The future of Australia's tax system: opportunity, growth and integrity
Speech to the Corporate Tax and Transfer Pricing Summit
It is always very gratifying, when I come to events like this, to see so many smart people coming together to work through the hard questions about what our tax system should look like for the future.
We’ve come together at a time when these questions could not be more topical, or their answers more contested. For those of us who’ve been toiling away in the tax space for some time, it has been both surprising and exciting to see usually-esoteric issues of tax system design move to the front and centre of the political debate in recent months. People care about tax at the moment; people are interested in tax at the moment, and that means there has rarely been a better time for your ideas to have an impact in the wider community. To be a tax expert today is like releasing a breakthrough pop hit after years of playing in grungy pubs – one morning you wake up, and lo and behold, the world wants to listen to you.
We’ve been hearing a lot recently about how important Australia’s tax system is – how it can support or obstruct growth; how it can encourage investment or scare it away; how it can make us an international magnet for business or see us lag behind in international competitiveness.
As the member of Labor’s shadow ministry whose primary responsibility is tax, I wholeheartedly agree that our tax settings matter. But just as the federal budget is not the entire economy, we shouldn’t confuse building an efficient and equitable tax system with the much bigger task of setting Australia up to grow and flourish.
In my time with you today I want to look at how the tax system intersects with a range of other policy settings and choices which have as much – if not more – influence over whether we can continue as a country of fair opportunity and strong growth. In looking to the global picture and questions about multinational tax policy, I’ll also argue that we should be thinking about Australia’s international competitiveness in far broader terms than how big a tax break companies can get if they do business here.
Let’s start with first principles though.
What is the fundamental point of the tax system? Across the political spectrum, I’d wager you’ll find people agreeing that the tax system exists to provide government with the resources it needs to invest in the things we, as a community, value. In fact, Malcolm Turnbull said as much at the Melbourne Institute’s Economic and Social Outlook Conference just a few weeks ago.
There are always going to be debates about what, exactly, those things are and just how much tax governments should collect to pay for them. But the essential purpose of the tax system is to generate revenue so that governments can invest in the common good. As I’ll talk about in a few moments, that common good includes the things that help businesses and the economy grow.
This central objective has become increasingly muddied in the past few decades as the tax system has been turned to a range of other, more specific tasks. We tax superannuation at a concessional rate because it was hoped this would encourage saving; we allow companies to deduct their research and development spending with the intention of stimulating Australia’s research sector; we tax long-held capital gains at a lower rate than wage income in order to encourage long-term investment.
As economist Saul Eslake pointed out in a recent speech, using the tax system to achieve so many different objectives has left us with a tax base that resembles ‘a giant Swiss cheese’ – that is, full of holes. Putting the onus on the tax system to achieve all of these smaller objectives has left us in the position where we’re no longer achieving the big one: delivering enough revenue for governments to invest in growth. Eslake argues that rationalising the number of loopholes and harmonising the treatment of income and expenditure across our tax system should be our priority going forward. In particular, he suggests we’d do well to ask what the public policy rationale is for each of our current tax settings and whether differential treatment via the tax system is really the best way of achieving that public policy objective.
I like Eslake’s metaphor because it reminds us that while we can use the tax system to do certain things, that doesn’t mean it is the most efficient, effective or fair way to go about it. So let’s look at a couple of examples of this in the context of Australia’s business sector.
An economy which offers opportunity is one where anyone with an idea and the drive can start a business. But what helps new businesses get started and survive? Access to capital in a stable financial system. Quick and easy-to-navigate licensing and regulatory processes. Good quality, reliable infrastructure, especially communications infrastructure like a fibre optic cable that connects right up to your premises. A legal and competition policy ecosystem that protects the rights of new companies and doesn’t lock them out by favouring established players. All of these policy levers are in the hands of government; none are connected to Australia’s tax system.
The tax rate that small businesses pay certainly has an impact on their financial viability. But with only around 600,000 of Australia’s 2.7 million small businesses paying net tax, and 72 per cent being unincorporated, cutting the company tax rate further may not do as much to help Australia’s small business as advocates from some lobby groups sometimes suggest. COSBOA’s Peter Strong acknowledged this point recently when he observed: “None of my people get excited about the tax break.”
Similarly, a short window of tax deductibility like the temporary $20,000 instant asset write-off measure included in this year’s budget may give a brief boost to growth. But when it cuts out at midnight on 30 June 2017, there’s a risk it will detract from growth. That’s why Labor took a different approach to the instant asset write-off scheme we implemented in government, setting the deduction cap at a more sustainable level and making this available to businesses on an ongoing basis, not just for two years.
We were less interested in delivering a temporary boost to retail spending, and more interested in creating an environment that supports stable business growth over the long term. Temporary fiscal stimulus is the right policy if you’re responding to a sudden external shock. But the government didn’t make that case when they introduced a two-year instant asset write-off, and a cynic might well say that the 2017 end date was chosen merely because it gets the government past the next election.
What helps medium-sized businesses grow, and big companies become mammoth ones? Being able to find enough trained workers with the diverse skills that business needs. Investment from partners at home and overseas. Efficient roads, ports and rail which support high productivity. A predictable political system that minimises sovereign risk.
Again, these are all levers that government can pull: we can invest in infrastructure or let it crumble. We can work to ensure all Australians have the skills and training to succeed in a changing workforce, or we can let luck and demography determine who benefits from a quality education. We can push on with reforms to our democratic institutions or let these succumb to the weight of their history.
The sole growth lever here that is closely connected to the tax system is investment. Now, if you only read some commentators, you would quickly come to the view that cutting Australia’s corporate tax rate in order to encourage investment is the most pressing public policy issue out there.
Not getting Australia’s 800,000 unemployed back into work, reducing inequality or cutting our carbon emissions. Not skilling our young people for a changing economy, or ensuring all Australian families are equal before the law. The chorus of voices calling for a cut to the corporate tax rate is loud and growing, but we need to keep some perspective here when considering options for change.
Australia’s corporate tax rate is 28.5 for small businesses and 30 for everyone else. But unlike most countries, we also have dividend imputation. That returns around one in every three dollars of corporate tax revenue to domestic citizens in the form of franking credits. In terms of the revenue we raise, a 30 percent tax rate with imputation is roughly equivalent to a 20 percent company tax rate without imputation.[i] (As a simple rule, you shouldn’t take seriously anyone who wants to talk about Australian company tax rates but doesn’t mention imputation.)
Now let’s look around the globe. The richest country in the world, the USA, has a corporate tax rate of 35 per cent. Germany, the European Union’s economic powerhouse, has a rate of 29.65 per cent. Across the world’s 10 largest economies, the corporate tax rate currently averages 29 per cent.
I expect to hear the immediate rebuttal that Australia is no USA, or even a sunnier version of Germany. So what about the resource-rich countries of Latin America then, which Australia has recently been competing with for foreign investment in the mining and resource sectors? Argentina’s company tax rate is 35 per cent. Brazil’s is 34.
In the World Bank’s most recent ranking of countries by GDP, Australia sits at number 12 – one spot behind Canada, which has a corporate rate of between 26 and 31 per cent depending on the province.
On the other hand, New Zealand – a country whose tax system the current government frequently suggests we should emulate – comes into the GDP ranking 42 spots lower at number 54 on the list. Singapore, which is another country some have suggested Australia compete with in the global tax game, is 24 spots behind us at number 36.
My point? Countries like America, Germany and even Brazil are powerhouse economies because they invest in growth. They build efficient rail and port systems that let companies be more productive and get their products to market more quickly. They fund research and development that leads to breakthrough new products and billion-dollar firms. In Germany’s case in particular, they support an education system that delivers workers with world-class skills, whether through university, a high-quality apprenticeship or other vocational training.
These countries are able to invest in the building blocks of growth because they expect the companies that benefit to contribute fairly to the revenue base which funds them. These countries invest so that their companies can grow. As companies grow, they contribute to the revenue base that enables further investment. Smart public investment in human and physical capital makes for more profitable firms. That’s a virtuous circle.
It’s the kind of virtuous circle we can create in Australia if we stop talking about a race to the bottom with countries much poorer than we are; and start thinking about how we join the pack with the world’s richest and most successful economies.
Of course, we can’t be complacent about where our tax rate sits in comparison with the rest of the world. After all, China’s corporate tax rate is now at 25 per cent, and the United Kingdom is progressively lowering its rate below 20 per cent. We need to keep an eye on international developments, and particularly consider how our tax rate affects investment and growth.
That’s why Bill Shorten and Chris Bowen have outlined Labor’s long-term objective to lower Australia’s small business tax rate to 25 per cent. We know this can’t be done tomorrow with the deficit as it. And it can’t be done while ever Commonwealth spending exceeds revenue by a full 1.5 per cent. But we’ve called on the Government to work with us on achieving that objective in the years ahead because we understand the corporate tax rate is part of the calculus that affects investment.
Let me be very clear however: a lower corporate tax rate alone will not make Australia a strong and competitive economy. If we want to be like the world’s richest countries, we need to invest in growth – just as they do.
One of the ways we’ll get to a lower rate in the long term is by ensuring that the tax net is as tight as it can be. A robust system where every company pays 25 per cent may well deliver a stronger revenue base than one where companies can use loopholes to avoid paying anything near the current rate of 30 per cent.
That brings me neatly to the question of tax integrity in a globalised business environment, which is what I’d like to spend my final few moments with you talking about.
In March this year Labor announced a $7.2 billion tax package to ensure big multinationals pay their fair share. This was the first time in decades that an opposition has put forward a fully costed, significant revenue package during the first half of the Parliamentary term. We have consistently argued that our package, delivered in concert with full implementation of the OECD’s multilateral Base Erosion and Profit Shifting Action Plan, would tighten Australia’s tax net and protect our revenue base into the future.
Our plan has several parts:
First, we propose revising the current thin capitalisation rules to reduce the amount of debt that companies can claim deductions for in Australia. Companies would no longer be able to automatically claim deductions up to a 60 per cent debt-to-equity ratio for their Australian operations.
Second, we propose to better align Australia’s rules on hybrid entities and instruments with tax laws in other countries. These are often classified differently around the world, with some jurisdictions treating their assets as equity, and others as debt. Standardising the rules would reduce opportunities for companies to ‘double-dip’ by claiming tax exemptions in one country and tax deductions in another.
While pursuing these reforms, Labor will also invest new resources in the Australian Tax Office. After major budget cuts under the Abbott Government, Labor will ensure the tax office has the resources it needs to identify and investigate multinational profit shifting.
Labor’s package is one that can be implemented alongside the changes the Government has proposed in the bill which it currently has before the Parliament. Their approach primarily looks at strengthening the anti-avoidance provisions in Part IV A of the Tax Act, using an approach which is untested in the international arena. In fact, they’re so uncertain about the impact of their plan that the Budget papers only contain a series of asterisk where there should be revenue estimates.
We are supporting the Government’s bill through the Parliament, with some important amendments which were negotiated in the Senate last week. These amendments would effectively reverse the Government’s recent attempt to gut Australia’s tax transparency laws. As a result, private companies earning more than $100 million a year would continue to be included in transparency reports published by the Australian Tax Office.
Labor has consistently supported tax transparency. We introduced the original tax reporting laws in 2013, and vigorously opposed the Government’s attempts to water these down. Tax transparency matters because without it, we have no way of knowing if big companies are paying their fair share. There are plenty that do, and their contribution deserves acknowledgement.
More importantly though, it is clear that some firms don’t. When companies are paying tax at a fraction of the standard rate, Australians should ask why. At a time when the government is talking about raising the GST to 15 per cent – a decision that would hit low-income Australians hardest – it is right that we should look closely at whether all taxpayers are making a fair contribution.
In restoring tax transparency while supporting the key multinational tax provisions, the Senate greatly improved the Government’s Bill. Yet when the Bill returned to the House for a final vote, the Government chose to block the amendments. They are delaying the passage of the entire multinational tax package simply to shield a handful of very large firms from scrutiny of their tax affairs.
Worse, Treasurer Scott Morrison is now attempting to bully the Senate crossbench into withdrawing the amendments which they thoughtfully negotiated and voted on in good faith. We need fewer temper tantrums from the Treasurer on this issue, and more recognition that transparency is in the public’s interest.
While Labor has given our support to the Government’s first steps on multinational tax, we don’t believe they go far enough. We are particularly concerned that the current package does not address the practice of companies loading debt into Australia to artificially inflate their tax deductions. Thanks to the ongoing corporate tax inquiry and other sources, we know that some big companies are transferring money into their Australian arms and dressing this up as a loan, even though it's really just shifting money from one pocket to the other. In paying back these artificial loans, companies can send their profits overseas while pocketing a tax deduction at the same time.
That's the problem Labor's package zeros in on. By moving to a world-wide gearing ratio approach, companies would only be able to claim deductions against the average amount of debt they owe to banks around the world.
It's a simple plan: if a company owes a lot to the banks, then it can claim a lot back in tax deductions. But if it doesn't owe the banks a cent, and all its debt is in opaque internal loans from overseas subsidiaries, this would no longer be a basis for claiming subsidies. After all, those deductions are effectively paid for by other Australian taxpayers.
The world-wide gearing ratio is already written into Australia's tax law, along with two other deduction tests. Adopting our plan simply means getting rid of those other two tests that lack a sound economic rationale.
Labor’s plan was grounded in careful OECD work, and costed by the Parliamentary Budget Office. Under Tony Abbott and Joe Hockey, the Liberals rejected it out of hand for purely political reasons. Joe Hockey had barely put down the morning papers reporting on our plan before he was out in the media crying doom, disaster and the end of business investment as we know it if Australia followed the OECD’s advice on debt deductions. I would urge Malcolm Turnbull and Scott Morrison not to make the same mistake.
Australia needs a tax system that rewards the productive, the innovative, the resilient, the clever and the competitive. Not a tax system that rewards those willing to push the envelope the furthest.
Australia is an importer of capital, and we have always needed investment from overseas. So we need a plan to win investment from the world, yes. But this plan should work because big firms think it is worth buying into Australia – not because our government thinks they have to cut special deals that sell us out. A plan that leverages the ingenuity of the Australian workforce, the strength of Australia’s institutions and the quality of Australia’s infrastructure.
Quite simply, our plan for winning investment from the world should not be premised on how big a tax break companies can get here because that is not a competition we’re ever going to win. It comes back to the point I made a few moments ago: if we want to join the countries at the top of the global league table, we need to invest in growth, not engage in a race to the bottom with our tax rate.
The multinational tax bill currently before the Parliament must not be the end of efforts to tighten Australia’s tax net.
In recent weeks the OECD has handed down the final set of deliverables for its Base Erosion and Profit Shifting Action Plan. This plan has been more than two years in the making and lays out a comprehensive 15-point agenda to close the loopholes that have opened up in the tax net due to changing technology and an increasingly global business environment.
The 15 items on the action plan tackle everything from the taxation of intangible goods to hybrid instrument rules and the creation of a multilateral tax instrument to allow more rapid coordination of rules between OECD countries in the future. Australia is making progress in some of these areas – for example, the effort to extend the GST to digital downloads, which was supported by both Labor and Liberal state and territory governments. But there is still a lot of work to do.
The Treasurer has the OECD’s blueprint and with it, the chance to take positive, practical steps to fix more of the loopholes in our tax system. His predecessor constantly put off acting by saying it was important for Australia to move with the rest of the OECD in tightening our tax laws. Well, the OECD’s plan is now on the table. There should be no more excuses and no more delays when billions of dollars in tax revenue are potentially at stake.
Everyone in this room is a tax wonk. We are all deeply engrossed in the intricacies of tax system design. But as much as tax fascinates us, we shouldn’t forget that it is a means to an end.
As I said at the outset, the tax system exists to provide government with the resources it needs to invest in the things we, as a community, value.
We value growth. We value opportunity.
If we want to continue Australia’s quarter-century run of economic sunshine, then we need to invest in growth; invest in opportunity. We cannot do that without a stable and sufficient revenue base.
Corporate tax will always be an important component of Australia’s revenue base, through that virtuous circle of investment feeding growth and growth feeding investment.
Our priority should be to get the settings right so that everyone pays their fair share of tax, at a reasonable rate, and on as consistent a base as possible. That’s Labor’s goal for tax reform.
It’s part of our much broader aim to ensure Australia continues to be a country of strong growth and fair opportunity – today and in the years ahead.
[i] Geoffrey Kingston points out that there are a range of ways to do this calculation. For example, he notes that in 2012 dividend imputation returned $19 billion out of $65 billion in company tax revenue. Geoffrey Kingston, Dividend imputation or low company tax? Finsia Journal of Applied Finance, No.2, 2015