This week, the Economic Reform Roundtable met to discuss how to boost Australia’s productivity, where Grattan Institute’s CEO spoke on four key areas for tax reform. A robust tax system plays an essential part in creating a competitive and productive economy – but how do we balance the system to create a better tax mix?
In this podcast, CEO Aruna Sathanapally and Senior Associate Jessica Geraghty break down how to build a better tax system for Australia.
Transcript
Jessica Geraghty: Australia is in the productivity doldrums. Productivity growth has slowed since the nineties and two thousands and is stuck languishing around 2016 levels. This matters because productivity growth is the key to raising our living standards in the long term.
It’s what allows us to do more with less. And the reason that over time our real wages rise. Higher productivity means we earn more per hour that we work, but also that we can choose to work less without reducing our consumption. In our Orange Book earlier this year, Grattan Institute called on the incoming government to adopt a prosperity agenda and to focus on productivity to tackle the big challenges that we face.
It’s important to note that many of the drivers of productivity are not in the government’s hands. The slowdown in recent decades reflects weak business investment. The slowest spread of new technology and the growth of the non-market sectors where productivity is not measured well.
For governments, technological leaps are hard to pick, and businesses ultimately make their own investment decisions. But governments do play an important role in strengthening the foundations that enable people to flourish, such as health and education. And in ensuring that tax and regulatory settings encourage a more competitive economy that incentivizes productive activities.
The government has recognized that lifting productivity is an imperative, and this week held a three-day economic reform roundtable. Treasurer, Jim Chalmers met with people from businesses, unions, universities, and think tanks, including our own CEO, Aruna Sathanapally, to discuss what can be done to kickstart productivity growth again. My name is Jessica Geraghty and I’m a Senior Associate in the Economic Prosperity Program, and today on the Grattan Institute podcast, I’m joined by Aruna Sathanapally Aruna, what was the vibe in the room yesterday?
Aruna Sathanapally: It was interesting ’cause I came in on the third day of, three days, and it’s pretty remarkable actually to have a group of such senior people give three whole days to, to talking about reform, to talking about how to boost productivity and, and, and boost prosperity. And there’s no mobile phones in the room, so everyone has to really concentrate.
I think the vibe was really constructive. People don’t give their time for nothing. There was a sense that there’s both a real challenge here and a real opportunity and a strong willingness to see where we could find some, some common ground.
Jessica Geraghty: So, the first couple of days covered a lot of ground from economic resilience to improving our regulation and AI and innovation. You were invited to the final day where you presented to the room on tax reform and what a better tax system could look like. What were your key messages to the group?
Aruna Sathanapally: Jess, you mentioned upfront that, you know, this government doesn’t hold all the levers when it comes to productivity, but tax is one of the ones that government does hold. it’s a really important policy lever to build economic prosperity. And I’ll, I’ll, I’ll try and explain why that is, because if we do tax well, what that enables us to do is to build up what we call human capital, like people’s education, people’s skills, people’s health, and then those really stable institutions that help people to invest and to innovate and to build a future for themselves. A good tax system helps you make those investments.
And I think. All of us in Australia benefit from that. And it’s also a tool that we have to shape the economy because the way in which we tax helps send messages about the sorts of activities we want more of, and the sorts of activities that we want less of.
In particular, the way in which we tax involves choosing between, a range of different taxes and some of those are better in terms of the impact on the economy. And some of those are, from the research shows us that they’re worse. That they tend to cause more of a drag. They tend to stop people doing as much of things that we value and might actually distort the economy and have people putting their money in time and things that are less productive.
One of the other key messages was really around the fact that, whatever our tax system may have been designed for in the past, we need to think about the future. So, this isn’t a set and forget. The world is changing, and our tax system needs to change over time as well. And I think that’s really important because tax reform has proved so hard that this has become one of those policies that ends up being a bit outta date.
And so, the world changes, but our tax system doesn’t catch up. And really, the Reform Roundtable, or at least the last day of it was a chance to just grapple with some of those big shifts that are coming at us. Like the population is getting older. The world is changing physically. And we know that, right.
Australians have seen the frequency of extreme weather events over recent years. Um, we also know that we’ve got huge opportunities to reshape our economy in the decades ahead. And we know that the world has become a less stable place, but that creates obviously risks, but also opportunities for Australia as a place where, people may wish to invest. People may wish to build businesses because of our relatively strong institutions and our higher degree of social stability.
Those are some of the things we want our tax system to be dealing with. So, coming out of that I gave a bit of an opening at the start of what was many hours and many really good contributions.
But in that opening. I laid out four big opportunities that I thought the group could talk about. And the first of those was our income tax system and bringing some balance to that because at the moment it leans very heavily on work and more lightly on other ways to make your money.
The second is improving taxation of businesses. The third was around, how you can use forms of taxes or charges as pricing signals and then get better use of your assets. And the final one was really thinking about, the GST, but also the broader position of the states, the state taxes and the state budgets.
Jessica Geraghty: Picking up on that first point about the personal income tax system, something that we often hear is that in Australia we are way more reliant on personal income tax than many of our peers in the OECD and at face value this is true. But if we dig a little deeper into the data, we see that that many of our OECD peers levy a form of tax called Social Security contributions, which are paid by employers and employees and are designed to cover things like unemployment benefits and pensions.
And so they are in effect, a tax on people’s earnings. And so, then if we take this broader view of personal income tax to include social security contributions, we say that Australia is really not an outlier. So, in that vein, you talk not about cutting personal income taxes, but about rebalancing the system to reduce the burden on working age people.
What do you mean by rebalancing the system?
Aruna Sathanapally: Yeah, so it’s important to clarify that what falls into that personal income tax bucket is largely the income tax that all of us know and, and probably don’t love, which is, the pay as you go. You work and a portion of that goes in a tax bill. But there are other forms of income as well, right?
So, people make income from shares, people make income from rent on an investment property. People make income during retirement from their superannuation balance and the returns that provides. So, there’s all sorts of ways in which you can make income. So, the personal income tax system covers income from work, but also what we call passive income. So, income that’s not labour.
When we say that the system’s imbalanced, it’s because there are good reasons why you tax passive income differently. But the way in which we do it now is so generous to certain forms of passive income that it distorts where people are putting their money.
The view is that looking at the research we’ve taken on balance is that we lean relatively heavily on working people. And that isn’t to say that our income tax rates are particularly high compared to other countries, but in our system, we don’t tend to do the other part of the puzzle very well and over time what that means is that the sort of do nothing policy fix is, we just keep raising more and more money on working people. I don’t think we should do that. I don’t think the evidence says that’s a particularly sensible way to raise money over time.
The better way to sort of bring that fiscal balance is for us to start looking at some of these concessions.
Jessica Geraghty: So, it’s not about uh, reducing the burden. It’s about spreading the burden more evenly across different types of income.
Aruna Sathanapally: But also, not about it. It’s not about increasing the burden. And I think that’s important for people to understand that when we’re talking about, lifting some of these taxes it’s not about raising how much, personal income. You know how important personal income tax is as a whole.
It’s about getting the mix right and that relates more broadly to some of the opportunities around revenue. There’s a lot of commentary around wanting to jack up taxes. I think that really misses the most important point, which is that there’s real opportunity to tax better. To switch from taxes that are more damaging to taxes, which are less damaging.
And you can raise the same amount of money in a better way from the perspective of economic growth and obviously from the perspective of fairness.
Jessica Geraghty: Another area where there’s discussion about taxing better is corporate tax. And so, in the few weeks leading up to the round table there was a lot of discussion after the release of the Productivity Commission report in late July. And so, in that report they proposed some changes to the corporate tax system, specifically reducing the tax rate to 20% for companies with revenue of less than a billion dollars and increasing a cash flow tax of 5%, which companies can reduce by undertaking investments.
Aruna, what are the issues with our corporate tax system and why is it so hard to ag agree on what should be done?
Aruna Sathanapally: As a starting point, we are going to need a substantial volume of business investment to boost productivity and to realize the opportunities that we have ahead to reshape our economy for the times. A lot of people have thought about the investment that we need to make in renewable energy and the investment in research around new industries and new technologies that could exist in the future.
There’s business investment across the economy that, we want to attract. There’s also the potential for new innovation. So that’s the problem. What’s happened over the past 25 years is that virtually every country we compare ourselves to has cut its corporate tax rate.
And so, while our corporate tax rate wasn’t particularly remarkable 25 years ago, these days it’s relatively high. It’s genuinely tricky to work out what to do about this because you can’t just cut the corporate tax rate without blowing a huge hole in the budget, and it’s not even clear that would be necessarily be the right thing to do because our corporate tax does two things. It raises tax on normal profits of business, which is the economic evidence shows you that’s damaging, that makes your economy smaller than it would otherwise be. And it also raises taxes on excess profits that, economists call economic rents.
But they basically come from the sorts of things that, you know either there isn’t a great deal of competition or there’s a particular regulatory setting, or it relates to commodities where prices could end up quite high. And that’s actually quite an efficient way to raise tax. So, our corporate tax does two things, and unhelpfully, perhaps it does those two things kind of equally. Roughly 50 50. So, we have to redesign the system in a way that does less of the thing that is damaging and more of the thing that’s quite an efficient way to raise money. So, the Productivity Commission has come up with an idea on how to do that.
And it’s not simple. It’s a bit more complicated. And I think some of the resistance has been to the idea of complicating the system. So, then the question is, okay, well what’s a design that would do that? Or potentially, is it not a matter of the corporate tax rate? Are there other things we can be looking at that will make business investment more attractive?
So, things that aren’t taxed, things that, that are in the regulatory space or things that relate to the complexity of the system. Can we make it simpler? Or things that relate to the other taxes that businesses pay that aren’t the corporate tax? Could we think of simplifying and consolidating some of those?
Jessica Geraghty: So, it sounds like there’s a, a bit more work to do in the corporate space. So, we’ve talked about corporate and personal income, which are obviously our two most significant tax bases. But you mentioned earlier a couple of other opportunities for tax reform. I was wondering if you could talk a bit more about those.
Aruna Sathanapally: One of the things that, if you think about using tax as a policy mechanism to get the outcomes, we want one of the productivity issues Australia faces is that we are a small population on a vast land mass. That means that per capita. So, per person we just need more infrastructure.
We don’t get the same economies of scale that a country that is smaller and with a larger population gets. That is what it is. But the consequences that it’s really important for Australia to make the best possible use of its assets. Infrastructure is expensive to build.
It’s expensive to build everywhere. It’s expensive to build here. So, when we build it, we need to make sure that we are building it in the right way, but also that we’re getting the most use out of it. And so that’s where the sorts of taxes or charges that introduce pricing of what we call externalities.
So, the impact that you have on assets can help you use them more efficiently. And that’s where something like road user charging comes in and the treasurer said afterwards there was a great deal of support for it. So, I can explain the reasons why that is. Road user charging helps pricing damage to the roads that mean that the people who cause the most damage pay for that, but also then puts in a signal that maybe if there’s a way that you could cause less damage to the road don’t do it. And that doesn’t exist at the moment.
But the other thing that road user charging can do is smooth out how people use the road by putting a charge on using it at the busiest times. And that means that if you absolutely need to use the road at that time, you will. But those who don’t will be nudged away from doing that and will use the road at other times. And that way you just make better use of these really expensive assets we have in our roads. But then the other example of pricing that, many people will be familiar with is that pricing can be, a really effective way of finding the least cost way to reduce carbon emissions.
You price it so that people have a sense of really what this is costing. And then those people who are emitting are factoring that into their cost base when they’re making things or, providing certain services. At the moment, we’ve got from reforms from the last term of, parliament.
We’ve got those prices in part of the economy. But if we can expand that carbon pricing across the economy, that means that we can find a better path to net zero, a less expensive path to net zero than if we don’t.
Jessica Geraghty: You said that all roads lead to the GST. Why is that? Why do all roads lead to the GST?
Aruna Sathanapally: Well, because this is one tax where, you know, we’ve talked a little bit about, corporate tax. We collect a bit more than other countries. There’s reasons for that. Income tax we collect, you know, a bit less than other countries. But I don’t, I don’t think that’s an area that we’re really wanting to lean on people more heavily.
It’s very clear that we don’t collect very much GST relative to other countries. And that’s a matter of our rate. It’s only 10%. Other countries have a higher rate. It’s also a matter of what we charge GST on. We’ve got some pretty big carve outs. And over time what we’ve spent on the carve outs has grown.
And as a result, our GST hasn’t grown and hasn’t kept pace with the economy. So, it’s gotten smaller. The reason that people tend to focus on the GST is not only, we don’t collect very much of it, but it’s quite an efficient, relatively efficient tax. It’s not as distorting as many of the other ways you could collect tax on the economy as a whole.
So, everyone goes there. Uh, But the final reason everyone goes there is usually because there’s some other thing that they wanna cut tax on or they wanna pay for. And so, people tend to talk about the GST as the way in which you pay for income tax cuts or corporate tax cuts or getting rid of stamp duty.
So, there’s lots of different potential uses for the GST increase. But of course, raising the GST is not a straightforward thing. It is highly unpopular. There is no government that is in support of it. And so, it’s a little bit of a glib statement that, everyone seems to end up in this place where it’s almost the magic pudding.
But that it can’t pay for everything. It could pay for some things, but it’s a really politically difficult one.
Jessica Geraghty: Yeah. Off limits perhaps for the moment. But it sounds like there was certainly a lot of interesting things for the government to think about coming from yesterday’s session. And so, the treasurer after the session announced 10 longer term reform priorities, one of which is building a better tax system, which is great to hear.
And in that work, they will focus on three principles. And so, the first was about ensuring a fair go for working people which will include that intergenerational lens. The second was about incentivizing business investment and finally having a more simple and sustainable tax system. But in your speech yesterday you said that it’s not about finding the perfect tax system.
So, what do you think the government should keep in mind throughout this process and what do we need to see from here?
Aruna Sathanapally: The treasurer listened to many different views and much, much evidence and advocacy over the course of the three days. And certainly, the day that I was part of tax reform is really hard. And I think there was a broad recognition that even putting it on the agenda is hard because the media coverage immediately jumps to tax hikes or the opposition might jump to tax hikes and everyone gets scared, right?
That this is cover for, you know, to what tax reform really means is just raising taxes. Good tax reform is not that. It’s about doing it better. So, getting it on the agenda is the first step, but. From here compromise is gonna be really critical for any reform to be successful.
And there’s a few reasons for that. It’s really easy for anyone who wants to torpedo tax reform to do it. There is a real temptation that if there’s any conflict or disagreement that’ll get picked up by the media and, they’re happy to kind of really feast on it, right? And there’s also potential for all sorts of, claims and analysis of what changing taxes will do and claims around what impacts it will have on people. And that’s difficult for tax reform because often the good taxes are more noticeable to people.
And the taxes that are more damaging are often just politically easier, and that means that it’s quite easy to run a scare campaign. And, you know, frankly, the GST or the land tax and stamp duty arguments are an example of that. So, stamp duty is a terrible tax is really expensive, and it really hurts.
But because you pay it at the same time as you’re paying for something huge, you might not notice a hundred thousand dollars, tax bill on the $2 million house, right? You’re gonna notice the $2 million house. Whereas the land tax that you pay every year, you could design it so that it would be less than that stamp duty, but you get the bill every year.
And it affects a lot more people on a regular basis. So that’s why this stuff is genuinely difficult. Which brings me to sort of your question on compromise that if we can get something that is a step better than what we have, that is far more important than holding out for the thing that is perfect that broad-based agreement around getting to something better is what we should be all aiming for.
Jessica Geraghty: Aruna, thank you so much for your time today. And thank you for listening. Grattan Institute is an independent not-for-profit policy institute. We rely on donations from our supporters, so please consider donating to our work Thank you very much for listening today.