CHAPTER SIX - ISSUES FOR FUTURE INQUIRIES

CHAPTER SIX - ISSUES FOR FUTURE INQUIRIES

6.1 It will be clear from the preceding five chapters that the Committee's terms of reference for this inquiry were extremely broad. Submissions and evidence were received on issues as disparate as income splitting, tax credits, the social responsibility of paying taxation, and vertical fiscal imbalance. While the Committee, in this report, has endeavoured to provide an indication of the breadth of that evidence and the dynamics of the issues raised, the Committee came to the view that it does not have sufficient evidence on particular issues to enable it to make considered policy recommendations.

6.2 As a result, the Committee had two options. It could have re-opened submissions in relation to this inquiry, continuing to gather evidence until, eventually, sufficient evidence was received to enable broad policy conclusions.

6.3 This would have taken a long time perhaps years and success was not guaranteed. Alternatively, the Committee could report the evidence received in this inquiry, and recommend a series of more focussed inquiries, to be conducted by the Economics References Committee in the 41st Parliament. In late 2003, the Committee agreed to the latter option. The current report therefore sets an agenda for future reports, based on the issues raised in submissions to this inquiry.

6.4 On 2 December 2003, the Committee convened a round table of experts on taxation matters to consider the evidence presented thus far, and to establish which issues should be pursued by future inquiries. Participants in that round table were:

  • Dr Bruce Bradbury, Senior Research Fellow, Social Policy Centre, University of New South Wales (appearing in a private capacity);
  • Associate Professor Owen Covick, Associate Head, Faculty of Social Sciences, School of Business Economics, Flinders University (appearing in a private capacity);
  • Mr Peter Davidson, Senior Policy Officer, Australian Council of Social Service;
  • Professor Robert Gregory, Economics Program Head, Research School of Social Sciences, Australian National University;
  • Professor Ann Harding, Director, National Centre for Social and Economic Modelling (NATSEM); and
  • Associate Professor Neil Warren, Associate Director (Research), ATAX, Faulty of Law, University of New South Wales.

6.5 This chapter presents the issues which, based on the round table and evidence received during this inquiry, the Committee considers should form the basis of future references. They fall into three broad categories:

  • Tax avoidance and the erosion of the tax base;
  • The relationship between the tax system and the social security system; and
  • Equity in the tax system.

Tax avoidance and the erosion of the tax base

6.6 In chapter 4, the Committee presented evidence in relation to compliance with the tax system. The round table agreed that this is a major issue which, in itself, justifies a substantial inquiry.

6.7 In chapter 4, the Committee referred several times to the fact that, when tax is avoided, the need for revenue does not disappear. Instead, it is redistributed among those who do pay their taxes. This redistribution is accomplished by holding tax rates at a higher level than would be necessary if higher levels of compliance were achieved. At the round table, Associate Professor Warren observed:

We play with the rates. We will push this threshold and we will play with that rate. But what is the rate on? The rate is on the base. What have we been doing with the base? We have been eroding the base. The capital gains tax changes erode the base. Negative gearing effectively erodes the base. All those actions effectively erode the base. If you need revenue but there are trusts, the growth of the self-employed and increased deductible expenses, what are you doing? Everything you are saying is eroding the base. What do you get if you erode the base? You raise the rate because you still want the same amount of revenue. It is like the old wholesale sales tax. The more the base lifts away, the more you ratchet up the rate and the more the base slips away.[204]

6.8 Another almost inevitable policy consequence of a disappearing tax base is to impose taxes which are, structurally, much more difficult to avoid. These taxes may not be particularly efficient from either an economic or equitable point of view, but they do produce revenue. Professor Warren described this as a "tax what you can" approach:

A few years ago I wrote a paper saying that if we continue down this path we will have a tax-what-you-can system, or TWYC. [] Basically, it is saying that if it cannot move out of your headlights, tax it. The states are on to this. What you have to realise is that the states are moving to a tax-what-you-can system. That means land taxes, property tax and stamp duty. As it sits, they tax it. If you change ownership of it, tax it. The states have moved into the taxing-what-you-can system. In a sense, that is what you are left with.[205]

6.9 The Committee supports the reference of an inquiry into tax avoidance, and the consequential erosion of the tax base. Such an inquiry could consider matters such as:

  • the effectiveness of ATO programs to increase tax compliance;
  • whether the ATO is targeting its compliance activities properly, or pursuing small taxpayers while failing to pursue large, corporate tax avoidance;
  • what the policy options are for stabilising or increasing the tax base;
  • whether the Commonwealth has responded to tax compliance issues with tax-what-you-can strategies; and
  • whether those tax-what-you-can strategies, if used, have resulted in inefficiency and inequity.

The relationship between the tax system and the social security system

6.10 This general issue has been discussed throughout this report, and in particular in chapters 2, 3 and 4. The tax system and the welfare system have now become so intertwined that it is virtually impossible to make recommendations in one field of policy which do not impact upon the other. This inquiry has brought forward two issues in particular which justify more detailed investigation by the Committee: the use of tax expenditures, and the impact of effective marginal tax rates.

Tax expenditures vs grants

6.11 Chapters 2 and 3 described how some forms of welfare (for example, Family Tax Benefits A and B) are delivered as tax expenditures, that is, delivered in the form of tax foregone, rather than as funds collected and then paid out. From a political perspective, tax expenditures are attractive, because they make it appear that the government is collecting less tax, and they also make it appear that the government is spending a lower amount on welfare payments. Both of these outcomes are often considered to have electoral appeal.

6.12 Tax expenditures are not used only in welfare policy. For instance, reduced excise on some forms of fuel are effectively a tax expenditure, as are programs like the private health insurance rebate.

6.13 Tax expenditures, however, raise two significant questions. The first is whether they provide the most effective way to deliver benefits to recipients, or whether they are simply employed for the abovementioned political reasons. The second is whether they are used as a means to minimise the parliamentary accountability of government. Budgetary scrutiny of tax expenditures tends to be less than scrutiny of other expenditure, because the budget process tends to concentrate on what governments do collect and spend, rather than what they don't collect or spend. During the round table, Mr Peter Davidson from ACOSS remarked:

The Treasury estimates we spend approximately $30 billion per annum on tax expenditures of which around one-third are superannuation tax concessions. That is roughly 15 per cent of direct outlays. Yet there is a lack of serious budget scrutiny of these tax concessions. We have an expenditure review committee which goes through direct outlays line by line. There is no equivalent process for tax expenditures. As a result, tax expenditures, as distinct from direct outlays, are the main source of what we refer to as well-off welfare in Australiathat is, poorly targeted assistance.[206]

6.14 The Committee supports a reference into tax expenditures, which might consider matters such as:

  • whether tax expenditures provide an effective and equitable way of delivering welfare to welfare recipients;
  • whether tax expenditures are an efficient policy tool more generally (that is, whether tax expenditures can be effectively applied to areas other than welfare); and
  • what institutional (and, if necessary, legislative) arrangements are necessary to place tax expenditures under the same level of scrutiny as other budgetary activities.
Effective marginal tax rates

6.15 The Committee has discussed the issue of effective marginal tax rates (EMTRs) at some length in chapter 3 of this report. EMTRs present a significant challenge to future tax and welfare policy. Simply increasing thresholds appears unlikely to do any more than suppress or delay the problem of EMTRs. It is clear, even on the evidence received in this inquiry, that more fundamental reform may be required.

6.16 At the round table, Professor Gregory indicated the difficulty of devising policies to deal with EMTRs:

To do something about them is impossible without hurting considerable numbers of people. The only way you can avoid that is to give everybody more money. When you add up the two million people that we have in various parts of the welfare system, even more money is just not possible. So any adjustment involves hurting a substantial number of people. That is the major reason why the government has, as you may have noticed, gone extremely slowly on welfare reform.[207]

6.17 The Committee supports a reference into effective marginal tax rates, and considers that this should be the first new references to flow from this report.. Organisations such as NATSEM, who have been producing significant research in this area, could provide a significant contribution. Such an inquiry might consider matters such as:

  • measuring the extent and incidence of high EMTRs in Australia;
  • gauging their impact on taxpayer and welfare recipient behaviour;
  • examining measures undertaken to deal with high EMTRs in other countries; and
  • considering alternative tax structures which could be deployed to reduce the impact of high EMTRs in Australia.

Equity in the tax system

6.18 The issue of equity in the tax system underpins every issue discussed in this report, from family tax benefits to vertical fiscal imbalance. The question of how the tax burden is shared among taxpayers is fundamental to any tax system and, as noted in chapter 4, a breakdown in the perception of fairness in the tax system may lead to further compliance problems, and to a culture which promotes the avoidance or evasion of tax, rather than the acceptance of tax as a social responsibility.

Intergenerational issues

6.19 While term of reference (d) invites the Committee to consider 'the intergenerational consequences of the tax structure', this inquiry did not receive a substantial amount of evidence addressing intergenerational issues directly. Rather, the issue of intergenerational equity underpinned other areas in the report, particularly in chapter 2 (in the sections entitled 'is the tax system a disincentive to establishing a family' and 'Families, tax and HECS) and in chapter 3 (in the section 'The tax system and retirement from the workforce').

6.20 It is reasonable to assert that all tax policy will have an intergenerational impact, because decisions about where and how the tax burden applies, will inevitably have an impact upon matters such as labour force participation and decisions to have, or increase, a family. However, advice to the Committee during the round table suggested that intergenerational issues also merited discrete investigation. Mr Peter Davidson, for instance, suggested that developing intergenerational modelling tools should be a priority:

I am becoming more and more concerned about the intergenerational issues. The Commonwealth at the moment has established some sort of cell based Excel modelling tool which underlays the sort of estimates that were in the Intergenerational Report. Obviously, that is an excellent starting point to look at what the future intergenerational transfers might be. However, if you were concerned about distributional impact, you would want to go to a much more sophisticated, dynamic micro-simulation modelling. In other words, once you are concerned about distributional impacts, you need to have models of individuals rather than the population aggregated into subgroups, which is what is done at the moment in that modelling. I would really again encourage the committee to recommend the development of more sophisticated decision support tools for analysing the intergenerational impact of taxes and transfers as well.[208]

6.21 A related issue, which might be considered by the Committee during such an inquiry, is the extent to which welfare dependency also has an intergenerational character. During the round table, Professor Gregory stated:

One project we are doing at my university which I think is very exciting is that we are now taking a big sample of children of welfare recipients who turn 16 and therefore become adults in their own right and see to what extent those children have an abnormal use of welfare. So we are looking at what you might call intergenerational issues. The preliminary work on that says that if your mother is a welfare recipient, you are four times more likely than anybody else to be on welfare yourself at 16, 17 and 18. When we try to adjust that for where you live and the sort of education you have, the ratio falls. But it is still very, very high.[209]

6.22 The Committee supports a reference into intergenerational aspects of taxation and welfare. Such an inquiry could examine:

  • ways in which the tax system could support adults' decisions to have children;
  • ways in which the tax system could maximise workforce participation ratios;
  • ways in which the tax system can assist younger generations to acquire the same capacity to own significant assets (including, particularly, their homes) as the older generations possessed at the same stage of life; and
  • the interaction between taxation and the decision to retire.
Self employed workers and wage earners

6.23 The Committee has discussed the issue of the tax treatment of self-employed taxpayers in some detail in Chapter 4 of this report. There appear to be two issues of real concern. The first of these relates to the apparently inequitable tax treatment of two workers, doing the same work for the same gross income, on the basis that one of them is self-employed and the other is an employee. During the round table, Mr. Peter Davidson suggested that this should be addressed by treating both types of worker identically for tax purposes:

In theory, it should not be much different. So the solution to this wedge that is emerging between self-employed people and employees from a tax point of view is to treat them as similarly as possible. In theory, for example, self-employed people should not be able to claim a wider swag of work related deductions than employees. In theory, they should not have a capacity to split their earnings with a spouse. Those elements of the tax system could be reinforced.[210]

6.24 Professor Covick noted that there are two ways in which this might occur: by reducing the deductions available to self-employed workers, or by extending those deductions to employees:

In 1998 in the ANTS package, it was proposed to try harder to get people deriving incomes from trusts to have the personal services element treated exactly the same as if they were wage and salary earners. Whereas it ran into problems in that the community regarded it as an extremely harsh and unreasonable thing to do to people who were benefiting from the previous arrangements, one possibility would be to say, Well, if community perceptions are now such that that is regarded as fair and reasonable, why not say wage and salary earners can do it as well and allow all wage and salary households to have a notional trust and their wage and salary income getting the same types of benefits for both income tax and means testing arrangements as self-employed households routinely get through the present arrangements? So you can either improve the comparability of treatment by trying to be as harsh to the self-employed as we are to the wage and salary earners who cannot get away from it, or if that is unconscionably harsh to the self-employed, why do we not regard it as unconscionably harsh to the wage and salary earners and bring them in the opposite direction?[211]

6.25 The second, though related issue, was discussed in chapter 4 following the evidence from the CFMEU. If, as a result of current arrangements, workers are effectively being forced into becoming self-employed, and thereby denied the rights attached to employment, then it is possible that equivalent treatment for both employees and the self-employed would reverse this trend. There would no longer be a tax advantage in being self-employed.

6.26 The Committee supports a reference into the tax treatment of self-employed workers. Such an inquiry could examine:

  • ways in which the tax treatment of employees and the self-employed would be brought into closer alignment, on a revenue-neutral basis;
  • ways in which the income of self-employed taxpayers, which fluctuates dramatically, can be more successfully assessed for the purpose of assessing eligibility for welfare benefits; and
  • ways to prevent the effective coercion of employees into becoming self-employed for the benefit of the employer.
Taxation of superannuation and other benefits to retirees

6.27 As discussed in chapter 3 of this report, there appear to be two opposite views regarding the appropriateness of the current tax regime for superannuation and post-retirement income.

6.28 On the one hand, there is a view that superannuation is taxed too harshly. For instance, in its submission, the Association of Superannuation Funds of Australia stated:

even if the relative tax treatment of superannuation were considered by the Government to be about right prior to the reduction in personal income tax rates and changes to the capital gains tax in 1999, then subsequent to the changes, superannuation taxation is now heavier than desirable. It also can be argued that even prior to the changes made to personal income tax rates that the system of taxing contributions, fund earnings and benefits received involved too heavy a burden of taxation of superannuation.[212]

6.29 On the other hand, there is a view that retirees enjoy tax treatment which is far more generous than for working taxpayers on the same income. As noted in chapter 3, the Senior Australians Tax Offset was singled out for particular criticism.

6.30 The Committee supports a reference into the tax treatment of superannuation and retirement income. Such an inquiry could examine:

  • whether the current process of taxing superannuation funds on entry to the scheme, during the period of investment, and then on payment from the scheme, can be justified;
  • whether the superannuation surcharge imposes unreasonably high effective marginal tax rates on some higher income earners;
  • whether the incurrence of tax expenditures in the form of tax concessions on superannuation is appropriate, and appropriately scrutinised; and
  • whether the Senior Australians Tax Offset provides retired taxpayers with an unfair tax advantage compared to working taxpayers.

Conclusion

6.31 The Committee considers that it would not be reasonable, on the basis of the evidence received during this inquiry, to make substantial or sweeping recommendations relating to tax policy. However, one role of the Senate Committee system is to facilitate public discussion on matters of national importance. In this report, the Committee has endeavoured to fulfil that role by setting out the evidence received as a contribution to current debates on tax policy, and by setting out an agenda for future inquiries into taxation issues.

Recommendation 1

The Committee recommends that the Senate should refer a sequence of taxation policy inquiries to the Senate Economics References Committee. These references may include the following areas, as well as any areas of importance which emerge in the course of the Parliament:

  • Tax avoidance and the erosion of the tax base;
  • Tax expenditures and grants;
  • Effective marginal tax rates;
  • Intergenerational issues;
  • Tax treatment of self-employed workers and wage earners; and
  • The tax treatment of superannuation and retirement income.

Recommendation 2

The Committee recommends that the first reference made in accordance with Recommendation 1 should be an inquiry into effective marginal tax rates in the Australian taxation system.

SENATOR URSULA STEPHENS

Chair