend which is applied to running costs. The operating expenses component of budget funding for statutory bodies that do not operate on the Public Account has also been reduced by 2 per cent from 1996-97. Bodies are expected to make the reduction in their operating costs rather than in other expenditure. In addition, the Government has decided to cease supplementation for new applications under the Movement to Award Wages program with effect from 20 August 1996 with appropriate transitional arrangements where matters are well advanced.

The excess cash balances of a number of statutory authorities will be run down by reducing 1996-97 Budget appropriations, where the cash balances are surplus to immediate need.

An efficiency dividend equivalent to that being applied to running costs has generally been applied to Commonwealth Own Purpose Outlays (COPOs) and Specific Purpose Payments (SPPs) which are of a running costs type nature, but which have not previously been required to provide an efficiency dividend. In addition the 2 per cent reduction applied to running costs in 1996-97 is also being applied to these SPPs and COPOs in 1996-97. This applies the same efficiency incentives to these elements of outlays as have been applied to other operating costs expenditure.

Approximately $300 million was carried forward from 1995-96 running costs budgets into 1996-97. It is anticipated that much of this will be used to fund redundancy payments (severance and accrued entitlements) needed to achieve reductions in staff costs in future years. This carry forward is partly offset by the allowance for carryovers from 1996-97 to the next financial year included in the Contingency Reserve, which has been estimated at $150 million.

Workload changes have added about $200 million to 1996-97 running costs. These are the result of increases in client numbers expected in the Social Security, Employment, Education, Training and Youth Affairs, and Immigration and Multicultural Affairs portfolios, and in the Child Support Agency of the Australian Taxation Office.

Price and wage adjustments ($345 million) since the last budget include the effect of supplementation for salary increases agreed under the Enterprise Agreement: Continuous Improvement in the APS, 1995-96 and the equivalent Australian Defence Force agreement. The Agreement adopts a service-wide approach under which standard salary increases in the Agreement are payable to all APS staff from common operative dates. Such increases under the Agreement are fully funded from the Budget in all agencies other than commercial bodies. An allowance for the prospective salary increase was included in the Contingency Reserve in the 1995-96 Budget.

Policy decisions since the 1995-96 Budget have added some $58 million in running costs in 1996-97. Decisions prior to the March 1996 Federal election added $91.7 million. Decisions since then have resulted in savings of $33.3 million.

Running costs savings agreed in the 1996-97 Budget include a 2 per cent reduction in the running costs of departments and agencies. For Defence, running cost savings have been redirected to fund capability enhancements. There have also been significant reductions in the running costs of some portfolios as a result of specific savings measures. The largest reductions in portfolio running costs are in the Departments of Industrial Relations and Transport and Regional Development, the latter in part reflecting changes to regional development priorities and programs.

Portfolios or agencies with large increases in running costs and the major activities contributing to these increases are as follows:

• Social Security: Largely attributable to the labour intensive nature of implementing activity testing, debt and fraud control measures and changes in client numbers.
• Industry, Science and Tourism: Largely stem from the carryover of 1995-96 running costs to 1996-97.
• The Australian Bureau of Statistics: To finance the 1996 Census of Population and Housing.
• The Australian Taxation Office / Department of the Treasury: For new policy initiatives and running costs carryover and borrowing provisions.

Forward Estimates of Outlays

Running costs are estimated to decline substantially in real terms from 1996-97 to 1997-98 with a total decrease of 11.5 per cent in real terms over the forward estimates to 1999-2000.

Reasons for the decrease in the forward years include:

• savings and efficiency measures implemented in this Budget;
• initial implementation costs for a number of savings measures in the Social Security portfolio in 1996-97 and 1997-98, which will decline from 1998-99;
• reduced costs in the Department of Social Security as a result of expected efficiency savings from the establishment of the new shopfront agency;
• phasing out of resources for major employment initiatives introduced since 1992;
• the peak in outlays for the Australian Bureau of Statistics in 1996-97 associated with the 1996 Census of Population and Housing; and
• reduced outlays in the Australian Taxation Office following the completion of the modernisation program.

Running costs agencies, excepting the Department of Defence, are required to pay an annual 1 per cent efficiency dividend to reflect public sector productivity improvement over time. The cumulative effect of the efficiency dividend is reflected in the forward estimates. The total efficiency dividend paid in 1996-97 is around $72 million.

Portfolio Staffing Levels

The 1996-97 Budget Papers include data on average staffing levels (ASL) for the budget year based on figures provided by portfolios. The total average staffing level (ASL) in running costs agencies is forecast to decline by 1737 in 1996-97 as compared to 1995-96. This is reflected in Table 2 below.

No staffing targets have been set by the Government, with staffing levels being addressed by the relevant portfolios in the context of resources made available under running costs arrangements. Some agencies staffed under the Public Service Act such as the Department of Administrative Services commercial bodies are not subject to running costs arrangements, and are therefore excluded from the portfolio estimates. Based on figures provided by Public Service Act agencies to the Public Service Merit and Protection Commission, it is expected that the total number of people employed (full-time and part-time permanent and temporary staff) under the Public Service Act will decline by some 10 500 between 30 June 1996 and 30 June 1997.

ASL figures are the most relevant for funding purposes, but do not indicate the reduction in total staff numbers that could occur by the end of the financial year. ASL is the average number of employees receiving salary or wages over the financial year, with adjustments for casual and part-time employees to show the full-time equivalent. This measure of employment allows for comparison between average employment in particular financial years, rather than reflecting the actual number of staff being employed at the end of financial years or at other specific points in time. If, as appears evident from the overall figures, a significant proportion of staff separations occur late in the financial year, the ASL reduction will be significantly lower than the corresponding reduction in total staff numbers between June 1996 and June 1997.

Table 2: Total Running Costs Budgets by Portfolio and Average Staffing Levels

Data for the Department of Defence aligns with data in the Appropriation Bills in Budget Paper No. 2 (1996-97). As such it includes Military Personnel costs and excludes property operating expenses appropriated under Sub Division 182-02 of the Bills. Defence operates under global budget funding arrangements and is not subject to most running cost operating arrangements.

While ASL has declined to some extent in most agencies, this has been partially offset as a result of initiatives such as those in the Department of Social Security and the Australian Bureau of Statistics.

The ASL numbers show a small percentage decline while running costs will remain constant in real terms in 1996-97. This arises because the running costs estimates for 1996-97 include factors which do not add to ASL numbers such as large carryovers for redundancy payments and other purposes and funding for increased salary levels resulting from decisions made prior to the Federal Election.

Endnotes

CHARTER OF BUDGET HONESTY

Bernard Pulle

In the 1996-97 Budget Speech, the Treasurer announced that the Government will enact a Charter of Budget Honesty. He outlined three roles for the Charter.

• It will require the Government of the day to publish a budget update signed off by the Secretaries to the Treasury and the Department of Finance at the commencement of each Federal Election campaign.
• It will require any future government to set out its fiscal strategy and report against it.
• It will require the Government to commit itself to responsible and accountable fiscal policy.

This announcement is in accordance with the Government's election commitment to introduce legislation to ensure greater fiscal discipline and enhanced reporting. The National Commission of Audit (NCOA) which presented its report to the Government on 21 June 1996 addressed the implementation of the Charter of Budget Honesty. The NCOA distinguished between fiscal reporting that is mainly concerned with the internal management of government agencies and the financial reporting that is a requirement of the Australian Audit Act 1901 or the New Zealand Public Finance Act 1989 and the more general fiscal reporting that is concerned with macroeconomic effects of government fiscal actions as under the New Zealand Fiscal Responsibility Act 1994. In the view of the NCOA, the Charter of Budget Honesty should be concerned more with the latter than the former.¹

Budget Paper No. 1 states that the Government will introduce legislation in the Budget sittings of Parliament to establish a new fiscal framework and it will incorporate many of the recommendations of the National Commission of Audit.²

The main features of the proposed fiscal framework will cover Fiscal Policy Formulation, Fiscal Reporting and Costing of Election Commitments.

Fiscal policy will be required to be formulated against a set of principles of sound fiscal management to be specified in the legislation. The principles will 'require a government to give consideration to the impact of fiscal policy on: government debt and managing fiscal risks, national saving, the stability and integrity of the tax base, and equity between generations'. It must be appreciated that these principles enshrined in legislation can only serve as guidelines and it is debateable whether such principles would in any way curtail the flexibility of the Executive Government of the day to act in a manner that might give varying weight to one or more of these principles in discharging its fiscal responsibilities depending on the needs of a particular time. Where fiscal policy impacts on the stability and integrity of the tax base there are constitutional restraints on the Commonwealth in extending its tax base to the detriment of the tax base of the States given the federal nature of the Commonwealth Constitution. The Budget Papers recognise the limitation of such legislation to prevent the Government or Parliament pursuing non-fiscal objectives which may call for a sacrifice of some of these principles in varying degrees at various times.

Fiscal Strategy Statement

The Charter of Budget Honesty will require the Government to present a Fiscal Strategy Statement each year to assist public evaluation of fiscal policy and will comprise three segments. The Statement will:

• outline short and longer term fiscal objectives and strategic priorities;
• specify expected fiscal outcomes or targets and specify key fiscal indicators against which fiscal policy will be set and assessed; and
• identify fiscal measures that are temporary in nature and adopted for the purpose of dampening economic downturns, and indicate the process for their reversal.

Given that fiscal and monetary policies impact on the economy as a whole, it is doubtful whether the impact of fiscal strategies can be isolated from the impact of monetary strategies. Economic downturns may be a result of a combination of factors and their reversal may call for a mix of appropriate fiscal and or monetary strategies. It may be argued that if the third segment of an annual Fiscal Strategy Statement is to be comprehensive, there may be a case for a corresponding Monetary Strategy Statement to enable a public evaluation of the impact on the economy of monetary policy in dampening downturns and achieving reversals. As monetary policy is generally accepted to be in the domain of the Reserve Bank whose independence it is stated Government policy to maintain, it may be reasonable to expect that the legislation establishing the Charter of Budget Honesty might give recognition to the Bank's independence. Alternatively if the legislation does not ensure the independence of the Reserve Bank to independently pursue monetary policy when the Charter is enacted, then this might imply that the Government could act under the legislation establishing the Charter to influence the Reserve Bank's pursuit of monetary policy.

On the other hand, the Charter of Budget Policy seems to be proposing to evaluate fiscal policy, not against the broad performance of the economy, but against a more narrow range of indicators such as public debt, the tax base and public and national saving.

Fiscal Reporting

The legislation to give effect to the Charter of Budget Honesty will require the following key reports to enable a government's fiscal performance to be assessed:

• economic and fiscal outlook reports twice a year: at budget time and mid-year;
• a pre-election report on the economic and fiscal outlook; and
• an intergenerational report on the long run implications of government policies every year.

Periodic Economic and Fiscal Outlook Reports

The Budget Economic and Fiscal Outlook Report will be published at Budget time and present fiscal projections for three years beyond the budget year together with economic assumptions on which they are based.

The Mid-Year Economic and Fiscal Outlook Report will update the information provided at Budget time and will be published at mid-year.

The Budget Papers do not indicate who will be responsible for these reports, although it states explicitly that the Secretaries of the Treasury and the Department of Finance will be responsible for the pre-election Economic and Fiscal Outlook Report.

Pre-election Economic and Fiscal Outlook Report

The Pre-election Economic and Fiscal Outlook Report will ensure that updated information is available within 10 days of the announcement of an election. Budget Paper No 1 states: 'This report is to provide an independent assessment of the economic and fiscal outlook prepared by the Secretaries to the Department of the Treasury and Finance.'

Intergenerational Report

The report will assess the long term sustainability of current policies and highlight its long term financial implications. Here again, it is not clear who will be responsible for this report.

Costing of Election Commitments

The Charter of Budget Honesty legislation will allow the Prime Minister and the Leader of the Opposition to request that costings of their announced policies be prepared by the Secretaries to the Treasury and the Department of Finance, during the caretaker period. The relevant Secretaries will publicly release the policy costings as soon as practicable after receiving a request. The availability of this information to the public will keep the electorate better informed of the financial implications of the election commitments of the Government and the Opposition.

The object of extending access to the Public Service to the Leader of the Opposition is to remove the advantage that the party in Government inevitably has in this respect.

Role of the Secretaries of the Departments of the Treasury and Finance

The report of the NCOA debated the advantages and disadvantages in making the Secretaries of the Departments of the Treasury and Finance (the Secretaries) responsible for the contents of the economic and fiscal outlooks published at budget time and at the time of the mid year review. The main disadvantage was that in consequence both departments would be drawn into the political process, particularly where officials and the government of the day held different views about the economic and fiscal outlook. The alternative was to make the Ministers responsible, but the NCOA did not consider it appropriate for the Ministers to be responsible for the pre-election forecasts. The NCOA noted that in practice the involvement of the officials of both departments in the political process has become inevitable in recent years when they make public comments before parliamentary committees and in other venues. The NCOA therefore recommended that in the interests of transparency and accountability the Secretaries should be made responsible for the contents of the economic and fiscal outlooks published at all times.³

In making this recommendation the NCOA did envisage situations where the Secretaries would have views of the economic and fiscal outlook different from those of Ministers. The consequence of certifying statements of economic and fiscal outlooks with which the Ministers may not agree may be seen to compromise Secretaries in the event of dissent. In practice this may lead to situations where compromise positions will be reached by the Secretaries and Ministers. Such outcomes could place at risk the ideal of better forecasts, immune from political considerations as envisaged by the NCOA. There is a case for the proposition that Ministers should be made responsible for the economic and fiscal outlook reports, particularly as the NCOA has proposed that the responsibility for the fiscal strategy in Fiscal Policy Statements should rest with Ministers.

Responsibility of the Ministers for Fiscal Policy Statements

The NCOA report states that ultimate responsibility for the contents of fiscal policy statements should rest with relevant Ministers who would also be responsible for the fiscal strategy. As discussed above, if Ministers are held responsible for the management of the economy as a whole, this implies responsibility for both the short term and long term consequences of fiscal and monetary strategies. In the final analysis this could be seen to be potentially in conflict with policies which vest an unelected authority with a significant share of responsibility for national economic management.

A role for an independent Auditor-General in the Charter of Budget Honesty

The need for an independent Auditor-General to enhance the credibility of the Charter of Budget Honesty has not been spelt out in the announcements made so far. The Joint Committee of Public Accounts (JCPA) has been requested by the Minister of Finance, in consultation with the Prime Minister, to 'suggest appropriate measures that could be incorporated into the Auditor-General Bill, or other legislation, to support the functional independence of the Auditor-General, in keeping with the nature of that Office'. The report is required by 12 October 1996.

This section of the review sets out briefly the contribution that may be expected of the Auditor-General in aspects of the Charter of Budget Honesty where an independent referee is required. The referee should be functionally independent of both the Treasury and the Department of Finance whose Ministers and Secretaries have key roles in the Charter of Budget Honesty. Under current administrative arrangements the Audit Act 1901 comes partly within the purview of the Prime Minister and the Minister for Finance. As such, in the public perception, the Auditor-General may not have the sort of independence required to add credibility to various reports which the Charter of Budget Honesty may require the Auditor-General to express an opinion on, from time to time. This may be remedied by making the ANAO an agency responsible directly to Parliament.

Auditing the 'whole of government statements'

The NCOA report considered that a fully audited consolidated financial report covering the year just ended and the previous year would be beneficial. The NCOA recommended that whole of government financial statements on the financial performance and position of the Commonwealth Government for 1996-97 should be fully audited and ready for tabling in Parliament by 30 September 1997. In addition to year end statements, the Government would be required, as from the financial year 1997-98, to prepare mid year statements as of 31 December. These will be reviewed by the Auditor-General in accordance with Australian Auditing Standard AUS 106, Explanatory Framework for Standards on Audit and Audit Related Services.⁴

Reporting on compliance with external reporting standards in the Fiscal Strategy Statement

A feature of the proposed fiscal framework is that governments will have to comply with external reporting standards such as those for ABS government finance reporting and standards set by the accounting profession. Where there is a departure from these reporting standards, the proposed approach and the reasons for such departure should be explained in the Fiscal Strategy Statement. There is no indication whether an independent Auditor-General responsible directly to Parliament, not under the control of the Department of Finance even for administration purposes, will be required to report whether the external reporting standards have been complied with and if not complied with, the extent of the departure and the consequences of departure to the projections in the Fiscal Strategy Statement.

Tax Expenditure Statements

The NCOA report recommended that tax expenditure should be treated as far as possible like program expenditure in all published fiscal reports and statements and in all budgetary processes.⁵ This will result in estimates of the revenue cost of tax concessions being included in budget statements and the scrutiny of tax concessions and their effectiveness. The Auditor-General should be clearly involved in an independent examination of statements of tax expenditures prepared by the Treasury and the relevant departments.

Reporting on pre-election estimates of revenue expected from anti-tax avoidance measures

Recent experience is that there is a tendency to bring up the question of additional revenue available from new measures to curb tax avoidance or tax minimisation schemes in the run up to an election. This occurred in the pre-election 1992 Budget and in the caretaker period preceding the 1996 federal election. These instances are covered in the section of this Budget Review dealing with anti-avoidance measures.

The question of relevance to the Charter of Budget Honesty is that when a statement of significant future revenue impact, arising from potential ATO compliance activities, is made in the Budget preceding an election or in the course of an election campaign by a Treasurer or Prime Minister in their caretaker roles, should the Secretary to the Treasury and the Secretary to the Department of Finance be required to certify to the general public by way of a Confirmatory Statement that there is a reasonable basis for such additional revenue collection?

Such a statement would not only establish the credibility of the assertions made by the Government but also assist the Opposition in that such additional achievable revenue could be factored into the pool from which Opposition party election promises could be funded. Most importantly it will contribute towards accountability of public officials and act as a safeguard against public officials being drawn into positions driven by political expediency, which may be untenable. Ministerial responsibility and accountability of public servants to Parliament and the general public merge in a grey area at normal times, but it may be argued that when the Government is in caretaker mode the accountability of public servants to the public should assume a dimension which might require independent responsibility in the context of a Charter of Budget Honesty.

The Auditor-General should be required to report on the Confirmatory Statements of the revenue potential from the new anti-avoidance measures. This particular role of the Auditor-General will be facilitated if the Treasury and the Department of Finance periodically estimate the 'Tax Gap', which is the difference between the tax due under the taxation laws of the Commonwealth administered by the ATO and the tax actually collected by the ATO. Estimates of the revenue potential from pre-election new anti-avoidance initiatives can then be measured against the most recent segmental estimate of the 'tax gap' which the new measures are intended to narrow.

Estimation and Publication of the Tax Gap

The Internal Revenue Service (IRS) in the United States takes the view that publication of tax gap details is warranted by the need to maintain public confidence in the integrity, efficiency and fairness of the Internal Revenue Service.

A Charter of Budget Honesty would not be complete if the majority of taxpayers who pay their taxes honestly are not taken into confidence by the Government in the same way that the US Government by requiring the IRS to publish periodic estimates of the tax gap.

The IRS Compliance Research Office publishes a study which estimates the non-compliance rate every three years. The amount of tax that is due but not voluntarily paid is the gross tax gap. This is comprised of the reporting gap, which is the amount of tax liability that taxpayers do not voluntarily report on their returns, and the remittance gap, which is the amount that taxpayers report on their returns as due, but which is not voluntarily paid-either because they do not remit it with their returns, or because their employers fail to remit what they withhold from their wages. The net tax gap is the part of the gross tax gap that is not collected through IRS enforcement activities.

On the face of it, the net tax gap would appear to be a source of additional revenue that could be realised without raising taxes. The IRS takes the view that a significant portion of the net tax gap could be collected with a balanced strategy that incorporates expanded and improved IRS programs (including taxpayer service, education, enforcement, and systems modernisation, as well as compliance oriented tax law changes intended to reduce complexity and eliminate various opportunities for non-compliance. However it states that enforcement alone is neither a cost-effective nor a socially acceptable method of collecting the net tax gap; the key is a balanced strategy.⁷

The practice of estimating the tax gap commenced in the United States in 1973 and has hovered around 17 per cent of total federal income taxes due each year. The study of the 1992 tax gap, the results of which were released in May this year estimated the net tax gap at US $95 billion.

In Australia, in the Draft White Paper titled Reform of the Australian Tax System (June 1985) prepared for by the Treasury for the Tax Summit of 1985, the annual 'tax gap' was estimated at $4.5 billion. More precisely the annual tax evasion was estimated at $3 billion and annual tax avoidance was estimated at $1.5 billion. This was the last occasion when an official estimate was published by the Government.

The Auditor-General qualified the Financial Statements of the ATO for the years ended 30 June 1992 and 30 June 1993 on the grounds that the amount represented by the 'tax gap' has not been brought into account. Prior to that, the Auditor-General had in the audit reports on the ATO for the years ended 30 June 1989, 30 June 1990 and 30 June 1991 drawn attention to the failure of the ATO to estimate the 'tax gap' and bring it into account or disclose it by way of a note to its Financial Statement.

Although the ATO financial statements for the subsequent years have not been qualified by the Auditor-General on the grounds that the tax gap has not been brought into accounted or disclosed in a note, the present occasion, when a framework for a credible Charter of Budget Honesty is being established, should not be lost to provide for a periodic study and publication of the 'tax gap' in the enabling legislation. There should also be provision for the Auditor-General to report on the methodology used for estimating the 'tax gap' and the reasonableness of the assumptions on which the segments of the tax gap are estimated.

Endnote

TAXATION ISSUES

John Harrison and Bernard Pulle

The policy

Taxation continues to be a central vehicle to the government policy. The Government has been committed to:

• relieving the tax burden on families;
• introducing no new taxes and not raising existing taxes; and
• preserving the social security safety net.

Election commitments

In addition to the above, the Government committed itself to:

• providing incentives for individuals to take out private health insurance;
• assisting small business; and
• implementing various initiatives to combat tax avoidance.

For a more detailed outline on the Government's election commitments announced in Meeting our Commitments, refer to Treasury, Sub Program 16.4.1-Income and other taxes.

The major taxation measures in the Budget

Major taxation measures found in the Budget involve income tax, capital gains tax and

anti-avoidance measures. This review deals with the following :

Income Tax

The major income tax measures include:

• Family tax initiative;
• Increased Medicare levy for higher income earners without Private Health Insurance, and Gun buy back;
• Private health insurance incentive;
• Reduction of Research and Development concession from 150% to 125%;
• Reduction of provisional tax uplift factor from 8% to 6%;
• Extension of the reportable payments system; and
• Increased tax on superannuation contributions of high income earners and other retirement measures.

Capital Gains Tax

The Major capital gains tax measures include:

• Rollover relief for small business and an exemption on the sale of a small business where the proceeds are used for retirement.

Anti avoidance measures

The major anti avoidance measures include:

• High wealth individuals; and
• Tax base protection measures in relation to withholding tax.

Family tax initiative

A Family Tax Initiative will be available from 1 January 1997 and will provide assistance through the tax system for families with children. An equivalent Family Tax Payment will be available fortnightly for low income families. This program will be delivered via the tax and social security systems where middle income earners will receive tax relief and low income families will receive a payment fortnightly.

Under the tax scheme, assistance will be provided in the form of increased tax free thresholds. A sole parent or one member of the family can increase their threshold by $1000 if they have a dependent child up to the age of 16, (or 18 for a secondary student), where the family taxable income is less than $70 000. This threshold increases by $3000 for each additional child after the first child. In addition, if a child is under the age of 5 years in a single income family less than $65 000, there is a further tax free threshold increase of $2500.

Families with a low combined taxable income will get a fortnightly payment of $7.70 for each child under 16, or 16-17 year olds in full time secondary schooling. This payment is known as the Family Tax Payment.

On the revenue side, the family tax package will cost $147 million this financial year, $441m in 1997-98, $591 million in 1998-99, and $595 million in 1999-2000. On the outlay side, it will cost $248 million this financial year, $483 million in 1997-98, $484 million in 1998-99 and $486 million in 1999-2000.

Relieving the tax burden on families was a key election pledge met by the Government, and provides additional tax assistance for lower income families where a parent is at home caring for young children. It also shows a greater commitment by the Government to assisting lone parents with financial support as they raise their children.

For further comment on the Family Tax Initiatives, refer to 14.4.0.

Increased Medicare levy-surcharge for higher income earners without Private Health Insurance and Gun buy back

A 1% Medicare levy surcharge will be applied from 1 July 1997 to high income earners who do not have private hospital coverage through health insurance. It will apply to single individuals with taxable incomes in excess of $50 000 and couples and families with combined taxable incomes in excess of $100 000. This measure is expected to raise $60 million in 1998-99 and $75 million in 1999-2000. This measure which is a penalty one in form is complementary to the private health insurance incentive measure. High income earners without private health insurance can avoid paying an increased Medicare levy by purchasing the cheapest, most basic hospital insurance available for as little as $8 a week for singles or $16 a week for families. It is anticipated that 70 000 wealthy single people and 65 000 couples and families will join health funds in a move that will increase the rate of private health insurance from a low of 33.6% at June end to 35.1%. On 28 August, some health insurance funds increased the contribution costs which will reduce the benefit of this policy.

The Medicare Levy has also been increased to fund the gun buyback scheme for 1996-97 only and is budgeted to cost half a billion dollars. This is an increase of 0.2%, raising the Medicare levy from 1.5% to 1.7%. Any surplus after the costs associated with the gun buyback scheme will be returned to taxpayers through the Medicare levy system.

Private Health Insurance Incentives

Membership figures for private health have fallen to one in three, compared to 45% in 1990. In order to boost the ailing health insurance industry, the Government has provided in the Budget an incentive for private health insurance. From 1 July 1997, means-tested incentives will be available for families and individuals with private health insurance. The Government has fulfilled its election commitment to offer $450 for families and $250 for couples with private health insurance on incomes up to $70,000 a year. Singles are offered $125 on incomes up to $35,000. Recipients will have the choice of claiming the incentives through their health insurance fund in the form of reduced premiums (with the health funds being reimbursed by the Government) or as an income tax rebate claimable after the end of the income year. The cost of the proposal will reduce revenues by $113 million in 1998-99 and $114 million in 1999-2000.

For further comment on private health insurance incentives, refer 8.2.3.

Reduction of Research and Development concession from 150% to 125%

The premium rate of deduction for research and development expenditure will fall from

150 % to 125% from 20 August 1996. The effect on revenue will be to increase it by

$59 million in 1996-97, $718 million in 1997-98, $630 million in 1998-99 and $840 million in 1999-2000.

For further comment on Research and Development, refer to 11.1.1

Reduction of provisional tax uplift factor from 8% to 6%

This measure has already been implemented and is expected to reduce revenue by $180m in the current financial year. Refer to Treasurer's press release No. 38.

Extension of the reportable payments system

The Reportable payments system (RPS) is a Tax File Number based payment reporting system which currently applies to certain payments in the fishing, clothing, and smash repair industries.

The Government has endorsed a previous proposal to extend the RPS to the fruit and vegetable industry. The Australian Taxation Office has commenced consultation with the industry and new arrangements are expected to be implemented during the first half of the 1997 calendar year. The measure is expected to yield $10 million in the current financial year and $100 million in each of the following 3 financial years.

Increased tax on superannuation contributions of high income earners and other retirement measures

For comment on these measures, refer to general discussion on Superannuation.

Capital Gains Tax Relief for Small Business

This review deals with certain aspects of the proposals for Capital Gains Tax (CGT) relief for small business announced by the Treasurer¹. The main changes will result in the provision of rollover relief for small business and an exemption on the sale of a small business where the proceeds are used for retirement. These two provisions when taken together should, subject to the terms of the legislation to give effect to these changes, enable the taxpayer owning a small business to escape liability to CGT if any capital gains made in the course of the taxpayer's career are rolled over until retirement. In consequence the hard work put in by small business will be rewarded by the capital accumulated in the business. The need to seek a retirement nest egg in a superannuation fund outside the business may not be attractive.

On retirement at age 55 or above, individuals will be allowed to claim CGT exemption up to a maximum of $500,000. Younger persons can claim the relief if the proceeds are rolled over to a superannuation fund or an approved deposit fund. Amounts exempt from CGT will be subject to Reasonable Benefit Limits. Thus provision will be made to merge the retirement relief with the relief for superannuation.

The downside of the proposals would be to make it a disincentive for small business to expand beyond the qualifying limit of net assets of $5 million, as the rollover relief and the retirement exemption will be lost should that occur. Further as the rollover relief will require reinvestment of the sale proceeds of an asset in a business, which is substantially the same kind as the taxpayer's current business, there will be little incentive to diversify and to enter new fields of business activity.

As in the case of most aspects of the CGT, the classification of assets into active and passive will add to its complexities. So, will the test to decide whether the investment is in 'another like business', based on the understanding of a reasonable person whether the asset is to be used in a business substantially of the same kind. The House of Representatives Standing Committee on Industry Science and Technology in its report titled Small Business in Australia-Challenges, Problems and Opportunities, recommended that the rollover relief be granted on the sale of a trading business which is rolled over into another trading business.² This recommendation has the merit of avoiding the complexities of classifying assets and ascertaining whether reinvestment was 'in a like business'.

Further difficulties and compliance costs would arise from the need to value a small business in order to ascertain whether the rollover relief is available on the sale of an active asset. The need for marginal relief for those taxpayers whose businesses fall outside the limit of $5 million will require consideration.

These measures will apply only from 1 July 1997 and not 1 July 1996 as was expected earlier. It is estimated that the rollover relief measure will result in a loss of revenue of $150 million in 1998-99 and the retirement relief a loss of $15 million from 1998-99.

The Treasurer also announced the extension of the principal residence exemption and other measures to remove existing anomalies.

Anti-Avoidance Measures

The Treasurer announced initiatives to improve tax compliance. This review will be restricted to measures proposed to curtail tax minimisation practices by certain wealthy individuals and the tax base protection measures that will be introduced in relation to withholding tax, as the need to deal with these issues has been known for some time and are connected.

Other tax base protection measures proposed would cover charitable trusts, thin capitalisation, company residence and luxury cars. The Treasurer also indicated that administrative arrangements will be changed to stop wholesales tax fraud relating to the sale of personal computers and related goods.

Combat Tax Avoidance by High Wealth Individuals

Additional funds of $19.2 million will be provided to the Australian Taxation Office (ATO) in 1996-97 ($9.7 million) and 1997-98 ($9.5 million) to establish a special high level task force to improve the compliance of high wealth individuals, who with aggressive tax planning and minimisation arrangements have put at risk revenue estimated at $800 million a year.

It is reported that a close examination of a sample of tax returns of such taxpayers by the ATO indicate that taxpayers with an estimated net worth of $30 million had returned taxable incomes of less than $20,000. Further the low levels of income returned entitle these taxpayers to low income rebate and also to apply for a range of social security benefits. In addition the ATO examination has revealed that companies and trusts controlled by or associated with such individual taxpayers also pay little or no tax.³

The prevalence of this form of tax minimisation and the extent of revenue at risk was brought to the public arena on 11 February 1996, in the midst of an election campaign, by the former Treasurer in a press release under the heading Increasing the Surplus and Funding: Labor's Election Commitments. The Financial Review of 12 February 1996 stated that Mr Willis described the proposed crackdown on tax avoidance and evasion by trusts, to recover $2.4 billion over 4 years, as 'probably the biggest tax scam since the bottom of the harbour'. In Attachment A to his press release of 11 February 1996 Mr Willis had outlined a number of complex tax minimising arrangements using trusts, including disguising income as capital, using multiple trusts to conceal common control, the creation of artificial losses, and the disguise of income earned by wealthy individuals and their families as loans and other benefits which are non-taxable.

The then Treasurer's press release left little room for doubt that $800 million from anti tax avoidance measures directed at trusts of wealthy individuals would be brought into revenue from 1997-98 and added to the Budget bottom line. The 1996 Budget Papers are more cautious than the pre-election forecast of Mr Willis. Thus Budget Paper No. 1 only provides for additional revenue of the order of $100 million in 1997-98 from high wealth individuals with no figure being put on the possible intake in 1998-99 and 1990-90.⁴

This cautious approach in the 1996 Budget Papers, in contrast with the then Treasurer's statement on 12 February 1996 relating to additional revenue, raises issues of significance in the context of the proposed Charter of Budget Honesty and these have been dealt with in this review under that head.

It is relevant to note that the use of trusts for tax avoidance has a long history. The attempts made in recent years to effect tax reform in this complex area can conveniently commence with Draft White Paper issued by the Treasury in June 1985 on the Reform of the Australian Tax System, as its major contribution to the July 1985 Tax Summit. Chapter 5 of the Draft White paper dealt with the erosion of the company tax base with the substitution of trusts for companies and attendant tax minimisation schemes. The concluding paragraph 5.27 stated:

Since the July 1985 Tax Summit, the previous Government introduced various measures aimed at tax reform such as treating public trading trusts as companies for tax purposes but stopped short of extending this treatment to all trusts.

Tax base protection measures in relation to withholding tax

Part IVA which contains the general anti-avoidance provisions of the Income Tax Assessment Act 1936 was introduced by the then Treasurer, Mr John Howard, who had stated that the arrangements of a normal business or family kind, including those of a tax planning nature, will be beyond the scope of Part IVA.⁵ Mr Howard had indicated that the purpose of Part IVA was to:

It is therefore significant that Mr Peter Costello, the Treasurer in the Howard Government, should in his first Budget Speech announce a measure to extend its operation. He stated:

The question of using withholding taxes to curtail tax avoidance also received attention in the pre-election Budget of 1992 to bridge the deficit totalling approximately $2.0 billion for the years 1994-95 and 1995-96. However, following the furore on the revelation of the likelihood of imposing withholding taxes, the then Treasurer Mr John Dawkins issued a Statement on Tax Policy which included an ATO estimate of raising $1.7 billion in the years 1994-95 and 1995-96, with a Compliance / Enforcement Strategy to replace the option of withholding taxes.

In 1991, the House of Representatives Standing Committee on Finance and Public Administration (SCFPA) investigated tax avoidance in the withholding tax area triggered by allegations made by the Melbourne academic Ms Barbara Smith that discretionary trusts are one of the main vehicles for withholding tax schemes. The SCFPA reached the inevitable conclusion that a system of uniform taxation of trusts and companies will eliminate tax avoidance opportunities and make revenue neutral the vehicle chosen for economic activity. In its report titled Follow the Yellow Brick Road⁸, SCFPA recorded that under the United Kingdom legislation the income of a trust is taxed at a flat rate (35 per cent for 1991) with the assessment raised on the trustee. The payment made to a beneficiary from the trust is treated as income and the tax paid by the trustee being available as a credit to the beneficiary. This is equivalent to treating the trust as a company and the beneficiary as a shareholder for tax purposes.⁹ In Recommendation 3, the SCFPA suggested the adoption of this model when it stated:

The SCFPA investigation had been triggered by the claim of Ms Smith that the revenue loss through withholding loss arrangements was of the order of $943 million per year in total withholding tax abuse. The ATO had been able to provide to the SCFPA an estimate that the tax avoided by such non-resident beneficiary arrangements was in the range of $100 million to $250 million, but the SCFPA formed the view that the evidence was inconclusive.

The tax avoidance measures announced by the Treasurer in relation to high wealth individuals and the application of Part IVA to withholding taxes are decisive steps to curtail an avenue of tax evasion and tax avoidance. It however falls short of the broad thrust of the recommendations made by the SCFPA in Recommendation 3 of its 1991 report Follow the Yellow Brick Road to move towards taxing trusts as companies.

Endnotes

SUPERANNUATION

John Harrison

The policy

Superannuation is the process of providing funds through employer and employee contributions so that periodic or lump sum payments can be made available upon cessation of work, either because of age or due to death, poor health or other infirmity. Australia has recognised the growth of its ageing population and that the aged will be living longer. The scenario forecasts that there will be a generation of too few workers to support the aged in their retirement, based on the pension being the principal form of retirement income. Superannuation continues therefore to be a central vehicle of the Government's retirement income policy. It helps to cope with an ageing population and assists Australia's national savings. As at March 1996, assets in superannuation funds totalled some $243.8 billion.

Election commitments

The Government has honoured its election commitments:

• Labor's One Nation tax cuts to be paid in full into super or similar savings vehicles; and
• Banks have been allowed to compete for super though Retirement Savings Accounts.

Effects of Superannuation reform

By and large, it is considered that the superannuation reform introduced has maintained confidence in the superannuation system. There was a lot of speculation prior to the Budget about how this highly concessionary industry could be affected, in particular through Budget leaks. However, much of this speculation has been found to be unwarranted.

Under the Budget, the range of measures has been designed by the Government to make superannuation arrangements fairer, more flexible and better suited to the needs of the modern workforce. The measures are entirely prospective and their net effect is to reduce revenue by:

• $47 million in 1997-98;
• $139 million in 1998-99; and
• $122 million in 1999-2000.

The superannuation measures in brief

The key measures introduced into the 1996-97 Budget regarding superannuation include:

• Surcharge of 15% on high income earners;
• Retirement Savings Accounts (RSAs);
• Contribution limit - 70 years;
• Superannuation low income spouse rebate;
• Opting out of super for low income earners;
• Capital Gains Tax (CGT) - exemption for sale of a small business;
• Abolishing super standard contributions limit; and
• Super Review - Employee contributions and the Government co-contribution.

Surcharge of 15% on high income earners

The concessionary nature associated with superannuation has been biased in favour of high income earners and the Government has decided to make the system more equitable.

From 20 August 1996, the Government has imposed a 15% surcharge on tax deductible employer contributions where the annual income of an employee is $85 000 or greater. There is a phasing in of the surcharge of 1% for every $1000, from $70 000 upwards to the full rate of 15% at $85 000. For the purpose of the surcharge, the annual income is defined as taxable income plus any employer / self employed deductible superannuation contributions for the year of income. This is to prevent the use of salary sacrifice to avoid the surcharge.

The surcharge will apply to tax deductible contributions made to any superannuation fund, including defined benefit funds, unfunded superannuation schemes and in the near future, Retirement Savings Accounts, by or on behalf of high income earners. The surcharge will not affect people already in retirement, nor will it affect already accrued superannuation benefits, including all past contributions and earnings on those contributions.

An Actuarial Advisory Committee will be established to advise the Government on the technical details of the application of this measure to defined benefit funds and unfunded and Constitutionally protected schemes, including any transitional arrangements.

Criticisms of the policy reported in the media have been mixed. Some have welcomed the policy in terms of its fairness, while others consider it creates a new wrong. Some tax advisers see that it is more equitable because the wealthy no longer receive the large concession from super arrangements. However, some advisers argue that under this policy, super is still seen as tax effective.

Those tax advisers who see it unfavourably have stated that it will force high paid employees out of the traditional salary sacrifice arrangements, where they will be encouraged to transfer their packages towards non-cash remuneration such as cars, payment of school fees and other costs, income splitting through trusts and the early repayment of a family home. There has also been speculation that there will be a move of investments away from superannuation to more favourable investments like negative gearing.

From a technical point of view, it is argued that a basic principle of income tax is that governments should only tax income in the hands of the taxpayer. Superannuation contributions are not income in the hand and may be locked up for 20 or 30 years. They should not be taxed on the basis of the contributor's income at contribution time, because when the benefit of the contribution is ultimately received, the superannuate may be a low income earner.

The policy has also been criticised by super funds because the administration of differential taxing poses a large administrative burden that would impose higher costs on all fund members.

Retirement Savings Accounts-RSAs

To enhance competition and choice the Government has decided to allow banks, building societies, credit unions and life insurance companies (life offices) to provide superannuation without a trust structure in the form of Retirement Savings Accounts (RSAs). It is seen that RSAs will particularly assist people with small amounts of superannuation and those close to retirement.

RSAs will be required to be 'capital guaranteed' and subject to the same retirement income standards and taxation benefits as other superannuation products. The Government expects that approved financial institutions will be able to offer RSAs from 1 July 1997.

The accounts into which a member and/or an employer on the member's behalf will be able to make deposits, have been designed to be fully portable, owned and controlled by the member and subject to the retirement income standards of superannuation products, including preservation. RSAs will also be able to accept superannuation contributions on behalf of non-working and low income spouses.

The Government maintains that RSAs will be a simple, low cost, low risk product especially suited to those with small amounts of superannuation such as itinerant and casual workers, those wishing to amalgamate several small superannuation accounts and those nearing retirement (wishing to minimise risk). Their introduction will complement existing arrangements by increasing competition and choice in the superannuation industry, thereby putting downward pressure on fees and charges and encouraging better standards of service.

The Government also considers that the provision of RSAs will benefit employers looking for a convenient superannuation vehicle for small contributions under the Superannuation Guarantee arrangements. Many employees will also benefit-such as those with broken work patterns, a particular problem for women, and itinerant employees-as RSAs will provide a flexible product to accommodate small and irregular contributions. Fees should also be low and the accounts will be subject to the member protection rules which apply to accounts with small balances (less than $1000).

Further, RSA providers will benefit from being able to offer cost-efficient delivery of superannuation and the ability to use more explicitly the institutions' name in marketing superannuation, as well as from enhanced customer relationships through provision of one stop shop services.

The concept of RSAs is very simple, and the Government sees optimistic outcomes from their introduction. Banks and like financial institutions are keen to become involved in the superannuation arena. However, the superannuation industry itself, by and large, has not warmly embraced RSAs.

Criticisms of the RSAs by the industry include:

• doubt about the policy in terms of its costs vs benefits;
• there will be more paperwork, more administrative activity;
• more marketing will be required to attract and retain members;
• there will be larger administration costs for employers, in particular for employers who have seasonal workers;
• employees are not necessarily better off with choice, given the poor knowledge base;
• higher service levels for employee enquiries will be required;
• there is complexity associated with RSAs in regard to tax and legal complications which are confusing for casual workers and approaching retirees;
• where there are membership dilutions of funds, there will be loss of economies of scale;
• smaller pools of assets (because of increased diversity of funds being used) means less efficiency in the markets and higher costs; and
• there will be higher transaction fees on employer accounts (more transaction because the money is disbursed to more places).

Accordingly, while prima facie the policy seems simple, easy and efficient, implementation may give rise to an array of problems.

Contribution limit-70 years

In terms of flexibility, from 1 July 1997 individuals are to be allowed to continue contributing to a regulated superfund up to age 70, provided they maintain a bona fide link with the paid workforce (that is they are gainfully employed for at least 10 hours per week over the year). The exemption age for the Superannuation Guarantee arrangements will also be increased from 65 to 70.

Superannuation low income spouse rebate

The Government seeks to make superannuation more responsive and flexible to people's lifestyle needs. From 1997-98 there is to be a rebate of 18% for superannuation contributions of up to $3000 per annum made by income earning individuals to the superannuation fund or RSA of a non-income earning or working spouse with an income below $10 800 a year. The contributions rules for superannuation will also be amended to allow such contributions.

Opting out of super for low income earners

From 1997-98, the Government will allow employees earning between $450 and $900 per month from an employer, the opportunity to negotiate the payment of additional wages or salary in lieu of Superannuation Guarantee (SG) contributions.

This policy has been received favourably for its short term flexibility, though some in the superannuation industry fear the potential impact which will reduce asset accumulations, and therefore reductions of retirement benefits for retirees in the future.

Capital Gains Tax (CGT)-exemption for sale of a small business

The Government will proceed with its election commitment to allow individuals to claim an exemption from capital gains tax (CGT) on the sale of a small business where the proceeds are used for retirement. The exemption will be restricted to businesses not wholly engaged in passive investment and will only apply where a direct interest in business assets is sold. Individuals will be allowed to claim a CGT exemption on or up to a total maximum capital gain of $500 000. The exemption can be claimed by a person aged 55 or older, or by younger people if the proceeds are rolled over to a superannuation fund or Approved Deposit Fund to be preserved until the superannuation preservation age (currently age 55).

For further information, refer to the general section on Taxation accompanying this section of the review.

Abolishing super standard contributions limit

The standard contribution limit allows an employer, who has ten or more employees, to elect to deduct superannuation contributions from assessable income using a standard limit per employee (currently $27 170). This limit is to be abolished on 20 August 1996. From that time a deduction will not be allowed for that part of employer contribution that will take the total employer contribution applicable to an employee over the age based limits for the 1996-97 or subsequent income years.

This proposal is considered to be fairer and will limit arrangements where large sums are paid for executives as part of their salary sacrifice.

Super Review-Employee contributions and the Government co-contribution

The Government has made provision in the forward estimates for payment equivalent to the 'LAW' tax cuts, as described in the 1995-96 Budget, to be delivered as matching government contributions to employee contributions to superannuation.

The Government will review the mechanism for the delivery of this contribution to ensure it is paid in an equitable and effective way, in conjunction with a review as to the technical implementation and workability of compulsory employee contributions.

The Government reserves the right to deliver this assistance to superannuation or like savings.

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Last reviewed 13 August 2001 by the Parliamentary Library Web Manager
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