TAX NEWS - June 2010

Australia Tax: Rudd government and Taxes

Australian government's response to the Henry tax review has set back the cause of policy reform in Australia.

It will also cast a shadow over attempts to improve the nation's global competitiveness for many years to come.

The implementation of the one big idea picked up by the Rudd government is shaping up as a train wreck, while the other tax initiatives are little more than gestures.

Many fundamental reform imperatives identified by Henry were flatly ruled out by the government, while no process has been established to advance government policy in any other area. In the wake of the mining tax debacle, it all looks too hard.

The Australian School of Taxation at the University of NSW is conducting a conference in Sydney on the Henry tax reforms over the next three days, with support from the Institute of Chartered Accountants and Treasury. But where a similar conference held a year ago in Melbourne buzzed with the exciting potential for far-reaching reform, the mood of tax professionals going into today's session is gloom over an opportunity squandered.

The contrast between promise and delivery is perhaps most stark in the area of savings. Henry highlighted the distortions created by the radically different tax treatment of different forms of savings.

Property investment benefited from negative gearing, capital gains tax discounts and depreciation allowances. Share investment could also be geared, while dividends benefited from imputation. Interest earnings, by contrast, are taxed at the full personal rate.

"The reform direction for savings income taxation aims to provide a more consistent treatment of savings income, to reduce opportunities for tax arbitrage and to reduce incentives for investors to take on too much debt, while broadly compensating for the effects of inflation, particularly for interest income," the review panel document said.

To meet these fine objectives, the panel recommended that income from savings should be discounted, for tax purposes, by 40 per cent.

Henry said the low rate of inflation since the Reserve Bank adopted inflation targeting meant the current 50 per cent discount for capital gains was excessive and encouraged arbitrage.

Introducing a discounted tax rate on net rental income would encourage property investors to use equity to finance their properties.

It would encourage more capital-intensive property development, with less reliance on the capital gain from land.

However, the government ruled out any change whatsoever to the capital gains regime, and was not interested in any changes that reduced the attractiveness of negative gearing.

Instead, it introduced a special tax deduction for interest earnings, the first $1000 of which will only be taxed at half the individual's marginal rate.

The mish-mash of different taxing regimes for different savings options, with incentives for excessive gearing, remains in place. A new exceptional tax deduction is introduced, further complicating individual tax affairs.

Capital gains and negative gearing have plenty of company in the herd of sacred cows that government refuses to touch.

A small but instructive area is the not-for-profit sector. Over the past decade, employment in this sector has become tax-driven as accountants have come up with clever ways to include fringe benefits, which are tax exempt in the sector, in salary packages.

The Henry review noted that this concession distorts labour markets -- nurses, for example, get about 6 per cent more for working in the not-for-profit hospitals than in private sector equivalents. It urged that the government directly subsidise employment in not-for-profits rather than rely on the tax system.

But the government does not want to go near the not-for-profit sector, ruling out any changes to its tax arrangements.

For good measure, it rejected the recommendation that large-scale trading income of clubs, such as gambling, catering and entertainment, should be subject to some form of tax. It does not want to put the clubs offside.

The reason mining was tackled by the government was partly because it was Henry's highest priority for action and partly because the mining industry was not part of the government's support base and is therefore not sacred.

Perhaps the most disheartening aspect of the government's response to the review was the complete absence of any process for advancing reform beyond the measures it announced on May 2 and in the budget.

Institutions which want to prepare responses to the Henry review have nowhere to send their submissions, because there is no continuing body building the case for further reform. The government appears to see its commitment to tax reform as largely completed. Wayne Swan has said he'd like to see the company tax reduced beyond the minor reduction agreed now, but has given no hint what action is being considered in any other area.

The government should have released the Henry review in January, shortly after it received it, as a green paper, and allowed a 12-month period of consultation, before publishing a white paper bringing together its response.

This would not only have flushed out the practical problems with implementation of the super-profits mining tax but would have given the government the opportunity to build the case for a more ambitious reform agenda than it was prepared to drop on to an unsuspecting public in May.

It may be that many of the review's recommendations would not have withstood intensive scrutiny. Some that make sense in the idealised world of tax theory were always going to come a cropper when faced with political reality. But it would have been good to go at least part-way to delivering on some of the review's objectives, such as simplifying the tax system, fixing the relationship between the tax and transfer system, improving the taxation of savings and investment, and lifting our international competitiveness.