Tax Reform for an Economy in Transition
Address to the Tax Institute NSW 5th Annual Tax Forum
18 May 2012
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Thank you very much for your kind welcome.
It's nice to see some familiar faces and so many members of a highly regarded Institute that's been supporting the tax profession and contributing to the community since 1943.
It's also a pleasure to carry on the conversation from the Tax Forum last October. Coming out of the forum, the Government has been developing policy options in a number of areas: business tax, not-for-profits, anti-avoidance rules, trust provisions and others.
Some of that work has borne fruit in the Budget and I will say something about that later.
But before I do so, I would like to step back from current issues to reflect on the bigger picture: why we impose tax, what we get for our taxes and how much tax we pay.
Importance of taxation
It has often been said that "taxation is the price of civilisation".
It stands to reason then, that the existence of tax practitioners is an obvious sign of civilisation. There might be some that disagree with this proposition, but I suspect there won't be too many in the room today.
Of course, taxation is the means by which we as members of the community are called upon to make a financial contribution so as to ensure that Governments, on behalf of us all, can provide the public goods and services that we all require, but could never adequately provide on our own as individuals.
Tax revenue is what allows governments to fund our education and health systems, fix our roads, provide adequate systems of law enforcement, ensure the defence of our nation, manage our national parks, fund access to high tech pharmaceuticals and medical research, deliver high quality infrastructure, commemorate our service men and women and ensure basic standards in the markets that Australians depend on every day.
And of course, taxation has always played a role in wealth creation and redistribution in Australia.
At the heart of this has been a recognition of the need to build strong incentives into our tax system, while ensuring the provision of an adequate social safety net.
As the lucky country, we have built a strong economy, but have also achieved one of the most egalitarian societies in the world. Our social structures are amongst the flattest in the world and we are a society where opportunity abounds for almost all Australians.
In the modern Australia, just about anyone can achieve success with the right mix of hard work and talent.
Of course, Labor Governments are focussed on ensuring that we create the right incentives and deliver the opportunities needed to ensure that all Australians have the chance to make a great contribution to the national effort.
Contrary to much of the heat in the current political squabbles of the day, Australia is not a high tax country by OECD standards. In 2010, Australia was 6th lowest out of 34 OECD countries in terms of its tax to GDP ratio.
Even with revenues slowly recovering from the GFC, the tax to GDP ratio in 2012-13 will be lower than the entire period of the previous Government.
A broadening of the tax base with the introduction of a number of new taxes around which there has been considerable public debate has been used by this Government's opponents to seek to portray us as a high-taxing Government.
I reject this characterisation and with taxation at 22.1% of GDP in 2012-13 – at lower levels than at anytime during the Howard Government - the facts speak for themselves.
Government's tax reform record
The Government has taken tax reform seriously since we came to office in 2007.
It's why, to date, the Government has adopted nearly 40 measures that progress recommendations of the Australia's Future Tax System review.
And it's worth noting that around 30 of the 138 recommendations in the Henry Review either recommend that no action be taken on a particular measure or require the States to get on board for progress to be made.
Of course, tax reform is not a one shot affair that can be completed in a single package or budget or even over a few years. It is a long term project that requires determination and consultation from governments, especially in times of fiscal constraint.
The release of the Henry Review in 2010, like the release of the Asprey Review some 35 years earlier, marks the start of a renewed national conversation on tax reform.
Many in this room would recall the Asprey tax review, which in 1975 recommended such radical changes as a tax on capital gains, a tax on fringe benefits, dividend imputation and even a value-added tax. Who would of thought that these changes would ultimately be picked up by Government – but of course it took the best part of 25 years for these reforms to be implemented.
Last year's successful Tax Forum continued the conversation initiated by the Henry Review.
And the Government has set up a number of Groups to keep the momentum going, including: the Business Tax Working Group, the Superannuation Roundtable and the Not-for-Profit Sector Tax Concessions Working Group.
The Budget handed down last week continues the Government's work on tax reform and sets out a Road Map for further reform, structured around three themes:
- investing in a productive economy;
- participation and reward for effort; and
- building a fairer and more sustainable tax system.
Investing in a productive economy
First, the Budget includes a number of measures to sustain investment and productivity in an economy going through a period of rapid structural change.
The Government will provide business tax relief with a loss carry-back proposal, to help incorporated businesses facing the pressures of a changing economy.
This will allow companies to 'carry back' up to $1 million of losses arising in 2012-13, and get a refund of tax paid on past profits. These businesses will be able to use their tax losses immediately, rather than wait until they have returned to profit.
In its first 4 years, this measure will provide much-needed assistance to nearly 110,000 companies struggling with the challenges of an economy in transition.
The Government will also cut red tape and boost cash flows for Australia's 2.7 million small businesses.
From 1 July 2012, small businesses will be able to write off each and every new business asset costing less than $6,500. This means that a business that purchases four items of equipment worth $6,000 each will be able to get a deduction of $24,000 in the first year (rather than $3,600 currently). As a result, if this small business is a company it will pay around $6,120 less tax for that year. A sole trader may be able to get an even bigger tax saving, depending upon their marginal tax rate.
This measure is worth around $1 billion in its first year alone.
Participation and reward for effort
The second pillar of the Government's vision for tax reform is to encourage participation and provide reward for effort.
Growing demographic pressures make it more important than ever that the design of the tax and transfer system encourages and supports Australians to get a job and actively participate in the labour market.
From 1 July 2012, the Government will triple the tax free threshold — the largest increase in history.
All taxpayers on a taxable income of up to $80,000 will get a tax cut, with most getting over $300 a year.
One million people will no longer have to lodge a tax return and around 630,000 more people will no longer have to pay any tax.
Tripling the tax free threshold is a better way to provide simplicity to taxpayers than the standard deduction for work related expenses.
And we will increase the threshold further when fiscal conditions allow.
Of course, it was a concern to hear from the Shadow Treasurer on Wednesday, that the Opposition are determined to unwind this reform if they come to power at the next election. To do this, would be to drive a stake through the heart of one of the most important elements of this Government's participation agenda.
The Government will also better target the support provided to dependants through the tax system. This will remove out-dated barriers to workforce participation — like the Child Housekeeper Offset that stems from a time when unmarried daughters were expected to stay home and keep house rather than study or work.
And the Government will replace the Mature Age Worker Tax Offset with better targeted participation programs aimed at older workers. This will improve value for money while protecting those who have built this Offset into their household budgets.
All of this comes on top of the $47 billion in personal income tax cuts we have delivered since we came to Office — meaning that from 1 July this year a person on $50,000 will be paying around $40 a week less tax than when Labor came to power in 2007.
These measures are directed fairly and squarely and ensuring that we build into the system the strongest incentives to encourage economic participation and ensure reward for those who contribute to the national effort.
A fairer and more sustainable tax system
Building on these tax cuts, this Budget includes a number of reforms aimed at improving the fairness and sustainability of the tax system.
We announced that we will better target the tax concession for living-away-from-home allowances and benefits, by ensuring that it is available only to people who are genuinely maintaining a second home away from their actual home, for a maximum period of 12 months.
I announced consultation on exposure draft legislation earlier this week.
The Government will also reduce the higher tax concession received by very high income earners on their concessional contributions into superannuation, so it is more in line with the concession received by average income earners.
As a Labor Government, we are absolutely committed to superannuation. After all, we introduced our compulsory superannuation system and we are progressively increasing the Superannuation Guarantee Charge from 9% to 12% to ensure that more Australians are able to retire on a decent standard of living. Both these advances have been made in the face of a very spirited campaign of opposition from our political opponents.
But just as the introduction of the compulsory superannuation system was about achieving fiscal sustainability for future generations confronting the effects of an ageing population, Governments must have regard to the equity and the sustainability of the superannuation tax concessions provided.
And of course, there have been other sensible measures announced in the Budget such as the reduction in the inbound duty free tobacco allowance from 250 cigarettes to 50 cigarettes from 1 September 2012. There simply is no good reason for keeping this arbitrary tax break.
These are all important tax reforms directed at sustainability and are consistent with recommendations of the Henry Review.
Criticism of Budget tax measures
Of course, the Budget included tough decisions that have attracted some criticism. Decisions like not proceeding with the company tax cut and standard deduction for work related expenses and increasing the withholding tax for managed investment trusts.
What I can say to you today is that these decisions were necessary to target relief to those most in need.
In the case of the company tax cut, it became clear that we were not able to get the cuts through parliament, given the intransigence of the Opposition and the Greens.
We are still committed to working with business and in particular the Business Tax Working Group to develop further reform options.
In the meantime, the Government's loss carry-back measure for companies and the instant asset write-off for all small businesses will provide more targeted and timely help for businesses dealing with the challenges and opportunities of the mining boom.
The increase in the managed investment trust rate was to better balance the need for Australia to be an attractive destination for foreign investment with ensuring Australia receives a fair return. This will apply to distributions relating to income years commencing on or after 1 July 2012.
Developing future policy directions
With the Budget handed down, the Government must now turn our attention to the next steps on tax reform.
Coming out of the Tax Forum last year, the Government is carrying the tax reform discussion forward through a number of different processes:
- The Business Tax Working Group will look at long term directions for reform of the corporate tax system. This will involve considering cuts to the company tax rate and other reform options, like an allowance for corporate equity.
- The Not-for-Profit Working Group will consider ideas for better delivering the support currently provided through tax concessions to the not-for-profit sector.
- The Superannuation Roundtable will consider ideas for providing Australians with more options in retirement and improving certain superannuation concessions.
- The State tax reform process, led by the Treasurers of New South Wales and South Australia, will consider options for improving the States' taxes, with a view to discussion by COAG before the end of 2012.
- The Government is establishing a Tax Studies Institute to be a centre of excellence for research on the tax and transfer system. We are continuing to consult with stakeholders on the model to adopt for the institute.
These processes are paving the way for further reform, informed by broad consultation and the best available evidence.
Consultation and law design
In all of these reform processes, consultation will be crucial to secure good outcomes.
The Government has made it a priority to consult stakeholders on broader policy issues, as well as on specific measures.
We haven't always done it perfectly, but we want strong and sustainable relationships with stakeholders, and to continuously improve our consultation processes.
That is why four years ago we commissioned the Tax Design Review Panel to look at ways to improve the development of tax legislation.
It is worth remembering that before we came to office, public consultation on draft legislation was the exception rather than the rule.
Consultation helps communicate the underlying policy intent of particular tax measures.
And importantly, it makes good law design easier.
So let me say something about a number of areas where the Government is consulting on ways to simplify, rationalise and improve the law.
Late last year, the then Assistant Treasurer released a discussion paper on modernising the taxation of trust income. The Tax Institute has been one of the louder voices calling out for reform in this area of the tax law.
The paper discussed the current issues with the taxation of trusts and outlined a number of possible options for reform, ranging from minor changes to the introduction of an entirely new model.
The paper drew heavily on the expertise of the private sector, through the Tax Design Advisory Panel and the Board of Taxation.
The Government welcomes the response to this paper. Treasury received 36 submissions, including one from the Tax Institute.
In line with the consultation strategy released at the same time as the consultation paper, the next step in this process will be the release of a policy paper that will provide more detail about how the different potential models might work in practice.
We will again draw on the expertise of the private sector to refine these models.
On 21 November 2011, the Government also announced that it would review the current definition of 'fixed trust'. Treasury is currently finalising a discussion paper which will examine different options for a more workable approach.
Finally, the Government is committed to delivering the new tax system for Managed Investment Trusts. We will continue to work with the sector to ensure that this new tax system operates effectively with the Government's broader reforms to update and rewrite the trust income tax provisions.
I want to thank the Tax Institute for its valuable contribution to these processes.
Another important issue for you and your clients, particularly for those small businesses operating through a trust, is Division 7A.
Division 7A plays an important role to ensure the profits of private companies are not paid to shareholders without the proper rate of tax being applied.
However, since its introduction in 1998, Division 7A has been subject to numerous amendments that have made it more complex.
Today I can announce that the Government has asked the Board of Taxation to undertake a post-implementation review of Division 7A and report to the Government by June 2013.
This review will look at ways to simplify this area of the law - which we know is a thorn in the side of many small businesses - while still ensuring that people cannot inappropriately access the profits of private companies.
As you know, in March this year the then Assistant Treasurer announced changes to clarify the definition of 'tax benefit' in the general anti‑avoidance rule.
The Government considers that changes to Part IVA are necessary because of a series of recent court decisions that suggest that there is a technical deficiency in the current rules regarding whether or not a taxpayer has obtained a 'tax benefit' in connection with a scheme.
Specifically, the changes will make it clear that taxpayers cannot avoid the operation of Part IVA by simply arguing that they wouldn't have entered into the scheme if tax were payable in connection with it.
Now, I am aware that some people in the tax community question the need for these changes and some have criticised the Government for announcing the changes without consultation.
I note that the Tax Institute has said that consultation on these changes isn't 'genuine' because the idea of making 'no change' is off the table.
Let me make a couple of points.
First, the Government did conduct targeted consultation before the announcement, including with representatives from the Tax Institute.
Second, I completely reject the notion that consultation is not genuine just because those consulted have not received the response from Government they were hoping for.
Having consulted and made the policy decision, the Government was clear from the outset that we would consult further on how to implement the policy without unintended consequences.
That is why I announced earlier this week that Treasury will conduct a series of roundtable discussions with industry representatives, legal experts and academics to identify and explore possible approaches to clarifying the law. The Tax Institute is represented on the roundtable by Mr Grant Wardell-Johnson and I hope to thank him for his efforts personally at a future meeting.
The roundtable met for the first time on Wednesday and I am told that there was a constructive discussion of how to design these changes.
The Government will also seek advice from senior tax Barristers with expertise on Part IVA before consulting publicly on draft legislation.
This extensive consultation process will help to ensure that the vast majority of taxpayers that do the right thing and pay their fair share of tax are not inadvertently affected by these changes and that those taxpayers who are not doing the right thing cannot escape their tax obligations.
Turning to not-for-profit sector reforms, let me start by painting a picture of the sector.
The NFP sector is large and diverse, and provides invaluable services to the Australian community.
An estimated 400,000 NFP entities enjoy income tax and other tax exemptions or have the status of deductible gift recipients. The quantifiable Commonwealth tax expenditure for the NFP sector in 2010‑11 was almost $3.3 billion.
The current framework for NFP regulations and tax concessions have developed in an ad hoc way and are complex and uncoordinated at the Commonwealth and State and Territory level.
In response, the Government is undertaking the most significant reforms the not-for-profit (NFP) sector has experienced over the last century. They include the establishment of a national regulator, working to harmonise and simplify regulation, and better targeting tax concessions for NFPs.
Yesterday, I announced a new two-stage approach to the establishment of the new national regulator, the Australian Charities and Not-for-profits Commission (ACNC), which is intended to come into being on 1 October 2012.
The Government announced in the 2011-12 Budget it would protect the integrity of the NFP sector and the revenue base by ensuring that tax concessions are used to directly support the purposes for which they were provided, rather than to support unrelated commercial activities operated by NFP entities.
In addition, in February this year, the Government announced a working group to consider ways to better deliver the support currently provided to the NFP sector through tax concessions. The working group includes representatives from the sector and technical experts who are considering whether there may be fairer, simpler and more effective ways of delivering the current level of support. The working group will complete its review by December this year.
Another element of the Government's NFP reform agenda is restating the special conditions for tax concession entities. This will make sure that income tax exempt entities must be operating principally in Australia and for the broad benefit of the Australian community. Deductible gift recipients generally must be operated solely in Australia with some limited exemptions for specific categories of entities' because overseas aid DGRs, environmental DGRs and possibly some others will be exempt.
The Government has been consulting extensively on the measures in the NFP reform agenda and will continue to do so, to ensure that we get it right.
Updates are available on the Treasury website.
I know there has been concern about some recent tax changes that have retrospective effect: particularly the consolidation, PRRT and transfer pricing measures.
I thought it would be helpful if I could give some insights into the Government's approach to retrospective legislation.
Because retrospectivity means different things to different people, let me be clear that for present purposes I define retrospective rules as those having effect prior to their announcement.
The first point to make is that retrospective legislation is not – and should not ‑ be done lightly.
As a former tax lawyer, I know that certainty in the application of our laws is one of the fundamental principles of good governance on which our prosperity is based.
Taxpayers, in making real business decisions, need to be able to rely on the law as it stands at the time.
If they are not able to – either because the law is uncertain or unclear or prone to changing ‑ then investors will be discouraged from investing or will need a higher return to compensate for this uncertainty.
In any case, it has long been accepted that in general the onus should be on Parliament to effectively translate its intention into the law.
So far, I think we would all be in agreement.
That said, there are circumstances where retrospective legislation is justified.
The traditional approach of the Australian Parliament has been to consider each proposal for retrospective legislation on its merits.
Bills that seek to introduce laws that will have application to prior years will generally be subject to additional Parliamentary scrutiny. I think it is particularly difficult to argue against the rigour of this scrutiny in the current Parliament, where the Government operates in a minority Government scenario.
Retrospective tax legislation is generally only done where the law is operating in a manner inconsistent with the Parliament's intention (this includes but is not limited to examples of egregious tax avoidance and evasion) and there is a risk of significant revenue loss.
Where the dividing line on these matters should be drawn can, of course, be open to debate and contention.
I note, the obvious point that taxpayers are generally much more relaxed about retrospective rules that operate in their favour. In fact, taxpayers often call for exactly that.
While it is clear that as a general rule such changes are less problematic, in my view it is far too simplistic to argue that beneficial retrospective changes are "good" and adverse retrospective changes are "bad".
First, just as for adverse changes, taxpayers have already made their business decisions on the basis of their understanding of the existing law.
This means that beneficial retrospective tax changes can effectively result in windfall gains for affected taxpayers at the expense of society as a whole.
Second, increasingly business and their advisers are having a more active role in the development of the taxation law.
I talked earlier about the benefits of this for better law design.
But to my mind, this should bring with it a shared responsibility for getting the law right the first time.
Third, beneficial retrospective tax changes that go too far carry with it the risk that the Government will need to subsequently introduce adverse retrospective tax changes.
The consolidation measures are a good example of this. The key reason why the amendments announced in 2011 needed to be retrospective was that the 'beneficial' 2010 amendments were also retrospective to 2002.
There is much more that could be said on this subject and much more that the Government is doing on tax than I have had the opportunity to discuss today, but I have been speaking for long enough.
Let me summarise by saying that the Government is advancing its tax reform agenda on two fronts.
We continue to consult on ways to rationalise, mend and simplify areas of law where economic change and years of amendments have damaged the coherence and effectiveness of the law.
And we are developing innovative policy for the future, to encourage investment and productivity, support participation, and ensure that our tax system is fair and sustainable for the long term.
And I welcome the Tax Institute's contribution to this ongoing conversation about tax reform.