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Tax Reform: Progress from the Forum We Had to Have

Published: November 22, 2011 in Knowledge@Australian School of Business
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While the headline taxes on carbon and mining profits were off-limits, the October Tax Forum in Canberra made progress by laying the groundwork for tax reform in key areas including company taxes and the harmonisation of state taxes. What's more, work is already underway to ensure the two-day talkfest results in action. Australian School of Business professor Neil Warren attended the forum and saw positive signs as the Australian states rose to the challenge of effectively getting their own houses in order. He was equally encouraged by the news of funding for a new Tax Studies Institute, which will bring together Australia's leading thinkers. As Warren outlines to Julian Lorkin of Knowledge@Australian School of Business, longer-term benefits look likely to flow from what many thought of simply as the tax forum we had to have.

 An edited version of the interview follows.

Knowledge@Australian School of Business: Now, Neil, you've been attending tax summits all your life, what did this one achieve?

Neil Warren: This one was different in that we didn't actually have a focus on the day. Looking back on the 1985 tax summit, then you actually had Option C – a package of broad-based consumption tax and a number of other personal income tax and company tax changes – so we had a focus. This one was different. We actually didn't have a focus, we were told what we were not to consider and there were the broad banners of subject areas we could talk to, but there wasn't a particular focus on the day other than not GST, not mining taxes, not carbon taxes.

Knowledge@Australian School of Business: Do you think the government wanted to have this tax forum?

Neil Warren: It did in a way. When the treasurer (Wayne Swan) opened it up he said "Look, these are tight budgetary times, you can all wheel out your wish list if you like. We're going to ignore the wish list and there's probably not that much we can do." In the lead up and in his opening presentation, he poured cold water over people's expectations of the forum. In a way he was trying to manage the expectations by knocking them really flat to the floor.

Knowledge@Australian School of Business: Do you think GST should have been excluded or should the tax forum have included everything?

Neil Warren: At the end of the day, people wheeled in GST as an issue that cannot be ignored. It didn't take centre stage, there were many other things to talk about and mining tax didn't really get a guernsey, nor did carbon tax – they are just big issues all on their own and the way they scheduled (the forum meant) they didn't get much airtime but there was plenty on the agenda anyway to discuss.

Knowledge@Australian School of Business: But there were some short-term changes that were announced, weren't there?

Neil Warren: There were a number of things at the end of the forum and in a way we need to reflect a little bit about its mechanics.

The first half of the first day was on business taxation and there was a polarisation with the unions saying business and Australians are under-taxed and the business groups and other groups saying: "We're overtaxed, this is a competitive environment." Ken Henry (former Treasury chief), who headed the Henry review (into Australia's Future Tax System), wheeled in effectively saying: "I'm not surprised by any of this disappointing discussion that's going on here."

So it started badly, but in a sense people began to discipline themselves when they realised they had to take some ownership. And some good things came out in the end. One of those was the discussion about the tax threshold, but in a way we've already had that discussion because the carbon tax is going to give us an A$18,000 threshold and the treasurer has said he'll look at A$21,000. The interesting discussions were the ones in relation to business tax and the state taxes.

Knowledge@Australian School of Business: The really notable one is the changes to the way we calculate corporate tax income. I recall that was raised in the Henry report, but was there a final agreement on it?

Neil Warren: Three things came out of the forum and the summing up by the treasurer:

The first was that Chris Jordan (NSW chairman of professional services firm, KPMG) would chair a working group that had two briefs, one brief was to look short-term at what they can recommend for the government in terms of the next budget and that was really around the particular issue of loss carry-back. And the second issue was to look at alternatives to the current company income tax arrangements, particularly around whether there should be some changes in the allowance for corporate equity – there's a lot of push for that internationally.

The second change was in relation to state taxes where (New South Wales treasurer) Mike Baird and (Queensland treasurer) Andrew Fraser agreed to work together to look at harmonisation of their state taxes, as well as to map out a plan for tax reform at the state level and come back to the Council of Australian Governments (COAG) with their plans.

And the third development, which is quite exciting for academic institutions, was the announcement that the government would fund a Tax Studies Institute to the extent of A$1 million a year over a number of years.

Knowledge@Australian School of Business: Picking up on the allowance for corporate equity, can you explain what that means because it seems to be taking away the attraction of debt for many companies?

Neil Warren: That's exactly the point. Looking at the way we calculate company income now, we say: "What are your expenses? You've got shareholder capital. What's the interest cost of debt. What are your supplier purchases? What are your sales?" And from that we work out the profit. It's an accounting concept of profit. Economists don't like that – they say: "That really distorts this decision about whether to use debt or equity." Because one gets a deduction before we count profit and the other one is in there and essentially you are working out the return to shareholder equity.

What would be better is if we made some allowance for both – the cost of debt and the cost of equity capital – and on that basis you are being neutral in terms of how you treat your debt and your equity. That's what the allowance for corporate equity is, in other words, allowing a deduction for the cost of equity capital.

Knowledge@Australian School of Business: Another tax that many economists don't like is stamp duty. They say that it distorts the markets and it's really been the bugbear of homeowners and builders and economists for a long time. What's really wrong with it and was there any resolution on it?

Neil Warren: (There was) a lot of discussion on what to do with conveyancing duties on properties. It's accepted that a lot of state taxes, such as insurance taxes and stamp duty on business transactions, should go and that's pretty well mapped out. What is much harder is what to do with conveyancing. Remember it's a bit over a quarter of state revenues, so it's a significant revenue source. The land tax is only about 13% or 14% of state revenue. So the discussion was about how to get away from a conveyancing duty, which is on all properties on market value, and move to a broad-based land tax, which is on unimproved value and currently only on residential rental properties.

Everyone agrees that the problem is a fairly simple one and that it's a significant impediment to labour mobility. If you want to move house in Melbourne, for example, the standard house has about A$25,000 of stamp duty, there's around A$20,000-odd in New South Wales for the standard house, and in Queensland it's about A$19,000. These are quite significant imposts. For example, if you moved from Brisbane to Perth, but then changed your mind and decided to move back to Brisbane, you would probably have spent 15% of the value of your property just in getting into one and out of the other – let alone the real estate agents' fees! In an era when we're trying to encourage labour mobility, it poses a significant impediment.

Knowledge@Australian School of Business: People have been chewing it over for a very long time, so was there any resolution?

Neil Warren: The resolution was that it would be part of the review that Andrew Fraser and Mike Baird will be conducting, so it's not something that's going to be resolved very quickly. The big problem is how do you transition from conveyancing duty, a tax which is on all properties based on market value and represents a quarter of all state revenue, to a land tax which has a very narrow base. At the present moment only about 20% of properties are in the land tax base, whereas 100% of properties are in the conveyancing duty base, and they have quite different calculations. And there is the issue that conveyancing duties (apply) when you sell your property and land taxes (are due) every year, and you can rightly say that the conveyancing duty is a land tax over the next X amount of time, so is the transition period between these 10, 15 or 20 years, how do you actually do the transition from one to the other? It's a politically sensitive issue, because you're going to have to start applying land tax to the family home.

Knowledge@Australian School of Business: A lot of discussion centred on the relative lack of revenue-raising options for Australian states, so can the states actually prove their stripes in reforming the state taxes?

Neil Warren: That's a really good point. At the beginning, the treasurer told the states not to come cap in hand, because he would not to give them money. "I don't have the coffers to assist you, you come up with your own plan," he told them. What was very good at the end was the government said: "Go out and get your house in order." And the states rose to it and said two treasurers will work together to get their houses in order. I believe that if the states do get their own taxes in order, the big issue will be what to do with payroll tax. Do you cut the threshold, lower the rate or broaden the base? They could raise more revenue because states only collect about half what they could collect due to their high thresholds which exclude about half of the base. I think the states have to work out how to use their own bases before they start asking for access to the Commonwealth. And I think if the states did show some initiative on that front the Commonwealth would kick into play, but the Commonwealth also has a responsible part to play here as well.

Knowledge@Australian School of Business: But was there much recognition that the states have already been heavily compensated, even as far back as when GST was introduced in 2000?

Neil Warren: That's one of the critical points. The Commonwealth is looking at the states' wanting access to the income tax base, on top of the GST and other taxes, such as the mining taxes, which are going to the states, and essentially telling them to go away and fix up their own backyards. I think there are good arguments for the states ultimately to have access to the income tax base, not revenue sharing but access to the base with some scope to impose their own additional rates on those. But it's clear the Commonwealth is not going to buy into this, or to make room for the states to do that, until they get their houses in order. That's actually quite clever leveraging by the Commonwealth because the states need to take a hard look at what they can do, before they start saying that other people should solve their problem for them.

Knowledge@Australian School of Business: With the forum over, what's the likelihood of getting six states and two territories to actually agree on anything in the next year or two?

Neil Warren: Not all eight will agree, but if you can get three or four of the states – some of the mining states and New South Wales and Victoria – you've got enough to set the precedent that the others will follow because there will be pressure on those to comply with harmonised bases. You have to accept at the outset that all states fundamentally will have difficulties agreeing. The question then is: Can we see leadership from Queensland, NSW, Victoria and Western Australia to demonstrate that the majority of Australian states – the "powerhouse", bigger states, if you like – can lead initiatives and achieve reforms? You won't get all eight to agree, I think that has to be accepted.

Knowledge@Australian School of Business: That's just as inevitable as death and taxes. If you look at the forum's post-mortem, what happens now?

Neil Warren:  Well, they've already announced the composition of the working group that Chris Jordan is leading, so that's already been set out and their terms of reference have been detailed, so that's underway, so it's progress. I believe the treasury people from Queensland and NSW have begun discussions. And, in terms of the Tax Studies Institute, I understand the academic institutions are talking to each other about how it might work and (federal) treasury is considering how such an institution will work in terms of governance and so on. So progress is underway and Chris Jordan's group has got some very clear marching orders in terms of what the government wants of it and what to look at.

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