A roadmap for the 2015 Budget: ways to increase tax revenue

Prime minister Tony Abbott has suggested that people will find the 2015 federal budget “pretty dull and pretty routine”, which has been interpreted as meaning the federal government is likely to continue its approach of cutting expenditure.

An odd feature of the budget discussion is the absence of measures that would increase total taxation revenue. This is a one-sided approach to preparing a budget.

A change in the size of the budget deficit can be achieved either by increasing tax revenues or by reducing total expenditures. I take as given the need to reduce the size of the structural budget deficit. So too is the need for reform of major expenditures such as health and income transfer programmes.

With treasurer Joe Hockey flagging the release of the Tax White Paper in coming weeks, it’s surely time to focus on the tax side of the budget.

How tax systems work

For each tax in our tax system, the tax take depends on two features of the tax; the base of the tax and the rate or rates of tax applied to the base. Consequently one needs to distinguish between the parameters in our tax system that fix the rates of taxation – for example, the 30% corporate tax rate or the marginal tax rates applied to household income – and those that fix the bases of taxes.

Examples of the latter are the exemption of household income received from superannuation and accelerated depreciation allowance in the corporate tax system. Discussions of tax takes usually focus on tax rates, not on tax bases.

Both the tax bases and tax rates offer many possibilities for increasing the total tax take. The bases of the various taxes could be broadened by reducing exemptions and loopholes. I’ve provided some examples below.

A strategy that increases the total tax take by broadening tax bases has several advantages. Removing concessions that favour particular sectors or classes of investors shifts the tax system towards neutrality and the tax system would become more efficient for a given level of payments by tax payers.

It would also make the system more horizontally equitable by treating like circumstances equally for all investors. And it would operate to increase equity among taxpayers of different income levels as most of the concessions and exemptions that might be eliminated benefit predominantly middle and upper income households. As a final bonus to the nation, it would simplify our tax systems.

Some possible changes to tax bases

There are many possibilities. Some of the big ticket items are:

• Eliminating negative gearing for housing investments
• Restricting the allowable deductions for depreciation and other business expenses
• Revising rules relating to income from trusts
• Tightening the rules for fringe benefit taxation
• Reforming the taxation of super contributions and income
• Reducing tax concessions for not-for-profit organisations

Every one of these proposals will meet objections from the taxpayers concerned but we need a national perspective.

Further strategy options

We can even contemplate a budget strategy that raises tax revenues without any change in tax rates. With a worsening structural debt problem and growing demands for public expenditures in several areas, now is not the time for tax rate cuts. For some years the corporate sector has been pressing the government to lower the corporate tax rate.

Our statutory corporate tax rate is higher than that of most countries in the Asia-Pacific region but our dividend imputation is more generous than most other countries, which reduces the tax burden for (domestic) shareholders. The real burden of corporate taxes is measured by the effective tax rates. These depend on other parameters which determine the base of corporate income tax liability, corporate “income”. If the government moves to lower the statutory corporate tax rate, it should at the same time close loopholes so that the total corporate tax take increases.

A few increases in applied tax rates are justified. One is removing the 50% reduction on capital gains income. Another is changing the base of taxes on these beverages to a uniform alcohol-content, as recommended by the Henry Tax Review and others, and setting the rate to increase total revenue. A third is capping the threshold for tax-free income from superannuation.

Some difficulties with the tax options

One possible objection is that the tax system is a complex one in which different taxes interact to determine the final liability of all taxpayers and they also interact with the transfer system. Consequently, changes to our tax system require a careful system-wide evaluation. This is true.

But this objection does not provide an excuse for inaction on the tax front. Some changes in tax regimes could be made in the next budget. Some taxes have less interaction; for example, taxes on alcoholic beverages.

The ground for tax reforms which improve the efficiency and/or equity of the tax system has been well prepared by recent tax investigations. The 2010 Henry Review was the most thorough investigation of our whole tax system ever conducted in Australia. Its analysis still applies, though the macro-economic circumstances of the Australian economy have worsened. We also have a Senate Enquiry into Corporate Tax Avoidance which is due to report in June.

In any case, this same objection that reforms need careful consideration over a longer period applies equally to many expenditure-reduction proposals. The unsuccessful and unpopular attempt to introduce a medicare co-payment shows the need for careful consideration.

A longer term perspective is required

A strategy of increasing tax revenues to reduce the deficit cannot all be carried out in a single budget. This strategy calls for an integrated program of changes over several budgets. In the 2015 Budget, the Government could announce some changes immediately while foreshadowing other changes to increase total taxation revenue in future budgets.

Above all, the budget strategy needs to look at both sides of the budget. A one-sided concentration on expenditure reduction measures is likely to impose real costs on households if the measures are not carefully designed and to impose the burden mainly on lower-income groups. A two-sided strategy opens up possibilities of increased national efficiency and improved productivity, and greater fairness.

Editor’s note: Peter will be answering questions between 10 and 11am AEDT on Friday March 20. You can ask your questions about the article in the comments below.

Peter Lloyd does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.