Budget Review 1997-98

May 1997

Contents

Introduction
Public Policy Context and Outlays Overview
Statistical Overview
Macro-Economic Policy Perspectives
Taxation Issues
Personal Savings Tax Rebate
Superannuation and Savings
The Defence Efficiency Review (DER) and Defence Reform Program (DRP)
Restructuring the Defence Budget
Outsourcing of Commonwealth Government Information Technology
Detailed Portfolio Reviews

Introduction-John Kain

This Review is designed to provide Parliamentarians with timely background, analysis and commentary on the 1997-98 Budget 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 addresses the impact of Budget measures on a portfolio basis, identifying those programs or sub-programs which would be affected most significantly from a financial perspective. It also highlights activities which will be subject to significant changes in policy direction, even if the financial implications of the Budget are relatively minor.

There have been some changes to program structures reflecting policy initiatives taken since the last Budget. Such changes may involve the creation of new programs or the elimination or merging of other programs; where relevant, the Review offers some explanation of these 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 policy rationale and implications of Budget measures 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 particular programs or sub-programs;
• the direction in which the 1997-98 Budget will lead the selected programs or sub-programs;
• the policy strategies underlying the directions proposed in the Budget; and
• where applicable, 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 provides 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. The following overview sections examine aspects of the Budget which have wide ranging fiscal implications across most activities of Government and which are also of prime concern to households and firms-specifically the Budget's taxation and superannuation policy initiatives and the tax rebate for savings measure. Initiatives in the area of the Defence budget and the outsourcing of Government information technology are also addressed

Public Policy Context And Outlays Overview-John Kain

This section is primarily descriptive and draws heavily on the official Budget Statements. Its purpose is to provide a broad public policy overview of the Budget and to highlight some of the key directions of outlay initiatives.⁽¹⁾

Public Policy Context

The Government's Budget priorities have been framed in the context of its broader social and economic priorities, in particular, the goal of achieving rising living standards and enhanced employment opportunities while meeting its social responsibilities. The Budget documentation identifies the latter as encompassing responsibility for public goods and services which the private sector cannot supply and the provision of a social safety net for Australians in need.

Within this context, the overriding aim of the Government's Budget strategy is stated to be the achievement of the maximum sustainable rate of reduction in unemployment by lifting the pace at which economic growth can be maintained without running into inflationary and external pressures, specifically current account deficit pressures.

The need for corrective policy responses to such pressures in the past have cut short periods of economic expansion in Australia, with adverse effects on growth and unemployment. The Government therefore considers that its economic strategy needs to be directed at alleviating these constraints by pursuing the public policy objectives of :

• keeping inflation low
• promoting an adequate level of saving to finance investment
• improving the supply capacity and flexibility of the economy through microeconomic reform.

The Inflation Objective

The Budget policy framework stresses that the maintenance of low inflation is important in avoiding spending and savings distortions and maintaining confidence in the economic outlook by reducing risk and uncertainty-including the risk of policy tightening. Australia's recent inflation performance is seen as a welcome improvement on the record of the previous twenty years.

In order to sustain the progress made to date, the Government has taken steps, through the Statement on the Conduct of Monetary Policy released by the Treasurer and the Governor of the Reserve Bank in August 1996, to strengthen the policy framework. In particular, the Government has endorsed the Bank's inflation target (underlying inflation of 2-3 per cent on average over the economic cycle) and enhanced policy credibility by clearly recognising the RBA's independent role in setting interest rates. The inflation outlook reflected in the Budget forecasts points to a continuation of low inflation; the Treasury's 'underlying' CPI forecast for 1997-98 (year average) is 2 per cent.

The Savings Objective

An important element of the Government's economic strategy is the goal of lifting national saving to a level adequate to finance national investment without having to rely excessively on foreign saving. The Government considers that excessive reliance on foreign saving is likely to result in higher borrowing costs and exposes Australia to sudden and disruptive shifts in market confidence.

Australia's large structural current account deficit reflects both inadequate national saving and inadequate investment returns overall. On the saving side, the principal cause is a deficiency in public saving especially at the Commonwealth level. The Budget provides for the pursuit of the savings objective through (1) fiscal consolidation measures to increase public saving at the Commonwealth level and (2) through measures to encourage private saving.

Notwithstanding these measures, the Budget forecasts suggest that the current account deficit will rise from an estimated $20 billion in 1996-97 (33/4 percent of GDP) to $21 billion in 1997-98 (4 per cent of GDP) while the household saving ratio will remain at 41/2 per cent, the same as that estimated for 1996-97.

The Microeconomic Reform Objective

The Government considers that the primary role of microeconomic policies is to improve the supply potential of the economy, to improve the operation of markets and to enhance worker skill levels. The Government's microeconomic reform priorities include labour market reform, competition policy, education and training, transport, small business deregulation and financial system reform.

The Government has placed particular emphasis on enhancing labour market flexibility through the Workplace Relations Act 1996. The new industrial relations framework is aimed at increasing the focus on workplace bargaining and limiting the role of the award system to that of a safety net, providing more choice in, and streamlining the process for, making workplace agreements and preventing excessive use of bargaining power by employers and employees. The Budget discussion observes that these changes have only come into effect very recently and will take some time to be utilised but that they will be crucial in reducing structural unemployment.

The Budget forecasts indicate that the Government expects the unemployment rate to fall from the 1996-97 estimate of 83/4 per cent (year average) to 81/4 per cent (year average) in 1997-98.

Overview of Outlay Initiatives

The 1997-98 Budget is significant in providing for an actual decline in real underlying Commonwealth outlays; if this goal is achieved, it will be the first time such outlays have declined since 1988-89 and will be contrary to longer term trends. For example, since 1960-61, real underlying outlays have grown in all years excepting 1987-88 and 1988-89. Throughout the 1960s, the average annual growth in estimated real underlying outlays was some 6.2 per cent, while the corresponding figure for the 1970s was also an estimated 6.2 per cent. In the first half of the 1990s, the average annual figure was some 4.7 per cent. Underlying outlays are estimated to have increased in real terms by 1.1 per cent in 1996-97 while a 1.4 per cent decline is estimated for 1997-98.

The Budget papers suggest a resumption in growth in real underlying Commonwealth outlays from 1998-99, but the forecast growth figure is a low 0.1 per cent while a projected growth of 0.5 per cent is identified for the year 1999-2000. Such outlays trends are in the context of forecasts of a continually growing GDP, suggesting a significant decline in outlays as a proportion of GDP. In 1995-96, this ratio was around 27.0 per cent; it is projected to fall to 22.9 per cent by 2000-01; this would be the lowest level of relative outlays since 1973-74, when underlying outlays were 20.5 per cent of GDP.

It is noteworthy that in general, the extent of outlay reduction measures proposed in this Budget are of a smaller magnitude than those adopted in the 1996-97 Budget, which has no doubt contributed to common public and media perceptions that this Budget is not as fiscally stringent as was last year's. However it needs to be borne in mind that many of the 1996-97 outlay reduction initiatives have continuing application in 1997-98 and subsequent years.

Major outlay measures for 1997-98 introduced in the Budget include:

As noted above, compared with the 1996-97 Budget, this year's Budget contains relatively few major new outlays measures; however many of the initiatives taken in the last Budget have a continuing effect on outlay patterns in 1997-98 and subsequent years.

The relative impact of Budgetary outlay measures on a portfolio basis is summarised in the following schedule together with aggregated forward estimates for each portfolio:

Underlying Outlays by Portfolio

(a) Increase in Finance outlays in 1997-98 primarily reflects cost of the Telstra sale in 1997-98 and proceeds from the sale of DASFLEET reducing outlays in 1996-97.

(b) Decrease in Administrative Services outlays in 1997-98 primarily reflects divestment of real property.

Government Departments and Agencies: Running Costs

Running costs are the recurrent and minor capital costs incurred by a budget department or agency in providing the Government with services for which it is responsible. They include salary costs, administrative expenses, employer superannuation costs and property operating expenses.

The schedule below shows the 1997-98 Budget and forward estimates of running costs for all portfolios. In nominal terms running costs are expected to increase by 0.8 per cent from 1996-97 to 1997-98 while in real terms they are expected to decrease by 1.1 per cent. Approximately $300 million is being carried forward from 1996-97 running costs budgets into 1997-98.

Substantial restructuring is being undertaken by Commonwealth departments and agencies in achieving Government objectives. Although no staffing targets have been set by the Government, relevant portfolios are expected to address staffing levels in the context of resources made available under running costs arrangements.

The total average staffing level (ASL) in running costs agencies is forecast to decline by 4285 in 1997-98 as compared to 1996-97. ASL is projected to decline to some extent in most portfolios. The anticipated increase in ASL in the Social Security portfolio largely reflects and is offset by the transfer of staff from the Department of Employment, Education, Training and Youth Affairs to the new Commonwealth Services Delivery Agency, which commences operation on 1 July 1997.

Based on point-in-time figures provided by Public Service Act agencies to the Public Service and Merit 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 16 500 between 30 June 1997 and 30 June 1998. This compares with a reduction of 11 200 now expected by Public Service Act agencies to occur between 30 June 1996 and 30 June 1997.

The expected reduction of staff numbers in the APS in the year to 30 June 1998 reflects the Government's restructuring of the public sector and includes the sales of businesses in the Department of Administrative Services and the transfer of the employment placement function out of the APS to the Public Employment Placement Enterprise (PEPE) and to private sector providers. PEPE will be a wholly-owned Commonwealth company with staff employed outside the Public Service Act.

Total Running Costs Budgets by Portfolio

(a) ASL figures are as provided by portfolios.

Endnote

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.

Underlying and Headline Outlays and Balances

In the 1996-97 Budget, the concept of underlying outlays and underlying balances was introduced to replace the headline amounts that have been used in the past. The underlying concept removes net advances and is thought to be a more reliable guide to trends in Commonwealth finances. (Net advances mainly include the items of equity asset sales and repayment of State debt). Also, 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 saving).

Portfolio Outlays

In this Budget, the underlying outlays concept has been extended to the portfolio outlays and underlying portfolio outlays are now published in Budget Paper No. 1. Portfolio outlays are the aggregation of outlays according to the Ministry which has the administrative responsibility for them. Table 1 shows the underlying outlays for each portfolio for 1996-97 along with estimates for 1997-98 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.

Table 1: Underlying Outlays by Portfolio, Current Prices.

Table 2 shows the headline outlays by portfolio and has been included for comparative purposes with Table 1. Headline outlays are no longer published in Budget Paper No. 1 but are published in the Portfolio Budget Statements (Budget Related Papers).

Table 2: Headline Outlays by Portfolio, Current Prices

Care should be exercised when assessing portfolio outlays figures as they may be significantly smaller than the corresponding total appropriations because of adjustments. Adjustments comprise Section 35 receipts, other receipts offset within outlays (e.g. assets sales and monies received from repayment of advances), movements in trust fund balances (e.g. the establishment of the Federation Trust) and appropriations classified as financing transactions (e.g. redemption of Commonwealth debt).

Budget Aggregates

The Budget aggregates are revenue, outlays and balance. Table 3 presents a time series of the Budget aggregates from 1960-61 to 1995-96 and estimates, forecasts and projections for future years to 2000-01. As this is the second Budget where underlying outlays have been used, and they are considered more appropriate for financial analysis, these are the only outlays data that have been shown. The revenue information has been split into its tax and non-tax components and all data are expressed as percentages of GDP to allow meaningful comparisons to be made over time.

Table 3: Budget Aggregates, 1960-61 to 2000-01.

The information in Table 3 is also displayed graphically in Charts 1 and 2. From Chart 1 the dominance of tax revenue as the major source of revenue is striking, while Chart 2 plots revenue against underlying outlays with the difference between the two series being the Budget balance-either deficit or surplus.

Chart 1: Budget Revenue, Tax and Non-Tax

(Percentage of GDP)

Chart 2: Budget Revenue and Underlying Outlays

(Percentage of GDP)

Macro-Economic Policy Perspectives-Phil Hanratty

Main Aggregate Features of the Budget

The 1997-98 Budget continues with the fiscal consolidation program begun in the 1996-97 Budget. It again focuses upon the 'underlying' Commonwealth budget deficit (which excludes loan transactions and asset sales) as a key performance indicator for fiscal policy, since it is widely agreed that this gives a more accurate picture of the effect of fiscal policy on the economy than the more encompassing 'headline' budget deficit.

This Budget achieves a further reduction in both this underlying deficit measure and in the relative size of underlying Commonwealth spending.

The level of underlying Commonwealth outlays are estimated to increase by just 0.5% in nominal (current dollar) terms in 1997-98 and to fall by 1.4% in real (inflation adjusted) terms. This is the first time since 1988-89 that such outlays will have fallen in real terms, although the percentage magnitude of the reduction in 1988-89 was much greater than the reduction which is estimated for 1997-98. Commonwealth revenue is also estimated to increase by 2.9% in nominal terms in 1997-98 and by 0.9% in real terms.

It is interesting to note here some changes in the size of Commonwealth spending relative to the total economy. The ratio of Commonwealth underlying outlays to Gross Domestic Product (GDP) increased gradually in the decades after World War II and reached a peak of 29.4% in 1984-85. Under the weight of fiscal consolidation and ongoing economic growth, this ratio fell to 24.1% in 1989-90, after which it again rose, due to the effects of recession and the introduction of fiscal expansion measures to stimulate the economy.⁽¹⁾

The current phase of fiscal consolidation, along with ongoing economic growth, has again helped to generate a fall in the ratio. It is estimated that this ratio will fall to 25.2% in 1997-98, with further reductions projected in the following years, based upon the assumptions of ongoing steady economic growth and the continuation of current fiscal policy settings.

The Commonwealth's underlying budget deficit is estimated to fall to $3.8 billion, or 0.7% of GDP, in 1997-98, compared to an estimated $6.8 billion, or 1.3% of GDP, in 1996-97 (see Chart 1). This deficit reduction seems very largely due to a combination of forecast stronger economic growth (about 3.75% in 1997-98 compared to an estimated 3.25% in 1996-97) and the ongoing effects of measures contained in the 1996-97 Budget. New fiscal measures contained in the 1997-98 Budget seem to have made only a relatively minor contribution to the lower underlying deficit expected next financial year.

The Commonwealth's underlying deficit has fallen gradually from its peak of 4.2% of GDP in 1992-93, which was recorded in the wake of recession and in the midst of fiscal expansion measures to stimulate the economy. Indeed, underlying budget surpluses are projected for the Commonwealth in the years after 1997-98, again based upon the assumptions of ongoing steady economic growth and the continuation of current fiscal policy settings (see Chart 1).

Underlying deficit reduction and asset sales are expected to be sufficient to allow the Commonwealth to reduce its outstanding debt levels in 1997-98. The aggregate face value of Commonwealth Government Securities on issue is expected to fall by about $5 billion over the course of 1997-98.⁽²⁾

Chart 1: Headline and Underlying Budget Balance

Source: Budget Statement No. 1, 1997-98: 1-11.

Main Macro-Economic Aims of the Budget

In the 1996-97 Budget the Commonwealth Government committed itself to pursuing, as a guiding principle, the objective of underlying budget balance on average over the course of the economic cycle. This fiscal policy is designed to ensure that the Commonwealth Budget does not, over time, make a net call upon private saving and thereby contribute to the national savings-investment balance and its external face, the current account deficit (CAD).⁽³⁾

The 1996-97 and 1997-98 Budgets implement deficit reduction in order to achieve this goal over the current economic cycle. Fiscal consolidation in years of steady growth in output and employment allows, on this view, fiscal expansion and increasing budget deficits when output and employment weaken or fall.

This fiscal strategy implies that the Commonwealth Government will, on average, attain a small, positive level of saving itself since such saving is essentially defined as Commonwealth revenue minus current Commonwealth consumption outlays. That is, underlying Commonwealth capital outlays, now generally of the order of something less than 1% of GDP, will be financed by tax and non-tax revenue rather than through borrowings, on average. Average Commonwealth saving, and its direct contribution to national saving, will be of this order of magnitude.

A central rationale for this fiscal strategy which has been often presented by the Commonwealth is that it will help to bolster national saving levels (i.e. the sum of public and private saving) and thus loosen the 'external constraint' (of large current account deficits) upon economic growth and employment growth in Australia. Initially, the stated goal of the current Commonwealth Government seemed to be one of reducing the Current Account Deficit while maintaining growth. More recently, its goal seems to have moved much closer to the milder goal of encouraging and expecting higher growth to occur without substantial increases in the CAD.

Higher national saving is viewed as being able to contribute to dealing with both of these formulations of the nature of the external constraint.

The Commonwealth Government also believes that the new tax rebate on savings, along with other policy measures contained in the 1997-98 Budget, will help to bolster national saving, through their encouragement of higher household saving, and thus help with relieving the external constraint upon growth. This tax rebate is discussed in a later article in this Budget Review.⁽⁴⁾

Effects on the Economy

As noted above, the 1997-98 Budget Papers estimate that growth in GDP will be about 3.25% in the current financial year, 1996-97, while growth in non-farm GDP is estimated to be lower still, at about 3%.⁽⁵⁾ Such growth clearly seems somewhat below that which the economy could have sustained, and certainly below that growth rate necessary to substantially reduce unemployment. The unused productive capacity so generated is one principal reason why higher expected growth in 1997-98 is, in turn, not expected to generate much excess demand pressures, and thus not place much upward pressure upon wage and price inflation.

It can be plausibly argued that the fiscal contraction contained in the 1996-97 Budget was one factor contributing to this less-than-optimal economic growth performance in the current financial year. Substantial cuts to Commonwealth spending on both goods and services and transfer payments were made in last year's Budget. In and of itself, this could be expected to reduce the growth in aggregate household income and consumption spending. This is exactly what the Budget estimates for 1996-97 show: the growth in real household disposable income (RHDI) fell from 4.3% in 1995-96 to an estimated 3% in 1996-97, while growth in private consumption spending fell from 4.2% in 1995-96 to an estimated 2.75% in 1996-97.⁽⁶⁾

Of course, other factors were at work in these slower growth rates, such as a substantial fall in the growth rate of farm production. Nevertheless, the fiscal contraction also probably played some role.

Growth in RHDI is forecast to accelerate to about 3.75% in 1997-98 while growth in private consumption is forecast to accelerate to about 3.5%. Higher growth in consumption is a principal reason why GDP growth is expected to accelerate, since consumption is a large part of total spending in the economy. This stronger forecast impetus to consumption in particular, and private final demand in general (if they eventuate), actually provides a better setting in which a strong fiscal contraction could take place than the weaker economic situation of 1996-97.

On the other hand, the strength of fiscal contraction which is planned in 1997-98 is clearly much weaker than that in 1996-97. In the current financial year of relatively weak growth in output and employment, the underlying budget deficit is estimated to have fallen by 0.8 percentage points of GDP. In contrast, despite the stronger growth expected in 1997-98, the deficit is forecast to fall by the smaller amount of 0.6 percentage points of GDP. Thus, the enduring, 'structural' fiscal tightening which occurred this financial year (which excludes transient 'cyclical' effects from changing economic conditions) is considerably larger than that expected next year.⁽⁷⁾

Overall, in the best of all possible macro-economic policy worlds, it might have been desirable to have a mild fiscal contraction in the current financial year and a stronger fiscal contraction next financial year, in order to provide smoother growth in demand, output and employment. The weaker private impetus for growth seen this financial year would have thereby had to confront only a relatively mild fiscal contraction instead of a strong one.

Of course, such policy judgements are relatively easy in retrospect but much more difficult to make at the time when faced with limited and often incoherent economic information. They also conflict with arguments about the 'political fiscal cycle' which assert that governments can only politically afford the 'bitter medicine' of strong fiscal contraction in the first year of their parliamentary term, unless a clear situation of national crisis emerges at other times.

The role of monetary policy can also be examined in the light of the somewhat inadequate recent experience on growth in output and employment. Although principally concerned with inflation control, monetary policy can, in principle and within this inflation constraint, help to compensate for the deflationary effects of fiscal contraction, so long as it is timed appropriately.⁽⁸⁾

Given that forecasts from the last Budget clearly indicated that underlying inflation was falling back towards its target range of 2-3%, it could be argued that the Reserve Bank of Australia (RBA) should have moved somewhat earlier to relax monetary policy (i.e. to lower official, short-term interest rates), in order to bolster spending on investment (business and residential) and durable consumption spending (e.g. on motor vehicles and household goods).⁽⁹⁾ Both types of spending are both quite sensitive to interest rate settings.

Indeed, it could be viewed as very lucky that the one-off fall in residential lending rates, brought about by intensified competition amongst such lenders occurred when it did and, thereby, fortuitously bolstered confidence and optimism in the economy, just as the effects of the fiscal contraction came into force. Without these, the RBA's monetary policy approach could have looked very anomalous and damaging to the economy.

On the other hand, it could be argued that it was very sensible of the RBA to be cautious about monetary policy relaxations at a time when it was (and still is) attempting to establish the credibility of its low inflation target and thus to lock in expectations of low inflation amongst wage and price setters, investors and consumers.

Turning to the coming financial year, while the forecast higher growth in demand, output and employment are welcome, there seem to be some 'downside' risks that they may not be met. Growth in RHDI and private consumption might be weaker than expected. This could be due in part to moderate ongoing wage growth and the relatively small recent outcome for the 'Living Wage' case before the Australian Industrial Relations Commission. As well, employment growth could be less than expected, due to the delayed effects of reduced output growth in 1996-97.

While growth in non-wage incomes will probably be stronger next financial year (although farm production is expected to fall), the lower propensity to spend out of income amongst such income earners may not generate sufficient consumption growth to achieve the Budget forecasts.

In this context, and with inflation expected to remain at the lower end of its target range, an early and relatively small further relaxation in monetary policy might be warranted to ensure that growth forecasts are met for next financial year. Investment and consumer durable spending would thus be further encouraged. Indeed, the RBA announced just such a small relaxation of 0.5 percentage points on 23 May, 1997.⁽¹⁰⁾

Again, these policy judgements and decisions are very difficult to make at this early, uncertain stage. Clearly, good macro-economic policymaking is, for these very reasons, 'just as much an art as a science'. That is, judgement plays a role alongside the use of quantitative macro-economic model simulations.

These situations again highlight the crucial importance of having access to accurate economic forecasts to guide macro-economic policy decisions. This is especially so for monetary policy whose lag of impact upon the economy is widely regarded to be significantly longer (and sometimes more variable) than that for fiscal policy. Of course, the associated dilemma for policymaking is that the farther into the future such forecasts range, the less reliable they generally become.

These cases also highlight the substantial problems of coordinating fiscal and monetary policy to help generate smooth and adequate growth in output and employment. This is especially so in an institutional context where these policies are operated by separate bodies (i.e. the Cabinet and the substantially independent RBA) which may have quite distinct (and somewhat different) perceptions, concerns and priorities about the performance of the economy.

Endnotes

1. Budget Paper No. 1, 1997-98, pp. 2-63.
2. ibid, pp. 6-5.
3. ibid, pp. 1-10.
4. 'Personal Savings Tax Rebate' by Phil Hanratty and John Harrison.
5. Budget Paper No. 1, 1997-98, pp. 2-4.
6. ibid, pp. 2-4.
7. ibid, pp. 2-63.
8. Indeed, the Reserve Bank Act 1959 specifically mentions 'the maintenance of full employment' as a policy goal, alongside that of inflation control.
9. For the latest example of this view, see: Terry McCrann, 'Beazley Must Get Hip on Reform', Australian, 24-25 May, 1997.
10. Paul Cleary and Tom Allard. 'Banks Slice into Rate Cut', Sydney Morning Herald, 24 May, 1997. For a somewhat pessimistic view of this relaxation, see: Editorial 'Be Prepared for Tightening', Australian Financial Review, 26 May, 1997.

Taxation Issues-Bernard Pulle

Budget Measures to Enhance Tax System Integrity-Is it Incremental Tax Reform?

In his Budget Speech the Treasurer announced various measures to enhance the integrity of the tax system by dealing with tax avoidance, unfair minimisation and evasion:

In a Press Release on 13 May 1997 entitled '1997-98 Budget-Major Revenue Measures', the Treasurer stated that measures aimed at tax base protection include: Trust Losses; Taxation of Trusts; Limited Partnerships, Taxation of Distributions Disguised as Loans from Private Companies; Measures to Prevent Dividend Streaming, Measures to Prevent Trading in Franking Credits, Tax Exempt Entities which Become Taxable-Notional Depreciation, Taxation of Foreign Source Income; Passive Income of Life and General Insurance Companies, Interaction of Foreign Company Measures and Capital Gains Tax Provisions, and Wholesale Sales Tax-Change in Temporary Importation Provisions.⁽²⁾

This section of the Budget Review will briefly examine how some of these measures might enhance the integrity of the tax system and the problems that might be encountered. It will not examine the details of each of these measures which are dealt with in Budget Paper No. 2. The significance of placing Trust Losses and Taxation of Trusts at the top of this list will not be lost to observers of incremental Tax Reform over the last 12 years.

Taxation of Trusts

Commentators have, during this period, suggested that the treatment of trusts (and family trusts in particular), as companies for taxation purposes may be one approach to discourage the use of trusts for income splitting and other tax minimisation practices. This was an approach considered in the Draft White Paper entitled Reform of the Australian Tax System, prepared by the Treasury for the Tax Summit of 1985:

The House of Representatives Standing Committee on Finance and Public Administration (SCFPA) in 1991, in its report entitled Follow the Yellow Brick Road, also recommended that there should be a system of taxing trusts and companies in a uniform manner. This report was issued after the introduction of the company imputation system. Recommendation 3 of this report stated:

The Treasurer announced in his 1997-98 Budget Speech that the Government will issue a discussion paper later in 1997 with a view to reviewing the taxation of trusts generally. The Budget Measures 1997-98 state that this review has become necessary as information gathered by the Australian Taxation Office (ATO) High Wealth Individuals Task Force (HWITF) has identified the use of complex trust structures for tax avoidance or undue tax minimisation. It adds:

The 1996-97 Budget provided additional funds of $19.2 million to the ATO ($9.7 million in 1996-97 and $9.5 million in 1997-98) to establish the HWITF to improve the compliance of high wealth individuals, who it was claimed had with aggressive tax planning and minimisation arrangements put at risk revenue estimated at $800 million a year. The prevalence of this form of tax minimisation and the extent of revenue at risk was disclosed on 11 February 1996, by the then Treasurer, Ralph Willis, in a Press Release under the heading, 'Increasing the Surplus and Funding: Labor's Election Commitments'. Although $800 million per year was the estimated income from tightening up tax minimisation schemes of high wealth individuals, the 1996 Budget Papers were more cautious than the pre-election forecast of Mr Willis. Thus the 1996-97 Budget Paper No. 1 only provided 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 1999-2000.⁽⁶⁾ It added:

It is significant that the Financial Implications of the Taxation of Trusts in the 1997-98 Budget Paper No. 2 do not indicate any additional revenue from the activities of the HWITF in the years 1997-98 to 2000-01. It would appear that even the $100 million which the 1996-97 Budget Papers anticipated would be realised in 1997-98 from the investigation into high wealth individuals is in doubt. The Treasury and the ATO are clearly reluctant to publish an estimate of the revenue that the activities of the Task Force will generate in 1998-89. This reluctance may be attributed to the uncertainties of the extent to which high wealth individuals with family trust structures would be able to utilise losses under the concessions announced in the 1997-98 Budget and referred to in the paragraph 'Trust Losses' below. An additional factor contributing to this reluctance is probably the awareness that the long lead time between the initial announcement in February 1996 and the yet to be enacted measures to curb such avoidance or minimisation practices may have afforded high wealth individuals an opportunity to reorganise their affairs to avoid any likely changes in the law. It is clear that the Government is conscious that timely legislative action may be necessary, even before the completion of the proposed review of the taxation of trusts, to prevent the further erosion of the tax base by the use of trusts. Budget Paper No. 2 states:

In his 1997-98 Budget Speech the Treasurer also conceded that following submissions from small business the proposals in the Exposure Draft of February 1997 relating to the treatment of trust losses will be modified so that they do not affect closely held family trusts utilising losses in the family group. That this was a concession to small business is seen from the attempts since the Budget of 1995-96 to regulate the trafficking in trust losses.

Trust Losses

In the 1995-96 Budget of 9 May 1995, the former Government announced measures to restrict the transfer of ownership or control of trusts that had accumulated losses. These measures were intended to reduce the opportunity for tax minimisation or avoidance by taxpayers with high marginal rates of tax acquiring such trusts and injecting income from other sources with a view to utilising the losses and thereby reducing their marginal rate of tax.

On 10 February 1997 the Government released exposure draft legislation on trust loss measures. The Budget Measures 1997-98 provide the outlines of the modifications to the draft legislation on trust losses⁽⁸⁾. In the 1997-98 Budget Speech, the Treasurer stated that the Government had responded to submissions from small business and would ensure that legislation dealing with the use of trust losses did not affect closely held family trusts utilising losses in the family group.⁽⁹⁾ The measures include the modification of three crucial definitions in the Exposure Draft: Definition of Outsider, Definition of Family Member and Application of the Definition of Benefit.

The exclusion of family groups from the trust loss provisions will probably reduce the additional revenue to be expected from these trust loss measures. As will be seen from the following table, it is significant that under the 1995-96 proposals the additional revenue in the first year was $90 million rising to $185 million in the second year. However, under the 1997-98 proposals the additional revenue in the first year is $5 million rising to $15 million in the second year.

(a) Budget Statements 1995-6, (Budget Paper No. 1), pp. 4-5, Table 2: Revenue Measures.

(b) Budget Measures 1997-98, (Budget Paper No. 2), p. 170

These modified definitions are likely to retain the attractiveness of the trust group as a structure for small business, given the scope for income splitting and tax minimisation and the availability of trust losses to family groups. However, it is necessary to await the Bill before making an informed comment on the consequences of these modifications.

Some Problems in Setting the Benchmark for 'Fair Tax Minimisation'

It is relevant to note that the opportunities for tax minimisation and avoidance have to a large extent been assisted by the liberalisation of trade and cross-border capital flows following deregulation. Thus, on the one hand, it is necessary for business to locate assets and operations offshore to meet challenges resulting from international competition. On the other hand, the opportunities for tax minimisation and avoidance presented by offshore business activity and electronic commerce have posed ever increasing threats to the integrity of tax systems worldwide, reliant mainly on the taxation of income.

Relevantly, after announcing that the Government has now settled details of the system for taxing foreign source income, the Treasurer stated:

There is clearly a difficulty in determining when assets are located overseas purely for taxation purposes. This difficulty also extends to determining what is 'unfair minimisation' referred to by the Treasurer in his recent Budget Speech.

The Wallis Inquiry succinctly stated the dilemma facing governments in managing these twin problems (permitting cross-border capital flows and presenting tax minimisation) as follows.

The Wallis Inquiry, whilst noting that it was beyond its Terms of Reference to make specific recommendations on taxation, has reported on the adverse effect certain taxation policies have on the competitiveness of the Australian financial system. The impact of a range of specific taxation policies is discussed in its report as being impediments to finance sector efficiency and include the Foreign Investment Fund (FIF) measures, Offshore Banking Unit and Regional Headquarters Regime, Interest Withholding Tax, and Tax Effects on Mergers and Reconstructions.⁽¹²⁾ Although there was no specific response in the 1997-98 Budget to calls from the Wallis Inquiry for the removal of taxation impediments referred to in its report, there may be scope when legislating for the broad range of tax base protection measures announced in the 1997-98 Budget to minimise the impact of some of the tax impediments referred to in the Wallis Report.

The need for a review of the taxation of trusts, the concessions made to small business on trust losses and the changes to the taxation of foreign source income are indicative of the dilemma facing the Government as to the extent to which it could go to permit the use of the trust structure or the locating of assets overseas for promoting commerce and finance sector activities in a global environment, whilst curtailing the opportunities they provide for tax avoidance, tax minimisation and tax deferral. In striving to achieve the correct balance it is inevitable that legislation regulating tax minimisation must be detailed and directed at complex transactions. Whilst tax law simplification is a desirable goal in the interest of a better understanding of the law and reducing compliance costs, the law must necessarily deal with complex transactions for the protection of the tax base. In the words of the Wallis Inquiry:

However, there can be no assurance that simplifying tax law will result in the emergence of simpler financial products. Moreover, the simplification of tax law cannot be divorced from a review of the policy underlying the law. The Joint Committee on Public Accounts, which has maintained a watching brief on the progress made by the Tax Law Improvement Project (TLIP) since its inception, has come to this conclusion in its recent report. The JCPA has tabled three reports in Parliament: Report 343 (November 1995), Report 345 (August 1996) and Report 348 (March 1997). In its concluding remarks in Report 348, the JCPA states:

Incremental tax reform over the last 12 years has been initiated by the Commonwealth Treasury and the Australian Tax Office (ATO) and there may be a public perception that they are purely revenue oriented and in the interests of the Commonwealth. This perception has also attached to the work of TLIP, which is a branch project of the ATO. The JCPA in calling for a Revenue Committee of Parliament is in effect seeking the establishment of a role for the Commonwealth Parliament, independent of the ATO and the Commonwealth Treasury, in examining reform measures on an ongoing basis with wider public participation. However, total tax reform involves Federal-State financial relations. A broader forum than a Revenue Committee of the Commonwealth Parliament may be required on a continuing basis to deal effectively with the tax reform issues that will arise from time to time.

All governments that face the prospect of the erosion of the tax base will need to be vigilant and move in with continuing tax base protection measures whenever necessary. Tax reform is an ongoing process and the measures for the protection of the tax base in the 1997-98 Budget are examples of the incremental tax reform that most argue will be necessary to meet the challenges of a dynamic commercial and finance sector environment. These problems are likely to persist even if the indirect tax base is broadened with the introduction of a Goods and Services Tax (GST).

Endnotes

1. Hon. Peter Costello, MP, Treasurer, Budget Speech 1997-98, AGPS, Canberra, 1997, p. 10.
2. Budget Measures 1997-98, (Budget Paper No. 2), AGPS, Canberra, 1997, pp. 170-197.
3. Treasury Reform of the Australian Tax System, Draft White Paper, June 1985, AGPS, Canberra, p. 56, para. 5.27.,
4. Follow the Yellow Brick Road, House of Representatives Standing Committee on Finance and Public Administration, (Report, March 1991), AGPS, Canberra, p. 34, para. 2.118.
5. Budget Measures 1997-98, (Budget Paper No. 2), p. 172.
6. Budget Statements 1996-97, (Budget Paper No. 1), pp. 4-5 and 4-12.
7. Budget Measures 1997-98, (Budget Paper No. 2), p. 172.
8. Budget Measures 1997-98, (Budget Paper No. 2), pp. 170-171.
9. Costello, AGPS, Canberra, 1996, op. cit., p. 10.
10. Costello, op. cit., p. 11.
11. ibid., p. 120.
12. ibid., Chapter 11.
13. ibid., para. 11.3.
14. Joint Committee of Public Accounts, Report 348: An Advisory Report on the Tax Law Improvement Bill 1996, (March 1997) para. 5.3, p. 39.

Personal Savings Tax Rebate-Phil Hanratty and John Harrison

Main Features of the Rebate

The savings rebate (SR) introduced in the 1997-98 Budget will reduce the tax burden on many forms of personal saving. It will be available only to individual taxpayers resident in Australia, and not to other taxpayers and entities such as companies and trusts. It will apply both to superannuation contributions made by employees (or the self-employed) from post-tax income, and to net personal income from many other savings and investments, up to an annual limit of $3 000. The SR scheme is 'universal' in the sense that there is no income test on eligibility for it.

The SR will take effect from 1 July 1998 at a transitional rate of 7.5%, and increase to 15% from 1 July 1999. The maximum rebate (i.e. maximum reduction in tax payable) will therefore be $225 for the financial year 1998-1999 and $450 for the year 1999-2000 and subsequent years (i.e. 15% of $3 000). The SR will thus first apply to superannuation contributions made in, and net unearned income received in, the 1998-1999 financial year.⁽¹⁾

Net income from savings and investments (i.e. gross income minus related allowable deductions) will attract the SR. This will include items such as interest, dividends ('grossed-up' by dividend imputation credits), rents, capital gains, privately funded pensions and annuities (including Commonwealth and State Government employee pensions), assessable bonuses from life insurance companies and friendly societies, partnership income, trust income and attributed foreign income.

Superannuation contributions made by employers or by self-employed individuals, for which a tax deduction has already been claimed will not qualify for the SR. Thus, only personal, 'undeducted' contributions will be eligible for it. Neither will the rebate apply to contributions made on behalf of a spouse, such as those that qualify for the low income spouse rebate announced in the 1996-97 Budget. Nor could a person claim the rebate when his or her spouse has claimed the spouse rebate on those same contributions.

In contrast, net business income received by an individual, other than wages and salaries, derived from operating as a sole trader or a partnership will qualify for the SR. Neither wages and salaries nor income from social security payments will qualify.

The SR will not be refundable in the sense that any SR tax benefits left over after an individual's tax liability has been reduced to zero will not be refunded through a further payment to that person by the Commonwealth. This makes the SR consistent with other tax rebates such as the low income rebate, the pensioner rebate and the franking rebate from dividend imputation. In contrast, the Family Tax Assistance scheme, introduced in the 1996-97 Budget, is refundable in this sense.

Arrangements will be made so that provisional tax payments can be adjusted to reflect eligibility for the SR. Individuals making Pay-As-You-Earn (PAYE) tax payments can also elect to have their tax instalment deductions adjusted to gain the benefit of the SR prior to the assessment of their tax return.

Effects on Household and National Saving

National saving is equal to the sum of public sector and private sector saving. The latter is equal, in turn, to the sum of household and business saving. The SR only applies to the case of households.

The SR will have countervailing effects upon the level of household saving. The SR will directly increase household incomes by the amount of its net cost to revenue for the Commonwealth. When fully operational, this cost to revenue is estimated to be about $2 billion per year. This generates an 'income effect' which is generally thought to reduce household saving. People will be richer, especially those with large existing stocks of assets, and so, it is argued, feel more able to indulge in extra consumption spending, which may increase disproportionately more than disposable income.

As well, people with fixed targets for saving (e.g. for a house deposit or a motor vehicle purchase) will be more easily able to reach those targets over the same anticipated time period, because of the higher after-tax return on new saving. They will thus be free to increase their consumption and reduce current saving efforts, while maintaining their existing targets.

On the other hand, the SR will increase the rewards for saving (and future consumption), and thus encourage the substitution of saving for current consumption. Thus, this is usually called the 'substitution effect'. Overall, these two countervailing effects are likely to largely cancel each other out.

Now, when we add in the fall in public sector saving which the SR will generate (i.e. the $2 billion cost to revenue), the aggregate effect of the SR upon national saving might seem to be more likely to be negative than positive.

However, there will be other effects of an SR which will bolster the case for an increase in household saving. For example, lower public saving could cause some far-sighted persons to adjust upwards their expectations of future taxation rates (which will 'pay for' the fall in public saving), and so adjust downwards their current consumption levels (and thus increase personal saving) in order to cope with this prospect. This might be called the 'precautionary' effect.

As well, higher after-tax returns to saving could actually make some far-sighted persons feel 'poorer' and thus increase their current saving efforts to make up for this. Future streams of income receipts (e.g. wages and salaries) will be converted into current dollar terms by a 'discounting' process which uses after-tax rates of return available. Since these returns will have been increased by the SR, the 'current wealth equivalent' of such future income streams will be smaller. This 'wealth' effect will probably tend to increase current saving by persons who take into account such considerations.

When we add up all these effects, the most reasonable conclusion would seem to be that the level of national saving is likely to be very little changed by the introduction of a SR, although a small reduction still seems more likely than an increase.⁽²⁾

Effects on the Distribution of After-Tax Income

Wage earners and social security recipients dominate the lower end of the distribution of after-tax income. Such persons have very few income-earning assets and make little use of personal superannuation contributions, and thus will not have the SR benefits available to them, to any substantial extent.

In contrast, the upper end of the income distribution is dominated by persons with large asset incomes who will be able to claim the full value of the SR and thus reduce their tax liabilities by this amount. Middle income classes are composed of a mixture of those on substantial wages, salaries and entrepreneurial income and those with substantial assets and asset income, or some combination of these.⁽³⁾ Many make use of personal superannuation contributions.

In consequence, it appears that those at the bottom of the scale will, on average, benefit very little from the SR, those at the top will benefit substantially and their financial advantage will only be limited by the overall cap on the size of the tax rebate, while those in the middle will, on average, receive tax benefits of an intermediate order of magnitude.

In this situation, available data suggests that the distribution of after-tax income will become more unequal, other things held constant, following the introduction of a SR. Inequality will increase especially in terms of the larger absolute size of the income gap between rich and poor; limitations on the overall financial size of the SR scheme will be the only limit on the size of this increase in inequality.

However, if the SR is viewed in conjunction with existing tax/ transfer payment schemes such as the income-tested Family Tax Assistance scheme, which was introduced in the 1996-97 Budget, then this total policy package might be much more likely to be neutral in regard to after-tax income distribution.

Effects on Economic Efficiency

Income tax drives a wedge between before-tax and after-tax rates of return on savings, and thus distorts household choices between consumption and saving. This generates economic efficiency losses because, at the margin, the broad social value of saving is now no longer equal to the personal value of such saving. Patterns of saving, across persons and also in aggregate, will be less than 'optimal' from society's point of view.

The SR will reduce the tax rate, at the margin, upon the return from savings, and thus reduce the magnitude of this distortionary wedge. In particular, the SR can contribute towards eliminating the highly distortionary effect that the interaction of the income tax and inflation has had upon saving/ consumption choices. This arises because the income tax is levied upon nominal income from assets rather than upon real (inflation adjusted) income. Since higher inflation increases nominal returns but not real returns, effective tax rates upon assets increase. This increases the distortionary effects of the tax system because tax is thereby levied upon the capital value of the asset as well as the income generated by it.⁽⁴⁾

Such distortionary effects have been much reduced by the reduction in inflation which has occurred in the last several years. Australia's official inflation target, and its recent inflation experience, is now in the range of 2-3% in underlying terms, which is much lower than the usual experience of the 1970s and the 1980s.

The remaining distortions arising from ongoing low inflation can be further reduced by the SR, especially for low income earners. For example, for those in the 20% marginal tax bracket, the full SR reduces the marginal tax rate upon asset income to just 5%. In contrast, for those in the highest marginal tax bracket of 47%, the SR will reduce their marginal tax rate upon asset income to a still-substantial 32%.

Thus, the potential economic efficiency gains, per person, could be much bigger for those at the low end of the distribution of income than those at the top. However, low income earners will have far less scope for higher saving than high income earners (the former's asset accumulation will always be limited), and thus they will have far less scope for taking advantage of these less-distorted choices. Those who can gain most in terms of economic efficiency will be least able to take up the opportunities for such efficiency gains.

More generally, the SR may also reduce economic efficiency losses which arise from variations in tax rates across assets (which, in turn, cause distortions in the composition of asset holdings). For example, the relative attractiveness of saving through investments in owner-occupied housing (where imputed rents to occupiers and eventual capital gains after sale are both tax-free) will be somewhat reduced by the SR, which will better align tax rates on other saving vehicles with those available on such assets.⁽⁵⁾

Administrative Aspects

The SR scheme rewards existing asset ownership just as much as its rewards new asset accumulation through saving. However, it is often argued that a much more effective saving scheme would reward new saving only (i.e. the creation of new assets) since the stated goal of the whole exercise is to increase the rate of national saving out of national income. In the latter case, increases in asset stocks, and the income generated by such increases, would draw the financial reward of tax concessions rather than total levels of assets per se.⁽⁶⁾

This reduces the 'waste component' of the scheme which arises in part from the unnecessary act of rewarding saving which has already taken place.

It should be pointed out that such improved saving schemes are more difficult to organise and monitor than the SR scheme announced in the Budget. In comparison, the SR can draw upon good existing systems of monitoring asset income flows which have come from the development of the Tax File Number (TFN) system by the Australian Taxation Office (ATO). Thus, the SR will be quite easy to administer with minimal extra cost.

This is because the TFN system already requires that most personal income flows be linked with a unique TFN which, in turn, corresponds to a unique taxpayer, and that such information be supplied to the ATO on a regular basis. In the case of personal superannuation contributions, such new asset creation is already reported under the TFN system. In this way, the ATO has the requisite information to check taxation returns and thus to control tax evasion and avoidance to a reasonable degree.

However, this TFN system does not currently directly monitor changes in the value of most asset holdings by taxpayers, but it would be just this sort of information which would be required in order to minimise misuse/ abuse under the better-designed saving incentive scheme mentioned above.

While such information could be collected by the ATO through extensions to the TFN system (and some does eventually emerge already when income tax is levied upon realised capital gains), it would entail additional administrative effort and cost to do so.

Conclusions

The economic effects of the SR seem to be quite mixed. While it is unlikely to increase the level of national saving (and could even reduce it somewhat), it will increase the economic efficiency of saving and investment patterns.

On the other hand, it appears that it will increase inequality in the distribution of after-tax income, especially in terms of the absolute size of the income gap between rich and poor. However, the SR will be easy to administer since it builds upon good existing systems for controlling tax abuse.

Endnotes

1. The Treasurer (Peter Costello), Savings: Choice and Incentive, Canberra, Australian Government Publishing Service, 13 May, 1997, p. 12.
2. Vince Fitzgerald, 'Costello's Tax Rebate is a Small Step in the Right Direction', Sydney Morning Herald, 16 May, 1997.
3. For some relevant data, see: Australian Taxation Office, Taxation Statistics 1994-95, Canberra, Australian Government Publishing Service, Table P18.
4. For some relevant discussion, see: John Freebairn et al (eds), Savings and Productivity: Incentives for the 1990s, Sydney, Allen and Unwin, 1989, Chapter 5.
5. Industry Commission, Availability of Capital, Report no. 18, Canberra, Australian Government Publishing Service, December, 1991, C25.
6. Geoff Carmody, 'Budget Incentives Fall Short of Coalition's Savings Goal', The Australian, 15 May 1997.

Superannuation and Savings-John Harrison

The Changing Policy Emphasis

Superannuation is the process of providing funds through employer/employee contributions and self funded 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, that the aged will be living longer and therefore 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 an important vehicle of the Government's retirement income policy. It helps to cope with an ageing population and assists Australia's national savings. As at December 1996, assets in superannuation funds totalled some $271.3 billion.⁽¹⁾

In February 1992, the One Nation statement was launched by the then Prime Minister Keating to promote jobs. Part of the package involved personal tax cuts of $8.6 billion, to be delivered in two stages in 1995 and 1996 financial years. These were called the L-A-W tax cuts as they were put into legislation. The first round of One Nation tax cuts were delivered seven and half months earlier than expected, applying initially to the 1994 income year and being fully operative in 1995 income year. The then Treasurer, John Dawkins, announced that 'implementation of the second round to tax cuts will be determined by the government at a time when fiscal conditions permit, probably in 1998.'⁽²⁾

On 9 May 1995, the then Treasurer announced that the second round of personal income tax cuts would be delivered in the 1999 financial year and would be redirected to employees and the self employed through the means-tested government superannuation contributions to be implemented as part of the superannuation package announced in the 1995-96 Budget. The form of contribution by the Government would be 3% of salary and would come from the One Nation tax cuts and paid into the superannuation accounts. Additionally co-contribution by employees of 3% would be introduced in 1999 and collected through the Super Guarantee system.⁽³⁾

In the 1996 election, John Howard as Opposition Leader announced a promise to honour the L-A-W tax cuts if the Coalition was elected. In the 1996-97 Budget, Costello, Treasurer advised that the Government had made provision in the forward estimates for payment equivalent to the L-A-W tax cuts, as described in the 1995-96 Budget, to be delivered as matching government contributions to employee contribution to superannuation. However, the Treasurer also advised that the Government would review the mechanism for the delivery of this contribution to ensure it would be paid in an equitable and effective way, in conjunction with a review of the technical implementation and workability of compulsory employee contributions. The Treasurer also advised that the Government reserved the right to deliver the assistance to superannuation or like savings.⁽⁴⁾

A year later, the Treasurer changed the L-A-W tax cuts to a savings rebate worth up to $225 a year until 1 July 1989, and $450 a year after that. The scheme outlined is the centrepiece of the Government's strategy of encouraging the contribution of individuals to national savings.⁽⁵⁾

The Government has moved away from the promises of the previous Government in terms of the quantum and design of the tax cuts. The savings rebate is some $2 billion cheaper.⁽⁶⁾ The Government is not ploughing money into individual superannuation accounts but is providing a taxation rebate to individuals as an incentive to promote individuals making superannuation contributions or savings.

The Government sees the saving rebate as representing an important enhancement to Australia's retirement income system, providing significant encouragement to people to save for their retirement through superannuation or other saving. The Government also sees that it is offering choice and incentive, allowing individuals to choose the form most suited to their needs. There has, however, been mixed reaction from the community. A comprehensive analysis of the savings rebate is provided in another brief in this report.

The Superannuation Measures in Brief

The other key measures introduced into the 1997-98 Budget regarding superannuation will amend the superannuation system. The Government is introducing these measures to make the system simpler and more flexible, offering individuals greater choice and control over their savings. These measures include:

• Choice of superannuation fund;
• Opting out of the Superannuation Guarantee (SG) System;
• Improvements to superannuation preservation arrangements;
• Increasing superannuation preservation age to 60 years;
• Reforms to early release of superannuation benefits;
• Savings through phasing out the Superannuation Holding Accounts Reserve; and
• Savings through phasing out the community education campaign on superannuation

Choice of Superannuation Fund

From 1 July 1988, employees will be given greater choice to which Fund or Retirement Savings Account their Superannuation Guarantee and award superannuation contributions are made. Employers will be required to offer new employees a choice of five (or more) complying superannuation funds or Retirement Savings Accounts (RSAs) to which such contributions could be paid. For existing employees, employers must provide a similar choice within two years of the date of effect of the legislation. The legislation will not override provisions contained in workplace agreements and State awards, and will only apply to public sector arrangements to the extent that employer Superannuation Guarantee and award contributions are funded. The Government sees that providers will be forced to compete and enhance their performance, thus benefiting savers. It will also give employees the power to protect their savings by taking them out of non-performing funds. The ATO, which is responsible for administering this measure, will conduct a public education program and provide enquiry services to assist employees and employers.

Opting out of the Superannuation Guarantee (SG) System

From 1 July 1988, low income employees earning $450 to $900 per month will be permitted to receive wages in lieu of SG contributions, to the extent that SG contributions exceed award superannuation obligations, and if their employer agrees. The $900 threshold will be replaced by an $1800 threshold over two months where an employee is under 18 years of age. The Government sees that this measure will improve the flexibility of superannuation, recognising life cycle issues are important, as well as saving for retirement. The ATO will assist employees to understand their options whether to opt out or not, and will be responsible for the ongoing administration of the opting out mechanism and monitoring employer compliance.

Improvements to Superannuation Preservation Arrangements

The preservation rules will be amended from 1 July 1999 to ensure that all future superannuation contributions, including personal contributions and earnings, will be preserved until preservation age, except in limited circumstances. Benefits which are unpreserved at that date will remain so. This measure will overcome the technical difficulties associated with the changes to preservation, announced by the previous Government, which were to have taken effect from 1 July 1988.

Increasing Superannuation Preservation Age to 60 Years

As indicated prior to the election, the Government will proceed with a phased increase in the preservation age from 55 to 60 by 2025. This proposal was first announced by the former Government in 1992. For someone born before July 1960 the preservation age will remain at 55 years, while for someone born before 30 June 1964 the preservation age will be 60. Increasing the preservation age to 60 will reduce the gap between the preservation age and the qualifying age for the Age Pension. People retiring prior to age 60 will still be able to access their benefits in the form of a non-commutable life pension or lifetime annuity.

Reforms to Early Release of Superannuation Benefits.

From 1 July 1997, the Government has decided to reform the arrangements for early release of superannuation benefits. The early release of superannuation benefits will be streamlined and tightened to ensure superannuation is directed towards providing for retirement income. This will improve both the equity and the administration of these arrangement, while reducing the scope for avoiding the existing rules. Early access to benefits will still be available in cases of genuine hardship.

Savings through Phasing out the Superannuation Holding Accounts Reserve

During the 1996-97 Budget year, the Government announced its commitment to allow banks, building societies, credit unions and life insurance companies to offer Retirement Savings Accounts (RSAs). RSAs will be especially suited to those with only small amounts of superannuation, as they are intended to be a simple, low cost and low risk product. The introduction of RSAs from 1 July 1997 will obviate the ongoing need for the Government to administer the Superannuation Holding Accounts Reserve (SHAR), which was established on 1 July 1995 to alleviate problems associated with small superannuation accounts. The ATO will continue to administer the SHAR in the short-term to facilitate the transfer of funds from the Reserve to RSAs or directly to contributors where appropriate.

Savings through Phasing out the Community Education Campaign on Superannuation

In 1995-96 the previous Government commenced a broad-based community education campaign on superannuation to inform the public about initiatives such as the SHAR. Changes in superannuation arrangements and, in particular, the phasing out of SHAR remove the need for education on the initiatives and funding allocated for the campaign is no longer required.

Endnotes

1. Insurance and Superannuation Commission, Bulletin, December 1996.
2. 1993-94 Budget Paper No. 1, p 4.8.
3. 1995-96 Budget Paper No. 1, p 4.7.
4. 1996-97 Budget, Treasurer's Press Release, No. 87.
5. 1997-98 Budget Paper No. 1, p 5-19.
6. 1997-98 Budget Paper No. 1, p 5-21, where the Treasurer's notes advise that 'the measure will reduce outlays compared with forward estimates for matching Government superannuation contributions as described in the 1995-96 Budget. The net fiscal impact of implementing the savings rebate but not going ahead with matching government superannuation contributions will be positive.' Given that the previous outlays were $4 billion, and outlays now are $2 billion, the positive saving is $2 billion.

The Defence Efficiency Review (DER) and Defence Reform Program (DRP)-Gary Brown

In October 1996 the Minister for Defence appointed a panel under the Chairmanship of Dr Malcolm McIntosh, to conduct a Defence Efficiency Review (DER). This panel, the Senior Review Panel, in turn appointed a number of subordinate teams to do detailed work and provide advice.

The Review's report, Future Directions for the Management of Australia's Defence, was published with supporting papers in March 1997. In accepting the Review report the Minister announced that a Defence Reform Program (DRP) based on the DER would commence almost at once. He made the Secretary of the Department of Defence and the Chief of the Defence Force personally and jointly responsible for implementation of the DRP.

Features of the DRP include:

• refocussing the Defence organisation on supporting the combat capabilities of the Australian Defence Force (ADF)
• reducing the size of the Defence Headquarters and central bureaucracy
• redefining the relationship between the Chief of the Defence Force and the Chiefs of the individual Services, but not so as to destroy the separate identity of the Navy, Army and Air Force
• reform of defence acquisition arrangements (because Defence spends about $2.4 billion a year on procurement, it is essential that this outlay be properly organised and managed)
• sale of various Defence properties and facilities around the country which have reached, or will in the foreseeable future reach, the end of their utility to the combat forces.

The DER report estimated that the reform program will generate one-off savings of about $550 million. Once complete, the program could generate at least $770 million and perhaps as much as $1 billion in annual costs cut from support areas.

The Government's policy is that savings generated within Defence will be retained within the portfolio. The intention is that these resources will be directed towards the so-called 'sharp end' of Defence-that is, into enhancing the operational capabilities of the Australian armed forces.

Defence receives a 'global budget': that is, the Government decides a quantum for Defence outlay for the coming financial year and allocates a total amount to the portfolio. The Minister then has the authority to approve allocations to programs and projects upon the advice of his officers and can redirect funding gained from efficiencies. Unlike other Departments of State, the Minister for Defence is not required to justify individual spending initiatives before the Expenditure Review Committee-which, in the case of other departments, examines individual projects. Thus it will not be necessary for Defence to seek any specific legislative approval or use any particular budget measure to internally transfer funds. Information on the progress of the DRP will be more generally observed by changes in the allocation of funds between Defence programs and sub-programs.

Under current funding agreements, Defence retains the proceeds of its disposals, although with some limitations regarding sales of property. After allowance for sales costs, Defence retains net proceeds of the first $100 million of revenue generated in any financial year and 50% per cent of all further revenue.

The DRP will involve a reduction of about 3100 civilian positions. About 2350 military positions will also disappear, with a further 2350 be redirected into combat and combat support areas.

In the longer term, a further 7000 military and 5900 civilian positions will be subjected to 'market testing'-a process whereby it is assessed whether or not the work done by these positions can be performed by the private civilian sector. How many of these positions will actually be dis-established and the tasks let out to private sector tender is something which can only be known once the testing is carried through.

The Defence Reform Program is a long-term exercise: for example, many of the property sales are scheduled for five years or more in the future, when the property's value to Defence expires. Likewise, civilian and military staff reductions on the scale contemplated require time to organise.

Accordingly, the 1997-98 Budget Papers (Paper No. 1, page 4-26) indicate that the present year's defence budget figures do not yet fully reflect the impact of DRP implementation. That impact will grow over the next several years, peaking in the 2002-03 financial year, before tapering off as all one-off measures are carried through and annual savings are reflected in diversions to the 'sharp end', the enhanced combat capability of the Australian Defence Force.

The tables on pages 39 and 40 below show the estimated savings and the accompanying transition costs associated with the DER from the 1996-97 financial year to 2006-2007.

Restructuring the Defence Budget-Derek Woolner

The 1997-98 Defence budget reflects the influence of the Defence Efficiency Review (DER) in that the entire program structure, under which Defence Function outlay is allocated, is changed. The program structure of the function increases from eight to 14 programs and the relationships between the old and new structures are sufficiently different for the Portfolio Budget Statements to present the 1997-98 Budget Estimate in the new program structure only and to warn, 'No comparison with the previous year is available at the program level'.⁽¹⁾

Defence Program Structure 1996-97 and 1997-98

To illustrate the point that these two structures cannot be compared and to demonstrate the extent of the Defence financial management reorganisation which they entail, it is instructive to look at the three Service programs. This will demonstrate also the repositioning of functions to different programs.

Comparison of 1996-97 and 1997-98 Navy, Army and Air Force Programs

As can be seen, the three Service programs have been stripped back to a basic structure of the combat Force, the training required to develop the capabilities of that Force and the executive for the management of the Force. This reflects an objective developed by the DER, that generic operations be controlled on a 'whole-of-Defence' approach rather than having each Service and, often, the civilian components responsible for their own support activities. Correspondingly, each of the generic activities was to have a single point of control. Hence, the Services' logistics functions have largely gone to Program 6 'Support Command', personnel administration has been centralised in Program 8 'Defence Personnel Executive', base accommodation will become the responsibility of Program 11 'Defence Estate', and so on.

Furthermore, it would seem that the remaining Services' sub-programs do not translate directly from the 1996-97 structure. Significant variations in expenditure can be noted from 1996-97 to 1997-98 in the 'Executive' sub-programs of all three Services and the 'Combat Forces' and 'Training' Sub-Programs of Air Force. This latter may be explained partly by the intention to focus the Services' training responsibilities on their own environmentally (sea, land, air) oriented objectives and allocate wider tri-Service and Defence training activities to Program 7 'Joint Education and Training'.

As might be expected with a restructure as extensive as this, the information provided in the 1997-98 Defence Portfolio Budget Statement is preliminary, incomplete and will, therefore, change. The DER reported in March 1997 and the Minister directed that the structure it recommended be instituted by 1 July 1997. There has been little time to do more than to put in place the new structure and the PBS notes that it was 'not possible to complete the reallocation of resources from the old structure to the new structure in time for inclusion in this Portfolio Budget Statement'.⁽²⁾ An example of this can be seen in Program 6 'Support Command', where there is no allocation shown against Sub-Programs 6.1 'Executive' and 6.2 'Joint Logistics' but instead a note that they will be allocated resources from within the overall Program total.⁽³⁾

It will take some time to overcome such problems and the Portfolio Budget Statement advises that the reallocated responsibilities will be shown in the 1997-98 Additional Estimates or in the 1998-99 Budget.

Endnotes

1. Defence Portfolio, Portfolio Budget Statements 1997-98, (Budget Related Paper No. 13A), p. v.
2. ibid.
3. ibid., p.80.

Outsourcing of Commonwealth Government Information Technology-Denis James

On 25 April 1997, the Minister for Finance, Hon. John Fahey MP, announced the Government's in-principle decision to outsource its information technology (IT) infrastructure. This decision applies to a range of IT infrastructure, from mainframes to desktop computers. The initiative applies to the IT infrastructure services of all Budget-funded agencies except for those whose running cost Budgets are less than $10 million and those subject to national security considerations.

The initiative is in accordance with more general Government principles and arrangements relating to the consolidation of purchasing and the requirement for market testing and competitive tendering in the letting of contracts. More specifically, the decision to consolidate and outsource IT infrastructure follows an evaluation, undertaken by the Department of Finance and the Office of Government Information Technology (OGIT), of the potential benefits which might be gained. The Government has stated that this evaluation 'found strong evidence of significant potential benefits from such consolidation and outsourcing within a whole of Government competitive tendering and outsourcing framework'.⁽¹⁾ The evaluation report is not a publicly available document.

Under the Government's decision, the provision of IT infrastructure services must be subject to market testing and outsourcing must occur if a strong business case exists for such an action. Market testing will involve identifying alternative means of delivering IT infrastructure services and undertaking a competitive tendering process to establish the best value for money outcome. The Government has decided that in-house bids may be considered by the agency head, as long as measures have been put in place to ensure competitive neutrality between internal and external tenderers. This requires that the tender process does not provide unfair advantage to an in-house option, that the process is visible and auditable and that internal bids are appropriately costed.

An important part of the Government's IT initiative is the consolidation of IT operations, or 'clustering'. As far as mainframe and large non-mainframe agencies are concerned, their principal modus operandi will be to join together to facilitate the consolidation of discrete mainframe data centres and the aggregation of mid-range and desktop/network infrastructures. OGIT will consult with the larger agencies to determine, on the basis of their operational needs, the appropriate cluster to which they might belong. OGIT will also become involved if any agency wishes, at a later date, to change from one cluster to another. However, a substantial amount of decision-making power will reside with the agencies. Through Cluster Steering Committees, agencies will be able to manage IT processes and contractual arrangements will ensure that agencies have the flexibility they need to tailor the services they acquire to their changing business environments.

Smaller agencies can choose to 'ride on the coat tails' of the cluster arrangements of the larger agencies and obtain services from the vendor chosen by those latter agencies or, if preferred, they can continue to purchase IT services under the Whole of Government Common Use Arrangements.

The Government claims that the consolidation and outsourcing process will lead to:

• improved service delivery by integrating services to common client groups through consolidation of IT infrastructure
• rationalisation and standardisation across agencies
• economies of scale from integration of data centre processing requirements
• cost-effective technical and user support across mainframe, mid-range and desktop/network platforms
• improved management of IT services and
• market leverage from larger volumes.⁽²⁾

There are currently around 2800 employees working in mainframe, mid-range and desktop areas. It is uncertain how many of these will be affected by the competitive tendering process as it will be up to individual agencies to decide the most cost-effective choice between in-house and external provision of services. Agencies are required to act quickly to implement the initiative. A twelve month market testing and contracting process is contemplated for each cluster transaction.

Regardless of the mix of IT sources utilised by an agency, the Government is requiring that the savings which it anticipates from the competitive tendering approach must be reflected in the running costs of all agencies. Current projections of estimated savings across all portfolios is shown in the following table.

Estimated Savings from Efficiencies in Whole of Government Information Technology Infrastructure ($m)

Further information concerning this measure may be found in the following Detailed Portfolio Review for Program 6A.8-Office of Government Information Technology (Finance Portfolio).

Endnotes

1. Budget Measures 1997-98, (Budget Paper No. 2, 1997-98), p. 160.
2. ibid., p. 161.

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