Infrastructure Australia’s Infrastructure Audit was released to the press in May this year. It circulated  quickly across the nation’s media houses. They all parroted Hanrahan: ‘we’ll all be rooned’ if we don’t resign ourselves to a big, new wave of investments.

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Current Affairs.

Since 1984 Federal Governments have produced a Women’s Budget Statement as one element of the official Budget Papers. The present government discontinued this practice last year.

In response, the National Foundation for Australian Women together with others took up the task of analysing the implications of the budget that were of particular interest to women. See link below for this analysis.  John Menadue.

http://sydney.edu.au/business/research/wwrg/budget

Current Affairs. 

John Menadue has written an excellent summary of what might originally have been a problem of the sociology of knowledge, where particular groups in society appropriate the debates relating to public policy. They usually ignore the intellectual currents that lie more deeply behind these policies, even though they have been strongly influenced by them. Whilst it is the task of intellectuals to expose these currents, it should be the task of public servants to assess their validity, when translated into specific policy recommendations, for implementation in the public sphere.

In 2000 I published a book applying technical myth analysis to narratives (newspapers, government reports) dealing with public policy as I had become so disturbed by the effects of deregulation and privatization and so disillusioned with the Labor Party’s abandonment of its traditional support base. In Chapters 2 and 5 I examined the role of business economists and consultants respectively and canvassed some of the issues Menadue has so eloquently summarized.[1] I touched on the role of lobbyists, but did not realize then how influential they would become. Certainly their preponderance in influencing government decision making in terms of public policy is decisive and seriously undermines democratic values and forms of decision-making. But this is part and parcel of neo-liberalism understood as both a political and a cultural system. It is essentially a form of neo-feudalism where those who control the resources are able to exercise greater control of these resources over time because of their access to political power and the commonality of their interests and those of the politicians.

Since the early nineties, if not before, public policy seems to have been largely defined by lobbyists, consultants, business economists and right wing journalists, all buttressed to some extent by think tanks like the Institute of Public Affairs, the Sydney Institute and the Centre for Independent Studies.

There are two aspects to the communicative function of these groups. Firstly, they are explicitly involved in presenting the virtues and benefits of a ‘free market’ to the general public. The main conduit for these views is via the mass media, both electronic and print. For the last two decades comment about matters of economic policy has, and continues to be, almost always sought from business economists and consultants from the four large consulting firms. As such these groups, and especially the large consulting firms, have become virtual public relations experts, spruiking the virtues of the free-market. Their message has a high degree of unanimity around it, even though there are no doubt slight individual differences.

Secondly, in conjunction with the registered lobby groups they apply their persuasive powers to individual ministers and other politicians to influence specific policies consistent with their more general belief in free markets. These policies in truth may have nothing to do with pure free market concepts but benefit small vested groups. The rejection of the mining rent resources tax is a good recent example as are the abolition of carbon pricing, and a likely rejection of a possible investigation of oligopolistic pressures in iron ore pricing. And, as Menadue, rightly says, they oppose any reform that may benefit society as a whole, as opposed to their own vested interest. Unless something is done to allow ‘non-organized’ voices to be heard in the forums where policy is influenced, democratic values and practices are certain to be diminished as they already have been, as Menadue’s article so clearly shows.

What is paradoxical about this is that the early Australian justifications for deregulation and privatization argued that government activity everywhere should be minimized because it was so easily captive to vested interests. As an example of this belief consider the following opinion expressed in 1994:

“In general, the decentralised decision-making of all members of an economy taps a richer base of ideas and provides a more effective system of screening profitable from unprofitable forms of change than a centralised group of people nominating industries or technologies for selective treatment. We were pleased to note the Prime Minister’s recent speech to the CAI in which he said “Government’s concern should be with the broader community and social change, while the focus of competition should provide the signals to which industry in the free play of the market will adapt.”[2]

Yet capture of the government by vested interests is exactly what has happened in the intervening twenty years. The underlying impulse in much that has been taking place in public policy fora is self-aggrandizement for specific groups. Success breeds success, of course, and the loss of valuable reform, especially in economic matters, renewable energy and climate change mitigation, has been astounding.

The contradiction between a perfectly free market, admittedly a practical impossibility, and rule by vested interests is facilitated by a central aspect of the neo-liberal state: the control of the flow of ‘community’ knowledge and a severe narrowing down of the level of public debate. The domination of the print media by the Murdoch press is an obvious example, but this control even spins over to more quality newspapers like the Age, which have progressively ramped up the reporting of free market propaganda over the past two decades. Even the ABC has felt compelled to swing some way towards this view by giving the Institute of Public Affairs important time slots on Radio 774, as does the Age regularly. This is not to say the press should not publish opposing views, but where there is an overwhelming preponderance of one point of view in public policy, then any pretense at pluralism may be just that, pretense. Finally, one can point to the great success Chris Richardson has had in getting his voice heard continually on economic matters when he was principal of Access Economics, which has now been melded into Deloitte’s, one of the large consulting firms.

What Menadue has so successfully demonstrated is the institutional organization necessary for the domination of public policy formation by a few voices. But there had to be a cultural space provided for these voices that would enable them to become so influential. Really this was opened up in the eighties following a period of economic stagnation in the seventies, a rejection of Keynesian pump-priming actions to increase investment. It was complemented by a view propagated by the Chicago School, and increasing numbers of other academic economists, that the purity of the market should be lauded, as in theory it represents the democratic choice of millions of consumers. And, as a corollary, that the government functions to lessen consumer choice because it represents vested interests that would potentially violate market flows and distort market choices.

Lobbying groups cannot and should not be banned, of course. This would be an extreme position, because in the final analysis they represent the kind of pressures any interest/pressure group would attempt to place on politicians. The problem occurs when politicians and lobbyists (including here consultants and the heads of the various industry, and now union groups) all come from the same background/class and their interests substantially coalesce. The movement of personnel between the federal treasury and the reserve bank, and the large consulting firms and into business economists’ positions over the past thirty years has been well documented. It leads to a considerable consensus of opinion amongst the upper level of the federal and state bureaucracy and the professional ideologists in the large consulting firms, lobbyists and ratings agencies. This is further exacerbated by the movement of politicians, once they retire, into consultancy firms, into honorary positions at universities and also into lobbying firms, as has also been documented elsewhere.

There is also the question of how much money all the groups involved in lobbying take out of the economy and whether this would be spent better in the production of actual physical and social capital rather than in support of rent seeking. Was there any justification, for example, in the $81 million paid to banks to organize funding for the ill-fated East West Link in Melbourne, when the state government could have borrowed the money itself at a much smaller cost? It would be instructive, but very difficult to quantify the amount of money governments and the private sector pay to the large consulting firms each year.

Whether the excellent proposals Menadue has suggested to limit the influence and effectiveness of consultancy firms can be implemented remains to be seen. I have no doubt they would be resisted very strongly by those whose activities they are meant to restrict.

In all of the argument pertaining to the underlying cultural conditions producing this dominance of knowledge and influence, the cultural conditions resulting from it are more difficult to spell out, but are crucial in reverting to acceptable democratic practices. Most commentary on public policy formation and political behaviour over the past twenty years has focused on how neo-liberal ideology has influenced economic policy and the withdrawal of government from many aspects of governing. Yet a recent book published in France (and now available in English translation) in 2009 argues that neo-liberalism has become a new form of rationality operating on all levels of society. P. Dardot and C. Laval have argued that the practice of neo-liberalism underlying free-market economics goes far beyond economic and political institutions. It functions as a new rationality in the world and that “far from limiting itself to the economic sphere, it tends to totalize, that is, to ‘form a world’ by its capacity to integrate all the dimensions of human existence.”[3] If this is true it is going to make real reform, and movement away from dominance by vested interests, very difficult.

Thus the move away from post-war government intervention to rebuild broken economies required a set of beliefs that would be condemnatory of government, laudatory of private sector entrepreneurialism and critical of vested interests who could capture legislative decisions. Time and again in the eighties and nineties the theorists of the free market attacked vested interests, of which the government is one, as undermining the democratic workings of the market. If this seems like a paradox now, so was it then.

What this has morphed into is a ‘neo-liberal’ ideology that places the market and individuality above everything. Once again the dominance of the consultants/lobbyists, business economists in pushing the barrow of vested interests must also be seen as part of the process of knowledge creation and control in contemporary first world (especially Anglo-Saxon) countries but also as an integral part in its repression of contrary opinions and in establishing this as the norm. In this sense their role in the creation and control of knowledge is little different from what one would have found in the centrally planned economies of the former soviet bloc.

Dr Greg Bailey is Associate Professor, Program Coordinator (Asian Studies), College of Arts, Social Sciences and Commerce, Latrobe University.

[1] Mythologies of Change and Certainty in Late Twentieth Century Australia, Australian Scholarly Publishing, Melbourne, 2000.
[2] “Revitalisation and Structural Adjustment of the Australian Economy”, Business Council Bulletin, 9 (October 1994), p.10. An almost identical formulation is given in J.J. Carlton, “Privatisation and Deregulation”, Canberra Bulletin of Public Administration, XIII/3 (1986), p.202; Competition and Economic Efficiency, EPAC Background Paper. No.19, (AGPS, Canberra, 1992), p.69.
[3] P. Dardot and C. Laval, La Nouvelle Raison du Monde: Essai sur la Société Néolibérale, La Découverte, Paris, 2009, p.6.

Current Affairs

Tony Abbott famously told Australians he wanted to be known as the infrastructure prime minister and in the 2013 election campaign committed to “retain and strengthen the role of Infrastructure Australia, to create a more transparent, accountable and effective advisory body”.

In contrast to last year’s $11.6 billion Infrastructure Growth Package, this budget has only three big transport infrastructure announcements. One is the claw-back of $1.5 billion from Victoria for the shelved East West Link, while offering to provide the full $3 billion the Commonwealth originally promised if any Victorian government decides to proceed with the project. Another is the decision to give $499 million to Western Australia, nominally for road infrastructure but effectively replenishing state coffers after the Premier complained about a shortfall in GST revenue. The third is the decision to establish a $5 billion Northern Australia Infrastructure Facility with concessional loans for ports, railways and electricity.

The first two of these are notable for several reasons. First, they both give preference to roads, rather than to whatever project can show the most compelling case for fixing an identified problem. It’s no surprise – the PM has insisted that the Commonwealth will only fund roads, not urban rail.

Second, both announcements appear to serve political goals. The East West Link decision locks away in the contingency reserve the funding previously allocated to the controversial Melbourne project. By earmarking the money for a resurrected East West Link, or perhaps a Transurban alternative to the western part of East West Link, the Commonwealth has put a clear hurdle in the path of the current Labor government’s access to the funds.

Meanwhile, the money for Western Australia appeases the Colin Barnett Government after COAG recently rejected its request to change the formula that determines the states’ shares of GST revenues.

The two announcements beg the question: is a piece of infrastructure really needed or is it being built to buy popularity? Until Infrastructure Australia was set up in 2008, there was no systematic approach to infrastructure needs or coordination across governments. The new body was set up because “infrastructure investment needs to be determined objectively and according to long-term need, not short term political interests”, as then infrastructure minister, Labor’s Anthony Albanese, put it, and it has bipartisan support.

Infrastructure Australia evaluates the need by publishing an Infrastructure Priority List for projects seeking more than $100 million from the Commonwealth. Four categories of approval range from “ready to proceed” to “early stage”, depending on how nationally significant and well-developed they are.

The big announcements in this year’s Budget do not appear on the Infrastructure Priority List as “ready to proceed” or even “threshold”. East West Link does appear, but is only ranked in the third of four categories. The Commonwealth seems not to be listening to its own independent advisory body.

Part of the problem is that the public doesn’t have access to an up-to-date Infrastructure Priority List – the most recent is from December 2013. Without up-to-date independent assessments, the transparency and accountability guarantees that motivated Minister Warren Truss to overhaul Infrastructure Australia last year are missing. The newly constituted body is required by law to publish evaluations of proposals received on its website each quarter, infrastructure plans within fourteen days of providing them to the Minister, and a review of its cost-benefit analysis method within six months of the legislation coming into effect. None of this has happened.

The issue matters. The scale of the money alone is huge – the Commonwealth is spending $5.5 billion this year on transport infrastructure, rising to $7.6 billion in 2016-17 and $10.3 billion the year after. The Productivity Commission has identified an urgent need to overhaul procedures for assessing and developing public infrastructure projects. Just last week, two state auditors general separately raised significant concerns about major transport infrastructure critical to their states. NSW’s Grant Hehir spoke of “significant levels of non-compliance” with the government’s external assurance mechanism for large construction projects, while WA’s Colin Murphy said that “Main Roads could not demonstrate that its projects and activities to address congestion have made the best use of resources”.

Whether or not big transport projects add up, governments should not overlook the considerable benefits available from smarter use of the infrastructure we already have. In a mature transport system, adding new roads and rail is very expensive and gains can be modest. Improving rail signalling to increase throughput, regulating traffic flows onto freeways, improving road access into ports, and encouraging public transport users to travel outside peak times are changes that can delay or remove the need for heroic and costly projects.

However, if there are such projects that are demonstrably the most cost-effective way to solve a real and important problem, then the case should be submitted to Infrastructure Australia, assessed, and published. With unemployment creeping up and little growth expected in business investment, if there is a time for the Commonwealth to commit to well-considered and cost-effective new infrastructure, then it is now.

Marion Terrill is Transport Program Director at Grattan Institute. This article was first published in The Conversation on 13 May 2015.

Fairness, Opportunity and Security
Policy series edited by Michael Keating and John Menadue.

To paraphrase Paul Keating, right now every galah in the pet shop seems to favour more infrastructure spending. The current Prime Minister wants ‘to be remembered as a Prime Minister who built the roads of the 21st century’. The business community is similarly demanding more infrastructure investment, while both Treasury and Reserve Bank, both of whom might be expected to be a bit more critical of spending proposals, have added their blessing to infrastructure spending.

In recent years, however, total infrastructure investment has already risen sharply. Public capital formation (largely infrastructure investment) was 36 per cent higher in 2013-14 than in 2006-07, and as much as 44 per cent higher in 2009-10, partly in response to the GFC. Capital formation in transport, postal and warehousing in 2013-14 was 48 per cent higher than in 2006-07I, and in only seven years its net capital stock increased by a staggering 39 per cent.

Calls for more assume that all infrastructure investment is warranted economically and will add to national productivity. Yet no attempt has been made to justify this assumption, which is beggared by almost all past experience.

The real problem with much infrastructure is that unlike most investments, the revenue stream and consequent rate of return are negligible or non-existent, whereas normally that rate of return would indicate where more investment is warranted. Happily since the micro-economic reforms in the 1980s and 1990s, investment in power supplies, urban water, communications, and air and sea transport are now mostly subject to market disciplines, and can be presumed to be justified[1]. But that is not the case for investment in road, rail and irrigation infrastructure, which have largely resisted competition reform.  Furthermore, few such projects have been submitted to proper cost-benefit analysis, so it is anybody’s guess as to whether spending taxpayers’ money in this way is justified.

Road spending: $140 billion of debt within a decade?

Most of the transport investment has been in roads. In 2012-13 (the latest year for which figures are available) Australia spent $24.9 billion on its roads – a figure higher than the entire Australian Defence budget for that year. But since 2007-08, a combination of stagnant fuel excise revenue and increasing road expenditures has meant that revenue from motorists no longer covers road spending. Accumulated deficits from road investments between 2007-08 and 2012-13 have now added $26.1 billion to Australia’s public sector debt, and as much as $6.6 billion alone in the latest reported year, 2012-13.

A reasonable projection of planned road expenditures indicates that the accumulated stock of debt to FY2023-24 could be of the order of $114 billion[2].   When added to the already accumulated debt, this amounts to a total accumulated road-derived public sector debt of $140 billion within a decade (a matter until now entirely unreported).

Moreover, despite an obsession with public debt, no government has provided any economic justification for most of this roads expenditure. Rather Infrastructure Australia has been highly critical of Australian road planning and assessment. Its 2013 State of Play report described Australia’s last major public sector infrastructure monopoly as ’standing out’ for poor performance: Australia’s roads ’have no economic efficiency objective’, ‘no coordinated planning or design’, ‘ no review of proposals or results’, and ‘no commercial medium for users to influence capacity or design’.

If investment in productive outcomes is the goal, some road projects touted as the highest priority for the nation make one wonder just how bad the ‘also-ran’ projects must be: Melbourne’s now-cancelled East-West Link project – a multi-billion dollar project with a business case returning as little as 45 cents for every dollar invested – should never have been approved. Sydney’s massive Westconnex tollway project is underway (total cost $14,900 million, 2014 prices), but has not yet been judged fit for government investment by Infrastructure Australia.

Almost all multi-billion dollar road projects have similarly escaped scrutiny: Queensland’s Bruce Highway upgrade (total cost $8,956 million, 2014 prices) is but one example amongst sixty-three $100 million dollar-plus road projects budgeted by governments for the coming 5 years which have not been sanctioned by Infrastructure Australia, despite bipartisan agreement that this must occur (the lone budgeted project to receive approval is the Pacific Highway upgrade).

Reform of road planning, funding and expenditures

The Government’s recent Review of National Competition Policy found that ‘Lack of proper road pricing distorts choices among transport modes … and also contributes to urban congestion… with road users facing little incentive to shift from peak to off-peak periods, greater capacity is needed.’ Accordingly the Review concluded that ‘Reform of road pricing and provision should be a priority. Road reform is the least advanced of all transport modes and holds the greatest prospects for efficiency improvements.’

Cost-reflective pricing is critical to progress. Unlike twenty years ago, technological leaps mean that road pricing based on distance, location, and congestion, is now feasible at low cost. The revenue raised could then signal the genuine (measurable) priorities to which all future investment should be linked.

However, full road pricing may well not be appropriate in all circumstances, or even in a majority of circumstances. For existing roads that have spare capacity and do not help create congestion, it is more efficient to reduce that spare capacity by increasing the traffic even if that means providing a free ride. In addition, many roads may fulfil a community service obligation to ensure that people have access to their homes and places of business, and full cost recovery is then impossible.

For these reasons other approaches to road planning and financing should also be strengthened. Above all, proper system design is required: infrastructure works best as an internally-consistent system, not as discrete projects dreamt up in isolation to alternatives or without due analysis of their interaction with other parts of the whole. System design should ask simple questions: what problem am I trying to solve? What are the opportunity costs of different approaches to solving the problem? To date, no such authoritative design function is in evidence at any level of transport bureaucracy.

Given that road revenues are now failing by tens of billions of dollars to meet road spending, system design can help governments avoid generating further billions of dollars in public sector debt without merit. It enables government to establish a hierarchy of transport solutions based on their ability to satisfy aggregate transport demand and their likelihood of paying for such outcomes by project cash-flows alone.

Second, rules requiring proper independent cost-benefit analysis of projects should be enforced. All major investments in roads should base themselves on proper business cases submitted to Infrastructure Australia. Approval should only be forthcoming if the project is reasonably expected to deliver an economic rate of return after careful assessment of the value of any external benefits and the extent and cost of any community service obligations, which should be publicly transparent.

Rail investment

The next 5 years of government road and rail network budgets see $46 billion of highway and freeway projects, but only $1.6 billion in national rail solutions. Yet transformational rail infrastructure projects appear to be there. For example, in 2010 a national freight railway spanning Australia’s east coast was found by a Commonwealth-commissioned report to be capable of reducing the cost of interstate freight by 48 per cent. Yet in 2015 this railway remains unbuilt, without any substantial capital allocated to it beyond initial planning funds; at the same time, the government has not entertained simple market testing to build such a railroad commercially and immediately, as often occurs internationally.

Similarly there are urban rail projects worth funding, but they are almost never big new extensions to the network. Australian cities do not have the population density to justify major extensions. Even in Sydney – Australia’s most densely populated city with about 50 per cent and 470 per cent more rail passengers than Melbourne and Brisbane respectively (yet with similar network capacity), past investments in the urban rail network have failed to pay off. Thus after allowing for an annual $1.6 billion worth of external benefits from less traffic congestion, pollution and health and safety, the regulator found in 2008 that an economic rate of return was only possible if the total capital stock was written down to a bit less than half its depreciated book value, and much less than half it replacement cost. This strongly suggests that new urban rail lines are unlikely to generate an economic rate of return, even when allowance is made for the external benefits.

A fundamental problem is that urban rail transit systems have only a very small impact on congestion, except for the main roads into the CBD. This is because these urban rail systems are focussed on transporting commuters to and from the CBD, but in Sydney for example, in 2008 these journeys amounted to only 4.5 per cent of all journeys and 11 per cent of the total person kilometres travelled in Sydney as a whole.

Most journeys in modern Australian cities are across town to multiple business nodes. These cannot be served by the urban rail network, at least as presently designed. Usually modern bus services represent the best public transport option for Australian cities, yet serious bus infrastructure remains under-appreciated.

Instead, urban rail projects that would engender an economic return are often modest efficiency and capacity modifications to the existing network: better signalling, more passing loops, increased station capacity, or filling in ‘missing links’, such as perhaps Melbourne’s Metro Rail project. Such projects become more evident through proper attention to system design, but they are obscured if public policy only seeks to feed the political addiction to ‘icon projects’.

Rural water

The situation regarding rural water is very similar to that just described for urban rail. Water for irrigation has consistently been under-priced, and practically no irrigation scheme in Australia has ever generated an economic return[3], even allowing for the external benefits from flood mitigation and other environmental benefits.

The most important irrigation investment in recent years has been the National Water Plan decision to spend $10 billion on improving water flows in the Murray-Darling Basin. From this, approximately $6 billion was to be spent on improving the supply of water to irrigators by efficiency improvements, with the balance to be spent on buy-backs from the most marginal irrigators. If the water pricing rules agreed to by COAG as part of the Competition Policy reforms in the mid 1990s had been adhered to, it has been estimated that this investment would have required the price of water to irrigators to increase between 10 and 30 fold, depending upon how much of the extra water was reserved to improve environmental flows[4]. Of course, the agreement for proper pricing was quickly abandoned, thus destroying the economic value of the investment.

In addition, the present Coalition Government has surrendered to pressure and the amount of water to be bought back has been reduced, notwithstanding there are plenty of willing sellers who want to get out of what is for them an uneconomic industry. But the consequence of this latest change is that the extra money now being invested in efficiency improvements further reduces the economic returns on this investment. 

Conclusion

Australia is racking up very substantial debts to finance unreformed infrastructure. Many investments appear uneconomic and will therefore lower national productivity, or at least the productivity of capital and total factor productivity.

It is scandalous that this investment escapes proper scrutiny, while at the same time the proponents are calling for cuts in other government programs, including education and training programs that would actually increase productivity and participation.

Going forward the Competition Policy reform agenda of the 1980s and 1990s should be completed so that all infrastructure is properly priced before any new investment occurs.

Luke Fraser is the founder and principal of a transport policy and investment advisory focussed on roads and freight. In 2012 he was appointed to the Prime Minister and Premiers Road Reform Project. Prior to this he was for several years a national road freight industry chief executive, as well as a member of the Australian Trucking Association Council, where he was the industry’s lead representative on pricing reform and market investment models. 

Michael Keating is a former Head of the Commonwealth Department of Finance. Subsequently he was Chairman of the Independent Pricing and Regulatory Tribunal of NSW, and responsible for pricing much of that State’s infrastructure services.

[1] Note that in recent years there has been substantial over-investment in electricity transmission and distribution which is a natural monopoly and therefore not subject to market disciplines.

[2] This projection is based on the National Land Transport Agreement for 2014-19 for Commonwealth road expenditures and assumes no real growth in State and Local Government road expenditures. The CSIRO has projected falling revenues from fuel excise over the next decade and beyond, but the revenue projections used here conservatively assume unchanged excise tax revenue in nominal terms and that the other revenue elements increase at the 10-year average. Sensitivity testing suggests that indexation of fuel excise would still leave a substantial deficit from present road investment plans. A forthcoming academic paper (L. Fraser) examines these matters in greater detail.

[3] Irrigators have never paid a cent for water from the Snowy Scheme. Instead all of the costs are recovered from electricity consumers, and notwithstanding that irrigators have first rights to that water.

[4] Michael Keating, Australian Economic Review, Infrastructure: What Is Needed and How Do We Pay for It? 2008, pp. 231-8.

Fairness, Opportunity and Security
Policy series edited by Michael Keating and John Menadue.

In his introduction to this series, Ken Henry said he could not recall a poorer quality debate, on almost any issue, than what we have had in Australia in recent times. Ian Marsh, in his contribution, advocated pursuing bi(multi)partisanship opportunities as far as possible.

Sadly, Henry’s comment seems most apt when it comes to retirement incomes policy, and Marsh’s call seems a long way off after the Prime Minister and Treasurer ruled out a comprehensive review of the policy after the recent Budget. This is despite the Treasurer recently saying in relation to taxation that all options were on the table, and the Opposition indicating a willingness to work with the Government. In addition, there has been some excellent work in academia over recent years, and a quality report from David Murray’s Financial Services Inquiry which highlights the importance of drawing all the threads of the retirement income system together. We can only hope some others in the Government can find a way to allow proper discussion and wide engagement on this critical issue for everyone.

Careful analysis of Australia’s retirement income system would reveal it has considerable strengths, but also some serious weaknesses and challenges, most of which have not been addressed by the Government’s Budget proposals – either this year or last year.

Such an analysis requires, first, some agreement on the objectives of the system. David Murray’s Financial Services Inquiry made an important contribution in its simple admonition to articulate in legislation the objectives of the superannuation system, the primary one being, ‘to provide income in retirement to substitute or supplement the age pension’. Such a focus would avoid debate being hijacked by those promoting housing investment, or infrastructure financing, or broader wealth accumulation and so on.

The wider retirement incomes system in fact has two objectives:

• The alleviation of poverty amongst the aged (addressed mainly by the age pension); and
• The maintenance of income and living standards at and through retirement (addressed mainly by superannuation).

These core objectives are complemented by general principles such as value for money and sustainable cost, simplicity and understandability, and stability and certainty.

Australia’s ‘multi-pillared’ system (to use the language of the World Bank) has considerable strengths. Its ‘foundation pillar’, the age pension financed by general revenue, addresses poverty alleviation reasonably effectively and efficiently. The level of the pension is slightly below the OECD benchmark for poverty (50% of median income) so the headline poverty rate amongst our elderly is quite high (35% compared to an OECD average of 12.5%0, but the severity of poverty is lower (the average gap being 12.4% compared to the OECD average of 18.4%). With significant increases in the pension over the last decade and more, and with increasing numbers having superannuation as well as the pension, our main underachievement against the first objective concerns those fully reliant on the pension who are in private rental accommodation whose after housing costs are much higher than those who own their own home or are in public housing. The case for increasing rental assistance is strong.

Perhaps our system’s greatest strength comes from our emphasis on ‘pillar two’ mandated contributions and ‘pillar three’ tax-encouraged voluntary savings. These pillars are mostly fully funded instead of a ‘pillar one’ national superannuation scheme with unfunded promised benefits as is common in Europe and North America. In theory at least, our approach imposes less risk on governments and future taxpayers, and hence offers greater intergenerational equity.

At the current mandated contribution rate of 9.5%, most people will accumulate superannuation savings which, with some age pension, will be able to deliver at least 70% net income replacement in retirement after 35 years of contribution. The rates are higher at low income levels because pension eligibility is higher. This suggests we have the mandated contribution rate about right already if one accepts the international standard of adequate income maintenance of between 70 and 80%. Raising it further would only force people on low incomes to save more when their needs are greater in order to improve retirement incomes that are already sufficient. Most people on or above median earnings are already contributing more than the mandated amount taking advantage of the incentives available and, on average, it seems they also are likely to have sufficient accumulated savings to achieve 75% replacement rates.

The problem is that these income replacement rates are only potentially available. That our system does not in fact deliver them and ensure they last everyone’s full life is perhaps its greatest weakness. It certainly contrasts with every national superannuation scheme in other countries, and indeed with our own age pension.

We allow people too much freedom to take benefits in the form of lump sums. This can leave people with insufficient funds for their later retirement years and make them overly reliant on the age pension. Evidence gathered by the FSI suggests that this is not as yet a major concern but it could become one.

Of more concern according to the FSI is that too many people are trying to manage longevity risk on their own. To do this, they are holding back consumption from their accumulated savings so as not to run out of savings before they die. The result is lower consumption (and a lower standard of living than their accumulated savings suggest they should be able to have in retirement), and much larger bequests to the next generation than they would have planned (and much more than the system was intended to provide). Also, some still live to a very old age and run the risk of running out of savings.

There is also capacity to exploit the tax concessions to accumulate wealth including for planned transfer to the next generation rather than genuine retirement purposes.

Our system needs products that deliver retirement streams and provide insurance against the risk of longevity, and for policies which promote the take up of these. The FSI proposed requiring superannuation funds to offer their members a ‘comprehensive retirement income product’ which would include a longevity insurance element. It hoped these products would become the default retirement benefit products which most will take up, and thereby also addressing in part some of the ‘market failures’ such as adverse selection. This may not be sufficient and, eventually, consideration may need to be given to a mandated approach and to complementary measures to address market failure such as the options identified in the Henry Report including the issue of longevity bonds and the sale of annuities by government to supplement the age pension. These might be more likely to make lifetime annuity products available and limit capacity for people to use superannuation tax concessions for purposes other than retirement income.

The structure of our system makes us much better prepared for demographic and economic changes, but we still have serious cost challenges. The 2015 Intergenerational Report projects the cost of age pensions will grow from 2.9% GDP to 3.6% over 40 years unless the legislation changes. Health and aged care costs are projected to grow further. These increases will need to be managed and, if possible, curbed while ensuring the programs still deliver what the community needs and prefers.

What the IGR did not report was the cost of superannuation tax concessions which are growing faster than the age pension and are concentrated on those on high incomes. We should not however exaggerate the scale of these.

Treasury estimates of close to $30 billion are based on a ‘comprehensive income tax’ benchmark or TTE approach (taxing contributions and fund earnings as income and exempting the benefits). This may apply to your bank account but it is clearly excessive as it eats into the real level of savings. Last year Treasury presented estimates of the tax expenditures if a ‘comprehensive consumption tax’ or TEE benchmark was used. This suggested the costs of superannuation concessions are around $12 billion. But even that is arguably more than the revenue forgone that might be reaped if we agree the purpose of superannuation is to spread lifetime incomes to maintain living standards in retirement. That would suggest an EET approach, the orthodox approach used elsewhere but way too hard for us now given policies of the last 25 years. I have not seen any estimate of our tax expenditures on this basis, but they would be much lower as few retired people would have large amounts of other income so the tax rate would be much lower than their marginal rate when making contributions.

Given it is not feasible now to replace the current regime with an EET one, the question is what tax arrangement might most closely replicate an EET one, containing the costs and ensuring tax equity. I suspect the Henry Report approach would get pretty near to it by allowing a 20 percentage deduction from contributor’s marginal tax rate when setting the contributions tax. In practical terms, this would mean applying a 30% contributions tax for all those with incomes at the top marginal tax rate and no change for the vast majority of contributors; Henry also proposed a flat 7.5% tax on fund earnings at both the accumulation and drawdown phases.

The Government is right to draw attention to the costs of the age pension even if our challenges are small compared to those facing many others. But we also need to be realistic and to consider carefully how the pension will fit with superannuation as our population ages and the transition to retirement shifts and varies.

Australia has already been remarkably successful in reducing eligibility for pensions amongst women under 65, and has legislated to increase the age pension age to 67. When considering possible further increases consideration needs to be given to the implications for those with limited capacity to continue work, and the savings actually generated by such a change. The savings may be modest given the falling numbers of full-rate pensioners and the increasing proportion of these already on welfare before transferring to the pension. The Government’s proposal to increase the age to 70 in the 2030s was designed to maintain the ratio of working years to retirement years: that has some attractions but we need to look more carefully at the effects of the increase to 67 first and review whether the overall impact of a further increase would be acceptable.

The Government proposed last year to change the pension index to the CPI rather than AWOTE. That was always far too tough, reducing relativities with community incomes very substantially if continued for a lengthy period. But as Minister Morrison suggested in February, there is a case for modifying the current AWOTE approach which will over time increase the pension relative to community incomes. Using the CPI for automatic increases then having independent reviews to make adjustments for community income changes every two or three years would in fact be very sensible, and could form the basis for a uniform approach to indexation of all welfare payments. The welfare lobby might like to reconsider its opposition to any change in pension indexation arrangements.

Tightening the means test offers another way of achieving savings but it is important to recall that the original intention of the superannuation reforms was to allow most retired workers to supplement age pensions not to fully replace them. We have already seen a drop in the proportion of the aged on full-rate pensions from around 60% to 50% and this is projected to drop to 30%. The proportion on part-rate pensions however is increasing, so the forecast involves only a modest reduction in the total pensioner population.

To achieve a much greater reduction would require radical changes which could have adverse implications. The income and assets levels at which pension eligibility ceases are of course a function of the level of the pension and the means test withdrawal rates. The income test withdrawal rate has already been increased to 50%: a higher rate could affect incentives to continue part-time work. The Government has proposed an increase in the assets test withdrawal rate but few (including in the welfare sector) seem to realise this involves an effective wealth tax of 7.8% removing incentives to improve assessable assets above the threshold, contrasting sharply with superannuation tax arrangements intended to encourage saving.

More sensible suggestions include Henry’s proposal for a single merged income test which converts assets into appropriately deemed income: this would not radically change the numbers eligible for some pension, but would provide a more coherent effect on incentives to work and save. Another is to include the home in the assets test beyond some threshold, allowing people to continue to receive the pension but requiring repayment from their estate through a reverse mortgage arrangement. But in all likelihood over half our retired population will continue to receive some age pension, and that should not be regarded as bad so long as the system as a whole is delivering adequate incomes efficiently and at an affordable cost.

All this goes to demonstrate how a bi-partisan review of our retirement income system could build on its strengths, make it more effective and sustainable, and give people full confidence as they plan for their retirement years.

The demographic changes now underway should not be presented as a crisis; they represent a triumph of increased life expectancy and years of health living at older ages. They provide new opportunities for people to contribute to society and their families and communities as they transition from full-time employment. Our retirement income system can provide the security people need against poverty and reduced living standards while offering the flexibility for people to manage this new transition to retirement in the way they want.

Andrew Podger, Professor of Public Policy, Australian National University. He was previously the Public Service Commissioner and Secretary of the Departments of Health and Ageing, Housing and Regional Development, and Administrative Services.

Fairness, Opportunity and Security
Policy series edited by Michael Keating and John Menadue.

After more than seventy years of ever increasing living standards Australians have come to expect further such increases as their right. But these increasing living standards are for the most part dependent on increases in productivity. So as Nobel Prize winner, Paul Krugman put it, while productivity may not be everything, it is just about everything.

Unfortunately in the last decade Australia’s productivity growth has slowed compared with the 1990s when it accelerated, probably partly in response to the micro-economic reforms of the 1980s and 1990s. Perhaps for that reason business and a lot of the commentariat seem to think that productivity improvement requires more micro-economic reform; to the point where commitment to micro-economic reform is becoming a litmus test of ‘good government’.

Furthermore, business’ definition of more micro-economic reform focuses principally upon reforms of tax and workplace relations. However, taxation and workplace relations legislation are highly contentious policy areas; indeed they represent the two most amended areas of Commonwealth legislation since Federation, reflecting key ideological differences in the traditional political divide between labour and capital. So reform of taxation and industrial relations is especially contested, as is any possible impact on productivity.

Less contested are the frequent demands for more infrastructure investment, including from those like the Reserve Bank who should know better. The reality is that too often infrastructure is seen as a free good, with remarkably little concern for whether such investment is warranted. More relevant for future productivity, as the recent Review of Competition Policy has reminded us, is that micro-economic reform in the past was principally about increasing competition.

Accordingly this article explores what drives increases in productivity, what is the likely outlook for productivity and what difference can policy make to that rate of productivity increase. In particular, it will be important to ascertain what proposals for so-called micro economic reform are really in the public interest and what mainly reflect the self-interest of the proponents.

Technological progress

Through history economic transformations and the associated productivity gains have been almost entirely in response to technological progress. The Stone Age was characterised by the technology of that Age, and all progress since then reflects new technologies, such as the invention of printing, new modes of transport and power, weapons etc., right up to the present impact of ICT. So the starting point for increasing productivity would logically be to consider the scope for accelerating the pace of technological change.

Of course, the differences in the technology levels experienced in different countries reminds us that institutions and policies can make a difference to the rate of adoption and adaptation to new technologies. So there is potentially a role for government to encourage and facilitate the rate of technological progress. Nevertheless, this role is less when a country, like Australia, is at or close to the global technology frontier and has limited scope to catch-up on others.

Furthermore, in this century productivity (at least as measured) seems to be slowing down, not only in Australia, but also in most of the other advanced economies. This slower productivity growth could in turn be consistent with a lower rate of global technological progress, making it more difficult for Australian government policy to engender faster productivity growth in the next decade or so.

What drives technological progress and its adoption

The key drivers of technological change are in fact familiar, as are the policies that can underpin these drivers, although they do not always receive due recognition by government and business.

First, continuing government investment and support for both public and private research and development is critical, as the economic returns are slow to be realised and difficult to appropriate. Even though most innovations are global, unless Australia is engaged directly in research we risk being slow adopters of new technologies. In addition, governments can play a role in encouraging closer links between researchers and industry, through the CSIRO and programs such as the Cooperative Research Centres which are jointly funded and managed by government, business and academia. It is therefore of considerable concern that government funding for research and development, and for the CSIRO and the Cooperative Research Centres have been substantially cut in recent years.

Second, skills are critical to the adoption and adaptation to new technologies. Governments need to foster a high degree of technological literacy and the necessary knowledge and skills to ensure the rapid adoption and use of externally developed technology.

Third, technology creation is not just the product of professional technologists or technology companies. We also need a workforce that is trained to use new technologies effectively, and productivity will be enhanced if our workers can quickly adapt to the use of new technologies. But too much of present-day training is highly specific to today’s jobs, making that adaptation more difficult. Workers also need more generic skills that allow them to understand better how and why technology works, rather than just being able to follow the manual and/or relying on experience. Instead training structures and content should provide them with the adaptability skills to allow them to quickly and effectively use the new technologies that will characterise tomorrow’s jobs.

Again it is of concern that in recent years the funding for tertiary education and training have also been cut substantially. The risks to future productivity growth are considerable, and all these cuts risk proving to be false economies as lower economic growth may further reduce Australia’s long-run fiscal sustainability.

Fourth, new technologies often require re-organisation of a firm’s business model and organisational structures, so that the quality of management makes a difference to the adoption and adaptation to new productivity-boosting technologies. The government’s programs of assistance to small business can help inform management of changes necessary to adapt to new technologies and the re-skilling that their firms will need to undertake. The impact of labour market regulation on the capacity of management to pursue changes in the organisation of work is also potentially important, and will be further considered in a discussion of labour market reform below.

The role and impact of micro-economic reforms

So given the over-whelming importance of technological progress for future productivity growth, what might be the impact of the various micro-economic reforms proposed and as listed briefly above.

Competition policy is the most important of these reforms. Competition is a significant driver of technological progress as firms strive to obtain a competitive advantage by developing and quickly adopting new technologies. Even within the boundaries of existing technologies competition typically provides the key impetus to increase efficiency which is then reflected in productivity gains. The recent report of the Competition Policy Review, by the Harper Committee, provides an authorative list of desirable reforms, of which the three with the greatest likely impact on our economic performance are:

1. Establishing choice and contestability in government provision of human services can both improve the quality of the services by empowering service users, and improve productivity at the same time. Progress along these lines is already being made for some government funded services, and in some instances costs have been driven down. One problem, however, is that the experience so far is that the service users do not always have adequate information to make a fully informed choice, and consequently the quality of service provision can deteriorate unless there are good regulatory systems.

2. Ensuring cost-reflective pricing of infrastructure would improve the efficiency of use of much infrastructure and would encourage better investment appraisal of future infrastructure proposals. By contrast, at present many uneconomic infrastructure investments gain approval, and represent a waste of scarce savings. Roads are the worst offender, but as recognised by the Harper Committee, reforms begun in electricity and gas need to be finalised and water reform needs to be reinvigorated. These issues will be discussed at greater length in another article on Infrastructure to be published in this policy series.

3. Using pricing or other signals to guide the allocation of our land and other natural resources towards their highest-value use, and in this context ensuring that planning, zoning and environmental regulations are applied sensibly.

Each of these reforms proposed by the Harper Committee to competition policy could improve Australia’s economic performance and quality of living standards into the future. However, they would not necessarily show up as an increase in labour productivity, at least as measured.

Workplace relations

Workplace relations, and particularly how work is organised in the workplace, can make a difference to the productivity of that workplace. Cooperation and trust based on fairness will provide a foundation for flexible workplace relations that will help ensure the most effective use of the firm’s existing capital and will also encourage new innovations and accelerate their adoption. The key question is, however, to what extent does Australia’s present system of workplace relations need yet another round of reforms and what can we expect from more such reform?

In 2012 the leading labour market economist, Professor Jeff Borland made the most exhaustive examination available of the impact of the various industrial relations reforms (Work Choices and Fair Work) in the 2000s. After considering the evidence on wages growth and earnings inequality, labour market adjustment, labour productivity growth and industrial disputes, Borland concluded that there was “Little evidence … of an effect from the industrial relations reforms made in the 2000s”. By contrast he did find “some evidence of an effect from the reforms to Australia’s industrial relations system that occurred in the 1990s”, when Australia switched from a centralised arbitration system of industrial relations in favour of enterprise-based bargaining. In Borland’s view “the limited effects of the reforms in the 2000s can be explained by the nature of those reforms – being primarily oriented to changing the relative bargaining power of employers and employees, rather than enhancing overall economic performance”.

Similarly the independent and comprehensive review of the Fair Work Act, also in 2012, found that “since the Fair Work Act came into force important outcomes such as wages growth, industrial disputation, the responsiveness of wages to supply and demand, the rate of employment growth and the flexibility of work patterns have been favourable to Australia’s continuing prosperity, as indeed they have been since the transition away from arbitration two decades ago”. While that review was concerned by the slower rate of productivity growth, it was “not persuaded that the legislative framework for industrial relations accounts for this productivity slowdown”.

Indeed there seems little doubt that since the advent of enterprise bargaining, Australia does have a more flexible industrial relations system. The then Secretary of the Treasury commented that “if it were not for our flexibility … Australia could not have avoided the worst of the impacts of the Global Financial Crisis’. More recently the evidence shows that relative wages adjusted quickly and flexibly to accommodate the increased demands by the mining and construction industries associated with the resources boom and without any upward pressure on inflation more generally. Equally the proponents of further system changes have not yet shown that changes in work organisation cannot be readily negotiated within the existing framework, so long as they are not a blatant attempt to reduce workers’ pay.

So in the light of all the evidence what exactly is another round of changes to the industrial relations system meant to achieve? Such changes are hardly likely to directly increase productivity. Instead the business agenda for workplace relations reform seems to be to provide a cover for cost-cutting rather than increasing productivity. As Borland puts it recent reforms and those now being proposed are “primarily oriented at distributive goals rather than efficiency goals. This leads him to conclude that “private interest can explain current lobbying for further reforms to Australia’s industrial relations system”.

Accordingly Borland’s end conclusion seems eminently sensible that “reform of Australia’s industrial relations system should not be an area of policy-making priority for governments”. Instead what does need improvement is how employers manage and organise the work to use their employees’ skills most productively. Too often employees report dissatisfaction that their skills are being under-utilised, and that the work could be organised more productively by allowing greater autonomy and discretion to individual employees and teams.

There are also problems in industries such as health where traditional demarcations need to be broken down and multi-skilling, broad-banding of positions, up-skilling and team work increased. John Menadue (postings 25 & 27 January) has shown how this would bring substantial productivity gains by releasing high-level specialist staff to focus on the tasks that only they can do.

But none of these improvements in how work is organised require changes to the workplace relations system; rather they require better management. Indeed, the fact that there are examples of such successful re-organisation strongly suggests that regulatory system does allow managers to manage productively. To the limited extent that it can, the government should therefore be encouraging this sort of better management, rather than forever tinkering with the legislative framework for workplace relations.

Tax reform

There may well be other reasons why Australia’s tax system could be improved, but any changes are likely to have only a marginal impact on productivity. Indeed the evidence suggests no correlation between actual levels of taxation and per capita GDP; one reason being because any such analysis fails to take account of how those taxes were spent.

To the extent that present Australian taxes do affect productivity, it is probably because of how they affect the allocation of savings and investment, and not so much through their impact on incentives to invest or work.

Tax reform was addressed further in another article in this series, but suffice to say that most tax proposals have distributional goals or at least distributional consequences, and thus often reflect self-interest, even if that is masquerading as in the public interest.

Conclusion

Productivity is mainly determined by technology and its use. In a globalised world there is only a limited influence of a national government like Australia’s to influence the development of new technologies and their adoption. Most important is the creation of an innovative culture through support for research, development and education and training, and forging closer links between the scientific communities and industry. On the recent record, with substantial budget cuts, there is plenty of room for improvement. Further micro-economic reforms should also be pursued where they have merits, with a focus on competition policy.

More generally, it seems quite possible that living standards in all the advanced economies, including Australia, will rise more slowly over the next few decades than over the sixty years leading up to the Global Financial Crisis. Accordingly a key policy responsibility will be to change popular expectations if they have to adjust to this new reality. And in that case overselling what can be expected from micro-economic reform will only exacerbate this adjustment problem.

Michael Keating AC was formerly Secretary of Department of Finance and Secretary Prime Minister and Cabinet

Fairness, Opportunity and Security
Policy series edited by Michael Keating and John Menadue.

State governments spend about 25% of their budgets on health and another 25% on education. A cooperative arrangement between the commonwealth and state governments in one of these areas would greatly improve the operation of our federation. This article will focus on possible cooperation in health.

A State handover of health services to the Commonwealth, as suggested by Tony Abbott many years ago, would be one way to overcome the waste and buck-passing between the Commonwealth and State governments in health. Kevin Rudd suggested that his government might take over state hospitals. Opinion polls suggested that the public would support this approach. But Kevin Rudd backed away. In passing it should be noted that the Commonwealth has no recent experience in running hospitals. It is not an easy task.

But as a Commonwealth takeover is most unlikely, an alternative would be to establish a Joint Commonwealth/State Health Commission (Joint Health Commission) in any State where the Commonwealth and a State government can agree – a coalition of the willing, a Commonwealth/state partnership on a state by state basis.

It is envisaged that the joint commission, with shared Commonwealth/State governance would be responsible for funding, planning and integrating all health services in that State. Consistent with an agreed plan, the Commission would then buy health services from existing providers – Commonwealth, State, local, NGO and private.

A political agreement between the Commonwealth and any State is essential. If this political agreement is achieved, we would see a more cohesive and integrated health service, delivered much more efficiently. Once the benefit was clear in one State, hopefully other States would follow.

I believe that this proposal would have strong public support. We are tired of the blame game.

Either the Commonwealth government or any State government could initiate the breaking of the impasse.

Background

The Commonwealth Government provides about 43% of national health funding and the State Governments and territories 26 %. Another 31% of funding is from non-government sources (mainly individual users of health services).

In both the NSW and SA health reviews that I chaired some years ago, a view was widely expressed that it’s all very well for State governments to review their health systems, but a major problem is the inefficiency, fragmentation, gaps, cost and blame shifting which results from the different roles of the Commonwealth and State governments in health’. This view was expressed, not only by those working in the health system, but also by the community generally. It was also frequently expressed by the media. The problem of divided responsibilities is well understood. The public doesn’t really give a hoot who plans and delivers health services. The public’s real concern is that the services are provided efficiently and equitably.

Integration of commonwealth and state health functions are essential. Professor John Dwyer, in this blog, estimated   that more than 600,000 state hospital admissions per year could be saved if there was more timely community intervention which is funded by the Commonwealth.

A solution requires a political agreement between the Commonwealth government and at least one State. The political issue cannot be avoided and attempts to get around this issue are likely to be unsuccessful, time-consuming and cumbersome. A bureaucratic or organisational response to a political problem will be unsatisfactory. The issue must be addressed politically. If there is political agreement, governance, financial, administrative and other issues could be successfully managed.

Such an approach would not produce a unified national health system, but six (excluding the territories for the moment) joint health systems which are State-based. Nonetheless, this would be superior to the present division and fragmentation. The six State-based joint commissions may also better reflect the different history and needs of respective States. One size doesn’t necessarily fit all.

The states may also be now more interested in what is proposed here because the 2014 budget suggests that over the next 10 years the Commonwealth will contribute $ 50 b less to state hospitals than the outgoing Labor government proposed. There was no certainty that this 10 year funding would have remained in place but I don’t think there is any doubt however that the Abbott government will attempt to shift more responsibility to the states for hospitals and schools.

A Joint Health Commission in any State where the Commonwealth and the State could agree would have the following characteristics.

1. Coverage of Joint Health Commission

The wider the coverage the better to ensure real and comprehensive resource allocation and integration of services across the full continuum of care. The following programs should be included as the planning responsibility of the Joint Health Commission.

• State Health (including Health Care Agreement)
• High level residential aged care
• Department of Veterans’ Affairs (DVA)
• Home and Community Care (HACC)
• Commonwealth Regional Health Services in rural and remote areas.
• Medical Benefits Scheme (MBS)
• Pharmaceutical Benefit Scheme (PBS)
• Aboriginal Health
• Local Government health
• NGOs (e.g. nursing services)
• Public health

State Health, HACC, etc. would tender for the provision of services to the Joint Health Commission. Similarly, local government and NGOs would tender, although allocations to them would probably need to be made through the State Health department.

Private hospitals could probably be excluded from this coverage, as they depend on private contributions rather than direct government funding – except for occasional seed money. But provision should be made for private hospitals, along with local government and NGOs, to tender for supply of services to a Joint Health Commission, (see 3 below). The private delivery of health services should be encouraged where it is consistent with the state-wide plan and is delivered efficiently.

Importantly, existing providers would continue to operate and provide services, and where appropriate, ministers – both Commonwealth and State – would continue to be responsible for their own services. But those services would be purchased by the Joint Health Commission as part of a state-wide plan, which I refer to under ‘functions’ below.

2. Pooled Funding of Joint Health Commission

The Joint Health Commission would receive a negotiated pooled allocation of funds from the Commonwealth and the State government. which reflected the coverage of programs for which it would be responsible (see 1 above), with appropriate population growth and cost indexation add-ons. As a starting point the shares of the two governments would reflect their current funding shares. Changes in the shares and total funding would be subject to the advice of the National Health Performance Authority (NHPA). That Authority would provide public advice to the two governments. The two governments would need to agree on annual funding arrangements.

Whilst confidence in the funding formula is developed, it might be useful to consider shadow funding in the first 3 years and move to actual pooling of funds thereafter.

3. Functions of Joint Health Commission

1. a) Shared Resource Allocation through the purchase of various services from providers – Commonwealth, State and local government, and NGOs as part of a joint strategic plan.

• In this case, shared resource allocation can be achieved through the establishment of a minimum set of Commonwealth and State programs.
• The major changes associated with the JHC would provide an opportunity to move from producer dominated health care delivery to an output/patient focussed delivery system. So many of our health programs reflect provider interests; the MBS reflecting the interests of doctors and the AMA, the MBS reflecting the interests of the Pharmacy Guild and Big Pharma and public hospitals reflecting the interests of their providers, state governments. Patients are a secondary concern. We need to shift to a patient focussed health system in such key areas as chronic, acute and occasional care.
• Funding would be allocated with agreed short and long term integrated outcomes, rather than siloed program outcomes, with specified standards and levels of performance.

1. b) Shared Performance Management

Oversee continuous improvement of the health system, monitor progress and establish reform targets and timelines:

• Development of standard measurement
• Benchmarking
• Patient-centred best practices

The NHPA provides an excellent opportunity for the establishment of a system that can meet the needs of consumers, community and health services. The NHPA can provide an approach that examines health status and outcomes, determinants of health, and health system performance.

The NHPA should facilitate the mapping of progress for the population of a State, region or service. It could also be used to examine progress in tackling a particular health problem (e.g. aboriginal health), and to take a wider look at the interface between health and other government departments, the private sector and non-government organisations.

4. Joint Health Commission Governance

The following features could be included, and would ensure full Commonwealth and State government input into the state-wide plan:

• Membership of the board should be high level to enable strategic decision-making on broad and longer-term issues.
• Maximum transparency and disclosure of the Joint Commission’s work and final recommendations in order to neutralise special pleading and vested interests and to ensure public understanding and support.
• The board of directors must have clear ‘governance’ responsibility and not a junior role. They should reflect the broad interests of the whole community and not be seen as representative of the Commonwealth or State or ‘insider interests’ that so dominate health systems in Australia.
• Independent chair appointed by the two Ministers from a short list provided by the respective Commonwealth and State Health CEOs. It might be useful to have the chair from another State.
• Apart from the chair, no jurisdiction to have more than 50% representation.
• Representation could include other Commonwealth and State jurisdictions (e.g. Indigenous Affaires) and people having experience in the private sector.
• The board would appoint the CEO who would be responsible to the board and not the two jurisdictions.
• The board would approve the strategic plan and budget.
• A constitution may be useful to provide more user-friendly objects, role, function and operating procedures, including engaging the private sector.
• Subsidiarity should be an important principle for governors in developing the state-wide plan. Management and service delivery should be driven down to the lowest and most local level possible, consistent with state and nation-wide standards.
• The Board should have a small secretariat, but rely on Joint Health Commission for planning etc. It must avoid a new level of bureaucracy.
• Board costs would be shared by Commonwealth and State.
• The Commonwealth and State minister would be responsible for negotiating high-level policy principles, including overall funding on the advice of the board. This would help reduce the risk of the board dividing on Commonwealth/State lines. Ministers must reach broad agreement if the Joint Health Commission is to work.
• The board should be responsible to the Commonwealth and State minister, with one financial report to both. If there is not agreement between the two ministers, there would be a public dispute resolution procedure which would encourage cooperation and dialogue between the two ministers. This would encourage public trust in the integrity of the process. I would expect that this would produce an agreement in almost all cases. If resolution is not possible, the Commonwealth minister would prevail; given the need for a stronger national role and that the Commonwealth Government provides 43 % of national health funds compared with 26 % by the states.

These governance arrangements could be reviewed in 5 years.

Summary   

A Joint Health Commission established upon agreement of any State with the Commonwealth would be a substantial improvement on the present arrangements. It would help break the impasse on federalism and better integrate health services. It requires a political decision between the Prime Minister and premier.

The public is tired of the blame shifting and fragmentation in health and would respond to a sea change such as this. Such a joint health commission in any State that agreed would help achieve what both of them are seeking in health – a better integrated health system and a favourable community response, A committed Commonwealth government could use its financial leverage to make such an offer attractive to the states.

A Joint Health Commission in any one State could begin to address the ‘big ticket’ problems in health delivery – the Commonwealth/State fragmentation, an eroding primary health care system, an antiquated workforce structure and obvious system failures in safety and quality.

Of course, the fragmentation in health is not just caused by Commonwealth-State fragmentation. The two big Commonwealth programs – MBS and PBS – are not effectively integrated.

All these big-ticket issues are lost sight of in the argy-bargy of Commonwealth/State blame and cost shifting.

Not only would a Joint Health Commission in one State be a substantial improvement, it would also be very symbolic, demonstrating that governments can address hard political issues in a cooperative way.

We must stop asking continually for more money or tweaking the health dollars, when many problems are structural. A lot of health spending is counter-productive – throwing money at problems to get them out of the media or for short-term political gain, rather than solving systemic problems. Any increase in health dollars must be accompanied by system change. A Joint Health Commission starting in one State is a sound way to begin breaking the impasse.

The key is political will by ministers. If there is the political will, the governance problems can be resolved.

There is no reason that the principles proposed above in health could not be applied in other fields such as education.

John Menadue AO was formerly Secretary Department of Prime Minister and Cabinet, Secretary Department of Trade, Ambassador to Japan and CEO of Qantas.

Fairness, Opportunity and Security
Policy series edited by Michael Keating and John Menadue. 

Oliver Wendell Holmes, the great American jurist, is reputed to have said, ‘I like to pay taxes. In this way I buy civilisation.’ However, in contrast to Holmes’ noble ideal, too often today we hear people railing about the burden of taxation, as though it is in some way an unfortunate even illegitimate imposition upon ourselves, our economy, and our way of life.

Lower taxation has been embraced by all political parties without any evidence that, given our already low starting point, less taxation will in fact lead to higher economic growth, let alone pay for itself. Indeed there is no evidence that the advanced economies with high growth rates of per capita income have lower levels of taxation. Nor have past cuts in our income tax led to faster growth, such as when the top income tax rate was reduced from 60 per cent to 45 per cent.

So as John Howard put it when he was Prime Minister, tax cuts should be considered ‘after you have met all the necessary and socially desirable expenditures’ (my emphasis). And as I argued in previous articles (posted 6/4/2015 and 23/7/2014), all the evidence is that these expenditure demands, even if efficiently funded, are most unlikely to be fiscally sustainable without a modest increase in taxation relative to GDP.

Indeed Australia already has lower taxation than almost any other advanced nation, but we aim to provide the same level of public services and welfare as the others.

Thus the biggest challenge facing modern governments is the gap between expectations on them and their capacity to deliver. In these circumstances, encouraging unrealistic expectations of tax cuts is only making government more difficult.

In fact each of the major tax reform packages in 1985 and 2000 did not achieve any reduction in total taxation. Instead they were about changing the tax mix in favour of more efficiency, revenue protection and/or more equity. Although some tax rates were lowered – notably income tax to offset past bracket creep that had pushed more people into higher tax brackets – but these reform packages did not lead to any reduction in taxation overall.

Revenue Outlook

Projections in the Budget and the Intergenerational Report (IGR) show the ratio of Australian Government taxation revenue to GDP rising from 21.9 per cent in 2014-15 to an assumed maximum ratio of 23.9 per cent reached around 2020, and then maintained beyond. This 23.9 per cent ceiling for future taxation is the same on average as during the Howard Government years following their tax reforms starting in 2001-02.

Consequently if taxation revenue went back to where it was after the Howard Government’s tax reforms and before the GFC it would be about 2.0 percentage points higher than now. Furthermore, as I argued in yesterday’s blog on Fixing the Budget, restoring taxation revenue to this extent over the next few years would most likely be consistent with what needs to be done on the revenue side of the Budget to maintain long run fiscal sustainability. It would also be consistent with what the Government apparently regards as an acceptable level of taxation.

One significant difference, however, is that my proposals (below) do not rely on bracket creep as taxpayers move into higher tax brackets, whereas as much as 85 per cent of the increase in taxation revenue presently projected in the Budget relies on bracket creep.

The problem with this reliance by the Government on extra revenue through bracket creep is that according to the Treasury someone on full-time average earnings can expect to enter the second highest 37 per cent tax bracket in 2015-16 if the present income tax rate scale is maintained, and the average tax rate faced by such a taxpayer will have increased by 5 percentage points between 2013-14 and 2023-24. Furthermore, unchecked bracket creep in income taxes tends to be highly regressive, impacting more than proportionately on lower income earners.

As in the past, any government is therefore likely to want to provide future income tax cuts, at least sufficient to offset the impact of unchecked bracket creep. The Government itself recognises this and has promised lower taxes after the Budget returns to surplus. But this is not expected until sometime after 2020, and by then the Government will be relying on all of the extra revenue from bracket creep until that time. On the other hand if some of that extra revenue from bracket creep were returned to taxpayers through a reduction in income tax rates, then of course this would increases the amount of extra revenue or extra expenditure savings that would need to be found elsewhere.

Tax Reform Options

Accordingly it is necessary to consider the alternatives to this reliance by the Government on bracket creep to boost its income tax receipts. Instead I propose to consider the options for another round of tax reform, but especially having regard for the present deficit budget outlook and future expenditure demands, and the consequent need to raise more revenue both at the Commonwealth and State levels of government.

Strategically there are three broad approaches in these circumstances to taxation reform:

• Broadening taxes
• Adjusting the mix of taxes
• Changing the tax rates

Typically tax reform involves a balanced mix of all three approaches. The task is to convince the public that the outcome is a more efficient system, especially in terms of its economic impact, that will raise the revenue that is necessary, but not more than necessary, and that it is fair.

Retaining company tax and broadening taxes

Judged against these criteria it is suggested that the best options to start with would be to:

• Not cut the company tax
• Broaden the tax base

Despite the lobbying by the business community, there is no need to cut the company tax rate. This would mainly advantage foreign investors, but the evidence is that Australia has no difficulty in attracting foreign investment. Instead, because of dividend imputation a cut in company tax would lead to lower imputation credits, and not benefit Australian investors much; indeed it could disadvantage Australian investors if it was financed in part by removing dividend imputation.

In a previous posting (22/7/2014) I discussed the possibilities for broadening the tax base. In brief, the possibilities that would seem to have the most positive impact as well as raising extra revenues are

• Reducing the favourable taxation of superannuation. The present tax concessions are more than necessary to encourage this form of savings for retirement, and they are inequitable, with more than half their value accruing to the top 20 per cent of income earners.
• Removing the 50 per cent capital gains discount. This discount is a distortion and its removal would help improve the efficiency of the housing market in particular, and make homes more affordable to new home buyers. Some commentators have similarly argued that negative gearing should no longer be allowed under the income tax, but strictly this is not a distortion because interest is a normal deduction before deriving taxable income.
• Restoring carbon pricing which is the most efficient and effective way of reducing carbon emissions and the risk of climate change.
• Removing the tax credit for fuel excise and increasing that excise. There is no economic case for subsidising one type of input to only some producers. Indeed it would be better to encourage greater fuel efficiency by increasing its price over time, up to say the price levels in New Zealand, and then fully indexing the excise rate.
• Improving the anti-avoidance measures. The Government is proposing some such action in this Budget, but much more needs to be done and can be done to protect the revenue.

A rough estimate is that these measures would increase annual tax revenues by around $29 billion when fully implemented; that is equivalent to filling the remaining gap of around 1.5 per cent of GDP that is needed to ensure ongoing fiscal sustainability after allowing for the expenditure savings identified in yesterday’s article on Fixing the Budget. 

Changing the tax mix in favour of more reliance on the GST

The other major possibility for base broadening which would increase the revenue substantially is the GST. The proceeds, however, of the GST accrue entirely to the States, and so they cannot be used directly to improve the Federal Budget. Nevertheless, if these extra GST transfers were used to offset reductions in some other payments by the Australian Government to the States, then such an increase in the GST could help restore and maintain Australia’s fiscal sustainability over time.

The implications of such a strategy based on an increase in GST revenue will mainly be discussed in tomorrow’s article on Federalism. Suffice to say here that the coverage of the GST is now only 47 per cent of total consumption, down from a peak in 2005-06 of 56 per cent, which was close to the OECD average, but much less than in New Zealand where 96 per cent of consumption is taxed.

If the GST base were broadened to include expenditures on food, child care, private health and private education, and water, sewerage and drainage, the total GST revenue would be roughly doubled raising revenue by more than $50 billion extra each year. While an increase in the tax rate from the present 10 per cent to 15 per cent on the present GST base would raise around another $25 billion each year, and on the extended base it would raise around another $100 billion annually.

The experience of the Howard Government, however, when it first introduced the GST was that a very large part of the proceeds were used to compensate lower to middle income families who were deemed to be disproportionately disadvantaged by the new tax. If that precedent continued to apply it might be prudent to assume as much as one third of the extra revenue would be needed for this purpose and not available to improve long-run fiscal sustainability. Indeed if the GST base were broadened as described above to include expenditures on food, health and education that are regarded as essential, then the pressures for compensation might be even greater[1].

Of course less substantial changes in the GST could readily be contemplated. The size of the package would probably depend mainly upon what is the preferred basis for future Federal-State financial relations and the overall governance arrangements for the Australian nation. As already indicated these issues will be explored in tomorrow’s article, but even if no substantial change in our federal-state financial relations is envisaged, a modest package of GST reforms to increase the revenue would be a good option if the other policy changes already canvassed do not prove sufficient to ensure on-going fiscal sustainability in the long run.

Increase in the income tax rates

As noted the income tax rates will effectively increase over time if nothing is done because of bracket creep as incomes rise and tax payers move up the rate scale. But this is an arbitrary and unfair way of raising additional revenue if that were needed. Instead in that case it would be better as a matter of deliberate decision to introduce a new income tax rate scale. Such a new rate scale could at least maintain the present progressitivity of the income tax rather than letting it degrade in an arbitrary way.

A further consideration is the overall tax mix. Many argue that Australia is too dependent on the taxation of income and that there should be more reliance on taxation of expenditure. In fact if we allow for various forms of compulsory social security contributions plus payroll taxes then direct taxes in Australia comprise around 63 per cent of total taxation compared to an OECD average of 61 per cent. This suggests that the present balance between direct and indirect taxation in Australia may well be sustainable. Nevertheless if additional revenue is needed to ensure long-run fiscal sustainability then it would be prudent to consider the options for increasing the GST before an increase in income tax rates.

Dr Michael Keating AC was formerly Secretary of the Department of Finance, and Secretary of the Department of Prime Minister and Cabinet.

[1] According to the Treasury, as a proportion of total spending, lower-income and higher-income households spend a similar proportion on GST-exempt goods and services in aggregate. However, while households may spend a similar proportion of their total spending on GST-exempt goods and services in aggregate, this is not necessarily true for the individual exempted categories of spending. For example, lower-income households may be more likely to spend comparatively more of their total spending on GST-exempt food, medical products and health services, or residential rent. Conversely, higher-income households may be more likely to spend comparatively more of their total spending on GST-exempt education or childcare services.

Current Affairs:  The Budget

Opinion polls and the public generally seem to believe that the Liberal Party is a superior economic manager to the Labor Party. There are also signs that the Liberal Party believes this about itself.

But the somersault in last night’s budget  was extraordinary. I don’t think I have ever seen a government repudiate so quickly – what it had been telling us for years – how it was necessary to ensure our future. We had dire problems of debt and deficit that the former government had bequeathed to the Abbott/Hockey government.

The debt and deficit rhetoric and actions taken in the 2014 budget have now been abandoned. The 2014 budget is a smoking ruin. 

If a private or public company was managed like the Australian economy the whole board would be sacked. 

The budget may be politically cute but our economic future is prejudiced. The headline in today’s AFR sums it up ‘Hockey spends up as deficits hung out to dry’. In the SMH Ross Gittins said ‘This is the budget of a badly rattled government that has put self-preservation ahead of economic responsibility. It will do much to restore Tony Abbott’s political fortunes but next to nothing to return the budget to surplus or hasten the economy’s return to strong growth.’  John Menadue

See below a post I made on this subject on 23 March 2015.

There is not fire after all. There is no emergency.

For the last 18 months Tony Abbott and Joe Hockey have been talking endlessly about a deficit and debt disaster. Clearly we should have been calling in the fire brigade to quell the fire that the Labor Government had lit.

We were told that there was a 13% debt to GDP ratio that the government had inherited. That debt would bring disaster unless the government took dramatic action to fix it. Joe Hockey told us only last week in releasing the report of the Intergenerational Review that the budget projections were so bad that we would ‘fall off our chairs’ when we saw them.

Yet since this government came to power, the budget deficit has deteriorated $80 billion over the Forward Estimates.

So in light of the desperate situation the government inherited and the deterioration in the budget under its own watch, what does the government do?

Tony Abbott now tells us that we can forget about any budget emergency and all the dire predictions of the past.  He told us only a few days ago that the next budget would be dull and that all the heavy lifting had been done. He assured us that there would be no more unpleasant medicine. He inferred that a nett debt of even 60% to GDP was no problem. He indicated that in the next budget, we would have tax cuts for small businesses and a revamped child care and family package.

I don’t think I have ever seen a government repudiate so quickly what it was telling us was so necessary to ensure our future. We had dire problems that had to be fixed. The government has now abandoned the rhetoric and its policies of the last 18 months.

And its 2014 budget is a smoking ruin.

How can Joe Hockey with any credibility present his next budget? The narrative of the last 18 months has all been torn up.  He and the government by their own actions have discredited their own claims to being good economic managers.  Billie McMahon did better than this.

In the Australian Financial Review on March 19, 2015, Laura Tingle put this mess together under the heading ‘Being governed by fools is not funny’. She is dead right. See link to her article below.

http://afr.com/opinion/columnists/laura-tingle/being-governed-by-fools-is-not-funny-20150319-1m2wd1

The government now wants us to believe that there was no emergency and no fire at all. It was all made up.

But the problem is that we do have budget difficulties that must be soberly and carefully addressed without penalising the vulnerable in our community.

What a mess!

The Senate committee hearings with testimony from high profile executives from some very large corporations have brought to notice the strategies to shift profits in order to avoid paying taxes in Australia.  The companies claim that they are acting legally.  The counter claim is that such manipulation of the law is unfair – it is not ethical.

I am not competent to deal with the all complexities on tax law or the international agreements that are relevant to this problem.  But even those who are competent do seem to suggest that there are problems largely arising from the failure of the law to keep up with changing technology in relation to the jurisdictional character of a nation state.  Trevor Boucher has provided such a contribution on this blog.

This is not a new problem.  The growth of large corporations in both Europe and the emerging US was greatly assisted by the introduction in law of limited liability for business corporations.  This change enabled the mobilisation of significant capital in order to undertake extensive enterprises.

Limited liability was a compromise on the part of the community in which the corporation was located to limit liability where it would normally have arisen in order to get things done for the benefit of the community.  However the internationalisation of business enterprises in the twentieth century has complicated the nation state basis of the location and operation of corporations.  This has been vastly accelerated with the growth of the internet and of information technology generally. It is not surprising that the IT companies Google and Apple are in the spotlight in the present debate.

Within nation states business corporations have gained significant influence on governments.  To some extent, we see that here in Australia but it is a trend that has advanced to a far greater degree in the US.  The capacity of the US government to secure legislation against the interests of business corporations is now very limited.

There is no ethical reason that should inhibit governments making laws that favour business corporations, or any other organisations such as unions, charities, or a multitude of other corporations as long as those laws serve a discernible good for the community which the government exists to serve.  Such tax concessions are in principle not much different from grants given to organisations or groups in the community.  Enormous subsidies to the car industry over the years have been justified on the basis of a benefit to the community.  That is in essence an ethical judgement.

Similarly grants to private schools, sporting bodies and a host of other community organisations are judgements made on the basis of a benefit to the community.  Not everyone agrees with every decision made by the government or particular ministers.  But that is part of the democratic character of the society in which we live.  People are free to seek to influence such decisions either to lobby for them or to campaign against them.  If they are to make a success of such endeavours they need to persuade either the broad community or those with authority to make decisions that their case is based on the benefit of the community.  That becomes an essentially ethical question – what is for the good of the community.

In the current debate there is some talk about whether the corporation is acting unethically – is the profit shifting for tax avoidance unethical, or in its more usual form in the debate is it unfair.  In a number of senses the corporation has some of the characteristics of a person – it can be sued for example.  It has a corporate memory, it has patterns of internal operating relationships that can be seen to be more or less attractive in ethical terms.  It can be seen to have a corporate memory, though like the memory of an individual that does not mean that that memory will or should determine future actions.  However it is hard to see the corporation as in itself an ethical agent in the same sense in which a human individual is.  Nonetheless it remains the case that the corporation is a complex set of internal and external relationships which are susceptible of ethical appraisal.

The key issue in the present situation is the decision making structure of the corporation, ultimately of the board.  In general board members are required to decide matters in terms of the purpose and well being of the corporation.  They are bound by what we might call an ethical obligation to the benefit of the corporation.  But as individuals they remain ethical agents who are not just board members but also citizens who belong to a community.  Their obligation to the corporation is secondary to their obligation to the community.

An analogous issue applies to the taxation laws of a country.  Significantly these are related to treaties the country has entered into in relation to taxation and trade.  Subverting the operation of those treaties is surely an ethically ambiguous activity.  In this sense the actions of Google and Apple, if they are indeed legal under our laws and treaties then it is difficult not to see them as thereby ethical.  If, however, those laws no longer satisfy the community benefit or fairness test then it becomes an ethical obligation to campaign to change them.

When they seem to us to be somehow unfair our options essentially are to work to reform the terms of operating, the law and the treaties.  Trevor Boucher has shown in his blog that this is not any easy task.

However I think there are two things that can be attempted that might enable a better judgement.  The actual facts of the law (see Boucher) and the details of what the companies actually do should be made transparent to public examination.  That at least would enable clarity of thought. I think it is entirely reasonable to seek to persuade the company to change its practices.  They don’t have to do what they are doing.  So bringing informed pressure on the relevant board members would be an appropriate strategy.

Clearly we need to persuade our government to address these issues and to seek to bring the law and the relevant treaties into line with the changed circumstances. Again there is nothing like exposure to public gaze.

In all this however we would be wise to recognise that Australia is a minnow internationally in this and we should expect the international giants to look after their own interests.

 

Bruce Kaye is an Anglican Theologian currently an Adjunct Research Professor At  Charles Sturt University. He previously taught a course on the rise and role of the business corporation at UNSW. He was formerly General Secretary of the Anglican Church of Australia. 

I certainly would not want to be seen as an apologist for multinational company groups in the current debate on what to do about profit-shifting tax avoidance activities of groups like Google and Apple.

But there are some significant legal/technical obstacles in the way of solutions.

Like other countries, Australia taxes each company in a group on the basis of where it is resident. An Australian resident is liable here on its worldwide income, but a foreign resident is taxed by Australia only on income with an Australian “source”. Put simply, profits have a source where the activity that generates the relevant income is located.

Our taxing rights are affected by the some 40 legally-binding (but terminable) tax treaties that Australia has with other countries. They are part of a world-wide net of such treaties, based on an OECD model. One key rule is that Australia can’t tax the business profits of a company resident in a treaty country unless it has a “permanent establishment” (PE) here. The concept of “permanent establishment” and the terms in which it is expressed –“ a fixed place of business”- were formulated in pre-information technology “old world” days of bricks and mortar, when there was a clear physical place where income producing activity was carried on.

In defined circumstances an agent in Australia of a foreign company could be a PE of that company, eg if the agent had authority to conclude contracts on its behalf. However with the availability and speed of technology, and no doubt readily available structuring advice, it is not difficult for groups like Apple and Google to so arrange things that their subsidiary that is drawing income from Australia does not have (for them) unwanted PE status.

The OECD /G20 is looking at this, with (as far as can be seen) attention being given to to patching up the agency rules. International consensus on changes, followed by bilateral or multilateral treaties and domestic enabling legislation is likely to be a drawn out affair. I am not holding my breath. How readily will the US sign on to measures that cause its companies to pay more foreign tax?

The UK (with a coming election) is going alone, despite OECD criticism, with its own “diverted profits tax” to address the exploitation of treaty provisions. Is Australia to follow with a similar unilateral approach? If one says that profits are diverted there must be a status from which the diversion takes place. If that status is determined by the existing “old world” tax treaties the UK approach might involve going around in circles. Also, each tax treaty has a standard provision that requires that its rules and limitations apply also to any later substantially similar taxes imposed in addition to the existing taxes.

On a different tack, let’s look at what a customer in Australia pays for an Apple device. We have been given to understand that this dealing is with a Singapore subsidiary that does not have a PE in Australia. Even if it did, only a small part of sales receipts would properly be taxable here. The devices are manufactured in another country and employ foreign- developed technology for which some royalty expense can properly be charged. Achievement of sales does not require a big marketing effort in Australia. We in Australia would think it inappropriate if China were to say that the whole or a substantial part of an Australian company’s receipts from the export to that country of Australian iron ore or coal was a profit made in China.

Turning to Google, if you place one of the ads from which it makes its money you are, apparently, dealing with a Singapore subsidiary that does not have a PE in Australia (see above).Courtesy of the technology you may be interacting with a computer or human being in another country/ countries. These days, that is not all that strange – when we ring up about a phone problem we can find that we are speaking to someone in the Philippines who can deal with it from there. A bank matter may involve use of a person in India. A daily newspaper finds it cheaper to have its sub editing done in New Zealand. In other words, use of overseas-located technology does not in itself speak of tax avoidance.

Coming at it another way, however, Google’s advertising service offered to Australians does have an Australian character. Technically though, it is a business profit shielded from Australian tax by the PE rule. In 1968, faced with a similar inability to tax know-how and other like payments we developed a new definition of “royalty” , gave royalties a statutory “source” in Australia where they are paid by an Australian resident  or are an expense of  a “permanent establishment” here. Without exception, we excluded them from the PE rule in all subsequent treaties.

The US itself, home to major multinationals, is necessarily part of any solution. A US parent is taxed there on foreign subsidiary profits remitted home as income, credit being allowed for foreign tax paid. Profits diverted into tax haven subsidiaries and not paid up to the parent are not taxed , although they are available for group use. In 1962, “controlled foreign corporations” laws were introduced to tax parents on income so diverted. (BHP has said that it pays our CFC  tax on income of its Singapore marketing company.) However, the US protective rules have major loopholes which Congress has not seen fit to close. Seemingly, the US prefers the extra tax-free clout that the loopholes give to their corporations over the contribution to its revenue that effective taxation would achieve.

Were the US to tax effectively, US groups would (because of availability of credit for foreign tax paid) have less incentive to avoid Australian and other foreign taxes.

The Government’s discussion paper would have us believe that a reduction in Australia’s company tax would lessen avoidance incentives. Well, for companies addicted to tax minimisation it would have to be a very big reduction. A reduction in our rate would do two things: for Australian-resident shareholders it would mean smaller imputation credits and thus more personal tax, while for foreign shareholders the benefit would accrue to them or the Treasury of their country.

It’s not easy.

 

Trevor Boucher was Australian Commissioner of Taxation 1984-93. This was followed by two years as Australia’s Ambassador to the OECD.

 

 

Senior executives of companies like Google, Microsoft and Apple have all admitted to the Senate in the last week that they have avoided billions of dollars of Australian tax by a range of devices such as transfer pricing and earnings made in Australia being diverted to Singapore which has a lower tax rate. In every case they have told us that it is all perfectly legal. And apparently it is. Other companies such as Westfield and News Corp have also received earlier publicity because of their massive tax avoidance. But it’s all been legal!

Michael West in the SMH on April 6, 2015 told us that Rupert Murdoch’s US Empire siphoned $4.5 billion from its Australian business, tax free. The Murdoch media complained to the rooftops about this report. It plays hard ball with all its opponents but really squeals when it is under attack.

Heath Aston  in the SMH on 1 April 2015   reported that according to the Australian Taxation Office ‘Australia’s biggest 900 companies claimed deductions and exemptions worth $25 billion last year – enough to wipe out two thirds of the entire Federal deficit.’  Yet many of these companies have been leading the charge that the government needs to show some backbone and fix the budget deficit. The Abbott government seems to prefer fixing the budget at the expense of the sick and unemployed.

Michael West in the SMH, who has been so persistent and effective in revealing tax dodging, told us on Feb. 13 2015 that documents obtained from the ATO under FOI show that ‘Australian corporation taxes are in crisis because of the explosion of tax haven dealings of multinational companies.. one of the most telling FOI finds is a comparison between trade and international-related party dealings. Together Singapore and Switzerland account for 40% of related party trade. That level of related party dealings bears little relationship to real trade’. As Michael West put it ‘In laymen’s terms the purpose of these related party deals is often to siphon profits out of Australia to avoid paying tax’.  Is this fair?

In the SMH on Feb.9 2015 Michael West estimated that Google ‘is making off with at least $130 million a year that belongs to the Australian taxpayer and rising’. Does that sound ethical?

Peter Martin in the SMH on May 13 last year revealed that 75 ‘ultra high earning Australians paid no tax at all in 2011-12’. Is that fair?

Michael West again in the SMH on 20 December 2014 reported that Glencore which has recorded revenues in excess of $10 billion p.a. paid only $400 million in tax over three years.

According to Roman Lanis of UTS the Westfield Empire paid an effective tax rate of only 8% over the last decade. With its chorus of lawyers and accountants, it was apparently able to make this legal. But was it right?

We hear a lot about dole-bludgers and welfare cheats but is all this tax minimisation fair and right?

The Tax Justice Network, in collaboration with United Voice, reported that 29% of Australia’s top 200 companies had effective tax rates of 10% or less. Even worse, 14% of these 200 top companies paid no tax at all. It estimated that these top 200 companies are avoiding tax per annum of $8.4 billion. These figures have not been seriously challenged.

These massive tax avoiders say that is all legal.  They have the benefit of expensive legal and accounting advice that ordinary tax payers cannot afford. Is that fair?

These major tax avoiders in collaboration with the Australian Taxation Office refused to have their affairs disclosed for public scrutiny. We are told it is ‘commercial in confidence’. Apparently the ATO thinks it should cosy up to wealthy companies and they will then hopefully cooperate. Does that same concern for taxpayers extend to ‘ordinary’ taxpayers?   There is a lot of unethical behaviour allowed for the powerful and wealthy which is not permitted for ordinary people and Australian companies, large and small.

We now also know that our four big audit firms are advising these tax-dodgers on how to minimise their tax. It is noteworthy that the European Union has recently enacted legislation curtailing the activities of audit firms who have been giving tax advice. Our ATO is apparently moving in the opposite direction by employing staff from the big four audit firms to replace the loss of experienced ATO staff. Talk about Dracula in charge of the blood bank! Michael West in SMH on 15 December 2014 described this quite bizarre action as follows “The ATO is running a pilot scheme whereby it outsources the duty of tax compliance for Australia’s largest companies to none other than the company auditor….The large taxpayers are to pay their own external audit firms.. read the Big Four… to conduct their compliance work as well as doing the audit’. It is hard to think of a more obvious conflict of interest than this.

The tax dodgers have clearly got many powerful friends amongst the political, business and professional elites. But they are friendless in the community. In March this year, Essential Research asked respondents how they felt about the tax being paid by various groups. They indicated that the following did not pay enough tax.

Large businesses- 60% did not pay enough tax.
People on high incomes- 59% did not pay enough tax
Mining companies- 67% did not pay enough tax
Companies- such as Google and Apple 73% did not pay enough tax.

In a panel of over 1400 readers of the SMH, 83 % agreed that the ATO should be free to name and shame companies suspected of not paying their fair share of tax. (SMH April 11-12 2015)

The same newspaper also reported that in a survey of marginal seats 90 % of people believe that the government has failed to tackle tax dodgers.

The Swinburne Leadership Institute Survey released today said that business leaders ‘are perceived to disregard .. the wider public good’.

The boards and CEOs of these companies have a heavy ethical and moral responsibility and dodging the issue by claiming confidentiality and that it is all legal will just not wash.

Corporations don’t make decisions. It is individuals who make decisions – and those decisions should not only be legal but they should also be fair and ethical.  That responsibility to act fairly and ethically cannot be avoided by individuals or deflected to someone else. Joe Hockey likes to infer that his business chums are ‘lifters’ but is it true of these tax dodgers!

There is difficulty in getting international cooperation to address this tax avoidance. A good start however  would be full disclosure including full disclosure of all subsidiaries, full disclosure of all related party transactions and balances and a breakdown of taxes paid in Australia and other countries. Jeffrey Knapp has outlined this in today’s The Conversation.

How can Tony Abbott seriously expect public support on necessary budged repair when we see such massive tax avoidance by large and wealthy corporations many of which are foreign owned.

Corporations have been given a privileged position in our society. It is called ‘limited liability’ in that shareholders can only be liable for the money they invest in a corporation and no more. That is an enormous advantage that has been conveyed by the community.  If and when a company goes bankrupt, the community, employees and creditors have to pick up a lot of the debts and consequences. But the advantage that we give to companies is obviously not reciprocated by many companies.

Business people should act in an ethical manner and not inflict damage on the nation for the sake of short-term commercial or personal gain.

These companies that are avoiding billions of dollars in tax in Australia take advantage of the infrastructure and services that have been paid for by the Australian taxpayer. They rely on highly trained and skilled Australian staff. Those staff have been educated and supported by Australian taxpayers.  In some instances, these companies have taken advantage of research grants – funded by the Australian government (and taxpayers).

There is also a matter of trust. As a community we need to have trust in our major institutions including corporations. In recent years the media has been full of comment about our loss of trust in politicians, parliament and political parties. But commercial institutions are also critical in our society and a major loss of trust in them has very serious consequences.

Many of our corporations are forfeiting our trust. We are getting into dangerous territory both for themselves and for ourselves.

 

 

The Abbott Government has promised a “comprehensive and inclusive” review of the tax system, but appears to have ignored a major issue: rising inequality of income and wealth, writes Mike Steketee.

The Abbott Government committed itself last week to a “comprehensive and inclusive” review of the tax system.

But the tax discussion paper it released to kick off the process does not find space in its 196 pages to canvass some of the major issues.

The rising inequality of income and wealth in developed nations has come into sharp focus in recent years but it does not seem to have made its way on to the Government’s radar, even though it is the tax system that potentially can play the largest role in influencing the trend.

Remember the Occupy movement that staked out Wall Street and spread to other countries? “We are the 99 per cent,” they said, pointing to the 1 per cent of Americans who held 40 per cent of the nation’s wealth. According to Nobel Prize winning economist Joseph Stiglitz, that was a rise from 33 per cent in about 1985.

The trend in Australia is the same, even if it is not as severe. On the latest figures available, the median net worth of Australian households – that is, their assets minus their liabilities – was 54 times higher for the top 20 per cent than for the bottom 20 per cent in 2011-12. That was up from 45 times higher in 2003-04.

If you prefer that in dollars, median household net worth increased from $27,508 to $29,600 over this period for those at the bottom, after taking into account inflation, while at the top it rose from $1.24 million to $1.59 million. That is a $2,100 increase compared to $350,000.

Bear with me for one more statistic: in 2003-04, 2 per cent of households had a net worth of $3 million or more – that is in current dollars, after adjusting for inflation. By 2011-12, that had risen to 3.1 per cent.

What we should do about such a trend is a value judgment. But hopefully the debate will go beyond declamations about class envy.

In his landmark study on inequality, Capital in the Twenty-First Century, French economist Thomas Piketty shows that the rate of return on wealth over most of history has run ahead of world economic growth. Although two world wars and a depression reversed the figures during the last century, he argues that all the signs are that wealth is increasing significantly faster than economic growth during this century and will continue to do so. He estimates 4-5 per cent for the rate of return on capital, versus barely 1.5 per cent for world economic growth.

It is a system that feeds on itself: the more wealth accumulated, the more that can be re-invested at relatively high rates of return. Piketty says world wealth per adult grew at an average annual rate of 2.1 per cent between 1987 and 2013 but at the very top it grew by 6.8 per cent. Bill Gates increased his fortune from $4 billion to $50 billion in the 20 years to 2010, according to estimates by Forbes magazine, while the French heiress Liliane Bettencourt saw her wealth increase from $2 billion to $25 billion.

Piketty calculates that if the top one thousandth of wealth holders achieve a 6 per cent annual return, compared to average growth of 2 per cent, the top’s share of wealth would more than triple over 30 years and represent 60 per cent of the world’s wealth. That is, not the top 1 per cent owning 40 per cent, as in the US now, but the top 0.1 per cent owning 60 per cent of global wealth. Such disparity, he argues, is hard to imagine under existing political systems “unless there is a particularly effective system of repression or an extremely powerful apparatus of persuasion or perhaps both”.

It may be that Piketty’s projections turn out to be inaccurate, as economic forecasts and projections often do. But he has documented in great detail a clear trend in rising inequality and there is little reason to think it will stop in the short term.

Back in Australia, the tax discussion paper argues that our income tax system is highly progressive – more so than most other developed countries and particularly when government payments are included. This is mainly because of Australia’s mean tested welfare system, compared to the flat rate social security contributions levied in many countries.

However, income tax has become less progressive in recent times, due mainly to the succession of income tax cuts during the Howard boom years. According to The Australia Institute’s Matt Grudnoff, only 3 per cent of taxpayers are in the top tax bracket now, compared to 13 per cent 10 years ago.

Nevertheless, the effect of a progressive income tax is to moderate the trend towards rising inequality of incomes. But it is a different story when it comes to rapidly rising wealth inequality. This is an area that is taxed very lightly in Australia.

The capital gain on the family home is not taxed at all, while that on other assets is taxed at half the rate of savings such as bank interest. Superannuation is taxed at a concessional rate that provides the largest benefit to higher income earners. The combination of the 50 per cent capital gains tax and negative gearing makes investment housing an attractive option for many, particularly higher income earners, while lower income earners are increasingly shut out of the market.

Unlike other developed countries, Australia has no wealth tax, inheritance tax or gift duties, although they potentially provide the most direct means of curbing rising wealth inequality. These options are given short shrift in the discussion paper – two paragraphs in 196 pages. “These taxes generate relatively little revenue,” it says. “…Furthermore, such taxes can be difficult to administer effectively.”

Piketty argues that the risk is that inequality in wealth will continue to rise unless there is some kind of global tax on capital. He says that a progressive annual tax on wealth at modest rates – for example, 1 per cent on wealth of between one and 5 million euros and 2 per cent above 5 million euros – would affect only about 2.5 per cent of Europe’s population but raise significant revenue – 300 billion euros, equivalent to about 2 per cent of total European GDP.

He concedes that the risk of evasion is high unless countries share bank information – something governments at least are talking about. But a progressive tax on capital would make it possible to avoid “an endless inegalitarian spiral” that he argues ultimately would undermine democracies.

If governments in Australia are not prepared to contemplate such a move, at least tackling the gross inequity of the superannuation concessions would be a start. Something approaching a political consensus appears to be emerging on this issue, although that is not to say it could not easily be derailed by the inevitable backlash from those affected.

Even agreement that superannuation should be used to fund retirement, rather than as a wonderful way to minimise tax and accumulate wealth to pass on to the kids would be a step in the right direction.

Mike Steketee is a freelance journalist. He was formerly a columnist and national affairs editor for The Australian.

This article first appeared in The Drum on 6 April 2015.

As a result of the lower iron ore prices there is a dramatic shake-up coming amongst our iron ore companies, the largest of which are foreign owned.

These companies conducted a vociferous campaign against the Resources Super Profits Tax. They were successful. As a result of the failures of the Rudd and Gillard Governments to effectively tax the mining companies, the state governments particularly of Western Australia and Queensland stepped in with very large increases in royalties. The Western Australian Government could hardly have believed its good luck in the royalties it extracted from the iron ore companies in Western Australia as a result of the China export boom.

But that has now all changed. The mining companies are stuck with these very high royalties whilst their profits have been reduced or eliminated. There is not much doubt that companies such as Fortescue would be now much better served if there had been a Resources Super Profits Tax rather than the large increases in state royalties that they continue to pay. Professor Flavio Menezes, Professor of Economics at the University of Queensland, said in The Conversation on 7 April 2015 ‘Fortescue Metal Group’s Andrew “Twiggy” Forrest was one of the most vocal opponents of the super profits tax. Fortescue’s financial position is currently under significant pressure due to falling iron ore prices caused by oversupply, and the slowing Chinese economy. Ironically, it would likely be better off today under a well-designed RSPT than under a royalties regime.’

In my blog of 17 October 2013, I pointed out the short-sightedness of the miners and the likely problems that they might face as a result of reduced profits and increased state royalties. See link below.

https://publish.pearlsandirritations.com/blog/?p=827 

I drew attention in that blog to the report of the GST Distribution Review of October 2012 that ‘Well designed rent-based taxes are likely to be more economically efficient than royalties, particularly in periods of low commodity prices or high costs. … Other factors, such as the size, variability and timing of the return received by government, as well as administration and compliance costs are also important considerations when choosing between alternative resource charging regimes.’

Guest blogger, Dr Michael Keating in a post ‘The mining tax debacle’ of 14 September 2014, commented that what was surprising is that the Labor Government did not elect to just extend to all minerals the existing Petroleum Resource Rent Tax (PRRT) which also had a 40% tax rate. This would have been much easier to explain and as acknowledged by the Henry Review, the PRRT can approximate the impact of the Resources Super Profits Tax.  See following link to Michael Keating’s post.

https://publish.pearlsandirritations.com/blog/?p=2424

An appropriate mining tax regime is still a matter than needs addressing in Australia. The efforts of the Rudd and Gillard Governments were clearly in the right direction, but very badly managed. The miners took advantage of their lobbying power. Their action seemed to be of great benefit to them at the time, but many miners now and in the future will pay a heavy price for a failure to set up an appropriate taxation regime for miners in Australia.

The miners are very likely to lament their action in destroying the Resources Super Profits Tax which was levied on profits. In its place, they have been levied with very high royalties by state governments which do not have a direct relationship to profits.

 

Despite the booming café and restaurant industry, the special pleading by employers on penalty rates and minimum wages goes on and on.

Employers seem to have little appreciation that there is a difference between the market and society. The latter is much more important. The right to a decent wage and time off for recreation and relaxation with family and friends is essential. Markets are important, but they are a means to an end.

Speaking of penalty rates, Peter Martin in the SMH  said ‘This Easter give thanks for penalty rates, they keep us human. Easter has become sacred even for the non-religious and the non-Christian.’

Many employers who call for cuts in minimum wages or penalty rates have little appreciation of the difficulties for low income earners. Attacking the low paid is easy pickings.

Workplace researcher Professor Barbara Pocock warns that cutting weekend penalty rates will erode the time Australians spend on informal relationship building with friends, family and neighbours. As soon as we take that wage premium off we make all time the same and we will see a lot more squeezing of that informal social time on Saturdays and Sundays.

One of Australia’s great achievements in nationhood was in 1907, the living wage. But employers keep pleading that minimum wages are too high and they should be reduced to increase employment and presumably profits! But there is no conclusive evidence to support that proposition. Late last year more than 600 US economists, including seven Nobel Prize winners, signed an open letter to Congress calling for an increase in the minimum wage. They said that the weight of evidence showed that increases in the wage had little or no negative affect on the employment of minimum wage workers.

The Chamber of Commerce and Industry in Australia has recently been encouraging businesses that were closed over Easter to put signs in their window saying that it was because of penalty rates that they could not open. The Small Business Minister, Bruce Bilson, repeated this line of special pleading.

These businesses must have decided to enter business knowing what the penalty rates were. Didn’t they factor that in to their business plans?

I suspect that a lot of special pleading on penalty rates is to divert attention from bad business decisions. It is so easy to blame ‘the system’ rather than acknowledge one’s own business mistakes.

In the last five years, spending at restaurant and cafes has climbed 36%. According to the ABS in 2013-14, the net growth in the number of cafes and restaurants was 7%. For all businesses it was 1%. The café and restaurant business is booming, but still the sector keeps complaining about penalty rates.

Employers who keep up their special pleading on minimum wages and penalty rates should really address the way they run their own businesses, and not always want to get the system changed to their advantage. They need to stick to their knitting.

If the last 20 years has taught us anything about industrial relations, it is that continual change is costly for all concerned. In 1993 the Keating Government abandoned our centralised IR system. In 1996 Peter Reith downgraded the role of IR tribunals. In 2005 John Howard gave us Work Choices. Then in 2009 Julia Gillard gave us the Fair Work legislation. Now the present government wants more changes. But what we really need is more stability in our industrial relations framework because in the end good relations at the work level are necessary to improve productivity, effective local management and employee participation.

The vested interests that want to cut penalty rates claim that we have an inflexible labour market that results in high wage costs. But all the evidence is that the annual rate of wage growth has declined substantially and that our labour market is showing considerable flexibility.

Clearly we need to review penalty rates and minimum wages and all industrial relations from time to time but we seem fixated with the need for change and more change, mainly for ideological reasons or perhaps to hide business failure.

Whilst employers and governments continue with their special pleading on penalty rates, the attitude of the public is very clear. According to Essential Research in January this year, 81% of voters think that people who are required to work outside normal hours should receive a higher hourly rate. 68% said that they would oppose cutting weekend and public holiday rates for hospitality and retail workers.

The public seems to have good sense in these matters, which employers and the government would be wise to heed.

According to the Government its first objective for tax reform is lower taxes. A responsible government would, however, first consider what revenue will need to be raised to efficiently fund the sorts of services that our society expects.

Of course, opinions may differ on what level of service provision is appropriate, and how it should be paid for. Unfortunately the various Intergenerational Reports and the Government’s decision to abandon its own Budget do not install confidence that lower taxes are in fact realistic.

Instead, given our present Budget deficit and the consistent projections of future deficits, it would be prudent to approach tax reform with the objective of restoring the present low ratio of taxation to GDP and even increasing it modestly in the future. Indeed, neither of the previous major tax reform packages in 1985 and 2000 reduced tax revenue, but instead they changed the tax mix, and in reality that is what we probably can expect from any future tax reform package.

In considering any changes to the tax mix, as the Treasury Tax Discussion Paper points out, we should seek to balance the core principles of efficiency, equity and simplicity as briefly discussed below.

A more efficient tax system

The Government’s starting point for a more efficient tax system seems to be that our system relies too heavily on direct taxes on income and not enough on indirect taxes on consumption and other immobile factors of production such as land. But if we allow for various forms of compulsory social security contributions plus payroll taxes then direct taxes in Australia comprises around 63 per cent of total taxation in Australia compared to the OECD average of 61 per cent, which suggests that our balance between direct and indirect taxation may well be sustainable.

However, what probably most concerns the Treasury is that our company tax rate at 30 per cent is higher than many other countries, and with the exception of the United States (whose company tax rate is close to 40 per cent), other countries have been reducing company taxes. Indeed, the Executive Summary to the Discussion Paper (probably written by Mr. Hockey) goes so far as to make the unsubstantiated claim that

‘each additional $1 collected by way of company income tax reduces the living standards of Australian households by around 50 cents in the long run because of reduced investment. This impedes Australia’s productivity and, in turn, reduces opportunities for better paying jobs’.

Living standards are of course determined by productivity and common sense suggests that company tax would cause nothing like a 50 per cent reduction in productivity. Instead Treasury estimates that the marginal excess burden of company tax is 50 per cent, presumably because around half of company tax is passed back into lower wages and forwards into higher prices.  But this ability to pass company tax on makes it less likely to inhibit investment and productivity.

Furthermore, because of dividend imputation, dividends paid by companies are much more lightly taxed for Australian residents than in most other countries. This means that the argument for a lower company tax really is primarily about what is necessary to attract foreign investors. But experience suggests that the returns on investment in Australia are sufficient, and that there has been no problem in attracting foreign investment, notwithstanding our higher company tax rate. Indeed, it is arguable that there has been too much foreign investment, which has pushed up existing asset prices (for example in property), and that this increase in Australians’ wealth has actually led to lower savings and investment by Australians themselves.

A proposal floated in the Discussion Paper is that dividend imputation should be scaled back or even dropped, presumably to help pay for a lower company tax rate. This proposal would effectively mean raising the taxes paid by Australian investors in order to finance lower taxes for foreign investors. But it is hard to see why Australians would want to back that, especially when it appears to be quite unnecessary, and when as Treasury used to believe, there are considerable merits in our system of dividend imputation.

The other major issue of tax efficiency I want to comment on is the taxation of savings. As the Treasury states:

‘Australia’s tax system treats alternative forms of saving differently. At one end of the

spectrum, savings held in the family home are taxed at average effective tax rates

approaching zero.  At the other end of the spectrum, savings held as financial deposits are taxed at full marginal rates, without any recognition for the costs of inflation.’ 

The policy rationale for these differences in the tax treatment of savings is not always clear, and they can distort the allocation of investment. In particular, the real estate market has probably been distorted in favour of investor housing by the incentive provided by the 50 per cent discount on the taxation of capital gains, and some would also argue by the possibilities of negative gearing. Removing that 50 per cent capital gains discount, or at least reducing it, would reduce housing demand, thus releasing more savings for other productive investments, and the lower housing prices would help first-time owner-occupier buyers.

A more equitable tax system

The proposal for improving equity that seems to be gathering support is to scale back the tax concessions for investment in superannuation funds. Some concession is justified because of the compulsory nature of superannuation savings and the fact that they cannot be accessed before retirement age.

But the rate of the superannuation concession is about four times as high for people on the top marginal tax rate as for people on a zero tax rate, and more than half the value of these concessions accrues to the top twenty per cent of income earners.  So some scaling back in these concessions for superannuation and also the concessional treatment of capital gains should be a priority. In addition these changes would improve efficiency of the tax system.

The other change that I suggest will need to be introduced some time to improve equity is a reconstruction of the income tax rate scales to offset the effect of bracket creep as incomes rise over time. As the Treasury Discussion Paper points out unchecked bracket creep affects lower and middle income earners proportionally more than higher income earners. For example, present projections of earnings show that if the present income tax rate scale is maintained over the ten years from 2013-14 to 2023-24, the average tax rates for different multiples of average full-time earnings can be expected to rise as follows:

• half average full-time earnings by 7½ percentage points
• average full-time earnings by almost 5 percentage points
• twice average full-time earnings by less than 4 percentage points.

In addition, someone earning full-time average earnings could expect to enter the second highest tax bracket as soon as 2016-17.

The Treasury Discussion Paper raises the possibility that these projected changes in average and marginal tax rates facing ordinary workers may affect their participation rates and thus the efficiency of the tax system. How far that is an issue is a moot point. Furthermore, the evidence suggests that there are other more important factors influencing workforce participation for those most at risk.

Nevertheless, these presently projected changes in average tax rates would clearly affect the progressivity of the income tax system and for good equity reasons the income tax rate scale should be adjusted in time to maintain the system’s present progressivity. One way would be to index the rate scale, but that does lock in government, arguably to an undesirable extent. On the other hand, if changes to the income tax rate scale are to be discretionary, they should still be factored into future fiscal planning.

A simpler tax system

One indication of the complexity of the Australian tax system is that Australians are more likely to use a tax agent to complete their tax return, and our businesses spend a lot on compliance and also on financial planning to avoid taxation.

A good way to achieve a simpler tax system would be to reconsider many of the present concessions. Indeed one reason for many of these concessions is that they are less transparent and less subject to review than Budget outlays, although their rationale is typically no different. They should be subject to the same level of scrutiny as the outlays.. So given the need for restoring the ratio of revenue to GDP and even a bit more, probably the best place to start would be with a genuine review of the various tax concessions.

Conclusion

One of Australia’s leading tax experts, Greg Smith, argued in an article posted here on 4 April, that Australia has a broadly effective tax system but some tidying up is now needed to restore the performance levels of the early 2000s. I would generally agree with this conclusion, although I might go a bit further if, as I expect, additional revenue will be needed to restore a modest Budget surplus and keep it there over the long run.

The priority for change to achieve the necessary increase in revenue will be to scale back the tax concessions, starting with the superannuation and capital gains tax concessions. In addition, the recent Intergenerational Report assumes more income tax revenue through bracket creep than is really desirable, and avoiding that will most likely require alternative sources of revenue.

The obvious additional revenue resource is the GST, but as recognised in the Discussion Paper, reforms involving the GST raise major questions regarding the future of federalism in Australia. Accordingly I propose to address the issues of fiscal federalism in another future article.

Dr Michael Keating AC was formerly Secretary of the Department of Finance and Secretary, Prime Minister and Cabinet.

 

 

 

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