Australia: Selected Issues
Author: International Monetary Fund. Asia and Pacific Dept
Publication Date:
30 Sep 2015
eISBN:
9781513556499
Language:
English
Keywords:
ISCR; CR; price; government; Australia; economy; capital gains tax; tax system; royalty regime; indirect tax; goods and services tax; Income and capital gains taxes; Income; Income tax systems; Global
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This Selected Issues paper analyzes the housing prices in Australia. Housing prices in Australia have increased strongly over the past two decades, including by comparison internationally. Thus housing prices are often argued to be overvalued. Many counter-arguments have been put forward for why such measures are flawed. This paper argues that housing prices are moderately stronger than consistent with current economic fundamentals, but less than a comparison to historical or international averages would suggest. International comparisons of price-to-income ratios suggest that Australia is broadly in line with comparator countries, although significant data comparability issues make inference difficult.

Abstract

This Selected Issues paper analyzes the housing prices in Australia. Housing prices in Australia have increased strongly over the past two decades, including by comparison internationally. Thus housing prices are often argued to be overvalued. Many counter-arguments have been put forward for why such measures are flawed. This paper argues that housing prices are moderately stronger than consistent with current economic fundamentals, but less than a comparison to historical or international averages would suggest. International comparisons of price-to-income ratios suggest that Australia is broadly in line with comparator countries, although significant data comparability issues make inference difficult.

Options for Tax Policy and Federal Fiscal Relations Reform1

A. Introduction

1. Australia’s streak of nearly a quarter-century of uninterrupted growth has left public finances in a solid position. The net debt-to-GDP ratio of the consolidated general government (i.e. the Commonwealth, states, and local authorities) fell from plus 23 percent in 1994 to minus 7 percent in 2007.2 The country has also weathered the global financial crisis (GFC) relatively well, with supportive macroeconomic policies and the China-induced boom in mining investment underpinning the economy during this period.

2. However, fiscal consolidation after the GFC is proving challenging. Fiscal deficits have returned, and net debt has risen to 15 percent of GDP by 2013/14. The end of the mining investment boom and sharp declines in prices for key exports (especially iron ore) have led to a slowdown of GDP growth, declining incomes, and eroding revenues, while efforts to cut back spending have met with political resistance.

3. In this context, the authorities are conducting reviews of their tax policy and federal fiscal relations. Both themes are closely interrelated, both from an economic as well as a political economy viewpoint. Reforms in these areas can help improve growth prospects of the economy, which will need to shift away from reliance on commodity-driven investment and growth. At the same time, comprehensive reforms can lay the groundwork for meeting longer-term fiscal challenges. They can be calibrated to be revenue neutral or achieve some net revenue gains to support fiscal consolidation. However, any reform package is likely politically difficult to agree on, and would require broad political consensus.

4. Key issues that successful tax and federal fiscal reforms need to tackle are:

  • Taxing efficiently. An efficient tax system not only minimizes unwanted distortions, thus increasing investment, employment, productivity and growth (Johansson et al, 2008), but also administrative costs for the state and compliance costs for taxpayers.

  • Boosting employment. This implies the reduction of disincentives to work, and of the cost of creating jobs.

  • Promoting investment. In a more globalized economy with more mobile factors of production (especially capital), maintaining an attractive investment environment is key for ensuring continued growth.

  • Ensuring fairness. At the same time, care needs to be taken that technological and other factors that tend to increase inequality do not lead to entire segments of the population being left behind. This implies that tax and transfer systems need to be equipped to support those who cannot work, or whose work does not earn them a sufficient income.

  • Environment. Taxation is an effective way to reduce negative externalities (e.g. to conserve natural resources and promote health) while raising revenue that otherwise may have to be raised in a way that is detrimental to overall welfare (taxing a ‘bad’ versus taxing a ‘good’).

  • An efficient state. Not only are the costs of administering the tax system an important factor, but also the incentives created by the federal fiscal system that the Commonwealth and states face to deliver public services efficiently and to a high standard.

  • Raising adequate revenue. Reforms will need to ensure that adequate revenue is raised, and should ideally facilitate further adjustments in the longer-term future to meet increasing spending needs arising from ageing (primarily pensions and healthcare costs, though these are projected to increase only modestly over the next 15 years—see Australian Government, 2015a) as well as potential demands for better public services, e.g. in education and infrastructure.

5. This paper analyzes key taxes and features of Australia’s tax and federal systems, and offers reform options. It is beyond the scope of this paper to examine each of the more than 100 taxes levied in Australia, or offer more than an indicative quantification of each reform option. Its aim is to discuss key features—including the main revenue earners as well as some of the more distortive elements—of Australia’s current tax and federal fiscal relations system, and offer interrelated reform options. The remainder of this paper is organized as follows: Section B discusses salient features of the Australian tax and federal fiscal system, Section C offers six reform modules, each comprising a number of individual measures, and Section D concludes.

B. Features of Australia’s Tax and Federal FISCAL System

General Observations

While imposing an overall smaller burden on the economy than in most other advanced economies, Australia’s tax and levy system is skewed toward relatively inefficient direct taxes.

6. Australia’s overall burden of government levies, at 39 percent of GDP, is comparably low. Its total levy-to-GDP ratio is 4¾ percentage points lower than the average of advanced-economy peers (Figure 1). This includes employer contributions to private pension schemes, which are compulsory and thus akin to a tax, at least from the employer’s viewpoint, even if the payment does not accrue to the government or a public social security fund (some companies may make higher contributions to private pension schemes than required by law as part of their compensation packages—however, this is likely to be an overall relatively small amount.)

Figure 1.
Figure 1.

Revenue Composition

Citation: IMF Staff Country Reports 2015, 275; 10.5089/9781513556499.002.A003

7. Six taxes generate 2/3 of total general government tax revenue, and 10 taxes over 90 percent. While there are over 100 taxes (Australian Government, 2010), the largest revenue earners are the personal income tax, the corporate income tax, the goods and services tax (GST), property and payroll taxes (including state payroll taxes and taxes on superannuation contributions), and fuel excises.

8. Revenues are skewed toward direct taxes. While the overall level of direct taxes as a percentage of GDP is broadly comparable to other OECD economies, revenue from indirect taxes on goods and services is low. Therefore, Australia’s revenue policy uses the space that its overall relatively low revenue burden provides largely to reduce indirect taxes.

9. Direct taxes on labor and capital are generally less efficient than indirect taxes. A wide body of literature, including the Australian government’s 2010 Henry Tax Review and the Australian Government’s recent Tax Discussion Paper, suggests that direct taxes on labor and capital (though not on immovable property) lead to larger economic distortions than indirect taxes (see also Johansson et al, 2008) and are most harmful to growth. The 2010 Henry Tax Review estimates that of the large revenue earners, insurance, payroll, and corporate income taxes generate relatively large marginal welfare losses, while the GST is the most efficient tax (land taxes are also efficient, but do not generate large revenues). It also notes that in Australia, the number of taxpayers using professional help filing their taxes is relatively high.

Key Taxes

Personal income and corporate tax rates are comparably high, but personal income tax revenue is undermined by large tax expenditures. The GST rate is low and productivity average.

Taxation of Individuals

10. Personal income tax revenue in Australia is below advanced economy peers (Figure 2). At the same time, tax rates are fairly progressive, with a top marginal rate of 45 percent (in addition, a temporary 2 percent budget repair levy was introduced in 2014/15) that sets in at a level of income (270 percent of GNI per capita) that is relatively low compared to OECD peers. However, there are significant exemptions and concessions, most notably the exemption of owner-occupied houses from capital gains tax (CGT; which is integrated into the personal income tax), the concessional CGT treatment of the sale of investor houses if owned for more than one year (the same as for other investment, e.g., equity), and the concessional taxation of employer superannuation (i.e. pension fund) contributions and of superannuation returns. The resulting tax expenditures are estimated by the Australian Treasury at over 4 percent of GDP in 2015/16.

Figure 2.
Figure 2.

Personal Income Taxation

Citation: IMF Staff Country Reports 2015, 275; 10.5089/9781513556499.002.A003

11. Many countries provide special tax regimes to support homeownership and savings for retirement (Boxes 1 and 2). While there may be good socio-political and economic reasons (e.g., promotion of homeownership as a social goal, or raising the national savings rate) for such policies, such special treatment can create significant economic distortions (some of which are indeed intended, though others are not), and are often costly in terms of foregone tax revenue. While estimates of distortions and the amount of tax expenditure are often of limited reliability due to the difficulty in quantifying behavioral responses to changes in policy, the broad estimates by the Australian Treasury indicate that they are substantial. However, beyond the direct fiscal cost effect, the support for homeownership also has an impact on the real estate market, and, together with superannuation subsidies, affect the progressivity of the tax system.

Taxation of Corporations

12. Australia relies to a significant extent on corporate taxes and levies (Figure 3). They represent 11¼ percent of GDP (including employer contributions to superannuation funds which do not accrue to the government), well above the advanced OCED average even if natural resource rent taxes and royalties are not taken into account. Corporations pay a number of taxes:

  • Company tax (4½ percent of GDP in 2013/14). At 30 percent, Australia’s company tax rate is above the average of advanced OECD (26.5 percent). The productivity of this tax is also well above the advanced OECD average, contributing to one of the highest shares of corporate tax revenue among advanced economies.

  • Employer contributions to superannuation funds (5 percent of GDP). Currently, the compulsory contribution rate is 9.5 percent of gross salaries/wages, but is scheduled to rise to 12 percent by 2025/26. These contributions are subject to a 15 percent tax in superannuation funds. While not a tax accruing to the government, these levies nonetheless represent a de facto tax to employers.

  • Fringe benefit taxes (¼ percent of GDP) are levied on certain benefits employers provide to their employees or their employees’ associates, for example the use of company cars for private purposes.

  • State payroll taxes (1½ percent of GDP). States levy payroll taxes which, however, do not flow into specific social security funds but contribute to states’ general revenue. Moreover, these taxes are not broad-based, and can exempt large numbers of employees (Australian Government, 2015b).

  • Royalties and resource rent taxes (about ¾ percent of GDP). These largely accrue to the states. Their productivity is difficult to assess, since royalty regimes are often complicated and differ widely across countries. Illustratively, Australia’s revenue natural resource revenues as a percentage of natural resource rents as calculated by the World Bank (see World Bank World Development Indicators) is about 10 percent, broadly comparable to Canada (11 percent).

Figure 3.
Figure 3.

Corporate Taxes

Citation: IMF Staff Country Reports 2015, 275; 10.5089/9781513556499.002.A003

Housing and the Tax/Transfer System

Australia’s tax and benefits system incentivizes investment in real estate. Both owner-occupiers and investors receive significant support through the tax system (Australian Government, 2014). This tends to increase demand for housing, with likely consequences for the real estate market. This in turn has potentially negative implications for housing affordability, financial stability, and equity.

The principal housing-related tax incentives are:

  • Owner-occupiers. Owner-occupied residences are exempt from CGT. While demand for the overall number of dwellings might be only little affected (since people who do not own homes would have to rent), it is likely to lead to overinvestment in housing since this form of investment is tax-preferred (see Australian Government 2014), and thereby drives up the value of dwellings.

  • Investors. CGT for real estate owned for more than a year is effectively halved, to account for the erosion of real value due to inflation. This is reinforced by the deductibility of interest payments and maintenance expenses from taxable income from other sources (though rental income is taxed), an uncommon feature internationally and among Australia’s peers. While this deductibility is not different from that of other investments, it facilitates ‘negative gearing’. As with incentives for owner-occupiers, it drives up prices, but likely does not trigger a significant supply response, which is largely determined by more fundamental factors such as zoning regulations and infrastructure availability.

A03ufig1

Investor Housing and House Prices

Citation: IMF Staff Country Reports 2015, 275; 10.5089/9781513556499.002.A003

Sources: ABS, RBA, IMF estimates.

The CGT concession for investors and the tax deductibility of net losses on housing investments from other income increase incentives for ‘negative gearing’. When an investor expects capital gains, a property investment may be worthwhile even if rental income does not cover interest costs and maintenance expenses. This effect is enhanced if the resulting loss can be deducted from taxable income, and by concessional CGT treatment. In an environment of rapidly rising real estate prices, the incentives for this form of investment increase, since low-taxed expected capital gains increase. Negative gearing thereby acts as an amplifier of price movements in the real estate market and encourages investment that would otherwise incur ongoing revenue losses. At the same time, however, this tax treatment could subsidize rents, since at a given dwelling price it makes a lower rent acceptable to landlords. However, as it also increases dwelling prices, the net impact is not clear—moreover, if the motivation is to help low-income renters, this can be done much more efficiently (e.g., through direct transfers).

The transfer system also has an impact on real estate investment. When the level of the (means-tested) Age Pension is calculated, the value of owner-occupied houses is exempt from the assessment of assets (Australian Government, 2014). While there is an argument that owner-occupied real estate does not yield an income stream, it encourages investment in real estate, increases Age Pension costs and likely benefits wealthier households. The amount of additional expenditure this generates is difficult to estimate, but could be substantial.

Superannuation and Income Distribution

Australia’s pension system is based on three pillars. The universal ‘Age Pension’ (the first pillar) is means-tested and taxpayer funded; the ‘superannuation guarantee’ (the second pillar) is a mandatory contribution made by employers on behalf of their eligible employees into a superannuation (pension) fund; and the third pillar consists of voluntary savings including additional contributions to superannuation funds. As the current working generation accumulates assets, overall reliance on the public pension system is expected to decline over the long run. With this move, responsibility for providing for old age is increasingly shifted to the individual (though a safety net remains), and the question of taxation of pensions arises.

There are two broad concepts for taxing pension savings. In principle, the ‘expenditure tax’ system, where either contributions or payouts are taxed, is neutral between current and future consumption, while the ‘income tax’ in which earnings of the pension funds are also taxed is neutral between current consumption and saving, which provides a (relative) disincentive to save (Whitehouse 1999).1 However, in practice, the effect on savings behavior and tax revenue depends on the progressivity of the income tax regime and the tax rates applied to contributions, fund earnings, and/or payouts.

Australia’s system incentivizes retirement saving and benefits higher-income earners. Australia taxes pre-tax (concessional) contributions (which are made by employers and the self-employed) and earnings during the accumulation phase, but at concessional rates. This represents a somewhat hybrid—and administratively complex and opaque—system, in which the disincentive to save is counterbalanced by concessional rates. The tax rates on contributions and earnings are largely flat, though a higher tax rate applies to contributions of high-income earners, and the tax on contributions for low-income earners are effectively reduced through a government subsidy. A highly stylized model calculation (for details of the model, see Appendix) suggests that the tax impact of the Australian concessional TTE system is close to that of a TEE system at full income tax rates, but provides significant savings incentives compared to an EET system, which most OECD countries have adopted. Moreover, higher-income earners gain relatively more from the favorable tax treatment of retirement savings (indeed, low-income earners lose: subsidies are insufficient to offset the effectively higher average tax rate on superannuation contributions than on other earnings), which undermines the progressivity of the income tax system.

A03ufig2

Tax Benefits of Superannuation System, compared to …

(% lifetime income)

Citation: IMF Staff Country Reports 2015, 275; 10.5089/9781513556499.002.A003

Sources: ABS, RBA, IMF estimates.
1 Corresponding to the three points at which pension savings can be taxed (at the contribution stage, when investment income and capital gains accrue to the fund, and when payouts are made), systems are classified as TEE (contributions are Taxed, earnings are Exempt, payouts are Exempt), EET, TTE, or ETT.
Sales Taxes

13. Australia stands out in that its revenue from value added tax is much lower than in almost all other OECD peers (Figure 4). This is in part due to the low standard GST rate of only 10 percent, but also due to numerous exemptions which narrow the tax base and reduce GST productivity. For example, New Zealand, with a standard rate lower than in most other OECD counties (though higher than in Australia) but almost no exemptions achieves one of the highest GST revenue-to-GDP ratios in the OECD (Box 3). GST is collected by the Commonwealth government but distributed to the states (see below).

Figure 4.
Figure 4.

GST

Citation: IMF Staff Country Reports 2015, 275; 10.5089/9781513556499.002.A003

Other Taxes

14. There are a number of other taxes which, while less important from a total revenue viewpoint, nevertheless have significant economic efficiency costs. Some of them are, however, an important source of revenue for states.

  • Stamp duties. Stamp duties on the transfer of residential and commercial property (‘stamp duties on conveyances’) are the third-largest source of tax revenue for states (after GST and payroll taxes). The 2010 Henry Tax Review and the 2015 Tax Discussion Paper both find that this type of tax has a large welfare cost—unsurprisingly, since it directly adds to transaction costs, impedes labor mobility, and can lead to the retention of land for relatively unproductive purposes. They are also a volatile revenue source, as they are driven by property prices and the number of transactions.

  • Insurance taxes. As with stamp duties more broadly, insurance taxes have large welfare costs, as they may lead to under-insurance or to people not insuring at all.

  • Energy subsidies. Australia levies excise taxes on fuels, the indexation of which has recently been reintroduced. Overall, however, taxation of energy is too low—as in most other countries—to adequately reflect negative externalities (Box 4).

GST Reform in New Zealand

New Zealand introduced its GST in 1986. At the same time, New Zealand’s economy was in crisis, and the government pursued a wide range of economic reforms to liberalize the economy and restore fiscal and external balance. The GST was introduced at a rate of 10 percent, which was later increased to 12.5 percent (1989) and 15 percent (2010). Its main aim was to increase revenues to put public finances on a sounder footing and to boost growth through reduced economic distortions and administrative and compliance costs. Equity considerations played a secondary role at the time.

The overarching principle of the GST (as well as of New Zealand’s tax reforms more broadly) was to establish a broad base and tax it at low rates. This led to the adoption of a GST at a single rate and with almost no exemptions. Most notably, food was included in the GST base at the full rate. This not only led to a broad base but also to reduced compliance and administration costs, as definitional issues that afflict more complex systems (including Australia’s) were avoided. As a result, New Zealand has the highest tax productivity in advanced economies (with the exception of Luxembourg, where significant cross-border sales boost VAT productivity).

The introduction of the GST was part of a comprehensive tax and welfare reform package. At the

same time, or very shortly thereafter, reforms of the income tax, company tax, and taxation of retirement savings were implemented. In addition, a major reform of the welfare system was carried out, which was critical to the political acceptance of the GST (Head 2009).

A confluence of political economy factors were key for the government’s ability to push through reform (White 2009). These included the adverse (macro)economic environment and dissatisfaction with the existing tax system, which created consensus on the need for reform. Moreover, the government was formed by one party in a unicameral parliament, with no need for a coalition at the national level and the absence of subnational levels of government that could influence the decision-making (in Australia, GST reform needs the support of the Commonwealth and all states).

Inequality

Despite a well-targeted transfer system, inequality in Australia has risen somewhat over the past decade, and relative poverty is comparatively high. Any tax reform should aim at least not to worsen inequality, and ideally to reduce it.

15. Inequality can affect economic outcomes. Lower net (i.e. after taxes and transfers) inequality is robustly correlated with faster and more durable growth, and redistribution appears generally benign in terms of its impact on growth (Berg, Ostry, and Tsangarides, 2014). Conversely, higher inequality can undercut the social consensus required to adjust in the face of shocks (Persson and Tabellini, 1994; Berg, Ostry and Zettelmeyer, 2012). This could be especially relevant in the Australian context, where a key element of tax reforms under discussion is an increase in GST revenue, which tends to affect poorer household disproportionately (even though the better off account for the bulk of the revenue lost from GST exemptions, which makes a low GST an inefficient form of support for lower-income households).

Energy Subsidies1

Energy subsidies have wide-ranging economic consequences. They distort resource allocation by encouraging excessive energy consumption, thereby artificially promoting capital-intensive industries; reduce incentives for investment in renewable energy; and accelerate the depletion of natural resources.

Energy subsidies are pervasive, including in Australia, and can impose substantial fiscal and economic costs. They not only include payments to producers, or consumers paying prices that are below supply costs (pre-tax subsidies): the most important element of total subsidies are tax subsidies, which occur if taxes for energy are below their efficient level (i.e. they are taxed lower than other consumer products, and/or end-consumer prices fail to take into account negative externalities—largely the effects of pollution and global warming). In most countries, taxes on energy fall far short of this, implying the full costs of consuming energy are not reflected in its price, as it should when energy is priced efficiently. Post-tax subsidies are the sum of pre-tax and tax subsidies.

A03ufig3

CO2 emissions per capita, 2010

(Metric tons)

Citation: IMF Staff Country Reports 2015, 275; 10.5089/9781513556499.002.A003

Source: World Bank.
A03ufig4

Post-tax energy subsidies, 2014

(% GDP)

Citation: IMF Staff Country Reports 2015, 275; 10.5089/9781513556499.002.A003

Source: IMF staff estimates.

In 2014, global post-tax subsidies for petroleum products, electricity, natural gas, and coal reached $5.2 trillion (6¾ percent of global GDP), of which $481 billion were pre-tax subsidies. Advanced economies account for about a quarter of the global post-tax subsidies. Australia, which has one of the highest emissions of carbon dioxide per capita among OECD countries (and, indeed, the world), has also significant post-tax energy subsidies, estimated at 2¼ percent of GDP—close to the OECD advanced economies average.

1 Based on IMF 2013 and updated calculations.

16. Inequality after taxes and transfers in Australia is similar to the OECD average, but relative poverty is comparatively high (Figure 5). The redistributive mechanism uses extensive means-testing to target transfers, but the limited size of the state (i.e., the amounts available for redistribution) circumscribes the extent of redistribution that can be achieved. Nonetheless, there appears to be scope to improve targeting those most in need.

Figure 5.
Figure 5.

Inequality

Citation: IMF Staff Country Reports 2015, 275; 10.5089/9781513556499.002.A003

17. Inequality has also risen somewhat over the last decade (though it has declined again slightly in recent years). While the increase of the Gini coefficient has not been marked and the post-tax/transfer relative poverty rate has not increased, the ratio of the income of the richest to the poorest has risen significantly. At the same time, pre-tax/transfer Gini inequality has declined slightly while post-tax/transfer Gini inequality has increased, implying a weakening of the redistributive system. Moreover, the post-tax/transfer relative poverty rate has increased slightly while the pre-tax/transfer relative poverty has declined.

Federal Fiscal Relations

Australia’s federal fiscal system is tilted toward the Commonwealth. But federations are complex and involve trade-offs between efficiency on one hand, and equity and autonomy on the other.

18. The Commonwealth government in Australia is relatively dominant (Figure 6). It receives (excluding its transfers to state and local governments) slightly over half of all general government revenue. States collect another 41 percent (excluding transfers to local authorities); local authorities the remainder. By comparison, in Canada the federal government receives less than 30 percent of total revenue, while provinces receive over half and local authorities about one-fifth.

Figure 6.
Figure 6.

Fiscal Federalism

Citation: IMF Staff Country Reports 2015, 275; 10.5089/9781513556499.002.A003

19. Australian states’ revenue-raising and expenditure autonomy is significant.3 Tax and nontax revenue are exclusively assigned to each level of government, which have full powers to change the base and rates. Therefore, states have full control over about 54 percent of their revenue, while about one quarter comes in the form of general revenue assistance from the Commonwealth (most of which is GST revenue), for which states neither set the rate nor the base independently. A further 22 percent comes in the form of Payments for Specific Purposes (PSPs; transfers from the Commonwealth), which implies that they are tied to specific sectors or to specific projects. The system of PSPs is complex, with different programs in different sectors. In particular, financing of specific projects and support for specific targets (through National Partnership payments, a subset of PSPs, which comprise about one third of total PSP payments) is extremely detailed, and often provides resources to only one state, and/or very small amounts. In contrast, Canadian provinces fully control close to 85 percent of their revenue. However, since GST transfers are untied, Australian states fully control close to 80 percent of their expenditure.

20. Horizontal fiscal equalization takes place through the distribution of the GST. GST revenue is distributed according to a formula that takes into account states’ revenue generating capacity as well as expenditure needs to ensure that states have the ability to provide public services to a common standard. The formula takes into account a wide range of factors, including population size, age, and structure; per-capita income; the impact of geography on costs; the presence of indigenous people; English fluency; and the capacity of various tax bases (Kirchner 2013). Overall, however, the redistribution is modest (11 percent of GST revenue, and about 0.4 percent of GDP). By comparison, Germany redistributes about ¾ percent of GDP among its Bundesländer, and Canada about 1 percent of GDP among its provinces.

21. These features represent a broadly reasonable compromise between efficiency and autonomy. Too high a degree of revenue autonomy, for example by allowing differentiated sales taxes, as in Canada, could create distortions within the national economy. Moreover, while states cannot unilaterally change GST in their jurisdiction, they receive the proceeds unconditionally, which implies considerable leeway in spending them. Similarly, while equalization payments constitute a disincentive for states’ own revenue-raising and economy-strengthening efforts, the effect is small (Novak 2011). Moreover, such equalization payments feature in all federations, and are an expression of solidarity within the federation, which is ultimately a political choice.

22. However, there are also important drawbacks embedded in the institutional set-up of Australia’s fiscal federalism:4

  • The GST-setting mechanism. The effective veto that each state (and the Commonwealth) has makes GST reform—which may be needed from time to time—politically difficult to achieve.

  • The equalization mechanism. The system is complex and some states argue for change on various grounds. However, the current system, and the tensions it generates, do not appear substantially out of line with the experience of international peers. The concept of “equalization” is also inherently political rather than purely economic.

  • PSPs. The system of PSPs, and especially the National Partnerships, appears somewhat micro-managing. While the underlying rationale of ensuring common standards across Australia is sound, they can also create perverse incentives, for example through matching requirements, which tend to increase state/local taxation (Spahn and Shah, 1995), or leading to an allocation of resources determined by central government priorities instead of those of the local population and its government/legislature.

  • States’ reliance on inefficient taxes. States rely to a significant extent on relatively inefficient taxes for their own-source revenue. State payroll taxes, stamp duties, and taxes on insurance comprise over 60 percent of states’ own-source tax revenue. This is a consequence of the exclusive assignment of taxes to different levels of government.

  • Infrastructure investment. Infrastructure investments often require a long time horizon and can justify borrowing against a future boost in productivity and tax revenue that well-planned infrastructure can generate. However, infrastructure investment in Australia is undertaken largely by states, which typically face tighter constraints on their ability to borrow than the Commonwealth, in part due to their limited revenue-raising autonomy. This may result in a sub-optimal provision of infrastructure nationally.

C. Reform options

Tax policy and federal fiscal relations reforms need to achieve multiple objectives, requiring a comprehensive reform package that implements various reforms simultaneously. Table 1 provides an illustrative scenario of a combination of reforms (not all costed). Any actual reform package could of course be geared to yield less or more gross or net revenue, use revenue differently, and distribute it differently between the Commonwealth and states.

Table 1.

Impact of Illustrative Tax Reform Options 1/

article image

IMF staff estimates based on 2013/14 outcomes (ABS and Commonwealth Treasury data).

Assumes GST productivity at New Zealand level.

Expenditure measure.

Illustrative calculation based on halving tax expenditure on capital gains tax discount for individuals and trusts. (+) = net revenue gain or expenditure reduction (not quantified).

23. Any reform of Australia’s tax and federal fiscal relations system will need to reconcile competing objectives. Overall, it should (i) increase efficiency and reduce distortions, thus promoting higher growth and incomes; (ii) at least preserve, if not improve, socio-economic equality while maintaining or strengthening incentives for work and investment; and (iii) provide for an adequate degree of fiscal autonomy of the states, while also preserving their ability to provide public services to a high common standard. This requires a package approach consisting of simultaneous changes to several taxes, as well as transfers—though some elements could be introduced gradually to avoid penalizing existing interests which are the result of decisions made under the current tax system, and thereby increase social and political acceptability.

24. Not all changes to the tax and federal fiscal system are equally critical. Some desirable changes may be politically more difficult than others to implement; therefore this paper presents a modular approach in which different options across and within modules can be combined. Nonetheless, key elements are linked, either because they are needed to balance revenue additions and subtractions, or because they compensate for adverse effects of other policies. Some reforms are key building blocks without which not much else can be accomplished, while others are more of an auxiliary nature.

Reform Modules

25. Module 1: Increasing efficiency while improving equity—GST reform and compensation. A key plank of fiscal policy and transfer reform revolves around an increase in GST revenue, and complementary reforms to income taxes and transfers to low-income earners.

  • Boost GST revenue. Central to any tax reform effort should be a significant increase in GST revenue. This tax is relatively less distortive than most other large revenue sources, and has the potential to raise sufficient additional revenue to reduce other, less efficient, taxes and to meet emerging longer-term spending pressures. Raising the productivity of the GST to New Zealand’s level, and the rate to 15 percent could, together, yield close to 6 percentage points of GDP in additional revenue, which would accrue to the states (if the higher GST revenue is not shared with the Commonwealth—see below).

  • Compensate lower-income households. Since the GST is relatively regressive, lower-income households would need to be compensated, reducing Commonwealth revenue and increasing Commonwealth expenses. Further increasing the effective income tax-free threshold to relieve the lowest income quintile of income tax payments, and partial relief of the second, third, and fourth quintiles would go some way to reduce the burden of a higher GST on households. However, this would be not enough for a full compensation of low-income households. Therefore, an increase in cash transfers would also be required. Figure 7 provides an illustrative example of (over)compensation of the lowest income quintiles and partial compensation (through a simple across-the board increase in cash transfers) of the other quintiles. The total cost in this example is estimated at close to 3¼ percent of GDP.

Figure 7.
Figure 7.

Compensating Lower-Income Households for GST Reform

Citation: IMF Staff Country Reports 2015, 275; 10.5089/9781513556499.002.A003

26. Module 2: Reducing risks—reducing distortions in the real estate market. Reducing the concessional treatment of capital gains, eliminating the deductibility of housing losses from other taxable income, and capping the exemption of owner-occupied housing for the calculation of the Age Pension, would likely reduce incentives for negative gearing and overinvestment in housing, and improve housing affordability, financial stability and equity. It would also likely improve the allocation of savings, and raise revenue to allow reduction in other taxes. Cutting stamp duties would reduce transaction costs in the real estate market, improving efficiency, and could partly offset the impact of the lower tax incentives. These reforms would need to be carefully calibrated to avoid a too severe shock to the market and unduly penalizing people who have made investments in the belief that the current system would continue to operate.

  • Revisit the level of CGT concessions for housing investors. Since the introduction of the CGT discount, inflation rates have declined, which would suggest a reduction in the CGT discount is warranted. To avoid distortions across asset classes, concessional taxation of capital gains of individuals and trusts on assets owned for more than a year should be aligned. A complete abolition of the CGT concession would yield slightly less than ½ percent of GDP; a reduction commensurately less.

  • Abolish deductibility of net losses from property investment from other taxable income. Similar to CGT concessions, the ability to deduct net losses arising from property investment from unrelated other taxable income reinforces incentives for negative gearing and supports overinvestment in housing. To avoid distortions across asset classes, deductibility of interest costs from other taxable income when making financial investment should also be abolished. Due to data availability issues, this measure has not been quantified.

  • Abolish stamp duties, and broaden the base for and raise land taxes. As outlined above, stamp duties on real estate transactions are highly distortive and could be abolished. To compensate for the revenue loss, recurring land taxes—the most efficient form of taxation—could be raised (at a uniform rate, to avoid penalizing larger-scale residential development), and the additional revenue distributed to states (not local governments). While, in principle, this switch could be revenue-neutral, it can also be calibrated to achieve a net gain or loss in revenue.

  • Limit primary residence exemption from Age Pension. Since the unlimited exemption of the primary residence from the assets used for the calculation of the Age Pension tends to lead to overinvestment in housing (and higher expenditure on the Age Pension), a cap for this exemption could be introduced. To avoid penalizing homeowners who have occupied their house for a long time and which has risen in value beyond such a threshold while not generating a revenue stream, the length of ownership/occupancy could be taken into account in determining the threshold, or a uniform high level could be used. Due to data availability issues, this measure has not been quantified.

27. Module 3: Improving fairness—reforming income and superannuation tax. The tax advantages deriving from tax concessions for superannuation are substantial. Changing parameters (thresholds as well as a move to more progressive taxation of superannuation contributions) could be calibrated to yield a net revenue gain (or loss, if the combination of other tax reforms yields sufficient fiscal space). However, adjusting any of these policies would need careful calibration and phasing, and should be introduced in tandem with measures to enhance efficiency.

  • Reduce superannuation subsidies for high-income earners. As outlined above, superannuation tax concessions are significant, and disproportionately benefit higher-income earners, reducing the progressivity of the tax system. At the same time, there is an economic rationale to continue to subsidize retirement savings—both to reduce demands on the Age Pension and to help maintain a high national savings rate. To re-strengthen the progressivity of the tax system and make the subsidization of savings more transparent, the tax rates and thresholds for mandatory superannuation contributions and earnings during the accumulation phase could be aligned more closely with income tax rates (though they could still be lower). This could remove the bias toward favoring higher income earners. The quantitative impact will depend on the calibration of these measures.

  • Remove the CGT exemption of inherited primary residences. This would be akin to an estate tax, but has the advantage of fitting in the existing tax structure, as well as avoiding possible forced sale of assets to meet tax liabilities that fall due upon death. To avoid circumvention of the tax through gifting, time limits for the non-taxation of gifts could be introduced. This would improve equality of opportunity, reduce the intergenerational transmission of inequality, and incentivize work for the beneficiaries of inheritances. It would also reduce incentives to invest in housing to the extent that people take intergenerational welfare into account. However, the yield would likely be modest.

  • Adjust income tax thresholds and/or rates. The reforms in Modules 1 and 2 and the reduction of superannuation concessions would leave middle- and higher-income households with a significant additional tax burden (though it should be noted that the actual income tax burden in these income brackets is not as high as the statutory tax rates suggest—precisely because of the tax concessions in superannuation and housing). This could be partially be compensated for by adjusting income tax threshold and/or rates. An illustrative example is provided in Figure 8. The total cost in this example would be close to ¼ percent of GDP (though more income tax relief could be provided dependent on the recalibration of superannuation tax concessions).

Figure 8.
Figure 8.

Compensating Middle- and Higher-Income Households

Citation: IMF Staff Country Reports 2015, 275; 10.5089/9781513556499.002.A003

28. Module 4: Taxing negative externalities and cutting inefficient minor taxes.

  • Tax energy right. The taxation of negative externalities arising from fuel consumption would achieve both a revenue gain that could be used for other purposes (reducing other taxes or increasing spending, such as investment in human capital or physical infrastructure), and an incentive to reduce the negative externality. Taxing energy right would yield substantial benefits for Australia, providing about 1¼ percent of GDP in revenue, reduce negative spillovers on Pacific Islands, and position Australia (again) at the forefront of international efforts to reduce carbon emissions.

  • Eliminate insurance taxes. Eliminating insurance taxes would remove one of the least efficient taxes at relatively little cost (½ percent of GDP).

29. Module 5: Boosting incentives for investment and employment—reducing company and state payroll taxes. Increased revenue from the reforms outlined above could be used to reduce the high and inefficient company tax, and eliminate payroll taxes. These would boost growth, jobs, incomes, and productivity.

  • Reduce company tax. Reducing the standard company tax rate by 5 percentage points to 25 percent for all corporations would bring Australia’s tax rate to the OECD average, and below that of advanced economy peers. The cost in foregone revenue would be modest, at ¾ percent of GDP.

  • Abolish state payroll taxes. Additional GST revenue would increase states’ scope to lower the overall tax burden of payroll taxes. Their abolishment would cost about 1½ percent of GDP. However, this would deprive states of a revenue source that is directly under their control and thus contributing to fiscal autonomy. An alternative would be base broadening (there are estimates that up to 50 percent of employees are exempt from payroll taxes; see Australian Government 2015b) combined with rate reduction, but this could imply significant additional compliance costs for small businesses. Should such a course be chosen, the net revenue impact could be calibrated to yield some reduction of the total tax burden.

30. Module 6: A more efficient state and strengthening of the federal fiscal institutional set-up. A substantial increase in GST would increase states’ revenues and reduce the vertical fiscal imbalance, and allow states to eliminate inefficient taxes. It would also provide scope for streamlining Commonwealth-state/territory fiscal relations through a reduction of specific purpose payments, in particular National Partnership payments. In addition, the institutional arrangements for future tax adjustments should be strengthened, and the central government’s role in infrastructure investment could be increased.

  • Abolish national partnership payments. While the aim of National Partnerships, to ensure high common standards across Australia, is appropriate, the costs are also substantial, both administratively and by creating perverse incentives. Instead, there may be scope for increased reliance on the political process in individual states to hold governments to account for adequate public service delivery. This would allow abolishing National Partnership payments, implying a shift of resources from the states to the Commonwealth of close to 1 percent of GDP.

  • Assign some GST revenue to the Commonwealth. The combined effect of the reform modules outlined above would be a significant net increase in states’ revenue, while the Commonwealth would not gain additional funds. However, the Commonwealth will face most of the consolidation and spending pressures in the medium term (see below). Therefore, some of the GST revenue could be assigned to the Commonwealth, along the lines of the German system, where a number of taxes are shared between different levels of government.

  • Reforming the GST-setting mechanism. The effective veto that each state (and the Commonwealth parliament) has over adjustments to the GST should be abolished. The current system, while a very—perhaps too—effective brake against ‘excessive’ revenues, as shown by Australia’s low GST take, makes adjustments in the national, but possibly against a particular state’s, interest very difficult. This is important not only in current circumstances but also for potential adjustments that may be needed in future.

  • Enhancing the Commonwealth’s role in infrastructure investment. With states more constrained in their ability to borrow, there is scope for the Commonwealth to play a larger role in public investment. For example, the central government could on-lend funds for infrastructure projects of national importance. This could also require enhanced coordination of infrastructure investment plans.

D. Conclusions

Comprehensive tax and federal fiscal relations reform can have multiple benefits, but these can be achieved only in a package.

31. The potential benefits of reform are significant. A comprehensive tax and federal fiscal relations reform has the potential to (i) support growth, investment, employment; (ii) reduce overall economic distortions, thus increasing productivity and incomes, by shifting the tax mix toward indirect taxes; (iii) reduce specific distortions and risks, e.g. in the housing market and those generated by externalities; (iv) make the tax and transfer system fairer and more transparent; (v) improve administrative efficiency and reduce compliance costs; and (vi) generate sufficient revenue to return the fiscal balance to surplus while allowing additional public investment.

32. Reforms need to be pursued in a package. Key changes, such as an increase in GST revenue, or housing and superannuation reforms, have significant implications for lower-income households, which will need to—and, given the high revenue potential of these reforms, can—be at least compensated. In addition, the effects of tax changes on the distribution of revenue between states and the Commonwealth will need to be taken into account, and addressed. Overall, a package approach represents an opportunity to streamline the tax system in a holistic way, which would also serve to reduce the need for further adjustments going forward, thus reducing uncertainty.

33. Some reforms are not critical for the overall package, but would nonetheless yield significant benefits. For example, the taxation of negative externalities, or the abolition of small and inefficient taxes would shift the tax burden toward undesirable activities, while saving administrative resources.

34. With regard to fiscal federal reform, the institutional set-up is at least as important as quantitative measures. To facilitate future tax reforms, streamlining the GST adjustment mechanism is vital, and giving the Commonwealth government a stake (by providing it some of the GST revenue, which is also necessitated by the effect of tax reforms) could also help. In addition, the Commonwealth and the states will need to decide on the balance between autonomy and uniformity, which is ultimately largely a political choice.

35. The reform package will likely need to yield a net revenue gain over time. While expenditure reduction can and should play a role in reducing the fiscal deficit, there may be limited scope for this avenue since expenditure is already relatively low compared to other advanced economies, and substantial spending pressures will likely emerge in the longer term. An illustrative reform scenario could deliver sufficient revenue to help return the general government fiscal balance to surplus (Figure 9), as well as sufficient fiscal space to allow an expansion of public investment to support productivity growth in the private sector and halt the erosion of public net worth. However, the distribution of fiscal adjustment between higher revenue and lower spending (in particular expense) is largely a political one. Key parameters of the illustrative reform package scenario outlined above are:

  • Revenue: +3.5 percent of GDP

  • Expense: +2.2 percent of GDP

  • Public investment: +0.5 percent of GDP

  • Deficit (reduction = −): −0.8 percent of GDP

Figure 9.
Figure 9.

Fiscal Impact of Reforms

Citation: IMF Staff Country Reports 2015, 275; 10.5089/9781513556499.002.A003

However, the effects of reform on specific population groups (as well as overall) need to be analyzed more thoroughly. The estimates presented in this paper are, in particular with regard to the housing and superannuation tax regimes, imprecise.

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Appendix—Technical Notes

This appendix provides technical explanations for the assumptions and calculation methods underlying the charts shown as well as the reform options discussed.

A. Figures

Figure 1, panel 1 (total levies): General government revenue (IMF data) plus employer contributions to autonomous pension funds (OECD data). 2013 or latest available data.

Figure 1, panel 2 (direct and indirect taxes): Direct taxes = total tax revenue minus taxes on goods and services plus employer contributions to autonomous pension funds (OECD data); indirect taxes = taxes on goods and services (OECD data). 2013 or latest available data.

Figure 2, panel 1 (personal income tax progressivity): OECD data on tax rates, GNI per capita based on IMF data. 2013 or latest available data.

Figure 2, panel 2 (tax wedges): OECD data on tax wedges, with employer contributions to autonomous pension funds (in percent of compensation of employees; OECD data). 2013 or latest available data.

Figure 2, panel 3 (taxation of individuals): Taxation of individuals plus employee social security contributions (OECD data). Excludes employee contributions to autonomous pension funds, which are assumed to be voluntary. 2013 or latest available data.

Figure 2, panel 4 (income taxation by quintile): Income tax paid: based on ABS data (65370DO001_200910 Government Benefits, Taxes and Household Income, Australia, 2009-10, Table 5—equivalized disposable income), adjusted for nominal per-capita income growth 2009/10 – 2014/15 (assumes equal growth across quintiles, does not take into account change in tax structure—increase in thresholds and rate adjustment—since 2010). Taxable income is assumed to be private income plus Age Pension payments. Average statutory income tax rate at average income in quintile: based on 2013/14 tax code (excludes temporary budget repair levy, assumes equal Medicare levy of 2 percent at all income levels). The calculation implies that the statutory income tax rate is lower than tax actually paid; therefore statutory income tax rate was assumed to be equal to tax actually paid.

Box 1 figure (investor housing and house price index Sydney): Investor housing: RBA data; house price index Sydney: ABS data (quarterly; missing months assumed in linear function between two actual data points—IMF staff calculation).

Box 2 figure (tax benefits of superannuation system): These calculations represent a simplified modal of actual income and superannuation taxation, and are not intended to estimate the total tax revenue lost from concessional taxation of superannuation, but provide an indicative distribution of the benefits from the concessions across income quintiles. Calculations at income levels indicated assuming (i) 40 years constant earnings (at income levels indicated); (ii) contribution rate to superannuation funds of 10 percent; (iii) returns on superannuation investments of 5 percent; (iv) payouts over 25 years at amounts that deplete accumulated savings. Income excluding superannuation contributions is taxed at average tax rate; superannuation contributions are taxed at 15 percent (30 percent for contributions over A$30,000); superannuation payouts are taxed at 15 percent.

Figure 3, panel 1 (taxation of corporations): Corporate income tax (OECD data) plus social security contributions and employer contributions to private pension funds (OECD data) plus payroll taxes (OECD data). For Australia: red bar: company tax (budget data); pink bar: payroll taxes plus employer contributions to social security funds (OECD data); brown bar: fringe benefit taxes, superannuation contribution taxes, resource rent taxes (budget data). 2013 or latest available data.

Figure 3, panel 2 (corporate tax productivity): Corporate income tax (OECD), tax rates by KPMG (http://www.kpmg.com/global/en/services/tax/tax-tools-and-resources/pages/corporate-tax-rates-table.aspx). 2013 or latest available data.

Figure 4, panel 1 (GST/VAT revenue and rates): General sales taxes – GST/VAT, other (OECD data), tax rates by Deloitte (http://www2.deloitte.com/global/en/pages/tax/solutions/global-indirect-tax-rates.html). 2013 or latest available data.

Figure 4, panel 2 (GST/VAT productivity): Calculation based on OECD revenue data, and IMF final consumption data. 2013 or latest available data.

Box 4, figure 1 (CO2 emissions per capita): World Bank: World Development Indicators.

Box 4, figure 2 (post-tax energy subsidies): IMF staff calculations.

Figure 5, panels 1-4: OECD data.

Figure 6, panels 1-4: ABS data and Commonwealth and state budget documents.

Figure 7 (chart and table): Applies reductions in income tax and increases in transfers as described in figure table to income quintiles as calculated from 65370DO001_200910 Government Benefits, Taxes and Household Income, Australia, 2009-10, Table 5—equivalized disposable income, adjusted for nominal per-capita income growth 2009/10 – 2014/15 (assumes equal growth across quintiles, does not take into account change in tax structure—increase in thresholds and rate adjustment—since 2010).

Figure 8: Income tax relief calibrated to yield target net effect of measures.

Figure 9 (chart and table): No reform scenario assumes no change in revenue, expense, and net investment after 2018/19 (end of authorities’ projection horizon). Reform scenario assumes gradual increase in investment from 2016/17 onward to a total of 0.5 percent of GDP above the no-reform scenario, as well as increases in revenue and expense as estimated in Modules 1-5.

B. Estimation of Impact of Reform Options:

Module 1

  • Raise GST productivity to Swiss level. Assumes Switzerland’s tax productivity (second-highest after New Zealand) and applies it to Australia’s final consumption. Subtracts current GST revenue.

  • Raise GST productivity further to New Zealand level. Assumes New Zealand’s tax productivity and applies it to Australia’s final consumption. Subtracts GST revenue reached at Swiss productivity level.

  • Increase GST rate to 15 percent. Applies 15 percent rate at New Zealand GST productivity.

  • Income tax relief (for GST increase) and increased transfer payments—see also figure 7. Applies reductions in income tax and increases in transfers as described in figure table to income quintiles as calculated from 65370DO001_200910 Government Benefits, Taxes and Household Income, Australia, 2009-10, Table 5—equivalized disposable income, adjusted for nominal per-capita income growth 2009/10 – 2014/15 (assumes equal growth across quintiles, does not take into account change in tax structure—increase in thresholds and rate adjustment—since 2010).

Module 2

  • Reduce capital gains tax discount for individuals and trusts. From Tax Expenditure Statement, 2014, E11.

  • Abolish deductibility of net losses from other forms of income (+). n/a.

  • Abolish stamp duties on conveyances. ABS data.

  • Increase land taxes to compensate for stamp duties. Set to offset abolition of stamp duties on conveyances.

  • Cap value of exemption of primary residence from Age Pension calculation (+). n/a.

Module 3

  • Adjust concessional superannuation taxation. n/a

  • Remove CGT exemption of inherited primary residences. n/a

  • Reduce personal income tax—see also Figure 8. Income tax relief calibrated to yield target net effect of measures.

Module 4

  • Taxing energy use right. IMF staff calculations (Global Energy Subsidies Update in IMF 2015) for energy subsidies; impact on revenue assumed similar to global total in relation to subsidies as calculated in Coady, Sears and Shang: How Large are Energy Subsidies?, IMF Working Paper, forthcoming.

  • Eliminate insurance taxes. ABS data.

  • Unilaterally remove external tariffs. Revenue from Commonwealth budget documents.

Module 5

  • Reduce company tax by 5 percentage points. Revenue from Commonwealth budget documents.

  • Eliminate state payroll taxes. ABS data.

Module 6

  • Abolish National Partnership payments. Expenditure from Commonwealth budget documents.

  • Assign 30% of GST revenue to Commonwealth. Calibrated to allow states most additional capital expenditure as a result of higher net revenue from reforms.

  • Additional public investment. Distributed between Commonwealth and states.

  • Deficit reduction—see also Figure 9. Assigned to Commonwealth, since states are projected to reach balance in 2017/18.

1

Prepared by Alex Pitt.

2

“States” refers to states and territories.

3

States have the power to raise revenue from a range of tax bases, but have not fully exploited them.

4

It is beyond the scope of this paper to assess the usefulness of GST revenue versus other revenue sources for equalization payment purposes.

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Cover IMF Staff Country Reports
Australia: Selected Issues
Author: International Monetary Fund. Asia and Pacific Dept
Volume/Issue:
Volume 2015: Issue 275
Publisher:
International Monetary Fund
ISBN:
9781513556499
ISSN:
1934-7685
Pages:
74
DOI:
https://doi.org/10.5089/9781513556499.002

Revenue Composition

Personal Income Taxation

Corporate Taxes

Investor Housing and House Prices

Tax Benefits of Superannuation System, compared to …

(% lifetime income)

GST

CO2 emissions per capita, 2010

(Metric tons)

Post-tax energy subsidies, 2014

(% GDP)

Inequality

Fiscal Federalism

Compensating Lower-Income Households for GST Reform

Compensating Middle- and Higher-Income Households

Fiscal Impact of Reforms