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PROTECTING PROSPERITY: WHY WE NEED TO TALK ABOUT TAX - PWC
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            Protecting prosperity:
            Why we need to talk
            about tax

July 2013

                                            Australia faces a historic choice
                                            in the years ahead. It could cut
                                            government services radically,
                                            it could build tax revenues by
                                            incremental change, or it could
                                            prioritise growth through
                                            carefully targeted expenditure
                                            cuts and tax reform.
PROTECTING PROSPERITY: WHY WE NEED TO TALK ABOUT TAX - PWC
Australia’s challenge
                   After 22 years of continuous economic growth,            This conversation is overdue
                   Australia now faces the risk of falling incomes and
                   increasing government debt.                              This is an issue that will not go away. As part of a
                                                                            broader community discussion about the challenges
                   PwC estimates that the combined annual deficits of
                                                                            Australia faces, we need an informed and intelligent
                   Australian governments will rise:
                                                                            conversation on tax. Leaders of civil society, business,
                   • from $27.4bn (1.9% of gross domestic product           unions and the public policy community must drive
                     [GDP]) in 2011-12 to $213.5bn (3.5%) by 2039-40        this conversation if we are to realise the benefits
                     and to $583.1bn (5.9%)by 2049-50.                      across all parts of society. The overall objective is two-
                   And our governments’ debt levels as a proportion         fold: economic growth, and enhancing the wellbeing
                   of GDP will rise:                                        of the Australian public.

                   • from 12.1% in 2011-12 to 32.9% by 2039-40              This report is PwC’s contribution to the debate. In it,
                     and to 77.9% by 2049-50.                               we do not recommend an optimal package of taxes.
                                                                            Rather, we seek to emphasise that there is scope for
                   These trends are unsustainable as the population ages.   raising government revenues while maintaining, or
                   Australian governments risk not being able to meet       even encouraging, continued economic growth and
                   the key needs of our community and a further slide       a fair and equitable approach to the vulnerable in
                   into debt. And higher debt at the Commonwealth level     our community.
                   would mean that another shock like the GFC in the
                   next few years could see its debt climb to 30% of GDP
                   by 2025-26.

                   We believe there is a clear need for comprehensive tax
                   reform – done the right way. The ‘right way’ means       Luke Sayers
                   increasing those taxes that have the least effect on     CEO, PwC
                   investment and employment, and at the same time
                   reducing reliance on taxes that distort incentives
                   to work, invest and transact business. It also means
                   addressing those factors which increase the complexity
                   of the tax system and the cost of compliance.

                   Such a reform would complement a reinvigorated focus
                   on productivity, and higher workforce participation
                   from older Australians and women with children.

                   And a good, comprehensive tax system needs to be
                   equitable. Any reform will need to include carefully
                   targeted compensation packages and an examination
                   of personal tax, company tax rates and concessions,
                   retirement funding, retirement age, and welfare
                   transfers.

2   Protecting prosperity | Why we need to talk about tax
Acknowledgements
We would like to acknowledge the following people who          Tax Experts Group
provided input and contributions to the matters discussed in
this publication:                                              Comprising the following Heads of Tax:

                                                               Adele Raj-Manning, Lion
Advisory Panel
                                                               Anne Richardson, Asciano
David Flanagan, Chairman, Atlas Iron
                                                               Anthony Portas, Anglo American Metallurgical Coal
Dr Lynne Williams, Economic consultant and board director
                                                               Darren Day, Woolworths Limited
John Daley, Chief Executive Officer, Grattan Institute
                                                               Frank Drenth, Corporate Tax Association of Australia
Launa Inman, former Chief Executive Officer, Billabong
                                                               John Condon, BP Australia
Louise Tarrant, National Secretary, United Voice
                                                               Kathryn Davy, News Limited
Mike Callaghan, former Deputy Secretary, Australian
Treasury                                                       Stephen Green, ANZ (now retired)

Nicola Ballenden, Representative, Brotherhood of               Tony Merlo, BHP Billiton
St Laurence
                                                               While the guidance provided by the Advisory Panel and Tax
Professor John Freebairn, Ritchie Chair, Department of         Experts Group has been most welcome, PwC acknowledges
Economics, Melbourne University                                sole responsibility for the final document and recognises
                                                               that members of the Advisory Panel / Tax Experts Group
Robert Neale, Chief Executive Officer, New Hope
                                                               may not agree with all matters referred to in the publication.
Corporation Limited
                                                               Information presented in this report refers to PwC analysis.
Ross Barker, Chief Executive Officer, Australian Foundation
                                                               Where indicated, this refers to PwC’s projections of economic
Investment Company
                                                               growth and government finances, which have been estimated
Toby Hall, Chief Executive Officer, Mission Australia          at both the state and national levels. These estimates are
                                                               based on the methodology used in the Commonwealth
                                                               Government’s intergenerational report, underpinned by the
                                                               ‘three Ps’ of population, participation and productivity. The
                                                               long-term projections of economic growth and government
                                                               finances take current government economic and finance
                                                               forecasts as a base. Trend growth rates over the longer term
                                                               are a function of the historical data and the assumptions are
                                                               based on data from official sources.

                                                                           Protecting prosperity | Why we need to talk about tax   3
4   Changing the tax landscape | A case for genuine tax reform
Contents

 06
 Executive
                        15
                        The case for
                                                               27
                                                               Why do taxes
 summary                action                                 affect economic
                                                               growth?

 33
 What are the
                        44
                        What could a
                                                               47
                                                              The way forward
 features of a ‘good’   change in the tax
 tax system? How        landscape deliver?
 does the Australian
 system measure up?

                                 Changing the tax landscape | A case for genuine tax reform   5
Executive summary
Australia is facing fundamental
challenges in maintaining prosperity
                                                  But the community, the unions,
                                                  business and public policy specialists
                                                                                                                             The case for action
into the future.                                  all need to be involved. They need to
                                                                                                                             Australia has enjoyed more than over
• Real income growth and strong                   understand the why and how of tax
                                                                                                                             22 years of largely continuous growth
  budgets are at risk if productivity             reform – and in particular, why it has
                                                                                                                             in real income per person (Figure 1):
  stays low and export prices fall.               generally failed in the past. There are
                                                  questions we need to ask, and answer,                                      • In the 1990s and early 2000s
• An aging population will                                                                                                     this flowed primarily from
                                                  before any decisions can be made.
  progressively increase the                                                                                                   productivity growth.
  proportion of the community                     And above all, the overriding two-fold                                     • From the mid-2000s, while
  dependent on those who are                      objective – to ensure growth, and at                                         productivity declined, this position
  producing income and put pressures              the same time enhance the wellbeing                                          was maintained because the
  on aged care spending.                          of Australians – must remain at the                                          prices of our exports, particularly
• These factors could lead to falls in            centre of the debate.                                                        minerals, rose and the prices of
  real per-person income for the first                                                                                         our imports – such as televisions,
  time in a quarter of a century, and                                                                                          computers and cars – fell.
  unless we rebuild strong budgets,
  governments might not be able to
                                                  Figure 1: Disposable income per person and GDP per person, Australia,
  cushion us from the next global
                                                             annual % change
  shock as they did from the GFC.
• State/territory governments in                   8%

  particular face a great challenge                                                                                           Dot-com bubble
  because the demands they face have               6%
                                                                                                                                                                                          GFC
  grown faster than GST revenues.
                                                   4%
• Ultimately, simply cutting waste
  is not going to be enough to do
                                                   2%
  everything we wish. Significant
  action is required to enable                     0%
  governments to boost revenues and
  address current deficits.                       -2%

Tax reform is the most comprehensive
                                                  -4%
way of addressing these issues. And if
we do it the right way – by ensuring we                                                      Asset-price bubble
                                                  -6%
lift only those taxes that have the least
                                                            1986-87

                                                                      1988-89

                                                                                1990-91

                                                                                             1992-93

                                                                                                       1994-95

                                                                                                                 1996-97

                                                                                                                           1998-99

                                                                                                                                     2000-01

                                                                                                                                                  2002-03

                                                                                                                                                            2004-05

                                                                                                                                                                      2006-07

                                                                                                                                                                                2008-09

                                                                                                                                                                                                2010-11

effect on economic growth, reduce our
reliance on taxes that are damaging,
and direct any compensation                                                               Disposable income per person                         GDP per person
measures to the most vulnerable –
                                                  Source: ABS Cat No. 5204.0
then tax reform can also help us drive
productivity growth and lift real
incomes per person.

6   Protecting prosperity | Why we need to talk about tax
Since the early 1990s, governments          Unless we rebuild strong budgets, the                                   • geo-political stress in east Asia
at all levels were able to build a          Commonwealth Government might                                             as China grows in economic and
strong budget position, with low            not be able to cushion us from the                                        military strength
debt levels, due to a combination of        next economic shock as it did from the                                  • a crisis in the Middle East
asset sales, strong revenue growth          GFC. A global shock in the next decade
                                                                                                                    • irrational exuberance or an asset
and some expenditure restraint.             could result from:
                                                                                                                      price bubble.
However, real income growth and             • the unresolved sovereign debt issues
strong budgets in the future are both         in the eurozone
at risk if productivity stays low and
                                            • soaring government debt in Japan
export prices fall. This could result
in falling real income per person for       • failed attempts to control the United
the first time in a quarter of a century.     States fiscal deficit
Exacerbating this problem is an aging       • efforts in China to restructure its
population, which over time will              economy and wind back stimulus
reduce labour market participation
rates and earnings, while at the same
time adding to government costs.
                                            Figure 2: Primary balance: Commonwealth and state/territory
Without changes in government                          governments, % of GDP
spending and a broader trend towards         4%

addressing participation, productivity,
and tax reform, PwC estimates that           2%
the combined annual deficits of
Commonwealth and state/territory
governments will rise from $27.4bn in        0%

2011-12 to $213.5bn by 2039-40 and
to $583.1bn by 2049-50 (Figure 2).          -2%

                                            -4%

                                            -6%
                                                    2001-02

                                                                                                                                                                                   2049-50
                                                              2005-06

                                                                                  2013-14

                                                                                            2017-18
                                                                        2009-10

                                                                                                                    2025-26

                                                                                                                                 2029-30
                                                                                                          2021-22

                                                                                                                                           2033-34

                                                                                                                                                     2037-38

                                                                                                                                                               2041-42

                                                                                                                                                                         2045-46
                                                                                                      Commonwealth            States

                                            Source: PwC analysis
                                            Note: The primary balance is defined as the difference between revenues and expenditures, excluding interest
                                            transactions. This chart uses official budget forward estimates where they are available. To this extent it relies on
                                            budget estimates of future revenue growth and expenditure paths. It is based on an assumption of a steady 1.5%
                                            improvement in productivity each year.

        Australia has enjoyed
        more than 22 years of
        largely continuous growth
        in real income per person

                                                                                                      Protecting prosperity | Why we need to talk about tax                            7
Another shock like the GFC could                  Figure 3: GFC type shock in 2016-17, primary balance,
accelerate the slide towards deeper                          Commonwealth Government, % of GDP
government debt (Figure 3).
                                                    4%
State governments face a particular
challenge because the income they
receive from the GST and their own                  2%
tax bases has grown more slowly than
the demands they face. This trend is
expected to continue into the future,               0%
without significant changes to either
the breadth of application or rate of
GST.                                               -2%

Based on these trends, it is estimated
that total general government debt                 -4%
will grow for all levels of government,
with the cumulative deficits as a
proportion of gross domestic product               -6%
(GDP), rising from 12.1% in 2011-
                                                            2001-02

                                                                                                                                                                                             2049-50
                                                                      2005-06

                                                                                            2013-14

                                                                                                       2017-18
                                                                                2009-10

                                                                                                                                 2025-26

                                                                                                                                           2029-30
                                                                                                                    2021-22

                                                                                                                                                     2033-34

                                                                                                                                                               2037-38

                                                                                                                                                                         2041-42

                                                                                                                                                                                   2045-46
12 to 32.9% by 2039-40, and then
to 77.9% by 2049-50. Rising net
debt levels for governments also                                                          Commonwealth: Base case               Commonwealth: GFC-type shock

means increasing costs associated
with servicing interest payable on                Source: PwC analysis
                                                  Note: This chart uses official budget forward estimates where they are available. To this extent it relies on
this public debt. Figure 4 shows the              budget estimates of future revenue growth and expenditure paths. It is based on an assumption of a steady 1.5%
path of debt with capitalised interest            improvement in productivity each year and with the addition of a GFC-type shock to revenue and expenditure.
if these costs are not met along the
way. In particular, it highlights that
debt interest payments contribute                 Figure 4: Total public net debt: Commonwealth and state/territory
to almost half the total liabilities (or                     governments, with public debt interest capitalised from 2016-17,
                                                             % of GDP
34% of GDP) by 2049-50.
                                                   80%
In this calculation, ‘interest
payments’ are based on current
interest rates and no allowance has                60%

been made for any increase which
might occur if the financial markets
                                                   40%
become less confident in Australia’s
creditworthiness or if global interest
rates increase from their historically             20%
low levels. Higher interest rates
would make Australian governments
progressively more vulnerable                       0%
to interest rate shocks. Recent
experience in the European Union
shows how rapidly rising interest rates            -20%
                                                            2001-02

                                                                                                                                                                                             2049-50
                                                                      2005-06

                                                                                            2013-14

                                                                                                       2017-18
                                                                                2009-10

                                                                                                                                 2025-26

                                                                                                                                           2029-30
                                                                                                                    2021-22

                                                                                                                                                     2033-34

                                                                                                                                                               2037-38

                                                                                                                                                                         2041-42

                                                                                                                                                                                   2045-46

and deepening sovereign debt can
damage business confidence in the
economy, and the need for dramatic                                                             State - Interest               Commonwealth - Interest
                                                                                               States - Principal             Commonwealth - Principal
public and private debt reduction.
                                                  Source: PwC analysis
The acceleration in deficits would
present itself as cumulative
debts building up each year –
almost doubling normal funding
requirements by 2049-50.

8   Protecting prosperity | Why we need to talk about tax
A further financial shock in this decade                 Figure 5: Commonwealth public net debt with a GFC-type shock, including
would also bring forward Australian                                 public debt interest capitalised from 2016-17, % of GDP
governments’ move into deep debt. In
                                                         120%
particular, sensitivity analysis shows
how vulnerable Australia could be to
                                                         100%
this type of shock, and how debt can
then increase exponentially if no action
                                                           80%
is taken to cut expenditure or boost
revenue (Figure 5).                                        60%

Therefore, governments at all levels
                                                           40%
will need to be very careful about
which expenditure programs they
                                                           20%
choose to support, and will also need
to focus on cutting waste. But Australia                    0%
is not a big-tax, big-government
spending economy compared with                            -20%
other countries with the same
                                                                 2001-02

                                                                                                                                                                                                                2049-50
                                                                           2005-06

                                                                                                          2013-14

                                                                                                                    2017-18
                                                                                          2009-10

                                                                                                                                             2025-26

                                                                                                                                                            2029-30
                                                                                                                                   2021-22

                                                                                                                                                                      2033-34

                                                                                                                                                                                2037-38

                                                                                                                                                                                           2041-42

                                                                                                                                                                                                      2045-46
standards of living (Figure 6).1

                                                                                                    Commonwealth: Base Case                            Commonwealth: GFC-type shock

                                                         Source: PwC analysis

Figure 6: Government expenditures and deficits, OECD countries, 2011

Government expenditure (% of GDP)
                                                                                                    Budget deficit (% of GDP)
       Denmark
          France                                                                                                                                                                                 Denmark
         Finland                                                                                                                                                                                 France
        Belgium                                                                                                                                                                                  Finland
          Austria                                                                                                                                                                                Belgium
        Sweden                                                                                                                                                                                   Austria
              Italy                                                                                                                                                                              Sweden
         Greece                                                                                                                                                                                  Italy
    Netherlands                                                                                                                                                                                  Greece
       Slovenia                                                                                                                                                                                  Netherlands
United Kingdom                                                                                                                                                                                   Slovenia
       Hungary                                                                                                                                                                                   United Kingdom
       Portugal                                                                                                                                                                                  Hungary
       Germany                                                                                                                                                                                   Portugal
            Israel                                                                                                                                                                               Germany
                                                                                                                                                                                                 Israel1
            Spain
                                                                                                                                                                                                 Spain
         Iceland
                                                                                                                                                                                                 Iceland
   New Zealand                                                                                                                                                                                   New Zealand
           Japan                                                                                                                                                                                 Japan
        Norway                                                                                                                                                                                   Norway
Czech Republic                                                                                                                                                                                   Czech Republic
         Poland                                                                                                                                                                                  Poland
          Ireland                                                                                                                                                                                Ireland
   Luxembourg                                                                                                                                                                                    Luxembourg
           OECD                                                                                                                                                                                  OECD
        Canada                                                                                                                                                                                   Canada
 United States1                                                                                                                                                                                  United States
        Estonia                                                                                                                                                                                  Estonia
Slovak Republic                                                                                                                                                                                  Slovak Republic
       Australia                                                                                                                                                                                 Australia
    Switzerland                                                                                                                                                                                  Switzerland
           Korea                                                                                                                                                                                 Korea

                      30             40                  50                          60             -10                       -5                       0              10                  20

Source: OECD 2012. OECD Economic Outlook. Volume 2012, Issue 2, No. 92

1.   Some OECD countries levy a social security contribution from employers as an element of their tax system. Australia has
     a Superannuation Guarantee Charge which enforces saving for retirement with limitations on early access. However the
     funds raised from this charge do not move through the budget system, and at all times lie within the control of private
     sector financial intermediaries, financing both public and private investment.

                                                                                                                              Protecting prosperity | Why we need to talk about tax                                9
Ultimately, simply cutting waste
is not going to be enough to fund
                                                          Why do taxes affect                                        In essence, all taxes affect growth,
                                                                                                                     but some are much more negative for
everything we wish to do: rebuild                         economic growth?                                           growth than others.
strong budgets; help fund community                                                                                  • Income taxes and means tests can
priorities like DisabilityCare Australia,                 Taxes are mainly used to support                             deter people from working at all,
education reform, and infrastructure                      public expenditure on services,                              can influence them to work less than
in our cities and regions; and lift our                   investment, infrastructure, education                        they would like, can deter them
defence investment to reflect the more                    and welfare. They are also used to                           from pursuing higher skills and even
clouded and uncertain medium-term                         secure equity, social or environmental                       cause them not to work in Australia.
strategic outlook.                                        outcomes.
                                                                                                                     • Company taxes can cut foreign, and
In addition to making expenditure                         However, taxes can have a negative                           plausibly to some extent domestic,
cuts, if we are to prevent what                           effect on economic growth because                            investment2 and the incentive to
could become increasing long-term                         they affect decision-making:                                 innovate, which in turn can cut
structural deficits growing even larger,                                                                               growth, reduce productivity and
                                                          • decisions by householders to save,
governments need to boost revenues.                                                                                    reduce real per-person incomes.
                                                            to buy services or property, to work
If we do this the right way – that is, by                   or to pursue education                                   • Taxes on transactions like stamp
lifting only those taxes that have the                                                                                 duty can stifle deals that would
                                                          • decisions by companies to produce,
least effect on economic growth, by                                                                                    have brought economic benefits to
                                                            provide jobs, innovate and invest
reducing our reliance on taxes that are                                                                                all the parties involved – businesses
damaging to economic growth, and by                       • decisions by investors about where                         or households – as well as to the
ensuring any compensation measures                          and how to invest.                                         community.
are targeted at the most vulnerable in                                                                               • Taxes on consumption, like the
                                                          Globalisation has increased the effect
our community – then tax reform can                                                                                    GST, affect economic growth
                                                          of taxes on growth. It has also affected
also help us drive productivity growth                                                                                 less because they do not change
                                                          the stability of revenue from corporate
and lift real incomes per person.                                                                                      behaviour as much, and especially
                                                          sources. Countries like Australia which
                                                          are small, open economies highly                             so when applied uniformly to all
Such a tax reform system should also
                                                          dependent on foreign investment,                             goods and services.
include addressing those factors which
increase the complexity of the tax                        trade and skilled migration, and with                      • Taxes on immovable resources
system and the cost of compliance.                        well developed web-based commerce,                           – such as land tax – have low
                                                          have to be increasingly aware of the                         economic costs.
                                                          effect their tax mix can have on their
                                                          competitiveness.

2.   The impact of company taxes on domestic investment is significantly reduced by dividend imputation which means that
     domestic investors’ dividend returns are taxed at their marginal income tax rate. However, many in business also argue
     that to the extent company tax reduces companies’ ability to retain funds, it can reduce investment capacity and growth in
     company value, which is also of interest to those domestic investors whose principal concern is capital gains.

10   Protecting prosperity | Why we need to talk about tax
Getting the structure of the tax
system right can boost growth and
                                         What are the                              • Is it fair? – The aggregate tax
                                                                                     burden should properly reflect the
lift productivity. The Organisation      features of a ‘good’                        capacity to pay and be supported
of Economic Cooperation and                                                          by positive income support for the
Development (OECD) has ranked taxes      tax system? How                             most vulnerable; people in the
from most to least growth-friendly –
with recurrent taxes on immovable
                                         does the Australian                         same position should be treated in
                                                                                     a similar way; there should be no
property (eg land) having the least      system measure up?                          discrimination between states and
negative effect on growth followed                                                   territories; and future generations
by consumption taxes, other property     No matter how much revenue a tax            should not be burdened to make
and environmental taxes, and personal    system raises, a ‘good’ tax system          the life of the current generations
income tax. Corporate taxes have the     should meet some key tests:                 easier.
greatest negative effect on growth.      • Does it enable healthy                  • Is it efficient? – All taxes damage
                                           government? – Australians expect          economic growth to some extent,
Assessments of Australia’s tax system
                                           all levels of government to provide       but some much less than others.
indicate that we are heavily weighted
                                           a range of services, facilities and       Most revenue should therefore be
towards those taxes which have a
                                           support for the disadvantaged, and        raised through those taxes which
greater proportion of welfare loss per
                                           to have the budget strength to deal       impose the smallest penalty on our
dollar of revenue collected. But taxes
                                           with natural, economic or national        economic wellbeing, are simple to
are about more than just growth,
                                           security shocks. This requires            understand and impose the lowest
and we cannot lose sight of those
                                           an adequate revenue stream to             costs to collect.
other goals.
                                           governments.
                                                                                   These priorities will often compete.
                                         • Does it support an efficient
                                                                                   The challenge of tax reform is to
                                           federation? – While the
                                                                                   balance improvements in efficiency
                                           Commonwealth has the most
                                                                                   with complementary measures to
                                           effective capacity to raise taxes,
                                                                                   maintain or promote fairness and
                                           states and territories should have
                                                                                   ensure the fiscal sustainability of all
                                           access to a predictable revenue
                                                                                   levels of government.
                                           stream that grows in line with the
                                           demands for services they deliver.

                                                      No matter how much revenue a tax
                                                      system raises, a ‘good’ tax system
                                                      should meet some key tests

                                                                        Protecting prosperity | Why we need to talk about tax   11
The Australian system of taxes and                        Table 1: Assessment of Australian taxes against OECD countries4
welfare benefits is regarded as among
the more equitable of the OECD                             Principle                                                                                                                                                                                                                                                                                                                           Rating
countries because it generally focuses
net government support on those most                                                                             Burden of tax & ability to pay
in need.
                                                           Equity                                                Non-discrimination
Recent changes have cut back on the
support for families at income levels
                                                                                                                 Limits to inter-generational impacts
which would traditionally have been
regarded as ‘well off’. However, the tax
treatment of superannuation incomes,                                                                             Economic distortion (elasticity and mobility)
indexation of pensions to earnings, and
the treatment of the primary place of                                                                            Application of tax (broad)
residence for means tests has resulted
in many older ‘well off’ Australians                       Efficiency                                            Effect on production
(ie with considerable assets) receiving
assistance. Those dependent on
Newstart, Job Seeker or Parenting                                                                                Competitive levels of taxation
Payment, by comparison, have faced
increasing financial stress.3                                                                                    Administration costs

Compared to many developed                                                                                       Revenue to support essential service provision &
countries and advanced developing                          Fiscal                                                revenue growth over time
countries, the Australian tax system                       sustainability                                        Limit vertical fiscal imbalance (VFI) between the
does not support growth as well as it                                                                            levels of government
could. This is due to the large amount
                                                          Source: PwC analysis on the basis of OECD reviews of tax and growth, and the academic literature
of tax revenue generated from income
and corporate taxes, which tend to
distort incentives more than other                        Figure 7: Corporate tax revenue, % of total tax revenue, 2010
taxes, along with the application of
                                                            25.0
exemptions and concessions which add
administrative complexity and cost to
the tax system.                                             20.0
                                                                                                                                                                                                                                                                                                                                                                                                                    18.5

Australia draws a relatively high
proportion of its government revenue                        15.0

from taxes on business activities and a
relatively low proportion from taxes on                     10.0
                                                                                                                                                                                                                                         8.6
consumption.

For example, the proportion of tax                           5.0

revenue collected from corporate taxes
is much higher than the OECD average
                                                             0.0
(Figure 7). High taxes on business
                                                                   Iceland
                                                                             Hungary
                                                                                       Estonia
                                                                                                 Germany
                                                                                                           Austria
                                                                                                                     France
                                                                                                                              Slovenia
                                                                                                                                         Spain
                                                                                                                                                 Netherlands
                                                                                                                                                               Denmark
                                                                                                                                                                         Finland
                                                                                                                                                                                   Belgium
                                                                                                                                                                                             Poland
                                                                                                                                                                                                      Italy
                                                                                                                                                                                                              Turkey
                                                                                                                                                                                                                       Sweden
                                                                                                                                                                                                                                Greece
                                                                                                                                                                                                                                         OECD
                                                                                                                                                                                                                                                United Kingdom
                                                                                                                                                                                                                                                                 Slovak Republic
                                                                                                                                                                                                                                                                                   Israel
                                                                                                                                                                                                                                                                                            Portugal
                                                                                                                                                                                                                                                                                                       Ireland
                                                                                                                                                                                                                                                                                                                 Czech Republic
                                                                                                                                                                                                                                                                                                                                  Switzerland
                                                                                                                                                                                                                                                                                                                                                Canada
                                                                                                                                                                                                                                                                                                                                                         United States
                                                                                                                                                                                                                                                                                                                                                                         Japan
                                                                                                                                                                                                                                                                                                                                                                                 New Zealand
                                                                                                                                                                                                                                                                                                                                                                                               Korea
                                                                                                                                                                                                                                                                                                                                                                                                       Luxembourg
                                                                                                                                                                                                                                                                                                                                                                                                                    Australia
                                                                                                                                                                                                                                                                                                                                                                                                                                Norway

deter investment, encourage the
movement of activities offshore and
encourage artificial strategies to avoid
tax. Tax revenues generated from these
sources are also quite volatile across                    Source: OECD 2012 Revenue Statistics 1965-2011, 2012 Edition
the business cycle.

Tax revenue generated by consumption
taxes, however, is generally lower
than the OECD average (Figure 8).
However, these taxes, along with taxes
on land, are generally more stable and
encourage saving.

3.   Daley, J. McGannon, C. and Savage, J. 2013. Budget pressures on Australian Governments. Grattan Institute, Melbourne
4.   Traffic light reporting has been used to illustrate how Australia compares with other OECD countries with respect to the principles
     of a good tax system. A green icon suggests that Australia’s tax system, or certain features of it, is consistent with or compares
     well against the other OECD countries; an orange icon suggests that our tax system, or certain features of it, is not completely
     consistent with the tax systems of other OECD countries; and a red icon suggests that our tax system, or certain features of it, is
     comparatively worse than other OECD countries.

12   Protecting prosperity | Why we need to talk about tax
What could a                                            Figure 8: Consumption tax revenue, % of total tax revenue, 2010

change in the tax                                         60.0

landscape deliver?                                        50.0

Australia faces a historic choice in the                  40.0

years ahead. It could cut government                                                                                                                                                                                                                                                  31.3
services radically, it could build tax                    30.0
                                                                                                                                                   25.7
revenues by incremental change, or it
could prioritise growth through carefully                 20.0

targeted expenditure cuts and tax reform.
                                                          10.0
Poorly considered expenditure cuts and
increases to growth-distorting taxes, such                 0.0
as company tax, personal income tax and

                                                                 United States
                                                                                 Japan
                                                                                         Switzerland
                                                                                                       Canada
                                                                                                                Italy
                                                                                                                        Belgium
                                                                                                                                  France
                                                                                                                                           Spain
                                                                                                                                                   Australia
                                                                                                                                                               Norway
                                                                                                                                                                        Austria
                                                                                                                                                                                  Luxembourg
                                                                                                                                                                                               Netherlands
                                                                                                                                                                                                             Sweden
                                                                                                                                                                                                                      Germany
                                                                                                                                                                                                                                United Kingdom
                                                                                                                                                                                                                                                 Denmark
                                                                                                                                                                                                                                                           Finland
                                                                                                                                                                                                                                                                     Czech Republic
                                                                                                                                                                                                                                                                                      OECD
                                                                                                                                                                                                                                                                                             Korea
                                                                                                                                                                                                                                                                                                     Iceland
                                                                                                                                                                                                                                                                                                               Slovak Republic
                                                                                                                                                                                                                                                                                                                                 Ireland
                                                                                                                                                                                                                                                                                                                                           Slovenia
                                                                                                                                                                                                                                                                                                                                                      Greece
                                                                                                                                                                                                                                                                                                                                                               New Zealand
                                                                                                                                                                                                                                                                                                                                                                             Israel
                                                                                                                                                                                                                                                                                                                                                                                      Poland
                                                                                                                                                                                                                                                                                                                                                                                               Portugal
                                                                                                                                                                                                                                                                                                                                                                                                          Estonia
                                                                                                                                                                                                                                                                                                                                                                                                                    Hungary
                                                                                                                                                                                                                                                                                                                                                                                                                              Turkey
                                                                                                                                                                                                                                                                                                                                                                                                                                        Chile
                                                                                                                                                                                                                                                                                                                                                                                                                                       Mexico
stamp duty, will reduce economic growth
and have broader impacts on the poor
and vulnerable.

With carefully targeted expenditure
restraint linked with comprehensive                      Source: OECD 2012 Revenue Statistics 1965-2011, 2012 Edition

tax reform, we could help rebuild
budget resilience at a state, territory
and Commonwealth level, and increase
                                                        Such changes to the tax landscape,
                                                        however, could bruise some of our
                                                                                                                                                                                                                                                            The way forward
the financial independence of states
                                                        other tax principles:                                                                                                                                                                               Tax reform requires more than just the
and territories. There would be a boost
to economic growth, productivity and                    • Shifting the burden of tax to                                                                                                                                                                     right conceptual solution. Previous
real per-person incomes if:                               consumption tax and land tax may                                                                                                                                                                  efforts at tax reform have often failed
                                                          place more relative pressure on                                                                                                                                                                   to achieve meaningful change because
• Australia relied more on
                                                          lower-income and older Australians                                                                                                                                                                certain elements were missing.
  consumption and land taxes, and
                                                          who are home-owners.
  less on corporate and personal                                                                                                                                                                                                                            Successful reform requires some key
  taxes, stamp duty, taxation of                        • Rebuilding budget resilience will
                                                          mean that not all the losers from the                                                                                                                                                             conditions to be present. For example:
  insurance, and payroll taxes in their
                                                          changes can be compensated.                                                                                                                                                                       • a broadly based understanding
  current form
                                                        • Reducing the corporate tax rate                                                                                                                                                                     that our public finances are
• taxes were more uniformly applied                                                                                                                                                                                                                           unsustainable without change
  with fewer exemptions and                               will confer some benefits on foreign
                                                          investors and on some high-wealth                                                                                                                                                                 • public acceptance that the hard
  concessions.
                                                          Australians through capital gains.                                                                                                                                                                  work on making reductions in
These two changes – together with                                                                                                                                                                                                                             government expenditure has begun
expenditure restraint - have the                        The big question is whether the                                                                                                                                                                       in earnest, before tax changes are
potential to address the major economic                 growth, private income and budget                                                                                                                                                                     considered
and fiscal challenges facing Australia                  resilience gains from tax reform                                                                                                                                                                    • public and political support
today. Any increase in GST revenue                      would be enough to support an                                                                                                                                                                         for change
paid to states and territories – beyond                 effective strategy for protecting the
                                                        more vulnerable in our community                                                                                                                                                                    • appropriate compensation but also
that needed to make an appropriate                                                                                                                                                                                                                            an acceptance that not everyone can
contribution to restoring fiscal resilience             and ensuring a smooth transition.
                                                        However, it is likely that it would                                                                                                                                                                   be made better off
– could be offset by a reduction in
                                                        be preferable to the alternatives:                                                                                                                                                                  • a willingness to balance
Commonwealth-tied payments. This
                                                        burgeoning deficits; savage cuts                                                                                                                                                                      competing interests
would give the states and territories
greater autonomy, provide latitude                      to government expenditure; or                                                                                                                                                                       • an ability to develop an
for states and territories to reduce or                 uncoordinated increases in taxes                                                                                                                                                                      emerging and at least tacit
improve the targeting of inefficient                    which distort behaviour and impede                                                                                                                                                                    bipartisan consensus.
taxes (eg stamp duty and payroll                        economic growth.
                                                                                                                                                                                                                                                            None of these conditions is easy to
tax), and offer scope for reducing
                                                                                                                                                                                                                                                            achieve but they can be established
Commonwealth-state overlaps. It
                                                                                                                                                                                                                                                            with an understanding of the
would also free up revenue for the
                                                                                                                                                                                                                                                            problems tax reform should address
Commonwealth to fund appropriate
                                                                                                                                                                                                                                                            and an emerging consensus on the
compensation through the personal
                                                                                                                                                                                                                                                            way forward.
income tax and transfer5 systems to
offset the effects of a broader or higher
GST on the most vulnerable.

5.   The transfer system consists of government welfare payments and tax relief provided to individuals and households.

                                                                                                                                                                                                   Protecting prosperity | Why we need to talk about tax                                                                                                                                                                                    13
An important concept, but one that                A lesson from Australia’s major            • the opportunities to lift growth,
is difficult to explain, is that it is            economic reforms is that public and          productivity and participation, and
Australian households who bear the                political will for reform is possible,       to secure government finances,
principal tax burden, even for those              but only if the timeframes are realistic     through comprehensive tax
taxes which are ostensibly focused on             and there is a body of business, civil       reform and targeted government
business. This is because business will           society and public policy leadership         expenditure restraint
often be competitively forced to pass             with a clear strategy for change.          • the implications for the vulnerable
those taxes on through prices, which              That groundswell of opinion will             and lower-income groups, as well
affect consumers, or through lower                only emerge from an open and                 as higher income Australians and
wages or lower employment. Taxes                  respectful conversation among all            foreign investors, of comprehensive
can lead to Australia failing to secure           the stakeholders to design a tax and         reforms in tax and government
foreign investment, with impacts on               transfer landscape that will build           expenditure constraint
employment and income, which will                 growth and protect equity.
                                                                                             • the means to ensure that all
affect households.
                                                                                               Australians, over time, can share in
Reform is best achieved if any changes            Questions we need                            the benefits of higher growth, while
                                                                                               protecting the vulnerable and lower
are part of a comprehensive package
of tax and transfer or welfare payment
                                                  to answer                                    income groups in the transition.
changes. It is also necessary that it be
                                                  Leaders of civil society (including
seen as part of a coherent strategy for
                                                  welfare groups and unions), business
lifting incomes and resilience which
                                                  and policy makers must be engaged
also involves restraint in government
                                                  in sustained conversation on a
expenditure. Public acceptance
                                                  comprehensive approach to reform. If
of reform, as well as business
                                                  we are to realise the potential benefits
confidence, is damaged by continual
                                                  for Australians across all parts of our
ad hoc changes to taxes, allowances,
                                                  society, that conversation needs to
investment rules and superannuation.
                                                  focus on some key questions:
Although there is now some                        • the challenges facing government
acknowledgement of the importance                   spending and revenue as the
of these issues, in the past political              community ages and the mining
leaders have found tax reform a                     boom declines
difficult discussion to sustain given             • the need to sustainably lift
the complexity of the issues, the                   productivity and the workforce
indirect and dispersed nature of many               participation of older Australians
of the benefits, and the clear and                  and women with children
direct effect on the potential losers.
This has sometimes led to proposals
being rushed and options prematurely
foreclosed. As a result, Australia’s
record of comprehensive tax reform
has been poor.

14   Protecting prosperity | Why we need to talk about tax
The case for action
Key messages                                could see falls in real per-person
                                            income for the first time in a quarter
                                                                                     • If we do this the right way – by
                                                                                       lifting only those taxes that have the
• Australia has enjoyed more than 22        of a century, and unless we rebuild        least effect on economic growth,
  years of largely continuous growth        strong budgets, governments might          reducing our reliance on taxes
  in real per-person incomes:               not be able to cushion us from the         that are damaging and targeting
  –– In the 1990s and early 2000s           next global shock as they did from         any compensation measures at the
     this flowed principally from           the GFC.                                   most vulnerable – then tax reform
     productivity growth.                 • State and territory governments in         can also help us drive productivity
                                            particular face a great challenge          growth and lift real incomes per
  –– From the mid-2000s, however,
                                            because the income they receive            person.
     productivity levels declined and
     this position was only maintained      from the GST has grown more
     because the prices of our exports,     slowly than the demands they face.
     particularly minerals, have risen    • Ultimately, simply cutting
     and the prices of our imports –        waste is not going to be enough
     such as televisions, computers         to do everything we wish:
     and cars – have fallen.                rebuild strong budgets, help
• Since the early 1990s to the mid-         fund community priorities like
  2000s, governments at all levels          DisabilityCare, education reform,
  were able to build a strong budget        and infrastructure in our cities
  position, with low debt levels due        and regions; and lift our defence
  to a combination of asset sales,          investment back to the long-term
  strong revenue growth and some            average.
  expenditure restraint.                  • Significant action is required to
• However, following the GFC this           enable governments to boost
  position changed dramatically, with       revenues and address current
  the Commonwealth Government,              deficits. Tax reform is the most
  and many state and territory              comprehensive way to address these
  governments, now in deficit.              issues.
• Real income growth and strong
  budgets are at risk if productivity
  stays low and export prices fall. We

      Significant action is
      required to enable
      governments to boost
      revenues and address
      current deficits.

                                                                          Protecting prosperity | Why we need to talk about tax   15
Is Australia’s                                          • As our population grows older, fewer
                                                          people as a proportion of the total
                                                                                                                                             balances have become heavily
                                                                                                                                             reliant on revenue boosted by
golden age at risk                                        workforce are willing or able to work.                                             cyclical factors and the continuation
                                                          This is beginning to happen now                                                    of ‘good times’ associated with
of ending?                                                as the eldest of the baby boomer                                                   strong commodity prices.10 With the
                                                          generation reach retirement age,                                                   easing of commodity prices,
Australia has had more than 22 years                      and will speed up in the years ahead.                                              there is further risk to the ability
of almost continuous growth in real                       This reduced workforce participation                                               of governments to bring budget
incomes per person. Continuous                            means lower growth in the economy                                                  deficits back into line.
economic growth over such a long                          overall and lower per-person incomes.                                      • A range of expenditure
timescale is the envy of most advanced
                                                        • GST revenue, on which Australia’s                                            commitments were entered into
countries. This growth has been
                                                          states and territories rely heavily, has                                     on assumptions of revenue streams
sustained in spite of external shocks
                                                          not recovered since the GFC. This                                            from carbon pricing and the
like the Asian Financial Crisis, the
                                                          is in part because the community                                             Minerals Resources Rent Tax, which
technology share market collapse, the
                                                          is saving more. While this is a good                                         are not likely to be met.
GFC and the deep problems in the
                                                          thing, it means lower revenue for the                                      • Flat or volatile revenue growth
eurozone.6 Even the dip in real per-
                                                          states. Also, where consumers are                                            at the same time as there are
person incomes at the height of the GFC
                                                          spending more, an increasing share                                           expectations of increased funding
was modest and short-lived (Figure 9).
                                                          of this consumption is in areas not                                          for critical services means that
In part, we recovered so quickly                          covered by the GST, such as private                                          it will be hard for all levels of
from the GFC because Australian                           health, private education, fresh                                             government to rebuild the strong
governments were able to put in place                     food, and (less importantly) small                                           fiscal position that the times call for.
substantial discretionary stimulus in                     online purchases, further dampening
both fiscal and monetary policy, while                    growth.                                                                    While assessing the efficiency of
maintaining a relatively strong fiscal                  • The relatively strong budget                                               current spending and cutting wasteful
position.7 This was because they went                     position at the Commonwealth                                               spending will provide one part of the
into the GFC with a budget surplus and                    level entering the GFC was not                                             solution, it is unlikely to adequately
negative net debt. Australia also was                     underpinned by sustainable                                                 address current, and more particularly
helped by strong stimulatory action by                    expenditure and revenue                                                    future, deficits.
China, which maintained the demand                        arrangements. Instead, budget
for our exports, particularly minerals.8
                                                        Figure 9: Disposable income per person and GDP per person, Australia,
However, there are a number of                                    annual % change
reasons to believe that there are risks
to continued growth in per-person                            8%

incomes or government budgets.                                                                                                        Dot-com bubble
                                                             6%
The main causes for concern are:                                                                                                                                                                    GFC

• Our productivity – growth in the                           4%
  value of what we produce for each
  hour we work and each dollar we                            2%

  invest – has been low over the past
  decade, until very recently when                           0%

  it rebounded somewhat. Without
  strong productivity growth, it is                         -2%

  hard to sustain real wages and
                                                            -4%
  employment growth.
• Prices for Australian exports,                            -6%
                                                                                                     Asset-price bubble

  particularly minerals exports, have
                                                                    1986-87

                                                                              1988-89

                                                                                        1990-91

                                                                                                     1992-93

                                                                                                               1994-95

                                                                                                                         1996-97

                                                                                                                                   1998-99

                                                                                                                                               2000-01

                                                                                                                                                            2002-03

                                                                                                                                                                      2004-05

                                                                                                                                                                                2006-07

                                                                                                                                                                                          2008-09

                                                                                                                                                                                                          2010-11

  either stabilised or reduced relative
  to their peak, and are expected to
  fall further.9                                                                                  Disposable income per person                           GDP per person

                                                         Source: ABS Cat No. 5204.0

6.  Commonwealth of Australia. 2010. Australia to 2050: Future challenges. January 2010. Canberra: Australia
7.  McDonald, T., and Morling, S. 2011. ‘The Australian Economy and the global downturn. Part 1: Reasons for resilience’. Economic Roundup
    Issue 2, 2011. Canberra, Australia
8. Connolly, E., and Orsmond, D. 2011. ‘The Mining Industry: From bust to boom’. Research Discussion Paper. Reserve Bank of Australia, Sydney
9. BREE. 2013. Resources and Energy Quarterly. March Quarter 2013. BREE, Canberra
10. Maher, Sid. 2013. ‘Decade of deficits’ puts focus on spending cuts, says new economic modelling’. The Australian. 4 March 2013

16   Protecting prosperity | Why we need to talk about tax
Risks to per-person                                       Figure 10: Contribution to growth in average incomes, by decade

income growth –                                                                                4                                                                                 4

productivity, prices                                                                           3                                                                                 3

                                                                                                                                                                                      Percentage points, annual average
and participation

                                                           Percentage points, annual average
                                                                                               2                                                                                 2
We can get a better sense of the
challenges ahead by looking at why we
have grown so strongly in the past.                                                            1                                                                                 1

Real per-person incomes provide a
useful measure of societal wellbeing                                                           0                                                                                 0
or living standards and are directly
related to the purchasing power of
Australians. A number of factors                                                               -1                                                                                -1
                                                                                                     1970s                 1980s                    1990s          2000s
directly influence growth in real
per-person income, including                                                                        Labour productivity            Labour utilisation        Terms of trade
productivity, terms of trade (the price                                                             Foreign income flows           GNI per person
for our exports compared to what
we pay for imports) and labour force                      Source: Australian Treasury calculations based on ABS cat. no. 5206.0, 6202.0 and unpublished ABS data
                                                          Dolman, B and Gruen, D. 2012. ‘Productivity and Structural Change’. 41st Australian Conference of
participation.                                            Economists. 10 July 2012

The picture over the past four decades
is very clear (Figure 10). There was
strong productivity growth in the                         The productivity story                                                            Productivity matters because it
1970s offset by a decline in labour                                                                                                         ‘grows the cake’ per person, and
force participation as the effect of very                 Productivity measures the volume of                                               assumptions regarding productivity
low birth and immigration rates in the                    production or output – that is, goods                                             levels significantly affect forecasts
great depression years outweighed the                     and services – for a certain volume                                               of economic growth. It does not
beginning of the post-war baby boom.                      of input (generally hours worked).11                                              guarantee real wage rises, but it
In the 1980s, productivity slumped                        Productivity growth occurs when                                                   creates the room for real wage rises
but this was offset by the net impact                     the volume of outputs increases for                                               without cutting job growth.
of the baby boomer generation which                       the same amount of work hours, and
                                                          generally this can be linked to:                                                  During the 1990s, productivity growth
supported workforce growth. Almost
                                                                                                                                            played a significant role in driving real
all the growth in real per-person                         • development and use of new
                                                                                                                                            per-person income growth and it is
incomes in the 1990s can be explained                       technologies (innovation/research
                                                                                                                                            widely recognised that this surge in
by productivity growth. As we reached                       and development, and capital
                                                                                                                                            productivity was a result of economic
the 2000s, productivity growth once                         investment)
                                                                                                                                            reforms introduced in the 1980s and
again slipped to low levels but this time                 • investment in capital and fixed                                                 1990s.12 These reforms removed tariffs
real incomes were supported by strong                       resources (eg plant, equipment)                                                 and subsidies, broke up monopolies,
terms of trade underpinned by the                           which enable labour to produce                                                  increased competition and also sought
positive surge in minerals prices and                       more, for less effort                                                           to improve work practices. They
falling cost of imported products.                        • workforce education and skills                                                  resulted in direct productivity gains,
                                                          • the effective organisation of the                                               such as better utilisation of labour and
                                                            factors of production (labour,                                                  capital, as these factors of production
                                                            capital and fixed resources such                                                moved to sectors with higher returns
                                                            as land)                                                                        and growth prospects. Indeed,
                                                                                                                                            productivity performance, as measured
                                                          • relocation of production and
                                                                                                                                            through real GDP per hour worked,
                                                            employment from less productive to
                                                                                                                                            increased during the 1990s, exceeding
                                                            more productive options.
                                                                                                                                            the long-term average (Figure 11).

11. PwC. 2012. Productivity Scorecard. September 2012. The PwC Productivity Scorecard is a quarterly analysis of labour
    productivity by state and territory and across 16 key sectors. Copies of the publication are available at:
    http://www.pwc.com.au/consulting/publications/productivity-scorecard-series.htm
12. Parham, D. 2012. Australia’s Productivity Growth Slump: Signs of crisis, adjustment or both?, Visiting Researcher Paper,
    Productivity Commission, Canberra; Megalogenis, G. 2012. The Australian Moment. Penguin Australia

                                                                                                                             Protecting prosperity | Why we need to talk about tax    17
Productivity performance in the                           Figure 11: Australia’s labour productivity: Real GDP per hour worked13
2000s has been quite different, with
productivity levels actually falling                          5%
below the long-term average. This
                                                                                                                                                                Average: 1990s (2.1%)
can be attributed to the fading effect                        4%                                                                                                                                                                           Average: 2000s (1.4%)
of earlier micro-economic reforms,
                                                                                            Average: 1980s (1.3%)
along with heavy investment in mining
                                                              3%
development and infrastructure in
power, water and communications.
These investments take a long time                            2%

to pay off – for example, desalination
plants started during the millennium                          1%

drought will not offer any real return
unless they are needed again in a                             0%

future major drought. Huge mining
                                                                                                                                                                                       Average: Long run (1.5%)
developments also take time to                                -1%
produce a return, and higher mineral
                                                                           1980-81

                                                                                            1982-83

                                                                                                             1984-85

                                                                                                                              1986-87

                                                                                                                                               1988-89

                                                                                                                                                                1991-92

                                                                                                                                                                             1993-94

                                                                                                                                                                                         1995-96

                                                                                                                                                                                                     1997-98

                                                                                                                                                                                                                1999-00

                                                                                                                                                                                                                           2001-02

                                                                                                                                                                                                                                     2003-04

                                                                                                                                                                                                                                               2005-06

                                                                                                                                                                                                                                                         2007-08

                                                                                                                                                                                                                                                                   2009-10

                                                                                                                                                                                                                                                                             2011-12
prices have encouraged lesser quality
mineral resources to be developed,
requiring more investment per tonne
                                                          Source: ABS Cat No. 5206.0 and 6202.0
of product.

Productivity levels were also much
lower than the United States                              Figure 12: Australia’s labour productivity relative to the
(Figure 12), along with a large number                               United States (%)
of Western European countries and a
                                                           94%
growing number of Asian economies.14

While there have been seven quarters                       92%

of stronger productivity growth in
the past two years, this is in part a                      90%

cyclical rebound (the productivity
series is quite volatile over short                        88%

periods). Partly it reflects the lag
                                                           86%
between major capital investments in
the mining sector and the increased
                                                           84%
production and revenue that they are
                                                                    1980

                                                                                     1982

                                                                                                      1984

                                                                                                                       1986

                                                                                                                                        1988

                                                                                                                                                         1990

                                                                                                                                                                      1992

                                                                                                                                                                                  1994

                                                                                                                                                                                              1996

                                                                                                                                                                                                         1998

                                                                                                                                                                                                                    2000

                                                                                                                                                                                                                              2002

                                                                                                                                                                                                                                        2004

                                                                                                                                                                                                                                                 2006

                                                                                                                                                                                                                                                           2008

                                                                                                                                                                                                                                                                    2010

                                                                                                                                                                                                                                                                              2012
now generating. It also likely reflects
the shake-out of the lowest performing
firms in the manufacturing and                            Source: The Conference Board Total Economy Database™, January 2013, http://www.conference-board.org/data/
                                                          economydatabase/
services sector placed under pressure
by the high Australian dollar. There is
insufficient evidence to conclude that
we have moved to a sustained higher
productivity growth path – a suitably
conservative assumption would be
to use an average of the productivity
series over the past decade and a
half. This would produce an annual
productivity growth rate of 1.5%,
higher than the long-term average,
but much lower than the 1990s
productivity surge.

13. Australian Bureau of Statistics, 2012. Cat. 5260.0.55.002 Estimates of Industry Multifactor Productivity,
    Australia: Detailed Productivity Estimates. [Online] Available at: http://www.abs.gov.au/AUSSTATS/
    abs@.nsf/Lookup/5260.0.55.002Main+Features12011-12?OpenDocument. [Accessed 3 March 2013]
14. Eslake, S. 2011. Productivity: The lost decade. Reserve Bank of Australia, Sydney

18   Protecting prosperity | Why we need to talk about tax
The export price story                                  The population and                                     Estimates of economic growth and
                                                                                                               per-person incomes are quite sensitive
While this deterioration in Australia’s                 participation story                                    to small changes in workforce
productivity performance during the                     The population is aging, and birth                     participation rates. In the years ahead,
2000s could have seen reductions                        rates, while they rebounded in the first               the impact of population aging on
in the living standards of Australian                   decade of the 21st century, are now                    workforce participation is expected
citizens, real per-person incomes                       stable. These factors affect workforce                 to accelerate if there are no changes
continued to grow. This was due to                      participation rates and therefore affect               to the timing of access to pension
a surge in Australia’s terms of trade                   economic growth.                                       entitlements and superannuation.
to their highest level in at least 140                                                                         Already, the participation rates of older
years, underpinned by a strong                          Over the past few decades, labour                      workers (aged over 55) and women
resources sector, which offset declining                participation rates have been                          might have reached a plateau.20
productivity levels.15 At the same time,                increasing and actually peaked around                  However, a finer disaggregation of age-
the value of the Australian dollar                      2010. This was partly due to a higher                  specific participation rates might tell a
relative to the United States dollar                    proportion of the population in the                    more optimistic story of the prospect
and the currencies of other advanced                    prime working years of life, along                     of a larger proportion of older people
economies also surged.                                  with higher labour force participation                 continuing to work into their later 60s
                                                        by women. It also reflected increased                  and early 70s.21
Our export prices have now stabilised                   participation by older people, partly as
or started to fall so they are no longer                a result of decisions to defer retirement              While there is some uncertainty
expected to lift our real incomes.16                    following the GFC, and in part because                 regarding movements in participation
Budget forecasts assume that terms                      of improving health among older                        rates, it is expected that demographic
of trade will decline from their peak                   Australians. The combination of                        change will, in the absence of
by 9% to 2014-15 and 16% to 2023.17                     increased workforce participation by                   interventions, be a drag on economic
Despite falling commodity prices and                    women and older workers in the short                   growth, growth in per-person incomes
terms of trade, the Australian dollar                   term effectively reduced the impact of                 and government revenues at all levels.
has until recently, remained defiantly                  the aging of the population on per-                    Moreover, it will simultaneously
high, significantly affecting trade-                    person income levels.19                                increase demands for pension, aged
exposed sectors of the economy.                                                                                care and health expenditure.22

These factors, combined with low (or
declining) productivity performance,
reductions in workforce participation
associated with an aging population,
and the absence of productivity-
enhancing reform measures, mean
that per-person incomes may
fall for the first time in nearly a
quarter of a century. Accordingly,
in line with forecast lower terms of
trade, any future growth in living
standards is expected to be driven by
productivity growth.18

15. Eslake, S. 2011. Productivity: The lost decade. Reserve Bank of Australia, Sydney
16. Kent, C. 2013. ‘Reflections on China and Minister Investment in Australia’ Address to the Committee for
    Economic Development Australia. Perth, 15 February 2013; Gruen, D. 2012. The Importance of Productivity.
    Productivity Commission-Australian Bureau of Statistics, Productivity Perspectives Conference,
    20 November 2012
17. Treasury. 2010. Mid-year economic and fiscal outlook (MYEFO). The Treasury, Australia. Accessed on
    May 2013. [Accessed at: http://budget.gov.au/past_budgets.htm]
18. Parkinson, M. 2012. ‘Challenges and opportunities for the Australian Economy. Speech to the John Curtin
    Institute of Public Policy, Breakfast Forum, 5 October 2012
19. Reserve Bank of Australia. 2013. ‘Box C: The Labour Force Participation Rate’ Statement on Monetary
    Policy. Sydney
20. Reserve Bank of Australia. 2013. ‘Box C: The Labour Force Participation Rate’ Statement on Monetary
    Policy. Sydney
21. Daley, J., McGannon, C., and Savage J. 2013. Budget pressures on Australian governments. Grattan
    Institute, Melbourne
22. Daley, J., McGannon, C., and Ginnivan, L. 2012. Game-changers: Economic reform priorities for Australia.
    Grattan Institute, Melbourne

                                                                                                  Protecting prosperity | Why we need to talk about tax   19
Conclusion                                               per-person incomes, and “in the long
                                                         run, productivity growth – producing
                                                                                                                  Fiscal challenges
The continuation of strong real per-                     more from the same inputs – is the only                  for Australian
person income growth is critical for                     sustainable way for future generations to
ensuring high living standards in                        enjoy higher living standards”.24                        governments
the future. Although strong export
prices and falling import prices have                    We also have some capacity to influence                  During the 1990s and into the 2000s,
enabled real incomes to grow despite                     workforce participation by older                         Australia’s government fiscal balances
falling productivity levels, these two                   Australians and women. This would                        were rebuilt to a strong position,
factors are substantially beyond our                     require new incentives through changes                   largely due to asset sales and strong
national control, being a function of                    to childcare support, effective tax rates,               tax revenues. In the years before the
global movements in prices and global                    and timing of access to superannuation                   GFC, rapidly rising commodity prices
minerals demand and production.23                        and the aged pension.25                                  provided a major boost to company
Commodity prices have already stalled.                                                                            profits and wages growth in resources
                                                                                                                  and in resources-related industries.
Productivity, on the other hand, is                                                                               This, combined with strong asset
at least partly within our control.                                                                               price growth, a maturing capital gains
Rebuilding productivity growth through                                                                            tax system, and strong household
targeted reforms will help Australia                                                                              consumption growth, meant strong
cope with shocks, including from the                                                                              growth in tax receipts. Governments
possible decline in our export prices,                                                                            also felt confident enough to provide
and will offset the impact of an aging                                                                            reductions in income tax rates, despite
population. Addressing productivity                                                                               the fact that structural balances might
levels is therefore critical given its                                                                            not have been as strong as underlying
importance for living standards and real                                                                          cash balances.26

         “In the long run, productivity
         growth – producing more
         from the same inputs – is
         the only sustainable way for
         future generations to enjoy
         higher living standards”.24

23. With high prices for minerals come incentives for mineral resources development in other countries,
    including developing countries. Future commodity prices are therefore expected to be directly affected as
    new supply comes on line
24. Parkinson, M. 2011. ‘Sustaining growth in living standards in the Asian Century’. Address to the Seventh
    Economic and Social Outlook Conference. Melbourne, 30 June 2011
25. Daley, J. McGannon. C and Ginnivan, L. 2012. Game-changers: Economic reform priorities for Australia.
    Grattan Institute, Melbourne
26. Parliamentary Budget Office. 2013. Estimates of the structural budget balance of the Australian Government:
    2001-02 to 2016-17. Parliament of Australia, Canberra

20   Protecting prosperity | Why we need to talk about tax
It was this strong public sector                         Figure 13: Primary balance: Commonwealth and state/territory
balance sheet that provided the                                     governments, % of GDP
Commonwealth Government with                               4%
the flexibility to respond to the GFC
through discretionary stimulus,
without exposing Australia to undue                        2%

credit risk. Even today, Commonwealth
finances are strong and the extent                         0%
of confidence in Australia’s public
finances continues to be reflected in
                                                          -2%
Australia’s AAA credit rating.27

However, governments at all levels are
                                                          -4%
facing a challenging situation.

Increasing budget                                         -6%

deficits for Australian
                                                                 2001-02

                                                                                                                                                                                               2049-50
                                                                           2005-06

                                                                                               2013-14

                                                                                                           2017-18
                                                                                     2009-10

                                                                                                                                   2025-26

                                                                                                                                             2029-30
                                                                                                                         2021-22

                                                                                                                                                       2033-34

                                                                                                                                                                 2037-38

                                                                                                                                                                           2041-42

                                                                                                                                                                                     2045-46
governments
                                                                                                         Commonwealth                        States
The Commonwealth Government is
                                                         Source: PwC analysis
now operating a budget deficit and
                                                         Note: The primary balance is defined as the difference between revenues and expenditures, excluding interest
has been for the past four years, due                    transactions. This chart uses official budget forward estimates where they are available. To this extent it relies on
to a range of factors including the                      budget estimates of future revenue growth and expenditure paths. It is based on an assumption of a steady 1.5%
                                                         improvement in productivity each year.
GFC and a reduction in company tax
and capital gains tax. While our deficits
are comparatively low when compared                      the Parliamentary Budget Office,                                          • the expectation that GST revenue
to other OECD countries, a return                        Australia moved into a structural                                           growth, which is critical for the
to surplus has been more difficult                       deficit of around 3.25% to 4.25% in                                         states, is unlikely to rebound.
than anticipated. This position is                       2011-12, and while this has recovered
                                                         somewhat, even with proposed savings                                      The longer-term implications for
also inconsistent with the primary                                                                                                 fiscal balances at the Commonwealth
objective of fiscal policy to maintain a                 it is expected to remain around 0.25%
                                                         to 1.5% of GDP in 2016-17.30                                              and state/territory level of an aging
budget surplus, on average, over the                                                                                               population (with its associated
medium-term.28                                           This short- to medium-term problem is                                     demand for services) and low
Concerns over budget deficits are also                   exacerbated by:                                                           productivity are quite significant. PwC
amplified when considered though the                     • an aging population, which                                              modelling to reflect these long-term
lens of ‘structural’ budget balances.                      over time is expected to reduce                                         forces shows a growing fiscal gap at
Structural budget balances adjust for                      participation rates and earnings,                                       all levels of government if expenditure
major cyclical and temporary factors                       and at the same time add to                                             and revenue policies remain
and can provide an indication of the                       government costs                                                        unchanged, and productivity continues
health of a government’s balance                                                                                                   at the average of the past 15 years.
                                                         • growth of per capita medical
sheet and debt sustainability. Recent                      expenditure driven by technology                                        While the 2013 Budget suggests
reports have suggested that it is                          and rising expectations31                                               a return to a surplus in the years
structural rather than cyclical factors                  • the expectation that the strong tax                                     ahead, modelling using the long-run
driving Australia’s increasing budget                      revenues of the early 2000s are                                         underlying drivers of the economy
deficits, reflecting actions by current                    unlikely to return, due to a range                                      – productivity, participation and
and former governments to reduce                           of factors (eg the GFC, continued                                       population – suggests that this might
taxes (personal income taxes, fuel                         subdued asset price rises, and a                                        be difficult to achieve and sustain
excises) and increased spending                            reduction in company tax and                                            (Figure 13).
levels.29 According to estimates by                        capital gains tax revenues)32

27. Parkinson, M. 2012. ‘Challenges and opportunities for the Australian Economy’. Speech to the John Curtin
    Institute of Public Policy, Breakfast forum. Perth, 5 October 2012
28. Australian Government. 2012. ‘Statement 4: Building resilience through national savings’.
    Budget 2012-13. Treasury, Canberra
29. Parliamentary Budget Office. 2013. Estimates of the structural budget balance of the Australian Government:
    2001-02 to 2016-17. Parliament of Australia, Canberra
30. Parliamentary Budget Office. 2013. Estimates of the structural budget balance of the Australian Government:
    2001-02 to 2016-17. Parliament of Australia, Canberra
31. Daley, J. McGannon, C. and Savage, J. 2013. Budget pressures on Australian Governments.
    Grattan Institute, Melbourne
32. Australian Government. 2012. ‘Statement 4: Building resilience through national savings’.
    Budget 2012-13. Treasury, Canberra

                                                                                                                     Protecting prosperity | Why we need to talk about tax                     21
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