The consensus on tax reform that is emerging (see e.g. AFR today, editorial, paywalled) is a continuation of the tax reform trends that have been around for at least two decades. The basic idea is to swap the tax mix around so that there are fewer adverse effects on working, saving, investing and taking risks. I summarise the main elements as 5 points.
- To make the company tax rate “competitive” by reducing it to 25% from 30%. In fact company taxes are effectively zero for resident shareholders – firms only act as tax collectors for resident shareholders who must pay taxes on the dividends that do or will receive. These witholding taxes are then rebated to resident shareholders. The main effect of company taxes in Australia is to drag non-resident shareholders into the tax base. This is not a small issue given the dominance of such shareholders in particular sectors of the economy. The main adverse effect of such taxes is on the size of the local capital stock given high capital mobility. By taxing foreign shareholders at the company tax rate the after-tax rate of return on capital is reduced which should reduce incentives to invest in Australia and lead to lower local wages. It is difficult to convince the economic Neanderthals in the Labor Party of this last point because they wrongly believe the brunt of this tax is borne ny firms notv workers or consumers. Chris Richardson et al. (also in the AFR today) argues we should not ignore this valuable possible reform simply because it is difficult to explain to those who have not studied economics.
- To increase the GST or broaden its base. It seems to me that GST reform requires a broadening of the GST base before any discussion of increasing its scale occurs. The current GST covers less than half of all goods and services sold in the economy (fresh food, health and education are the large exempted areas of spending) and the distortions here will increase as, for example, the population ages and spends more on health. As with company tax reform this is a hard agenda item to sell. How many of our current batch of politicians woyuld go into an election advocating inclusion of fresh food, health or education services in the GST? I can imagine the outrage. But again it is a move that would bring in a lot of revenue and eliminate many economic inefficiencies. Simply expanding the tax base rather than increasing the GST rate on a narrow base to generate the same revenue would provide much greater efficiency gains. An increased GST would, of course, raise even more revenue. The proposals for doing this are based on the case for reducing other highly distorting taxes such as stamp duties and excises on insurance. GST impacts on low income earners would be compensated for by further increases in the tax free threshold.
- To cut income tax rates particularly on higher incomes and, as mentioned, to increase the tax free threshold to compensate low income earners for the effects of the increased GST. This seemsc to me the most debateable of the measures proposed in the sense that there is little hard evidence confirming its value. Indeed the evidence goes in different directions depending on which version of “optimal tax” literature you believe. The older theories that date to Mirrless (but which are repeated in the recent 2010 Mirrlees Review of the UK tax system) propose a flattening of the tax system and increasing exemption levels. Recent work by Diamond and Saez (2011) suggests substantially increasing marginal tax rates in the US economy. The difference in results can partly be explained by different assumptions about labour supply elasticities – in non-technical terms by how much work effort and therefore gross incomes are increased when marginal tax rates on higher incomes are cut. If these elasticities are large then cutting these taxes means boosting incomes a lot which provides a substantial base for effecting redistributions. The rich anyway pay most of the income taxes in our society so it is just so important to understand what will happen here accurately. The Diamond-Saez study uses low labour supply elasticities but uses aggregate economy-wide data on labour markets whereas the Mirrlees Review work used more disaggregated data (e.g. families with two incomes) and got much higher elasticities. I don’t find convincing evidence anywhere on the labour supply behaviour of high income earners. Nor do I find alarmism over the role of bracket creep as a key argument for income tax reform given the slow recent growth in wages.
- Cutting stamp duties and excises on such things as insurance. Almost everyone agrees these are highly inefficient taxes and that they should be scrapped. The GST measures advocated might replace some of this state income but there are competing claims on such extra revenues from the income and company tax cuts. Another proposal is to use a broad-based property tax (of the type levied by local governments) as a substitute for conveyancing charges. Then tax liabilities would not depend on the size of conveyancing costs but on the value of the propoerty you buy and the time you live there. This would promote labour mobility (sometimes a good thing) and not penalize those who must shift house frequently.
- The biggest deficiency in the current tax discussion is the almost complete neglect of environmental taxes. Two taxes alone would account for at least $20b in extra revenue – a congestion tax that reflected congestion in Australia’s capital cities would yield at least $10b and a comprehensive carbon tax which would yield at least $10b plus whatever is saved from the ineffective carbon emission subsidy scheme. These taxes would target “bads” not goods in our society and, by being levied, would address significant externalities that damage our lives. These really are “no regrets options” that address significant social concerns positively and help make budgets more sustainable at the same time.