Why common-sense tax reform is vital to Australia’s future

tax reform

A few weeks ago, I discussed the limitations of using monetary policy – increasing interest rates – to tackle inflation. I highlighted that only 37% of Australians have mortgages, so they are the only ones that are directly affected by higher rates. Conversely, around 30% of Australians without mortgages benefit from higher interest rates as they earn more on their savings. This creates a counterproductive effect on curbing inflation.

Fiscal policy could be better

Fiscal policy can be a more effective tool for managing the economy, including inflation. It refers to how the government spends taxation revenue to influence the economy. Its strength lies in its ability to specifically target different segments of the economy and various demographics through adjustments in taxation and government spending. This targeted approach can yield more precise and effective outcomes compared to the broader impact of monetary policy.

Why tax reform is needed?

Not only could fiscal policy be more effective as a means of managing the economy and inflation, but also help repay government debt. We must not forget that the federal government’s debt is on track to hit nearly $1 trillion in the coming years, roughly 40% of the GDP. To repay this debt, future governments will need significant surpluses, making tax revenue a vital component.

I find it intriguing to explore potential tax reforms, though I acknowledge this is a contentious issue without a perfect solution. What truly matters is establishing a tax system that’s fair, adaptable to a modern economy, and empowers the government to manage economic matters effectively.

Reform GST

Most developed economies have shifted from relying heavily on income tax to embracing consumption taxes like the Goods and Services Tax (GST). Currently, Australia receives 12% of tax revenue from GST and 39% from personal income taxes. Consumption taxes offer various advantages over income taxes.

Firstly, a consumption tax broadens the tax base by taxing spending rather than income. This minimises taxpayers’ opportunities to evade or minimise tax payments. Additionally, it enables governments to reduce taxes on essential goods while imposing higher rates on luxury items.

Moreover, administering a consumption tax is relatively straightforward, especially with the prevalence of electronic payments and cloud-based, real-time accounting software. 87% of all payments in Australia are now made electronically so managing a consumption tax is easier for businesses and the government.

Finally, lowering income taxes allows more money to flow into the economy via consumer spending and helps Australians save and invest more.

In comparison to Australia, many developed economies apply higher rates of consumption tax. For instance, the UK applies a 20% rate, while in Europe, rates range between 19% and 21%. In Canada, the range varies from 12% to 20%. In contrast, the USA doesn’t have a federal consumption tax, though most states levy sales taxes of less than 10%.

There are two changes that the Australian government could make to GST to fund other tax reform measures, being:

  1. Increasing the GST rate on non-essential goods and services will not only raise more tax revenue but enhance wealth equality as wealthier individuals who spend more will pay more tax; and/or
  2. Raising the flat GST rate from 10% to 12.5% could potentially increase total GST revenue by 25%.

Cut income tax further

From 1 July 2024, income tax rates will be flattened such that there will only be three marginal tax rates:

  • $18,201 – $45,000 = 21% including Medicare
  • $45,001 – $200,000 = 32% including Medicare
  • Over $200,000 = 47% including Medicare.

As Australia puts greater reliance on GST for increased tax revenue, there’s potential to lower marginal income tax rates. This shift away from such heavy reliance on income taxes can benefit Australians significantly. It allows more money to circulate within the economy and offers individuals greater opportunities to save and invest, ultimately contributing to a stronger economy.

The Stage 3 tax cuts, scheduled for implementation in 2024, mark a positive step in this direction. However, the government could consider a plan to raise the highest rate threshold above $200,000 in the medium-term, say within the next 4 to 5 years or more. This strategic move could further enhance the balance between taxation, spending power, and economic growth for Australians.

Cap the main residence CGT exemption

Australians can avoid paying any CGT on their main residence because their home is used for personal purposes, not to generate taxable income or gains. That’s why you also cannot claim a tax deduction for home loan interest.

However, perhaps this exemption should be capped. A wealthy person who makes a $20 million gain on selling their home can surely afford to pay some tax. The government could consider introducing a generous cap on the main residence exemption of say $2 to $3 million.

Inheritance tax

Numerous countries, including the US, UK, Japan, and various Western European nations, impose inheritance or estate taxes. However, Australia currently doesn’t have an estate or inheritance tax in place.

Baby Boomers are expected to bequeath $224 billion each year in inheritance by 2050, representing a fourfold increase in the value of inheritances over the next 30 years. This presents an opportune moment for the Australian government to consider implementing an inheritance tax. Such a tax could capture a portion of this wealth transfer, thereby enhancing wealth equality and increasing tax revenue.

An effective approach could involve establishing a high tax-free threshold, ensuring that this tax primarily targets affluent estates rather than the average Australian.

What’s stopping a government from making these changes?

Politicians in Australia have faced challenges in garnering public support for ambitious tax reforms. Examples from the past illustrate this struggle: Opposition leader John Hewson’s unsuccessful attempt to introduce GST in the early 1990s led to his defeat in the 1993 Federal Election. Similarly, Bill Shorten’s proposals to increase CGT and abolish negative gearing contributed to his loss in the 2019 Federal Election.

However, John Howard took a different approach. He capitalised on a political advantage and called for an early election in 1998, campaigning successfully for the introduction of the GST, which was later implemented in 2000. This successful implementation came from clear communication and sufficient time for the Australian public to embrace the idea.

Regrettably, the tendency in politics to prioritise short-term gains often hampers the creation of conducive environments for long-term policy initiatives. What’s needed is a political party with strong public support and the ability to effectively communicate the necessity of tax reform, allowing ample time for Australians to understand and accept the proposed changes. Unfortunately, this doesn’t seem likely to occur.

Fiscal and monetary policy work well together

Employing a combination of both monetary and fiscal policies represents the most potent method for steering the economy, tackling inflation, and bolstering Australia’s economic strength while enhancing wealth equality. However, this strategy hinges on the willingness of a bold government to wholeheartedly embrace comprehensive tax reform.