Opinion & Commentary
Going for the tax policy gold
International competitiveness is front and centre in the federal government’s “root-and- branch” review of the tax system. But despite its motherhood quality, international competitiveness is not the be all and end all of tax policy. A more balanced view would recognise that much of the case for “root and branch” tax reform rests elsewhere. Moreover, competitiveness is too often measured by dubious international comparisons, which are too easily manipulated to support a predetermined objective.
The first product of the review, describing the “architecture” of the tax and transfer system, draws heavily on comparisons between Australia and international averages – particularly OECD averages of tax rates, the composition of tax revenue by type of tax, and the overall tax burden. But by definition, these are a guidepost to mediocrity – the average of the best and the worst. They would struggle to win even the bronze medal for tax policy. Why on earth should Australia go for the bronze when gold is within our grasp?
Memories are short. Tax policy was thoroughly tested against OECD comparators just two years ago, when Peter Costello commissioned the Warburton/Hendy review of international tax policy benchmarks. This exercise carried all the signs of a setup, designed by the government to secure a respectable excuse for not cutting tax rates much (as distinct from lifting thresholds) in the face of pressure to slash them. Are we to be led down this well-worn path of inaction again by Costello’s successor?
As my CIS colleague Andrew Norton wrote recently in Policy (Winter 2008), Australia suffers from an “OECD cringe,” which “turns the plausible idea that we can learn from other countries into the misconception that we should imitate them no matter what they do.”
OECD tax averages are heavily swayed by the very high taxing, big government countries of ‘old Europe’. These countries have public sectors approaching, and in some cases even exceeding, 50% of GDP and commensurately heavy tax burdens. Many other OECD countries, Australia among them, have smaller public sectors and tax burdens and are the better for it. We should use this as our reference group and leave ‘old Europe’ in the category of nice places to visit.
Another point against OECD tax policy averages is that - with a few exceptions such as Ireland and, in a different era, New Zealand - the boldest experiments in tax reform have not occurred among the OECD member countries, but in the emerging countries of Eastern Europe and Asia. Are these not relevant to Australia’s international competitiveness?
For these reasons, findings such as the one that Australia’s top marginal income tax rate approximates the OECD average simply do not help to inform the tax reform debate.
The essence of the international competitiveness argument is that Australia will suffer in the competition for cross-border resource and financial flows if our tax system is relatively unattractive. This is true, but a much broader case for tax reform should and can be made. Cross-border opportunities only expand the sphere of tax policy influence on resource allocation; they do not define it. Surely, resource allocation within our borders is more important. In a closed economy, cross-border flows would not be a consideration, but this would not render tax policy unimportant; to the contrary, the design of the tax and transfer system would be a major influence on allocative efficiency, prosperity and well-being.
The broad case for tax reform starts with the adverse effects of high tax rates on decisions by individuals and businesses to work, to invest and to build capital. This involves personal income tax rates all the way up the scale, as well as company tax rates. There is a strong case for cutting all of them, not primarily for international reasons, but because it would be good for the domestic economy. Then comes the related issue of how the income tax and transfer systems interact to produce even higher effective marginal rates. Related to that is the bewildering complexity of the current system. Finally, there is the issue of state taxes, some of which are the most distorting in the whole tax landscape.
The benefits of getting these things right are primarily homegrown and have little to do with international linkages. Get them right, and international competitiveness will follow. If the review wants to draw on international experience, it should search the world for case studies of what works best in tax policy, not seek to match the average of the good, the bad and the ugly.
Robert Carling is a Senior Fellow at the Centre for Independent Studies
