A taxing problem.

The first reaction to the possibility of tax debate has to be a humanitarian one: if John Howard has such a dull life that only `the great adventure of tax reform' is able to generate any excitement for him, then he deserves our sympathy. Further reflection, however, suggests that something more sinister is afoot. The relentless propaganda for a Goods and Services Tax (GST) is the spearhead of a renewed campaign to shift the burden of taxation even more from the rich to the poor.

Contrary to all the hyperbole, the Australian tax system is not in a state of profound crisis, and its `reform' is neither a necessary nor a sufficient condition for a dramatic (and much-needed) improvement in economic performance. Nevertheless there are serious problems.

1. The continuing shrinkage of the personal income-tax base under the influence of a wide range of rorts, all of which benefit the well-heeled (income splitting, family trusts, overseas tax havens, dividend imputation, negative gearing, and a rate of corporate income tax that makes it folly not to incorporate yourself).

2. The notorious and long-standing problem of `vertical fiscal imbalance': the Commonwealth raises the revenue and the States spend it. This was, of course, dramatised by the 1997 High Court decision on the unconstitutionality of state franchise fees (which should not have taken anyone by surprise, as the case had been rumbling on for years).

3. The irrationality of the present indirect tax system, which bears almost entirely on goods and hardly at all on services. There is no good reason why tax should be payable on cookers but not on restaurant meals, on washing machines but not on laundries, on televisions and video recorders but not on going to films.

In principle, at least, the first problem could be solved by changing the law to close the loopholes. There are still areas of the world where a progressive income tax raises a large proportion of government revenue, and all the traditional ethical arguments in its favour still apply. A GST would do precisely nothing to solve the second problem: being a tax on goods and services it could only be levied by the Commonwealth, leaving the States every bit as dependent on Canberra as they are at present (more so, if the proceeds are used to replace current State taxes).

The only serious case for a GST is in relation to the third problem. The Melbourne University economist John Freebairn has estimated that a 10.9 per cent consumption tax would be required to raise the $25.9 billion needed (in 1995-6) to replace the present wholesale sales tax, payroll tax, stamp duties and financial institution duties. If food, education and health expenditure were to be exempt, this would rise to 15.6 per cent. This, let it be noted, leaves the income tax system unchanged: to deliver cuts in personal income tax, a higher (much higher) GST would be needed. Note, too, that three of the four taxes to be abolished are levied by the States, so that a Freebairn GST would worsen the problem of vertical fiscal imbalance. Nor would it deliver to the farmers Tim Fischer's promised cut in fuel taxation (and a good thing, too), or reduce the highly regressive but socially justifiable taxes on alcohol and tobacco.

Freebairn's is a minimalist position, a modest proposal for a small but useful reform. No one expects it to eliminate the trade deficit, restore full employment or double the rate of economic growth. There is no reason to suppose that a full-blooded 25 per cent GST, accompanied by substantial cuts in income tax, would perform any of these miracles. In their hearts the economic rationalists know this, which is why they continue to place much more emphasis on labour-market deregulation (read, union-bashing) and competition policy (ditto) than on fiscal reform. More radical economists might instead stress failures in interest rate, exchange rate and industry policy. However, as we seem doomed to have a `tax debate', like it or not, it might be worthwhile considering some really adventurous options in the hope of shifting the focus away from the objectionable (and boring) topic of GST. Here are five suggestions to begin with.

A progressive consumption tax

The case for taxing consumption developed from the Left by the Cambridge economist Nicholas Kaldor almost half a century ago. Kaldor's proposal differs from GST in that it is levied upon each individual consumer once a year, rather than on every particular transaction. The tax rate would therefore depend on the individual's annual consumption expenditure, and not (as with GST) on the nature of the goods or services consumed. The rate structure could thus be as progressive as that of the present system of income taxation, whereas with GST there would be overwhelming pressure in favour of a single rate, or at most two or three lower rates for food and other basic necessities.

Kaldor pointed out that a consumption tax of this type had been endorsed by an impressive list of social theorists, few of them especially radical, from Thomas Hobbes through John Stuart Mill to Alfred Marshall, A. C. Pigou, Irving Fisher and Luigi Einaudi. It was also supported--with serious reservations as to its practicability--by John Maynard Keynes. Their principal argument was one of equity. Income is not a fair measure of the capacity to pay, since it ignores the ability of the wealthy to finance consumption expenditure through dis-saving--that is, spending out of capital, or running down wealth. Income taxation thus contains `a bias in favour of property owners whose taxable capacity is underrated relatively to those who derive their income from work'. A progressive expenditure tax, on the other hand, `would tax people according to the amount which they take out of the common pool, and not according to what they put into it'. It would in addition encourage savings. Unlike a GST, a progressive consumption tax would bear most heavily on the rich. Opposition to it, Kaldor believed, would come from the wealthy, who would be keen to defend `the protective barrier which the very inefficiency of the existing instruments of taxation provides against the danger of further encroachments of the egalitarian tide'. (This was written in 1955). Never one to understate his case, Kaldor concluded that, if expenditure were to replace income as the taxation base, `so far from making the rates more progressive it would be essential ... to reduce the scale of progression of the rates quite considerably if a revolutionary change in the position of different social classes were to be avoided'.

In the event a Kaldor tax was not introduced in the UK, in part because of these political and distributional consequences, and partly due to the administrative complications which, Kaldor acknowledged, would have posed a major problem for his proposal. It seems never to have been seriously considered in Australia.

A wealth tax

Kaldor discussed a number of imperfect substitutes for a progressive consumption tax, including the taxation of capital gains and the direct taxation of capital ownership. The former, of course, already exists in Australia, and is one of the very few fiscal measures which reflect any credit on the Hawke-Keating Labor Governments. Wealth taxation is another matter altogether. With the exception of State land-taxes and local council rates, capital has always escaped taxation in Australia (and the recently announced changes to water pricing arrangements in Victoria represent a further small move away from the taxation of wealth). In terms of social justice this is very hard to justify, and its omission from the 1996 ACOSS document on taxation reform is difficult to understand. By almost any standard, the rich derive advantages from their ownership of wealth over and above the income that it provides for them. Social status and economic security are two of the evident benefits of being wealthy. Wealth brings with it the ability to spend more than you earn in any given period, either by self-financing (dis-saving, running down your wealth) or by being able to borrow on the security of your assets at relatively very low interest rates.

Even a small wealth tax, levied only on the very rich, would raise substantial sums in revenue, as the following back-of-an-envelope calculations suggest. The Treasury estimates total private sector wealth in 1997 to have been $1.9 trillion. Thus an average wealth tax of 1 per cent would yield $19 billion annually, or almost three-quarters of the yield from Freebairn's minimalist GST. The tax could be structured so that the threshold was very high (well over $1 million, for example), with a top marginal rate for the super-rich of 2 per cent or 3 per cent. More modestly, a wealth tax might be confined to the top 1 per cent, the lucky 50,000 Australian families who together own $230 billion-worth of assets, or 12 per cent of the total national wealth. A 3 per cent flat tax rate on these plutocrats would raise a handy $6.9 billion annually. Various intermediate possibilities might be considered. (Data on the distribution of wealth are taken from the Melbourne Age, 1 October 1997).

A wealth tax might reduce saving by the very rich, but this disadvantage would be offset by the positive effect on the efficiency of investment, since it would provide a incentive for them to shift to higher-yielding (and presumably more productive) assets. The principal objection, inevitably, is political. In the past, wealth taxation has been a sure election loser, despite its apparently uncontroversial operation overseas.

A capital transfer tax

A slightly less contentious possibility would be to restrict capital taxation to inherited wealth, exempting the self-made woman and the genuinely thrifty by reintroducing taxation of the blatantly `unearned' wealth of Lachlan Murdoch, James Packer and the like. The pre-1983 system of death duties is not a serious contender, since it could be avoided very easily by means of inter vivos gifts and become, in effect, a voluntary contribution. A Capital Transfer Tax is a much more attractive proposition. Restricted to gifts and bequests of (say) more than $1 million in any year, it would be levied on recipients--not on donors or deceased estates--at their marginal rate of income taxation.

Since capital is for the most part transferred by conveyance or other legal deed, and not by brown paper bags full of banknotes, such a tax would be difficult to avoid. It would be a small but useful revenue raiser. If, for example, the richest 1 per cent live on average for seventy-five years, and transfer 1.33 per cent of their wealth to their sons and daughters each year, a Capital Transfer Tax at 47.5 per cent would yield approximately $1.5 billion annually (0.475 x 1.33 per cent x $230 billion). Extending the tax base to the top 10 per cent of wealth-owners might treble the potential revenue. It would be reduced somewhat by exempting transfers to spouses and dependent children (though the ACOSS proposal to exempt `family farms' would open a very large loophole).

To a very large extent these first three proposals are alternatives, in descending order of preference. There is a lot to be said for a progressive tax on consumption, which would render superfluous the separate taxation of wealth or capital transfers. A wealth tax would be a second-best solution, and since a large majority of really large fortunes are inherited this would remove any pressing need for a capital transfer tax. But the yield from the latter would fall short, by an order of magnitude, of the amount needed to eliminate payroll tax, or reduce the burden of income taxation on the working poor, or to restore state finances in the wake of the High Court decision, let alone a combination of these three worthy goals. However, all is not lost. Two additional new taxes might help to fill the gap.

The Tobin tax 

The case for a tax on foreign exchange transactions, first proposed by the US Nobel laureate James Tobin, will have gained increased support in our region since the South-East Asian currency upheavals of mid-1997. The argument in favour of a Tobin Tax is simple and compelling. Foreign-exchange transactions are overwhelmingly speculative in nature: $300 trillion a year in 1995, worldwide, up 50 per cent since 1992 and no less than sixty times the amount required to finance world trade. (I have taken these figures, and much of the argument in this section, from a recent paper by Philip Arestis and Malcolm Sawyer.) Contrary to the belief of many mainstream economists, foreign-exchange speculation is not akin to arbitrage--smoothing out otherwise excessive price fluctuations--but is instead profoundly destabilising. By creating uncertainty it discourages trade and investment; by increasing the power of financial markets over governments, it inhibits the adoption of sensible macroeconomic policies and in particular deters attempts to stimulate aggregate demand in order to reduce unemployment. Foreign-exchange speculation absorbs significant amounts of real resources (clever people in expensive offices) that could be used more productively. It is a zero-sum game--`rent-seeking behaviour' par excellence.

A Tobin Tax might well appeal to conservative regimes as a libertarian alternative to the Mahathir solution (which involves the use of the Internal Security Act and perhaps the firing squad as a last resort). Its relevance to the Australian tax debate lies in its revenue potential. Based on 1995 transactions volumes, Arestis and Sawyer estimate a global tax yield of $200 billion, of which Australia's share would be approximately 3 per cent. In local currency a 0.25 per cent Tobin Tax would have raised well over A$8 billion in 1995. The 1998 yield would almost certainly be higher, possibly $10 billion.

There are, of course, some snags. An obvious tension exists between the revenue-raising and speculation-deterring effects of the tax: the more it eliminates financial parasitism, the lower is the tax base. There will certainly be opportunities for avoidance and evasion, though they could well be less than in the case of a GST. And there are significant political problems. A Tobin Tax could not feasibly be introduced piecemeal, on a country-by-country basis; international agreement would be necessary. The speculators will undoubtedly howl like the proverbial scalded cat and, as we are dealing here not just with maverick billionaires like George Soros but also with every bank and transnational company in the developed world their cries of pain will be heard in every cabinet room. Arestis and Sawyer suggest a more positive way of looking at it. The very fact of introducing a Tobin Tax would signal a welcome decline in the political influence of the financial markets. And $10 billion a year for the Australian Taxation Office.

A carbon tax

As part of their proposed Environmental Taxation Reform package, Clive Hamilton, Tor Hundloe and John Quiggin have suggested the introduction of a tax on carbon dioxide emissions, the revenue from which would be used to eliminate payroll taxes. A Carbon Tax would bring substantial environmental benefits, reducing both urban air pollution and greenhouse gas emissions. Australia is probably the world's largest producer of greenhouse gases in the world, per head of population (30 per cent more than the United States, for example). This has already become a source of diplomatic embarrassment for the Howard Government. Global warming will eventually have serious adverse economic consequences: one European Union study estimated a permanent reduction of 1.6 per cent of world GDP for each one degree of warming.

A Carbon Tax set at $23 per tonne of carbon dioxide equivalent (at 1992/3 prices) would yield $6.3 billion per year, enough to compensate for the abolition of payroll taxes. Phased in over three years, it would raise fuel prices by an average of 43 per cent. At the retail level the impact on consumers would be much less: price rises of 7 per cent for petrol, 17 per cent for gas and 21 per cent for electricity. The net effect, allowing for the benefits expected to accrue from the elimination of payroll taxation, would be small but valuable increases in national income, real wages and employment, a slightly lower price level, and a reduction of 11.7 per cent in Australia's greenhouse gas emissions. These are short-run estimates. In the longer term, the emission reductions would almost certainly be larger, and the induced shift to (relatively labour-intensive) renewable energy sources would increase employment quite significantly.

The Carbon Tax would be mildly regressive, since poor households spend a larger proportion of their incomes on fuel than do the more affluent. But the equity impact would be much less than that of a GST, and the poor could be compensated by quite small increases in welfare payments. They would benefit more than the rich from the reduction in pollution, which is itself a regressive phenomenon. And to be Australian would no longer be a source of shame when global climate change is under the international spotlight.

Conclusion

There are thus many alternatives to a GST, all of them preferable in terms of equity and most of them easier to administer and more advantageous on efficiency grounds. None of them solves the fiscal crisis of the States, but nor would a GST. It would be good to see the ALP taking the initiative in the `great tax debate' and aggressively advocating at least some of them. Personally, I am not holding my breath.

John King teaches economics at La Trobe University.