Chapter 2Views on Australia's taxation system
Introduction
2.1This chapter begins by outlining the purposes of tax, summarises the elements of Australia's tax system, and gives a brief overview of some of the critiques of the current tax system made by submitters.
2.2The chapter then considers the views of submitters regarding Australia's tax system, including proposals for reform. These are set out according to the terms of reference.
2.3The chapter concludes with the committee view.
Purposes of tax
2.4Tax serves several purposes in Australia’s economy and society.
2.5Firstly, it provides revenue to fund democratic institutions, services, and programs. These include parliament, the judicial system, defence, education, infrastructure, policing, the prison system, aged care, and income support.
2.6Secondly, tax can have a fiscal impact on the economy by altering aggregate demand and economic activity through both stimulatory and contractionary measures.
2.7Thirdly, tax (and expenditure) can have a redistribution effect and can be used to address matters of equity, fairness, and opportunity including through transfer payments to Australia’s most vulnerable citizens.
Elements of Australia’s tax system
2.8Australia's tax system is a mix of federal, state, and local taxes. The Commonwealth government collects the majority of tax revenue, primarily through income tax and the Goods and Services Tax (GST). Key elements include:
Income tax with progressive rates such that higher earners pay a larger percentage of their income in tax.
A 10 per cent GST on most goods and services.
Company tax.
Capital gains tax.
State-level taxes such as stamp duty and payroll tax.
2.9Australia has a tax-free threshold of $18200, meaning individuals earning below this amount do not pay income tax. The Low Income Tax Offset provides additional tax relief for low income earners up to $66667, with a maximum benefit of $700 for those earning up to $37500. Most taxpayers also pay a 2percent Medicare levy.
Critiques of Australia’s current tax system
2.10Submitters made various critiques of Australia’s current tax system, including that it is unsustainable, overly dependent on personal income tax, fails to appropriately tax wealth, and contains taxes that have a distorting effect on economic activity ranging from the capital gains tax discount to stamp duty.
2.11While many of these critiques are covered in substantive sections of this chapter (for example, the issue of wealth is covered in the section on capital gains tax), the following paragraphs provide an overview of some of the areas that submitters suggested merit reform. The section finishes with a possible set of criteria by which to judge such reform.
2.12The Institute of Public Affairs cited a 2023 speech by Dr Ken Henry who stated that the objective of a national tax system is to ensure it is:
…capable of generating sufficient revenue to underwrite fiscal sustainability, without unacceptable consequences for economic efficiency, fairness (including intergenerational equity), risk, and system complexity.
2.13The Institute of Public Affairs noted Dr Henry stated that Australia fails on every aspect.
2.14The Institute of Public Affairs submitted that ‘Australia is one of the most income tax burdened nations in the developed world, with income tax being proportionately higher than the vast majority of other OECD nations’. They cited Dr Henry’s speech stating that he noted the only revenue base ‘growing faster than GDP is personal tax, while all other tax bases are unreliable and only add complexity to the system at large’.
2.15Similarly, the Property Council submitted that since the 1970s, Australia’s tax mix has been ‘heavily weighted towards income taxes on individuals and corporates rather than taxes on consumption (such as the GST) and taxes on savings (such as superannuation)’:
The unsustainability of the tax mix is demonstrated in the Institute for Management Development (IMD) World Competitiveness Report 2023 where out of 64 countries, Australia ranked 57th for individual tax burden and 56th for company tax burden and the IMF continually emphasises the need for structural reform that includes rebalancing the tax system towards more reliance on indirect taxes.
2.16The Property Council also submitted that reform of Australia’s tax system has effectively stalled over the last decade and that since 2015, none of the amendments to the corporate tax system have addressed any of the systemic issues identified in the 2010 Henry Tax Review and the 2015 Commonwealth Treasury Re:think Tax Discussion Paper.
2.17Professor Emeritus Frank Stilwell and David Richardson set out four criteria by which to assess proposed improvements to the tax system: equity, efficiency, simplicity and potency. They argued that only if these conditions are met can the tax system be deemed satisfactory and sustainable:
Equity requires that the tax system be fair, raising tax according to people’s ability to pay, and contributing to greater equality of opportunity and outcomes.
Efficiency requires that the tax system should not distort the economy by encouraging unproductive activities.
Simplicity requires tax arrangements to be transparent and widely understood, avoiding complicated loopholes that enable tax avoidance.
Potency requires that the tax system generates revenue sufficient to meet society’s needs for public expenditure.
Term of reference (a): Taxing people who earn less than the cost of living
2.18The submissions received that related to the social and economic impact of taxing people who earn less than the cost of living mostly focussed on two issues.
2.19Firstly, the issue of welfare churn and its impacts on low- and middle-income earners. The impacts of churn identified by submitters can be summarised as the complexities, inefficiencies, and costs for both taxpayers and government of complying with the requirements of both the tax and transfer systems, as well as the disincentives for work caused by the resulting high effective marginal tax rates for low- and middle-income earners when welfare benefits are withdrawn as income increases and tax is paid.
2.20Secondly, submissions considered tax settings in retirement, and the impacts on the workforce participation of senior Australians.
2.21This section of the report firstly considers cost-of-living metrics, income tax thresholds, and welfare churn. It then turns to the topic of tax settings in retirement.
Cost of living, the poverty line, and income tax thresholds
2.22The Institute of Public Accountants noted that ‘there is currently no official or statutory definition of a “poverty line” or other “cost of living” income threshold in Australia’.
2.23However, the ‘poverty line’ for different types of households exceeds the tax-free threshold, as does the income eligibility threshold for many transfer payments. The Institute of Public Accountants pointed out:
…even if it is assumed that the ‘cost of living’ metric is as low as the poverty line, it is clear that many individuals and families at or below the poverty line would be subject to income tax on their employment income.
2.24As noted earlier, the statutory tax-free threshold in Australia is currently $18200, but the effective annual tax-free threshold is $21884 once the low-income tax offset is factored in.
2.25The single JobSeeker payment is $20228 per year and because Jobseeker is deemed taxable income, ‘a single person can only earn $1656 of annual income before they start paying income tax’.
Welfare churn and the tax and transfer systems for low- and middle-income households
2.26The Institute of Public Accountants noted that the taxation of people who earn less than the ‘cost of living’ must be considered together with the transfer system because the tax and transfer systems interact and work together. Due to the progressive nature of both systems, those who earn the least (and have the lowest tax burden) are generally the greatest beneficiaries of the transfer system.
2.27Both the Australian Taxpayers’ Alliance and the Institute of Public Accountants submitted that a large proportion of Australian households experience churn where they pay tax and receive payments at the same time. The Australian Taxpayers’ Alliance submitted:
The issue of tax-welfare churn is a common problem across the developed world, where families are in the strange situation of both paying income tax to the government and simultaneously receiving welfare payments back from that same government.
2.28Indeed, the Institute of Public Accountants noted that ‘couples with children pay roughly the same amount of tax as they receive in cash and non-cash benefits’.
High marginal tax rates and disincentives for workforce participation
2.29The Australian Taxpayers’ Alliance submitted:
People earning as little as $5000 per year can end up facing effective marginal tax rates of 70 per cent, due to the double-hit of both losing their welfare payments at 60 per cent and also paying income tax at an effective rate just over 10 per cent.
2.30The Australian Taxpayers’ Alliance argued that ‘besides being pointless and wasteful, this also leads to large work disincentives for low-income earners, catching them in a so-called “poverty trap”’.
2.31In that regard, the Institute of Public Accountants cited a Productivity Commission report which explained that an increase in tax, or a decrease in transfer payments, may decrease the incentive to undertake paid work because it makes unpaid activities relatively more attractive (the substitution effect).
2.32Associate Professor Ben Spies-Butcher also noted that the targeting of social benefits creates high effective marginal tax rates as benefits are withdrawn for those on moderate incomes. He argued that benefit withdrawal effectively acts as a less visible and inequitable form of tax:
Generally, the goals of targeting would be better achieved through the tax system than the welfare system, where benefit withdrawal rates act as a less visible form of taxation. The lack of visibility has also led to changes to indexation that reinforce these problems while having the largest negative income effects on middle-income households. As households and work patterns have become more diverse, so tight targeting and the combination of household and individual means-testing has reinforced these incentive and equity problems.
Proposals to improve workforce participation for low- and middle-income households
2.33The Institute of Public Accountants urged the Government to explore the extent to which the income effect and the substitution effect apply in the current situation and:
develop tax and transfer policies which encourage and reward workforce participation while ensuring that more households can sustain the rising cost of living;
consider raising the tax-free threshold to something closer to the cost of living or poverty measure, while also appropriately reducing the transfer payments payable to these taxpayers, such that they will not be worse off but much complexity and compliance will be removed.
2.34The Australian Taxpayers’ Alliance recommended that welfare payments be made non-taxable, so that workers would be able to earn up to $21884 before paying income tax to help reduce effective marginal tax rates for persons in this category.
2.35The Australian Taxpayers’ Alliance was also of the view that the government should set an aspirational goal of removing the bottom tax rate entirely. This would increase the annual tax-free threshold to $45000, directly benefiting those workers as well as reducing the amount of tax-welfare churn and improving work incentives for low-income earners.
2.36Associate Professor Ben Spies-Butcher suggested that combining tax reform with more universal and individualised benefit payments could increase the incentive and productivity benefits of reform as well asbeing more equitable.
Tax, senior workforce participation, and equity in retirement
2.37Views differed on the best approach to the tax policy settings in retirement. Concerns included the impacts of Australia’s aging population, the disincentives for senior Australians to stay in or re-enter the paid workforce, and the budgetary cost and potential unfairness of superannuation tax concessions.
2.38Australia has an ageing population. Over the next 40 years, it is predicted that the number of Australians aged 65 and over will more than double and the number aged 85 and over will more than triple.
2.39Australia’s aging population means there will be proportionally fewer individuals of working age contributing to the revenue. As the income tax base becomes smaller, the dependence on income tax as a revenue source will ‘become more burdensome for working Australians’.
2.40The Institute of Public Affairs noted that the combined effect of tax and pension rules means ‘that a pensioner or veteran who works is potentially subject to an effective marginal tax rate of 66 per cent’. Consequently, the Institute of Public Affairs argued this was the reason ‘why only three per cent of Australian pensioners work’.
2.41The Institute of Public Affairs pointed to recent survey data from National Seniors which found that ‘20 per cent of Australian pensioners would enter the workforce if these tax and red tape barriers were removed’:
This means that 20 per cent of Australian pensioners are entering early retirement because it is simply not financially viable for them to work.
2.42By contrast, the Institute of Public Affairs pointed to New Zealand where the current rules allow pensioners and veterans to earn employment income without reducing or affecting their pension entitlements:
If a pensioner or veteran in New Zealand earns income, they only have to pay income tax on their combined income earned and benefits received.
2.43Consequently, one in four New Zealand pensioners work compared to only three per cent of pensioners in Australia.
2.44The Institute of Public Accountants cited a Productivity Commission Report which found that incentives to save and invest are particularly affected by retirement income policies such as eligibility for the Age Pension and the tax regime for superannuation.
2.45The Association of Superannuation Funds of Australia (ASFA) noted that when Australia compulsory superannuation was introduced:
…the reforms to the taxation of superannuation led to the adoption of a flat rate of taxation on superannuation contributions and investment returns, with concessional treatment of income in retirement on top of that.Subsequently, payments from superannuation became largely tax free when received at age 60 and over.
2.46ASFA argued that because superannuation benefit payments are generally tax free after age 60, they ‘have played an important role in assisting individuals with living expenses in retirement, including when their income is less than their required expenditure for living expenses, requiring a drawdown on capital’.
2.47Anglicare Australia submitted that ‘security in retirement depends on pensions that prevent poverty and fair superannuation that cushions the loss of income from employment’. Anglicare Australia argued that Australia’s tax system fails on both criteria:
The tax treatment of superannuation is too generous for people with high incomes and inequitable for people on low incomes. This entrenches inequality in retirement and reduces the funding available for quality aged care and income support.
2.48Anglicare Australia noted that since Australia’s system of compulsory superannuation came into effect in 1992, concessions and benefits for those who build high superannuation balances have grown steadily.
2.49Anglicare Australia stated that this has occurred to such an extent that tax concessions for superannuation cost $48 billion in 2023, almost as much as Age Pensions which cost $55 billion. Further, Anglicare Australia stated that 58 percent of the cost of the concessions benefitted the wealthiest 20 percent of Australians, while zero percent benefitted the bottom 20 percent of Australians.
Proposals to improve senior workforce participation
2.50The Institute of Public Accountants argued that considering Australia’s growing and ageing population, the government should consider tax incentives to encourage continued workforce participation as well as to enhance private savings for retirement to reduce reliance on the Age Pension:
In order to sustain the Budget in the coming decades, it is imperative that the Government considers whether there may be greater incentive, possibly in the form of concessional taxation, for capable older Australians to remain in the workforce, and to continue to save through superannuation or other privately held investments for their retirement, rather than relying on the Age Pension and reducing their workforce participation to meet the eligibility income thresholds.
2.51Similarly, the Institute of Public Affairs argued that tax reform was vital to promote the workforce participation of senior Australians and remove the costs associated with working.
Proposals around equity in retirement
2.52The Institute of Public Accountants also noted that a pensioner’s home is not included in the assets test for the Age Pension (although it will affect the assets threshold). They therefore suggested there are reasons for the government to consider how the family home is treated for the purposes of eligibility thresholds:
An Age Pensioner holding onto a large family home which has experienced huge capital growth over many decades, which could be sold, would be in a much better position to be able to privately fund some of their retirement needs compared to a lifelong renter, and may have much less need to stay longer in the paid workforce earning taxable employment income.
2.53Anglicare Australia recommended:
All tax concessions for superannuation contributions, including the 15percent employer contributions tax rate, deductions for contributions, and rebates for contributions by low-income earners and for spouses, should be replaced by an annual refundable rebate paid into the fund, capped at a contribution level sufficient to support an acceptable retirement income for a typical worker.
The annual non-concessional contributions cap should be reduced to three times the concessional cap, and people should no longer be able to make up to three years’ contributions within the cap in a single year. The exception to the general prohibition on direct borrowing by super funds for limited recourse borrowing by self-managed funds should be removed.
2.54The Institute of Public Affairs argued that the tax on superannuation savings should be halved.
Term of reference (b): Assumptions used by Treasury in modelling income tax cuts
2.55The Australian Taxpayers’ Alliance submitted that ‘Treasury does not actually use a tax model in their modelling of tax cuts’.
2.56The Australian Taxpayers’ Alliance argued that Australia should adopt a tax model similar to that used in the United States and the United Kingdom that estimated the impact of tax cuts on behaviour and drew implications about the change in economic output and the tax base:
A more robust parameter is the “elasticity of taxable income” (ETI), which captures not just labour supply changes but also work effort, tax minimisation, tax evasion, and jurisdiction hopping. Research into the ETI has boomed over the last 30 years with hundreds of global studies suggesting a mid-point elasticity of roughly 0.3 on average and significantly higher for high-income earners. The UK and USA governments have taken the obvious step of incorporating the ETI into their tax model, and provide public detail about the assumptions of their tax model. Australia should do likewise.
Terms of reference (c) and (d): International tax arbitrage
2.57The Organisation for Economic Co-operation and Development (OECD) notes that tax arbitrage poses a sophisticated challenge to tax systems internationally by facilitating inappropriate tax avoidance.
2.58The OECD defines tax arbitrage as:
…the exploitation of differences in the tax laws of two or more jurisdictions that result in the lowering of a taxpayer’s worldwide tax liability through transactions in which income is not taxed anywhere in the world. That is, tax arbitrage facilitates the creation of income that is subject to double non-taxation.
2.59The resulting double non-taxation, the OECD notes, is contrary to the principles underlying the norms of international taxation:
Double non-taxation … distorts economic behaviour because taxpayers will tend to favour cross-border tax arbitrage transactions over domestic transactions or other types of cross-border transactions, thereby undermining the principle of neutrality. Furthermore, taxpayers who do not have access to arbitrage opportunities will have higher costs of operations and will thus be prejudiced because they will not have the benefit of such de facto subsidies. Taxpayers who do engage in tax arbitrage transactions tend to be the wealthy and well advised because the transactions often require extensive resources and the expertise of sophisticated tax advisors. In addition, because double non-taxation reduces the tax revenues of one or both of the countries, governments may ultimately need to compensate for a shortfall in revenue by shifting the burden of tax to other constituents, such as to labour.
International efforts to address tax challenges
2.60Ever since the 2008 global financial crisis, the G20 and OECD (including Australia) have made collaborative efforts to address the tax challenges of a global digital economy.
2.61The OECD prefers multilateral solutions to international tax arbitrage because unilateral solutions do not provide broad solutions, and taxpayers have exploited bilateral treaties for tax arbitrage through a process known as ‘treaty-shopping’.
2.62Since 2013, Australia has passed many laws attempting to reduce the corporate tax gap (or loopholes) caused by cross-border tax arbitrage activities, including:
Multinational Anti-avoidance Law (MAAL) (2015).
Diverted Profits Tax (DPT) (2017).
GST on imported digital products and services (2017), low value imported goods (2018), and on offshore sellers of hotel bookings (2019).
Implementation of almost all the 15-Actions (except for Action 1) from the OECD/G20 Base Erosion Profit Shifting (BEPS) Project, including updating transfer pricing laws, Country-by-Country Reporting, the updated OECD Multilateral Instrument, Mutual Agreement Procedure, and Automatic exchange of information on cross-border arrangements.
2.63On 27 November 2024, the Parliament passed the Pillar Two minimum tax bills, part of the Two Pillar Solution (BEPS 2.0 project) agreed by the OECD/G20 Inclusive Framework member jurisdictions, in order to address the remaining Action 1 (Tax Challenges of the Digital Economy) of BEPS 1.0.
2.64As noted in the Explanatory Memorandum to the bills giving effect in Australia to Pillar Two, its effectiveness on preventing international tax arbitrage activities and increasing tax revenues, is likely dependent on its implementation by a critical mass of member jurisdictions.
2.65Despite the legislation already in place in Australia, areas remain of concern to the ATO due to ongoing tax arbitrage activities, including:
transfer mispricing;
hybrid mismatch;
structured arrangements designed to reduce Australian tax;
tax consolidation including multiple entry consolidated (MEC) group changes, losses, uniform capital allowances, thin capitalisation, capital gains tax, collective investment vehicles (MIT and AMIT) specific issues, superannuation fund specific issues, and misalignment of accounting and income tax outcomes.
2.66Terry Dwyer noted that many countries have lower company tax rates than Australia and that income will always flow to the lowest tax jurisdiction. He also noted that royalties are very important for the pharmaceutical and IT industries and suggested a ‘5 per cent annual charge on the self-declared value of royalty and copyright protection in Australia with forfeiture of intellectual property to the Crown if not paid’:
That would not breach the World Trade Organisation treaties and would be a better way of collecting revenue from companies like Pfizer and Microsoft.
Terms of reference (e) and (h): Capital gains tax concessions
2.67The committee received several submissions covering the issue of capital gains tax and the appropriate taxation of wealth. This section begins by setting out some of the data on wealth, followed by the impacts of tax policy on wealth. It then looks at the capital gains tax discount, the issues raised by tax concessions, and the proposals put forward by submitters.
Data on income and wealth in Australia
2.68Stilwell and Richardson pointed to Australian Bureau of Statistics (ABS) data which showed larger disparities of wealth compared to income disparities:
the richest 20 per cent of households receive, on average, 5.3 times more income than the poorest 20 per cent of households.
the top 20 per cent of households have 154 times more wealth than the bottom 20 per cent of households.
2.69Anglicare Australia pointed to ABS data from the Australian National Accounts Distribution of Household Income, Consumption and Wealth series which shows that wealth in Australia is unevenly distributed:
As of 2019–20, the average wealth of the highest 20 percent of wealth-holders was $3240000. This is over five times that of the middle 20 percent, who had a more modest $588000, and 90 times the wealth of the lowest 20percent with just $36000.
2.70The ABS Survey of Income and Housing shows that household wealth is mostly held in housing and superannuation assets:
38 percent of household wealth is held in owner-occupied housing;
12 percent of household wealth is held in investment property;
22 percent of household wealth is held in superannuation; and
20 percent of household wealth is held in financial assets such as shares, bonds, bank accounts, and trusts.
2.71From 2003 to 2022, the overall value of household wealth almost doubled from $676000 to $1177000:
The average value of household superannuation assets rose by 155 percent from $92000 to $234000
The average value of investment property rose by 99 percent from $74000 to $147000
The average value of shares and other financial assets rose by 76 percent from $125000 to $220000
For the largest asset, owner-occupied housing, there was a 58 percent increase from $302000 to $479000.
For other non-financial assets, there was a 20 percent increase from $88000 to $106000.
Impacts of tax policy on wealth disparities
2.72Stilwell and Richardson submitted that ‘understanding the role of tax in relation to inequality requires recognising the distinction between inequality of incomes and inequality of wealth’:
Incomes comprise flows of wages, professional fees, profits, interest, rents and government transfers.
Wealth comprises stocks of assets, such as shares and real estate.
2.73Stilwell and Richardson noted that income and wealth are related ‘because wealth commonly yields extra income flows for its owners, typically coming as dividends, interest payments and rents’, allowing the recipient to purchase more assets.
2.74Think Forward and Peter Sutton both submitted that income earned from wealth is taxed very differently to income from work because incomes earned from wealth (capital gains, dividends, and rents) are often party to tax concessions. This results in wealthy older Australians often paying less tax on the same income as younger workers without assets.
2.75Stilwell and Richardson argued that because ‘capital gains and wealth are currently either lightly taxed or completely untaxed in Australia, the overall tax burden is falling more heavily on to the wage-earners who can least afford it’.
2.76Anglicare Australia submitted that wealth inequality has grown significantly in Australian as a ‘direct result of tax settings that have supported some to build wealth while making it more difficult for others to get ahead’:
The biggest contributors to the widening of Australia’s wealth inequality gap have been tax concessions that boost superannuation assets for the wealthiest households, and those that promote investment in property.
2.77Anglicare Australia argued that the unbalanced nature of Australia’s tax policy settings has profound economic and social outcomes that can:
…widen the wealth gap, limit opportunities for people from less wealthy backgrounds, and entrench intergenerational poverty. This in turn erodes trust in institutions and undermines social cohesion.
2.78Similarly, Stilwell and Richardson submitted that greater inequality produces poorer economic outcomes and less contented societies.
Capital gains tax
2.79Capital gains tax was introduced in 1985 when capital gains for assets held for more than 12 months began to be taxed at the usual marginal rates but with nominal gains deflated by the change in the consumer price index (CPI) over the period the asset were held.
2.80Since 1985, capital gains tax has allowed one dwelling and the land on which it sits (the ‘family home’) to be tax exempt. Capital gains on other assets were fully taxable at standard income tax rates.
2.81ASFA submitted that the Ralph Business Taxation Review in 1999 argued that an improved capital gains tax regime was needed to stimulate saving, investment and economic growth:
Rather than capital gains tax applying to the CPI deflated increase in value, marginal tax rates would be applied to a discounted portion of the capital gain.
2.82In 1999, the Howard government introduced a 50 per cent discount on the rate of capital gains tax payable.
2.83ASFA noted that Australian trusts can discount a capital gain by 50 per cent, and complying super funds can discount a capital gain by 33.33 per cent. Companies cannot use the capital gains tax discount.
2.84ASFA also noted that the general approach in jurisdictions around the world is ‘to tax capital gains on assets held for more than 12 months at rates lower than those that apply to other income’.
Views of submitters on the capital gains tax discount
2.85Stilwell and Richardson argued that, since its introduction, the capital gains tax discount has distorted Australia’s tax and investment arrangements because it creates an ‘implicit incentive to hold non-productive assets rather than to invest productively in the Australian economy and incur the full corporate tax rate on any profits earned’.
2.86Similarly, Think Forward argued that taxing working income more than asset income incentivises the passive hoarding of wealth and is a driver of Australia’s low rates of entrepreneurship:
…providing generous tax concessions on unearned incomes (rents, dividends, capital gains) makes investing in unproductive assets (like property) more lucrative than investing in or starting a business and increases the price of assets such as housing and land. This means increased mortgage or rent payments, and less money for entrepreneurship or consumption.
2.87By contrast, ASFA argued that the great bulk of capital gains realised by superannuation funds relate to active investments in companies and other business-related activities rather than passive holdings of real estate.
2.88Stilwell and Richardson also argued that the capital gains tax discount undermines the potency of the whole tax system because:
…whenever the discounted capital gains tax rate is below the tax on company profits, there is an incentive for a business to represent or disguise profits as capital gains for the ATO’s assessment of tax payable’
2.89Anglicare Australia noted that more than 80 percent of the savings from the capital gains tax concession go to the wealthiest quintile, and just two percent to the bottom 20 percent.
2.90Stilwell and Richardson submitted that capital gains provide a negligible boost to the incomes of the bottom 20 per cent of households, but, on average, more than double the incomes of those in the top 20 per cent of households.
Proposals put to the committee about the capital gains tax discount
2.91Stilwell and Richardson argued shifting the focus of tax policy from taxing wages and earned income to taxing unearned income, wealth and capital gains would help make the tax system more equitable, efficient and sustainable.
2.92Stilwell and Richardson therefore argued that the capital gains tax discount should be removed because it ‘violates the equity, efficiency and potency of the tax system. The discount has neither ethical nor economic justification.’
2.93Think Forward suggested that the capital gains tax discount be halved to restore equity between wealth holders (typically older) and workers, while accounting for inflation's impact on returns. This would also reduce the demand for homes as speculative assets and save the budget billions of dollars.
2.94Anglicare Australia proposed reducing the capital gains tax discount over a ten-year period to guard against any impact on housing markets.
2.95Unions NSW recommended that negative gearing and capital gains tax discounts be limited to one investment property per owner.
Terms of reference (f) and (g): Company tax rates and franking credits
2.96Company tax rates can be measured in various ways. The most common are the statutory tax rate and the effective tax rate.
The statutory and effective corporate tax rate
2.97Australia has a statutory corporate tax rate of 30 per cent, with a reduced rate of 25 per cent for small or medium business companies with an aggregated turnover below $50 million.
2.98The effective company tax rate is ‘the ratio of corporate tax to company income’. The effective corporate tax rate can differ from the statutory corporate tax rate ‘because taxable income can vary from economic income due to features of the tax system, such as accelerated depreciation, industry-specific concessions or non-compliance’.
2.99Differences in institutional arrangements mean that caution is important when making international comparisons because a country's corporate tax ranking can vary depending on the effective tax rate measure used.
Franking credits
2.100Franking credits were introduced in 1987. Before then, company profits were effectively ‘double taxed’. That is, they were taxed by the company when it made profits, and then again by individuals (or other taxpayers) when they received company profits in the form of dividends.
2.101The primary purpose of franking credits is to ensure that company profits are taxed only once, at the shareholder level, rather than being taxed both at the corporate and individual levels. This system aligns with the principle that income should be taxed based on the ultimate recipient, which in this case are the shareholders.
2.102Under this system, when a company pays tax on its profits, it receives franking credits. The franking credits can then be attached to dividends paid to shareholders and represent the tax already paid by the company on behalf of the shareholders.
2.103Shareholders must include both the dividend and the franking credit in their taxable income and can use the franking credits to offset their own tax liabilities.
2.104Foreign shareholders do not receive franking credits as they are not subject to Australian income tax. This ensures that the benefits of the franking credits system are targeted at Australian residents.
2.105Since 2000, individuals and superannuation funds have been able to claim cash refunds for any excess imputation credits. Franking credits are refunded by the ATO if the amount of franking credits received is greater than the shareholder’s tax bill for the year. While the franking credits issued by companies have increased over the last decade, the franking credits claimed by shareholders and the franking credits refunded by the ATO have decreased in the last five years.
2.106The proportion of franking credits refunded is:
individuals—15 per cent;
large superannuation funds—2 per cent;
SMSFs—62 per cent; and
charities and the Future Fund—100 per cent.
Views on dividend imputation and the franking credits system
2.107The Institute of Public Accountants noted that the Parliamentary Budget Office found that one feature of a dividend imputation system is that no special tax arrangements are needed to tax dividend income. Dividends are simply included with other income and the combined income from all sources is taxed.
2.108By contrast, tax systems in other countries often involve separate arrangements for difference sources of income which increases complexity and the costs of administration and compliance.
2.109From 2024–25, the marginal tax rate of 16 percent will apply to individuals with taxable incomes between $18201 and $45000, and the marginal rate of 30percent will apply from $45001 up. For every $1 of a franked dividend, only individuals in the two lowest tax brackets would receive a refund.
2.110In effect, given the average marginal tax rate for shareholders is close to 30 per cent, the total amount of refunds is generally balanced out by the total amount of additional tax paid by shareholders on higher tax rates. Therefore, the Institute of Public Accountants stated that altering the current system may not significantly increase revenue, but it would increase complexity and costs.
2.111In this regard, the Institute of Public Accountants pointed out that the Parliamentary Budget Office found that prior to 1 July 2000, the inability to obtain refunds of excess franking credits led to several effects which would likely recur if franking credit refundability was removed, including:
incentives to invest in Australian shares would decrease because the overall after-tax return would be lower for Australian shares, with a resulting fall in Australian share prices, and a corresponding increase in incentives to invest in assets such as foreign shares, fixed interest or rental properties;
incentives for small businesses to remain unincorporated, such that the profit for a sole owner was taxed at the owner’s marginal rate, however low that was; and
incentives for self-managed superannuation fund (SMSF) members to roll their investment into a large superannuation fund that has a greater capacity to absorb franking credits.
2.112Therefore, the Institute of Public Accountants argued that if the refundability of franking credits was removed or the imputation system restricted, it would likely lead to adverse outcomes for taxpayers, disincentivise investment in Australian companies and SMSFs, and potentially increase reliance on the Age Pension if taxpayers cannot rely on franking credits as a post-retirement income stream.
2.113The Institute of Public Accountants also drew attention to a 2019 report from the House of Representatives Standing Committee on Economics into the implications of removing refundable franking credits which found that removing refundability may increase dependence on the Age Pension, thereby defeating the purpose of reducing government expenditure:
For older Australians, stakeholders commonly expressed concerns about increased stress arising from the threat of reduced income and increased complexity from the need to alter financial arrangements, including an inability to return to the workforce.
2.114The Institute of Public Accountants acknowledged the ‘substantial costs incurred in the operation of the imputation system, including the compliance costs borne by companies and shareholders and for the ATO, the costs of administration and compliance activity’.
2.115Therefore, the Institute of Public Accountants suggested government consider:
whether the refundability of franking credits reduces the effective tax paid on the underlying profits to less than the company tax rate of either 25percent or 30 per cent; and
whether all the costs of dividend imputation are outweighed by the benefits of effectively taxing distributed company profits at the shareholder’s marginal rate.
2.116The Australian Taxpayers’ Alliance argued that ‘capital income is already double taxed to the degree that the domestic savings used for the investment was already taxed before it was invested’. They therefore argued that Australia’s system of dividend imputation credits is an efficient method for ensuring that capital income is not triple-taxed.
2.117The Australian Taxpayers’ Alliance also pointed to complicating factors when trying to determine the most equitable tax rate for capital gains and proposed a method that compensated the investor for the time value of money:
A basic principle of income tax policy is that all types of income should generally be taxed at the same rate, to avoid a bias towards less productive activities and unwanted arbitrage between income types.
The complicating factor with capital gains is that the real income from capital investment is not the same as the nominal return on capital invested. This is because of the time delay, which creates additional costs for the investor that need to be factored in when trying to determine the real net income from that investment.
The ATA propose that the government considers the option of returning to cost-base indexation, but instead of indexing to inflation the government should index capital cost to inflation +3% to compensate for the time value of money.
2.118With respect to the actual net company tax rate after franking credits have been refunded, Terry Dwyer submitted:
The net company tax rate on distributed profits is zero and is meant to be zero. The whole point of company tax imputation is to treat the company as a withholding agent for the ultimate taxpayer being the shareholder.
2.119By contrast, Anglicare Australia argued that ‘refundable tax credits are an anomaly in the Australian tax system, as most tax concessions in Australia are nonrefundable tax offsets’. Further, they argued that the recipients of franking credit cash refunds are typically wealthier retirees who do not pay income tax, own their own home, and have other tax-free superannuation assets.
2.120Therefore, Anglicare Australia recommended ‘reforming dividend imputation to end tax loopholes that benefit wealthy Australians, ending the practice of paying cash refunds for people who have managed to reduce their tax rate to zero and pay no income tax’.
Term of reference (i): Related matters
Stamp duty and industry levies
2.121The Property Council cited the Commonwealth Treasury as identifying stamp duty as ‘the tax with the highest cost to living standards and economic growth’. The Property Council submitted:
Stamp duty distorts business decisions, locks families out of housing choices, worsens housing affordability, suppresses economic activity and leaves governments with highly volatile revenue streams.
2.122The Property Council also noted that ‘foreign investment is crucial to Australia’s prosperity’:
However, over the past several years Australia’s reputation as a stable economy with low sovereign risk and a strong rules-based system that provides the opportunity to safely and consistently invest capital has waned.
2.123To that end, the Property Council recommended:
…Treasury amend the thin capitalisation legislation to introduce a “carve out” for the real estate sector, like in the US and UK that will allow for returns to stack up against our global competitors for capital allocations to deliver a greater flow of capital and more developments across Australia.
2.124The Property Council also argued that ‘industry levies generally appear to be at odds with the features of efficient tax system design’:
They are definitionally narrow in their application, often levied on inefficient tax bases, and can come with high collection costs.
2.125The Property Council submitted that 17 new or increased taxes on property have been introduced in Victoria in the last few years, eroding confidence in the market.
2.126To that end, the Property Council recommended that Commonwealth, state and territory governments work closely together to improve Australia’s tax system and remove distorting taxes.
2.127The Association for Good Government proposed a transition from stamp duty to land value tax.
2.128Terry Dwyer submitted that land is the only real naturally appreciating asset. He therefore proposed a uniform land value charge to capture gains as they accrue on a regular basis, noting that this approach would avoid the distortion that occurs under the current system when certain landholders never sell their property.
Return GST revenue to the states it is raised in
2.129The Institute of Public Affairs proposed that the Commonwealth government could continue to collect GST revenues (consistent with the current High Court interpretation of the Commonwealth’s power to levy excise) but the revenue could be distributed to each state according to where the revenue was generated. The Institute of Public Affairs identified the following benefits of such an arrangement:
This would have the benefit of removing the arbitrariness and complexity of the current system and negate the perverse incentives: states would be encouraged to promote greater economic growth, as such growth would lead to higher consumption spending and, in turn, GST revenue.
Vertical fiscal imbalance
2.130The Institute of Public Affairs cited former Labor finance minister, the Hon Peter Walsh AO, for the view that ‘a fundamental principle of responsible government in any system is that each government must raise the money that it spends’.
2.131In this regard, the Institute of Public Affairs submitted:
…the mismatch between revenue raising (mostly by the Commonwealth) and direct spending on public services (mostly by the states) has led to a perennial “blame game” between the different levels of government whenever money is wasted or fails to reach the people who need it.
2.132The Institute of Public Affairs argued that ‘addressing the vertical fiscal imbalance by restoring the revenue raising abilities of the states is critical to restoring accountable government’. To that end, it recommended transferring income tax responsibilities to the states, which would:
…promote tax competitiveness across the country, while also giving the states greater capacity to raise the revenue needed to pay for their programs.
Special economic zones
2.133Special Economic Zones (SEZs) are zones within countries with special regulatory arrangements to promote economic development and growth. The Institute of Public Affairs argued that successful SEZs attract domestic firms and multinational companies, which contribute to business investment, local employment, and economic growth.
2.134A key component of an SEZ is the granting of tax concessions to ‘incentivise entities to remain in the zone, support the creation of jobs, and help build and maintain critical infrastructure’.
2.135The Institute of Public Affairs recommended the implementation of a SEZ in Northern Australia.
Indexation of income tax brackets
2.136The Institute of Public Affairs submitted that income tax brackets should be indexed to address bracket creep, which allows inflation to increase relative marginal tax rates over time.
Savings Trust Accounts
2.137The Australian Taxpayers’ Alliance noted argued that Australia’s tax policy settings create a bias against savings, resulting in lower levels of domestic investment. It submitted that:
…by international standards, Australia has relatively high levels of income tax and relatively low levels of consumption tax. The main difference between the two types of tax is how they impact on savings and investment, since income tax applies to all taxable income while consumption tax only applies to the income that is spent. Our heavy reliance on income tax creates a bias against savings, leading to artificially low levels of savings and domestic investment.
2.138To counter this, the Australian Taxpayers’ Alliance proposed the introduction of Savings Trust Accounts where workers can make tax-deductible contributions of up to $30000 per year with the following conditions and benefits:
People should be free to make additional contributions above the $30,000 threshold, but those contributions would not be tax-free. Earnings on the STAs should also be tax free, and withdrawals from the STAs should be taxed at the taxpayers’ marginal tax rate. This would boost domestic investment (one of the main drivers of productivity) and improve financial security for households (making it easier for families to save for large expenses and consumption smoothing).
Persons in serious financial hardship
2.139Associate Professor Ann Kayis-Kumar of the UNSW Tax and Business Advisory Clinic drew attention to three aspects of the interface between persons ‘in serious financial hardship’ and the tax system:
Weaponisation of the tax system by perpetrators of financial abuse.
Disproportionately high tax compliance costs.
Barriers to accessing Centrelink support.
2.140Accordingly, she made three recommendations:
Legislative reform overriding the general rule requiring the offsetting of tax refunds against outstanding tax liabilities in situations of financial hardship.
Modernise serious hardship relief provisions by legislating for ATO discretion for tax relief for victim-survivors of economic abuse experiencing serious financial hardship.
The ATO/Treasury to consult on the design and operation of the existing regulatory regime as it impacts victim survivors in Australia. Following this initial consultation, we recommend the co-creation of a best practice model for the adoption of US-inspired innocent spouse relief in the Australian context.
Resources tax
2.141Peter Sutton submitted that Australia does not adequately tax its resources which ‘are finite and will eventually be exhausted’. By contrast, he noted:
Qatar charges a minimum tax of 35 per cent on petrochemical industries and petroleum.
Norway taxes the profits of its oil and gas sector by 78 per cent, including a 22 per cent corporate rate and a 56 per cent special tax.
Eliminate bias in the income tax system
2.142The Institute of Public Affairs submitted that the income tax system has a systemic bias in favour of dual-income households. They therefore argued that a taxpayer in a single-income household should be allowed to transfer part of their income to their spouse for tax purposes.
Cash economy
2.143Dr Cosmas Moisidis noted that cash remains a significant part of the Australian economy with the Reserve Bank reporting that in June 2023, $101.3 billion in cash was in circulation, including an increased demand for $100 banknotes.
2.144Dr Moisidis argued that the size of the cash economy ‘erodes confidence in the Australian Tax System when millions of wage and salary earners rightly believe that participants in the cash economy are not paying their fair share of tax’.
The tax gap
2.145The tax gap is an estimate of the difference between the amount of tax the ATO collects and what the ATO would have collected if every taxpayer was fully compliant with tax law. The Australian National Audit Office noted that the ATO 2021–22 annual report estimated that the overall net tax gap for the Australian tax and superannuation system was $33.4 billion for 2019–20.
Ending fossil fuel subsidies
2.146Dr David Morawetz submitted that the Australian tax and expenditure system needs to do more to reduce excessive inequality. He argued that this could be afforded by abolishing what he characterised as Australia’s $42 billion a year subsidy to fossil fuels.
Relationship between small business and the ATO
2.147The Business Union submitted that tax laws which target big business can adversely affect micro, small and medium-sized businesses.
2.148The Business Union noted that while Australian tax law generally specifies the objective, the administration and application is generally left to the discretion of the ATO. The Business Union contended that ‘the ATO frequently misinterprets tax law’, inflicting ‘enormous harm upon individuals who are engaged in business’.
2.149The Business Union drew attention to a 2021 report from the House of Representatives Standing Committee on Tax and Revenue. Based on the findings of that report, the Business Union recommended:
The legislative powers of the Inspector-General of Taxation be upgraded to include automatic and unrestricted access to all ATO files for individual and business taxpayers.
An alleged tax debt cannot be collected until the debt is proven.
The onus of proof of a tax debt is with the ATO.
The budget of the Inspector-General of Taxation be substantially increased to equate to a set percentage of the ATO’s budget so it has sufficient funds to perform its statutory functions.
2.150The Business Union contended that these changes would strike a better balance between the ATO and micro, small and medium-sized business people, ‘with a singular focus on ensuring that taxpayers pay the correct amount of tax’.
Private trusts and companies
2.151Anglicare Australia submitted that the foregone revenue from discretionary trusts is entirely received by the wealthiest 20 percent of Australians. They argued that this demonstrates that Australia has a two-class tax system where discretionary trusts allow high-wealth households to minimise their tax obligations.
2.152Anglicare Australia therefore recommended:
applying capital gains tax to untaxed and preferentially taxed distributions to the beneficiaries of closely held discretionary trusts, including distributions arising from asset revaluations; and
the income retained in private companies, apart from a reinvestment allowance for companies engaged in active business, be taxed at the top marginal rate of personal income tax plus Medicare Levy.
Committee view
2.153The committee notes the breadth of the inquiry terms of reference and thanks the individuals and organisations that provided their thoughts and ideas to the committee.
2.154There were several topics where ideas differed markedly, but also those where views converged—for example, a recognition of the high effective marginal tax rates that both low- and middle-income earners as well as retirees face on taking on paid work and that effectively discourage workforce participation in both cohorts.
2.155In this regard, the committee notes the last comprehensive review of the tax system undertaken by Dr Ken Henry was completed in 2010. This was a significant undertaking with substantial resources.
2.156The committee is of the view that a meaningful review of the matters covered by the very broad inquiry terms of reference would likely require a similarly resourced undertaking. However, the committee is not currently calling for such a review to be commissioned.
Senator Andrew Bragg
Chair
Liberal Senator for New South Wales