Prime Minister John Howard and his Government face a difficult task with the reform of business taxes. The Government has achieved a reform of personal and wholesale taxes, but at some cost. It has had to water down some of its original proposals. Moreover, it probably started with a package less than its ideal in the hope of attracting wider support. In particular its GST-income tax package did nothing to reduce Australia’s high top marginal rate of income tax. At 48.5 per cent, it acts as a disincentive to individuals in Australia, a disincentive for foreign investors to set up quarters here and an incentive to engage in tax avoidance.
But the Government is on the right track. It must broaden the base and lower the incidence of taxation. This will maximise the revenue base to do those things which only governments can do and will minimise any distorting effect taxation has. People tend to prefer low-tax activity to high-tax activity.
With business tax, the Government faces several very tricky influences.
First, it cannot treat business tax in isolation. Taxes which might appear primarily to be business tax, such as company tax, fringe-benefit tax and capital gains taxes have profound affects on individuals.
Secondly, the Australian tax system has to be seen in a global context. High company taxes can scare foreign investment.
Thirdly, business taxes have to be fair. It is no good reducing in the name of international investment if that leads to a perception that business is not pulling its weight.
Fourthly, the reforms the Government settles on must clear the hurdle of the Senate.
On company tax, there has been an argument that the 36 per cent should be cut to 30 per cent and in return the accelerated investment allowance be tightened. This has several difficulties. First, the further apart the company and the top personal rate is, the greater incentive for tax-minimisation schemes. Secondly, individuals use the accelerated investment allowance, too, but they would not get the advantage of the reduced company tax. Thirdly, it would result in some industries that invested heavily in equipment, like mining and agriculture, copping it, while others that did not invest heavily in equipment, like IT and services, getting the lower company rate with little pain.
Lower company tax is probably not a goer, mainly because the Government squibbed on lower top marginal income taxes in its GST. One can see why. If the rate were cut, say, 10 percentage points, it would mean people on a $1 million a year would get a tax cut of $100,000. The Opposition would have had a field day, even though so few on $1 million a year that the argument is trivial, compared to the benefits gained from the incentive of a lower tax regime and the disincentive to bother with minimisation schemes.
Capital-gains tax is a different story. This week Mr Howard rightly pointed out the biggest drawback to the present rate. It acts as a disincentive to foreign investors who have the option of going to lower-taxing countries. Australia can sustain a higher capital gains tax than many other countries because we have other major advantages: stable political system, good environment, social and economic advantages for workforces and so on. But it cannot sustain such a high rate – the full marginal rate for personal taxpayers and the full company rate for companies. That said, idle speculation should be discouraged. The answer is to devise a simple sliding scale of capital gains tax so that assets sold in the first year attract the full rate, sliding down to, say 10 per cent or so, after a period of 10 or 15 years. This would attract, from both overseas and within, the sort of investment that brings jobs and wealth generation – long-term investment, while at the same time discouraging the quick-buy-and-sell opportunists. The Democrats should look with encouragement on any change to the capital-gains regime that encourages employment-generating long-term investment.
As a minor point a fairness issue must be addressed. Capital losses should be immediately deductible against any income, not just present capital losses, or at least indexed. Waiting for future capital losses to offset gains is distorting and unfair because the taxpayer is hit with inflation eroding the value of the deduction.
The fringe-benefits tax regime needs a rethink. Its principle is fine. It has prevented wholesale avoidance of income tax. In the 1970s and early 1980s people could get paid a great proportion of their income in tax-free benefits. It had to stop. The trouble now is that fringe-benefits is a nightmare for business to administer as it reaches into ever more ordinary transactions incidental to business and at an ever more petty level.
Other business taxes also need reviewing. Some reforms, like reform of payroll tax, BAD, FID and stamp duties were sacrificed on the altar of getting the GST through. The exemption on food had to be paid for somehow. But there is no reason why some of these could not be revisited in the context of business taxes.
It will be a complex and difficult task. But Mr Howard has shown tenacity with respect to the GST, so he should remain tenacious with respect to business tax to make it fairer and simpler.
In dealing with the Democrats he can use the fairness issue as a weapon. Any reform of business tax must include strong anti-avoidance measures, particularly against using off-shore entities. Family trusts must also be looked at. If Mr Howard addresses these matters squarely he can garner more Democrat support than he would otherwise get.
The Democrats would be embarrassed if they knocked back a comprehensive attack on avoidance.