The recent significant tweak to stage three tax cuts by the government has reignited discussions on the necessity for comprehensive tax reform, with the International Monetary Fund (IMF) underscoring its importance for long-term fiscal sustainability and heightened productivity.
AMP’s chief economist, Shane Oliver, is the latest to acknowledge the need for reform, stating: “To boost productivity growth, we need to reform our tax system.”
In a recent analysis of the tax system, he highlighted the initial stage three tax cuts as a positive step but noted, “The stage three tax changes unravel this modest reform.”
Calling the policy reversal “another backward step” in terms of tax reform, Dr Oliver highlighted five key issues with Australia’s tax system, including its heavy dependence on income tax, the complexity introduced by various tax concessions, its progressiveness, the persistent challenge of bracket creep, and its numerous anachronisms.
On issue number one, he highlighted that income tax, constituting 62 per cent of tax collections compared to the OECD average of 34 per cent, is highly distortionary, emphasising that a goods and services tax (GST), at a uniform rate on all items, would be far less distortionary.
“A GST is a far more efficient tax than income tax and a greater reliance on it versus income tax will likely lead to more productivity,” Dr Oliver said.
Moreover, he suggested that Australia’s substantial dependence on income tax will give rise to “equity issues”, with an escalating burden on younger workers as the ageing population contributes to mounting health and aged care expenses.
On issue number two, Dr Oliver said that while prominent tax concessions such as negative gearing, the capital gains tax discount, franking credits, superannuation and trust structures are frequently debated for their impact on government revenue and tax system distortions, the issue is “more complicated”.
He explained that the removal of negative gearing for property investment, for example, would actually create a distortion and could make the issue around property affordability worse by reducing the supply of rental property. Curtailing dividend imputation would also be a “big mistake”, while capital gains tax, Dr Oliver admitted, is potentially excessive and could use a revision.
“There is a case to consider removing the capital gains tax discount and return to the pre-1999 approach of adjusting capital gains for price inflation,” he said.
On issue number three, Dr Oliver opined that not only does the Australian tax system have a high reliance on income tax, it is also “highly progressive” and acts as a deterrent to work effort.
“The current top marginal tax rate at 47 per cent (including Medicare) is above the median of comparable countries and kicks in at a relatively low multiple of average weekly earnings,” he said.
“As a result, the Australian individual tax system is highly progressive and this is reflected in the fact that the top 3.6 per cent of taxpayers earning more than $180,000 pay around 32 per cent of income tax and the top 10 per cent pay nearly 50 per cent of income tax.
“This is likely working against Australia’s long-term interest to the extent that it discourages work effort and hence productivity.”
Regarding issue number four, Dr Oliver proposed indexing tax brackets to inflation as a solution. He pointed out that bracket creep has overtaken increased mortgage payments in impacting household income.
“Just keeping up with inflation can see a worker pushed into a tax bracket that was never intended for them,” Dr Oliver said.
“The ideal solution is to index the tax brackets to inflation. This would keep the government accountable by denying them the ability to give back bracket creep and claim it’s a tax cut and force them to pass higher tax rates through Parliament if they want more tax revenue.”
Dr Oliver highlighted tax system anachronisms as issue number five, including diminishing GST relevance, distortive state stamp duties impacting housing affordability, discouraging state payroll taxes, and levying car tariffs without an industry to protect.
Ultimately, the economist said, what is needed by way of tax reform is simple.
He suggested lower personal tax rates with higher thresholds; a lower corporate tax rate; a higher and more comprehensive GST; compensation of low-income earners and welfare recipients for increasing the GST; the indexation of tax brackets to inflation; and the removal of stamp duty and its replacement with land tax.
“This would take political courage as seen a generation ago. But failure to do so will only hamper productivity and living standards for all Australians,” Dr Oliver said.
Last month, the IMF stated it sees merit in “comprehensive tax reform” and highlighted that rebalancing the tax system from direct to indirect taxes, while addressing regressive impacts, would promote greater efficiency.
“Comprehensive tax reforms remain indispensable to long-term fiscal sustainability and productivity,” the fund said.
“High reliance on direct taxation is amplifying challenges of financing health and aged care as population ageing lowers the share of workers and declining productivity growth puts a drag on wages.”
Referencing the government’s 2023 Intergenerational Report, the IMF also underscored the growing dependence on bracket creep in the absence of tax reforms.
“Addressing these challenges heads on will avoid costly delays in tax reforms needed for sustained and shared prosperity.”
