In July 2000, the Government introduced the largest tax reform in Australian history, introducing The New Tax System. It was designed to make our economy stronger, generate more jobs, improve living standards and fund essential services. The inefficient wholesale sales tax and a raft of inefficient state taxes were replaced with the goods and services tax (GST). The Australian Government has now reached agreement with all the States on a timetable to complete this process.
The New Tax System introduced significant personal income tax reductions and reforms to the family tax benefit system. Since The New Tax System the Government has continued its tax reform agenda. Reforms have been introduced to increase incentives to work, save and invest, improve Australia's international competitiveness and reduce complexity and the compliance burden the tax system places on Australians. These changes are summarised in Box 1 with more detail provided in Appendix A.
Tax reform is an ongoing process. Tax reform is not a once-for-all-time event, nor does it involve concentrating on just one particular element of the tax system. Tax reform requires the full consideration of the taxation system as a whole, the careful balancing of competing priorities and awareness of current and future economic, social and environmental pressures.
Continued tax reform undertaken in a coherent and fiscally responsible manner is crucial to sustaining Australia's economic prosperity and is central to building on the sense of equity and fairness that is part of the Australian way of life.
The Government has reshaped Australia's personal, business, indirect and international taxation landscape. The Government has delivered carefully designed packages such as The New Tax System and More Help for Families as well as delivering other elements of on-going reform through the annual budget. Balanced decisions have been made, including after reviews of the tax system, such as the Review of Business Taxation, Review of International Tax Arrangements and Review of Aspects of Income Tax Self-Assessment.
The International Comparison of Australia's Taxes was commissioned to help benchmark Australia's tax system with other developed countries. International comparisons inform good tax policy formulation by helping us learn from the analysis and experience of other countries, and allowing us to check whether features of our tax system may be hindering our competitiveness.
Major conclusions from the international benchmarking (see Box 2 for further details) were that:
- Australia is a low tax (see Chart 1) and low spend country, with most lower taxing countries, especially the United States and Japan, funding higher spending through large budget deficits;
Chart 1: Total tax burden for OECD countries, 2003(a)
- The OECD's measure of the tax burden is the total taxation revenue of national, state and local governments expressed as a percentage of gross domestic product. For Australia, the data are for the 2003-04 financial year, the latest year where comparable international data are available.
Source: OECD Revenue Statistics 1965-2004 (2005 Edition).
- Australia's mix between direct and indirect taxes is in line with other OECD countries, but the composition is different;
- on direct taxes:
- Australia's overall level of taxation on wages and salaries is relatively low, although the composition is very different from other countries — Australia is one of only two countries without any social security taxes, with the result that Australia's individual income tax burden can appear high when partial comparisons are made with other countries. Our top marginal tax rate is slightly higher and the top rate threshold slightly lower than several other countries. Overall tax rates on families are low, but effective tax rates can be comparatively high because of our highly targeted welfare system;
- on companies, Australia's company tax rate is on par with other countries but the business tax base appears to be broader in some areas; and
- very few other countries have superannuation arrangements, and hence tax arrangements, of a similar nature to Australia; and
- on indirect taxes, Australia has a lower reliance on value-added and sales taxes, and a higher reliance on property and transactions taxes. Australia does not levy any wealth, estate, inheritance or gift taxes. Australia's taxes on petrol were the third lowest out of the 30 OECD countries.
While international benchmarking is a useful tool for focusing on particular areas of the tax system, policy decisions by government must consider the most appropriate choices given Australia's own history and culture as well as its social and economic challenges. For instance, the Government has ruled out any increase in the GST, or the introduction of any wealth, estate, inheritance or gift taxes. Some tax areas where Australia seems to lag are the responsibility of the States. The Australian Government has used the information in the International Comparison of Australia's Taxes to inform its choices in putting together the continuing tax reform package in this budget.
Box 1: Government's tax reform achievements
Some of the key taxation reforms undertaken by the Government in the last ten years include:
Further details about these reforms are included in Appendix A.
Box 2: International Comparison of Australia's Taxes
The International Comparison of Australia's Taxes (ICAT) was established to provide objective, descriptive information on Australia's tax system compared with that of other OECD countries. The ICAT examined taxes at national, state and local government levels. All major forms of taxation were considered.
Australia's mix between direct and indirect taxes is in line with other countries but the composition is different (see Chart 2). In Australia, 60.9 per cent of taxes are collected from direct taxes on incomes such as wages, salaries and profits (the OECD average is 62.2 per cent), with the remainder from indirect taxes such as the GST, excise and customs, and property and transaction taxes.
Chart 2: Direct and indirect taxation revenue as a proportion of
Source: OECD Revenue Statistics 1965-2004 (2005 Edition).
Australia's overall level of taxation on wages and salaries is relatively low at 14.0 per cent of GDP — this is significantly less than the OECD unweighted average of 19.5 per cent. As indicated in Chart 3, the composition of Australia's taxes on wages and salaries is very different from other countries. Australia is one of only two countries without any social security taxes (the other being New Zealand). This is the greatest difference between Australia's tax system and those of other developed countries. Chart 3 shows that these social security taxes are often the major source of taxation on wages and salaries — they can be at tax rates of over 30 per cent of wages and salaries, all on top of income taxes. These social security taxes can be paid by employees or employers. When paid by employers, the economic effects are very similar to payroll taxes.
Chart 3: Components of direct taxation in respect of
Source: OECD Revenue Statistics 1965-2004 (2005 Edition).
Australia's previous top marginal tax rate of 48.5 per cent was slightly higher and the previous top rate threshold slightly lower than other countries. Changes in this budget will move Australia's top marginal rate into line with the unweighted average (46.5 per cent relative to the average of 46.7 per cent), and the top threshold will move above the OECD average (see Chart 6).
Overall tax rates on families are low. For all of the eight different types of single and family types considered by the OECD, Australia's average effective tax rate is in the lowest eight out of the thirty OECD countries. Effective tax rates in Australia can be comparatively high because of our highly targeted welfare system.
In measuring the impact of the tax system on companies, there are some classification issues in making international comparisons. With this qualification, Australia's overall tax collection from companies was the third highest in the OECD as a proportion of GDP. There are two possible sources for higher collections — either higher company tax rates or a larger company tax base. Australia's 30 per cent company tax rate is on par with other countries (unweighted average of 28.5 per cent). Even after allowing for the growth in company profits and Australia's increasing level of incorporation, Australia's company tax base appears to be broader than other countries. This budget includes measures that will slightly narrow the company tax base, either to improve efficiency by moving our depreciation arrangements closer to economic depreciation, or to reduce the compliance costs of small businesses.
As shown in Chart 4, the previous gap between Australia's top personal marginal tax rate and the company tax rate (18.5 per cent) was slightly above the OECD average (17.8 per cent). With the two percentage point reduction in the top personal tax rate announced in this budget, Australia is now slightly below the average.
Chart 4: Difference between top marginal tax rate and
Source: OECD Tax Database (preliminary data); KPMG (various); Deloitte (2006); various country websites.
Apart from the absence of social security taxes, and Australia's targeted welfare system, the other major difference between Australia and other countries is our full imputation system with refundable credits.
The benefit of this arrangement for Australian resident shareholders is that double taxation of domestic income from companies is removed. As such, domestic source dividend income in Australia is generally taxed at a lower rate than most other OECD countries that only provide partial relief from double taxation.
This is a particular benefit for low to middle-income earners. For example, Australia's overall level of taxation on dividend income for a shareholder earning the average wage (31.5 per cent) is the second lowest of the ten countries examined in the report, and considerably lower than the average of 41.9 per cent.
On indirect taxes, Australia has a lower reliance on value-added and sales taxes (4.3 per cent relative to the OECD average of 6.8 per cent). Australia's GST rate of 10 per cent is below the OECD average of 17.6 per cent.
Australia has a relatively higher reliance on property and transactions taxes — the seventh highest in the OECD. Australia has the highest financial and capital and transaction tax burden of the 10 countries examined closely by the study.
Australia does not levy any wealth, estate, inheritance or gift taxes.
Australia's taxes on petrol were the third lowest out of the 30 OECD countries.
Throughout the 448 page report there are a number of boxes that provide additional comparative information on Australian taxes, for instance:
The ICAT report is available at http://www.comparativetaxation.treasury.gov.au.
Key drivers of the Government's ongoing tax reform agenda
On achieving office in 1996, the Government set a fiscal objective of not increasing the overall tax burden from 1996-97 levels. The Government has observed that objective and, since 2000, has substantially reduced the tax burden from 1996-97 levels as part of major structural tax reform. The Government's tax reforms have been strongly supportive of sustained economic growth while at the same time promoting equity and reducing tax system complexity. The key drivers of the Government's ongoing tax reform agenda have been:
- improving incentives to work;
- improving incentives to save and invest;
- improving resource allocation;
- reducing complexity;
- recognising the contribution of families; and
- ensuring the sustainability of the revenue base.
These drivers are also important in the development of policy to address Australia's future demographic challenges.
Improving incentives to work
Australians' decisions on whether to work and how long to work are influenced by the tax system, the provision of income support and retirement incomes policies. It is important that government policies do not discourage people from working.
Paid work provides individuals with substantial benefits. It provides them with the means to satisfy their needs and those of their families, the opportunity to develop personally, live independent lives and interact socially. In addition, labour force participation is a key driver of economic growth.
Ensuring that the tax and income support systems provides an adequate balance between equity and fairness, and assistance for those in need without providing disincentives to work, requires careful consideration.
The measures announced in the 2006-07 Budget will boost incentives to work in a number of ways.
The increase in the 30 per cent tax threshold from $21,601 to $25,001, in addition to the substantial increase in the Low Income Tax Offset, will increase incentives for workforce participation, particularly for secondary income earners who are arguably more responsive to changes in tax.
The reduction in the top tax rates to 40 per cent and 45 per cent and the increase in the top tax thresholds, all from 1 July 2006, will enhance the international competitiveness of Australia's personal income tax arrangements. Maintaining the competitiveness of our personal tax system is important for sustaining workforce participation and productivity in Australia.
The Government has carefully considered the impact of the budget on effective tax rates. Australia has a highly targeted welfare system. Its Family Tax Benefit system recognises that households with children face greater costs than those without. Family Tax Benefit Part A (FTB (A)) is directed towards those families with lower incomes. The necessary implication of targeting benefits is that as these benefits are withdrawn, effective marginal tax rates are increased. The alternatives are either not to provide these benefits (thereby leaving beneficiaries much worse off) or else creating universal entitlement systems with the higher spending, higher taxing and greater churning that is integral to such systems.
Although our targeted tax and welfare systems necessarily create higher effective marginal tax rates, the Government seeks to identify and act where it can to reduce these and minimise their impacts. For instance, the higher threshold for FTB (A) ($40,000) was carefully chosen so that it did not overlap with the phase-out of the Low Income Tax Offset (now $40,000). The reduction in the Medicare levy phase-in rate from 20 per cent to 10 per cent for low-income earners has important impacts on effective tax rates for low-income earners.
Effective marginal tax rates have been significantly decreased for families over recent years. For example, before 2000-01, families faced a 50 percentage point increase in their effective marginal tax rates from the withdrawal of family payments above the base amount. The New Tax System of 2000-01 reduced this withdrawal to 30 percentage points. In 2004-05 the withdrawal rate was reduced to 20 percentage points.
It is also important that retirement incomes policy does not encourage early retirement. Australia has one of the lowest participation rates in the OECD for those over age 55.
The Government's plan for superannuation would encourage older Australians to remain in the workforce. Under the plan, superannuation benefits from taxed funds received after age 60 would not be included in a person's assessable income for tax purposes, which may reduce the tax paid on work income. Further, the assets test taper rate for the age pension would be reduced, removing the current disincentive towards working and saving stemming from the possibility of a person losing more age pension than they can earn from additional savings.
Improving incentives to save and invest
Improving incentives to save and invest is an important element of the Government's pro-growth policies and strategy for addressing the demographic challenges facing Australia over the coming decades.
Taxation is only one of a number of factors that are taken into account when making saving and investment decisions. Still, the tax and superannuation systems do affect saving and investment behaviour.
At the aggregate level, saving is important because it provides resources to fund investment. Investment is a key element of productivity growth and hence of economic growth.
At the individual level, saving provides individuals with the means to fund future consumption and in particular their retirement. The importance of private saving for retirement purposes is increasing. Australians are generally spending a longer period in full-time education, retiring earlier and living longer. As a result, the number of years spent in the workforce has proportionately declined whereas the potential costs of retirement have increased.
The Government's proposed changes to the retirement income system, in addition to the other measures announced in this budget, would increase incentives to save and invest in Australia and encourage greater innovation and entrepreneurship. This in turn would improve productivity and economic growth.
The removal of benefits tax and the halving of the pension assets test taper rate would provide significant incentives to save. Further, the reductions in personal income tax will increase the return from all forms of saving by individuals.
The changes to the tax depreciation rates will increase incentives for business to undertake investment in new plant and equipment that is necessary for them to keep pace with new technology and remain competitive. The budget also contains a package of measures aimed at encouraging investment in the venture capital industry.
Improving resource allocation
The aggregate level of savings and investment is a key factor in economic growth. Even more important is the quality and effectiveness of the saving and investment undertaken.
The tax system affects resource allocation within the economy. Where effective tax rates differ between options to save and invest, saving and investment will be shifted from those that are relatively highly taxed to those that are lower taxed. This will distort the pattern of saving and investment, leading to inefficient resource allocation.
As individuals do not all have the same access to saving and investment options, tax distortions can also have distributional implications.
The Government's tax policy strategy is to ensure that the tax system has minimal effect on allocation of resources in the economy. An exception to this is where the tax system is used to address a market failure, such as the case with respect to retirement incomes and the demonstrated tendency for people to under‑provide for their retirement.
In order to improve resource allocation in the economy the Government will increase depreciation rates under the diminishing value method to align depreciation deductions for tax purposes more closely with the actual decline in the economic value of an asset.
A certain level of complexity will always be associated with raising revenue on a broad series of transactions and a wide and diverse population base. Even the simplest tax system will be associated with a rising level of complexity as markets become more and more sophisticated.
Nevertheless, it is important to ensure that the tax system is as simple as possible. Complexity increases the costs of transactions, which in turn reduces production possibilities and consumption opportunities.
In recognition of the potentially significant economic and social costs of complexity, the Government established the Taskforce on Reducing Regulatory Burdens on Business (the Taskforce) in October 2005. Commissioned to examine and report on areas where regulatory reform can provide significant immediate gains to business, the formation of the Taskforce was a further indication of the Government's commitment to reducing the burden of regulatory activity.
In April 2006, the Government issued an interim response to some of the Taskforce's recommendations, including reforms to fringe benefits tax that the Taskforce had identified as a priority for reducing tax complexity for business. This budget builds on those announcements, with a range of measures directed at further reducing the complexity faced by small business. These include changes to make the Simplified Tax System even more attractive, aligning thresholds for small businesses to make it easier for them to understand their eligibility, and simplifying and extending access to capital gains tax concessions.
Announced with this budget, the Government's plan to simplify and streamline superannuation is a fundamental reform responding to the Taskforce themes of reducing complexity and the compliance burden. The complexity of the existing superannuation tax arrangements means that an individual approaching retirement often needs to seek financial advice before making a decision on how to take their superannuation benefits. Independent evidence given to the House Standing Committee on Economics, Finance and Public Administration inquiry into improving superannuation savings of people under 40 stated that the cost of this financial advice could be in the order of $3,000 to $10,000 depending on the complexity. The Government's plan for the superannuation system would remove the current raft of complex tax arrangements that apply to individual superannuation benefits and would dramatically simplify superannuation for retirees as well as reducing the compliance burden facing superannuation funds.
Recognising the contribution of families
The Government recognises the importance of the contribution of families in Australian society. The 2006‑07 Budget builds on the Government's More Help for Families initiative, providing further assistance to families with children, to help them balance work and family responsibilities. Improvements in FTB (A) rates and income tests have directly benefited the family budgets of over 1.8 million Australian families.
In this budget, the Government is expanding the number of families eligible for the maximum rate of FTB (A). The threshold where families lose eligibility to the maximum rate will be increased from $33,361 to $40,000 from 1 July 2006. It is expected that this measure will assist almost half a million families annually.
To illustrate the changes, in 2000-01 a family with a private income of $40,000 and one child under 13 would have received $975 in FTB (A). In 2005-06, this family receives $2,873. In 2006-07, this family is estimated to receive $4,318 — an improvement of a further $1,445.
In addition, the Government has decided that the Large Family Supplement to the Family Tax Benefit should be extended to all families with three children, where it was previously available only to families with four or more children. This measure will benefit around 440,000 families.
Ensuring the sustainability of the revenue base
Australian Government finances are strong. In this budget the Government has forecast its ninth budget surplus in 2006-07. Further, Australia is now one of only a few countries among the OECD with negative net public debt.
Nevertheless, the Government's Intergenerational Report 2002-03 projects that over the next 40 years Australia's steadily ageing population is likely to place significant pressure on Australian Government finances. This ageing of the population is expected to have a profound effect on the economy and, potentially, on our living standards.
In order to ensure future generations of taxpayers do not face an unmanageable bill for government services provided to the current generation, changes to the tax system must have regard to the longer‑term sustainability of the revenue base.
The process of protecting the revenue base is an on-going one. This budget includes five measures, estimated to protect over $2.3 billion in revenue over the forward estimates period, to improve the integrity of the tax base. If major issues emerge about the integrity of the tax base, the Government stands ready, as it has done with 'Operation Wickenby', to provide the resources to ensure that everyone pays their correct level of taxes.