Carling’s premise is that, while action is needed to correct
structural budget deficits, the criticism of tax concessions has lost sight of
the legitimate reasons for many of them. In the search for budget savings, it
is important to keep tax concessions in proper perspective and not throw out
the good with the bad. The legitimate scope for additional revenue from cuts to
concessions is much narrower than is often suggested.
Typically criticism of tax concessions relies heavily on the
official estimates of tax expenditure published by Treasury in the annual Tax
Expenditure Statement (TES), but a great deal of mythology has grown up around
such expenditures. The inherent limitations of estimates are often overlooked
and the figures are misinterpreted even against the advice of the Treasury. The
caveats surrounding the estimates amount to a strong warning to users, but one
that often goes unheeded by the critics of particular tax expenditures.
Each tax concession should be assessed on its own merits.
The 50% capital gains tax (CGT) discount is probably
the most unfairly maligned of all tax concessions. There is a strong case that
the optimal capital gains tax rate is zero. It is now part of the folklore
surrounding capital gains tax that the reform in 1999 ‘halved’ the tax on
capital gains. It did no such thing — as there was already an effective
discount for inflationary gains — but there was a reduction in CGT, which was
and remains sound policy. Further easing of CGT would be beneficial. Increasing
the severity of CGT would be damaging to investment, and in any case it would
not meet its advocates’ goal of raising significantly more revenue.
Negative gearing, although not classified as a tax
expenditure, is criticised as a tax ‘rort’ that artificially boosts the demand
for housing, and therefore house prices. However, deductibility of interest on
borrowings made to undertake an investment is nothing more than a specific case
of the general principle that expenses incurred in generating income are
deductible for tax purposes. Rational investors will engage in negative gearing
only in the expectation of future net income, which is taxable. A case for
limiting deductibility of expenses could be justified only if rental income was
in some way taxed concessionally, which is not the case.
Dividend imputation was once proclaimed as one of the
significant reforms of the 1980s, but is now questioned by official inquiries
such as the Henry tax review, the recent Murray Financial System Inquiry, the
recently issued discussion paper for the white paper review. The effect of
imputation is to eliminate double taxation of dividends as both company and
personal income. Tax experts believe the benefits of this have diminished as
Australia has become more open and integrated with global capital markets,
while for the same reason international investment considerations weigh in
favour of a lower company tax rate. Domestic capital market considerations,
however, favour retention of imputation. Ideally both imputation and a lower
company tax rate would apply, but fiscal constraints may preclude this.
Superannuation tax concessions present a large target
to their critics, but the belief that these concessions are grossly excessive
and poorly structured lacks firm foundations. Superannuation, with its
long-term focus, is the best example of why saving needs to be taxed at
relatively low rates to avoid tax-induced distortions. This principle is widely
recognised in tax systems around the world — and Australia is no exception.
Statements often made about the huge fiscal cost of
Australia’s superannuation tax concessions are based on the comprehensive
income tax benchmark for measuring tax expenditures, but the characteristics of
superannuation make it unsuitable for such a benchmark. The most appropriate benchmark
is an expenditure tax under which contributions and fund earnings would be
tax-exempt but end-benefits fully taxed. When measured against such a
benchmark, tax expenditure on superannuation is much lower than commonly
believed, or non-existent.
Apart from the overall fiscal cost, other issues to be
addressed are: the large relativity between superannuation concessions and the
tax rules for other forms of saving; the distributional effects of
superannuation concessions; and the implications of tax-free superannuation
benefits being available as early as age 60.
GST concessions are substantial, and removing some of
them could raise as much revenue as another policy option often flagged:
increasing the rate to 12.5%. In some cases, removing concessions is not
straightforward — for example in education, health and medical services, the
subsidy from government is such a large component (if not all) of the ‘price’
that imposing GST on them would discriminate against private providers. The
problems with an extension of the GST base are least acute in the cases of
uncooked food and water supply. However, equity and compensation issues loom
large.
If reductions in tax concessions are found to be justified,
they should form part of a broad, revenue neutral tax reform with offsetting
reductions in income tax rates.
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