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Australian Government - GST Distribution Review

Chapter 1 - The tax system in Australia

This Chapter provides a basic outline of the tax system in Australia, briefly explaining the classes of revenue collected by different levels of government, the economics of taxation, and setting out information on recent tax reforms.

In Australia, taxes are defined as ‘compulsory, unrequited [meaning one sided or unreturned] transfers to the general government sector’.1 Taxes fund general government expenditure and provide public services, but also serve other purposes, such as deterring certain types of behaviour.2

The Australian tax system is a federal one — Commonwealth, State and local governments all levy taxes of different kinds. The revenue raised by different taxes in Australia is illustrated in Figure 1.1.

Figure 1.1: Ranking of Australian taxes by revenue raised, 2009-10

Figure 1.1:  Ranking of Australian taxes by revenue raised, 2009-10. This Figure shows the revenue raised by different taxes in Australia in 2009-10.  Ninety per cent of total tax revenue is raised from 10 taxes, with the remaining 115 accounting for only 10 per cent of tax revenue.  The ten taxes that raise the most revenue in order of revenue raised are: personal tax, company tax, GST, payroll tax, fuel excise, local government rates, conveyance stamp duty, superannuation, tobacco excise and land taxes.

(a) Fuel excise and tobacco excise includes excise equivalent customs duties on these products.
Source: Australia’s Future Tax System, Report to the Treasurer, Overview, page 12.

At the last count,3 the Commonwealth levied 99 taxes,4 the States levied 25 and local governments were responsible for one. Ninety per cent of total tax revenue is raised from 10 taxes, with the remaining 115 accounting for only 10 per cent of tax revenue.

The ability of different levels of government to impose taxes is subject to the Australian Constitution.5 The High Court’s interpretation of the Constitution has been pivotal in assigning taxing powers between the Commonwealth and States.6

1.1 Revenue raised by States

States raise revenue from a variety of sources, both through taxes and by non-tax means. The amount raised by the States from various sources will depend on local economic conditions. For example, revenue from payroll tax depends on a number of factors, which can change from year to year, such as employment rates and business growth. Hence, the relative importance of a specific source will change over time, reflecting the changing economic circumstances of States.

As shown in Table 1.1, the largest components of State tax revenue are payroll taxes and conveyance duties.

Table 1.1: State own-source revenue, 2010-11

$ million

NSW

VIC

QLD

WA

SA

TAS

ACT

NT

Total

Payroll tax

6,399

4,354

3,023

2,623

951

286

286

164

18,086

Conveyance duty

4,045

3,910

1,933

1,140

784

145

272

102

12,331

Motor vehicle tax

2,444

1,503

1,768

946

495

139

119

47

7,461

Land tax

2,289

1,398

1,042

516

576

75

110

-

6,006

Gambling tax

1,757

1,652

945

191

404

95

53

50

5,147

Insurance tax

2,035

1,456

546

468

371

65

60

33

5,034

Other taxes(a)

1,448

584

718

656

250

55

344

1

4,056

Royalties

1,240

58

2,722

4,213

161

49

-

155

8,597

Sales of goods and services(b)

4,838

5,944

4,172

1,754

1,879

362

428

205

19,582

Interest income

468

420

2,365

320

168

40

180

80

4,041

Dividends and
income tax equivalents

2,110

408

1,232

1,066

403

159

266

26

5,670

Other non-tax revenue(c)

2,656

1,762

1,219

454

389

80

137

46

6,743

Total

31,729

23,449

21,685

14,347

6,831

1,550

2,255

908

102,754

(a) The taxes in this category differ from State to State and include a range of minor taxes.
(b) Includes use of government provided services such as hospitals, and public safety user charges.
(c) Includes revenue from fines, regulatory fees, licences etc.
Source: ABS Taxation Revenue Australia, 2010-11, cat. no. 5506.0, ABS Government Finance Statistics, Australia, 2010-11, cat. no. 5512.0 and State financial statements.

As can be seen from Table 1.1, apart from taxes, States raise revenue from sales of goods and services and collect a variety of non-tax revenues, such as fines and regulatory fees. Royalties are a relatively large source of revenue for Western Australia, Queensland and the Northern Territory, but comprise a much smaller share of revenue for the other States.

States are responsible for the delivery of a variety of services, such as health care and education and States’ expenditure is much larger than their own-source revenue. The funding gap between State expenses and own-source revenue is largely made up by transfers from the Commonwealth, including GST payments totalling $46�billion in 2010-117 and other Commonwealth grants totalling $53 billion in 2010-11.8

Figure 1.2 shows the main State expenses compared to own-source revenue.

Figure 1.2: Total State expenses and revenue, 2010-11

Figure 1.2: Total State expenses and revenue, 2010-11 - the Figure shows State expenses compared to own source revenue.  State expenses are much greater than their own-source revenue.  The main areas of State expenditure are health, education, public order and safety, and transport and communications.

Source: ABS Taxation Revenue Australia, 2010-11, cat. no. 5506.0, ABS Government Finance Statistics, Australia, 2010-11, cat. no. 5512.0 and State financial statements.

1.2 A brief history of taxation in Australia

When the Commonwealth of Australia was established in 1901, the Constitution gave the Commonwealth exclusive power to impose duties of customs and excise and duties on goods traded between States were removed. Over time, the mix of taxes imposed by the States and Commonwealth has changed, with the Commonwealth either taking over or relinquishing some tax bases. Key developments affecting States include changes to income tax, land tax, payroll tax, franchise fees and the GST.

Tasmania was the first State to introduce income tax in 1880 and by 1907 all States had some form of income tax. The Commonwealth first introduced income tax in 1915. Between 1915 and 1942 income taxes were levied by both the States and the Commonwealth. Income tax was ceded to the Commonwealth in 1942 as a war-time measure in exchange for Commonwealth grants to the States.

Land tax is another field in which the Commonwealth and the States had concurrent taxes in the past. Victoria introduced the first land tax in 1877. South Australia was the first State to tax the unimproved value of land in 1884 with most of the other States following suit over the next two decades. The Commonwealth introduced land tax in 1910. Concurrent State and Commonwealth land taxes were in place until 1952, when the Commonwealth abolished its land tax.9 Currently, the Northern Territory is the only State that does not impose a land tax.

In 1971, after the States requested access to income tax to supplement their tax base,10 the Commonwealth passed authority over payroll tax to the States. Initially payroll tax was uniformly applied, but over time various States have changed both the rate and the base to which their payroll taxes apply. This has led to payroll tax being applied to a narrower base than in 1971.

In 1997, the High Court declared business franchise fees levied by the States to be invalid, resulting in a major loss of revenue for States.11 Victoria estimated that it would have raised $1.2 billion from business franchise fees in 1997-98 and that more than $5 billion overall would have been collected by the States that year.12 To replace the lost revenue, at the request of the States, the Commonwealth increased taxes on petrol, alcohol and tobacco, and passed the revenue from the increases to the States.13 The resultant payments to States were known as revenue replacement payments.

Because of a constitutional constraint,14 the Commonwealth was required to impose uniform rates of taxes on petrol, alcohol and tobacco across all States. This led to higher rates of taxation in a few States than was previously the case. Some States, such as Queensland, returned the extra revenue to consumers for a time to avoid price rises. Revenue replacement payments ceased in 2000 with the introduction of the GST.

In 2000, the introduction of the GST (partly to replace the Commonwealth’s Wholesale Sales Tax) — with the arrangement that the States receive the GST revenue — gave the States another broad revenue base. The GST arrangement was also used to implement a range of tax reforms that saw the removal of several inefficient State taxes, such as financial institutions duties and stamp duties on marketable securities, as well as other minor taxes, such as bed taxes.

A timeline of major changes to the tax system is included in Appendix B.

1.3 Incidence and bases of tax

Ultimately all taxes are borne by individuals regardless of the entity or product that the tax is applied to. For this reason, economists will often refer to the ‘economic incidence’ of a tax — meaning where the burden of the tax ultimately lies — by way of comparison with the ‘legal incidence’ of a tax — meaning who has the legal obligation to pay it.

For example, the economic incidence of a tax on company profits can fall on the shareholders (through lower profits), workers (through lower wages) or consumers (through higher prices), even though the company is the legal ‘taxpayer’. Similarly, although the GST is liable to be paid by GST registered enterprises, the economic incidence of GST also falls on the consumer of the product or service on which the GST is levied. Where the individual (whether shareholder, worker or consumer) is a foreign resident, the tax consequences may differ from those for a domestic resident. For example, overseas consumers of Australian goods do not always pay GST, and are usually subject to personal taxes in their country of residence.

While individuals ultimately bear the burden of all taxes, they use their income (in the broadest sense of that term) to pay these taxes. This income is derived from earnings on three factors of production — labour, capital and land (including natural resources).

Earnings from land, capital and labour are subject to a number of taxes. Once these taxes have been paid, the remaining income is saved, or used to consume goods and services, which may also be taxed. Hence, economists generally agree that consumption taxes, such as fuel, tobacco and alcohol taxes, and transaction taxes such as stamp duties also target earnings from the three factors of production.

1.4 Impact of taxes on behaviour

Taxes affect the behaviour of individuals and firms by creating incentives that would otherwise not be present. For example, when goods are taxed more heavily and prices go up, individuals may shift consumption away from them. Taxes can also have an impact on work incentives, through income tax, or on savings behaviour, through taxes (or tax concessions) on capital income. A tax on capital income may reduce investment in firms. Firms may also avoid certain projects or investments if the returns to capital from them are highly taxed compared with other projects.

The behavioural effects of a tax lead to efficiency losses referred to as the ‘dead weight loss’ or ‘excess burden’ of a tax. Figure 1.3 illustrates the excess burden of a tax using demand and supply curves. In this example, before the introduction of the tax, markets are in equilibrium with demand for the good equal to its supply. Introducing a tax increases the price paid by consumers, lowering their demand for the good, which in turn lowers the return received by suppliers of the good.

Figure 1.3: Excess burden (or dead weight loss) of a tax

Before the introduction of a tax:

Figure 1.3: Excess burden (or dead weight loss) of a tax before the introduction of a tax. This Figure illustrates the excess burden of a tax using simple demand and supply curves.  In this example, before the introduction of the tax, markets are in equilibrium with demand for the good equal to its supply.  Introducing a tax increases the price paid by consumers, lowering their demand for the good, which in turn lowers the return received by suppliers of the good.  The excess burden is a result of the fact that the loss to consumers and producers is greater than the revenue collected by the tax.

After the introduction of a tax:

Figure 1.3: Excess burden (or dead weight loss) of a tax after the introduction of a tax. This Figure illustrates the excess burden of a tax using simple demand and supply curves.  In this example, before the introduction of the tax, markets are in equilibrium with demand for the good equal to its supply.  Introducing a tax increases the price paid by consumers, lowering their demand for the good, which in turn lowers the return received by suppliers of the good.  The excess burden is a result of the fact that the loss to consumers and producers is greater than the revenue collected by the tax.

The excess burden is a result of the fact that the loss to consumers and producers is greater than the revenue collected by the tax. Even if all tax revenue is returned to individuals, society as a whole would be worse off because the tax has distorted individual and firm behaviour. The size of the excess burden depends on factors such as the tax rate and the price responsiveness of demand and supply.

Taxes with lower excess burdens are regarded as more economically efficient.

Estimates of the average excess burden of major Australian taxes and resource royalties are shown in Figure�1.4.

Figure 1.4: Average welfare loss from selected taxes

Figure 1.4: Average welfare loss from selected taxes. Estimates of the average welfare loss from major Australian taxes and resource royalties are shown in this Figure.  Royalties and crude oil excise produce the largest average welfare loss followed by insurance taxes, then motor vehicle taxes and conveyance duties.  GST, land tax and municipal rates are all low estimated welfare loss taxes.

Source: KPMG Econtech (2009), CGE Analysis of the Current Australian Tax System, 2009 for the AFTS�review, page 44.

Figure 1.4 suggests that several State taxes are amongst the least efficient and that considerable welfare gains may arise from replacing them or improving their design.

1.5 Tax reform and the GST

A significant reform to State taxes took place in 2000 with A New Tax System (ANTS). The Commonwealth introduced the GST (replacing the Commonwealth’s Wholesale Sales Tax), and allocated the revenue from it to the States, on certain conditions. In exchange for revenue from the GST, the States agreed to abolish a number of their least efficient taxes.

A timetable for phasing out 10 State taxes was outlined in the Intergovernmental Agreement (IGA) on the Reform of Commonwealth-State Financial Relations, signed by the Commonwealth and all States in 1999. From 2000, GST grants replaced financial assistance grants and revenue replacement payments from the Commonwealth. The Commonwealth provided transitional budget support to the States following the introduction of the GST and State tax reform.15 Revenue collected by the GST was to be distributed to the States on the basis of HFE, as had been the case with financial assistance grants. In return, the States abolished accommodation tax, financial institutions duty, quoted marketable securities and debits tax by 1 July 2005.16 It was agreed that the relevant Ministerial Council would review the need to retain non-quoted marketable securities duty, lease duty, mortgage duty, credit arrangement and rental duties, cheque duty and real non-residential property conveyance duty by 2005.

At the Ministerial Council meeting on 23 March 2005, the Commonwealth proposed a timetable for the abolition of the duties listed in the IGA. The timetable was rejected by the States. States proposed their own timetables which differed for each jurisdiction. In 2008 the States and the Commonwealth signed a new IGA which gave the States until 2013 to abolish the taxes (other than real non-residential property conveyance duty) listed in the original agreement.17

1.6 The AFTS review

AFTS background

The AFTS panel was commissioned by the Commonwealth in 2008 to conduct a ‘root and branch review’ of Australia’s tax and transfer system, including State taxes.18 The review was tasked with making recommendations to position Australia to deal with the demographic, social, economic and environmental challenges of the 21st century. The review panel was chaired by Dr Ken Henry AC, and included Dr Jeff Harmer, Professor John Piggott, Heather Ridout and Greg Smith.

The final report was delivered to Government in December 2009. Of the 138 recommendations contained in the final report, around 20 related to State taxes.

AFTS findings — general

The AFTS review found the broad architecture of the tax and transfer system was sound, but would face substantial challenges in the future. The system needs to be robust, yet flexible enough to adapt to changing circumstances.

The AFTS broad vision for Australia’s tax system was that:

  • revenue raising should concentrate on four robust, efficient, broad-based taxes on:
    • personal income
    • business income
    • rents, including rents from natural resources
    • consumption
  • narrowly based taxes should only be used where they improve social outcomes or market efficiency through better price signals
  • administration of the tax system needs to be more transparent and responsive to problems experienced by taxpayers.

In considering the mix of different taxes within this architecture, AFTS concluded that a good tax system should be based on the principles of:

  • equity — meaning that individuals in similar circumstances should pay the same amount of tax and those with greater capacity should bear more of the tax burden
  • efficiency — meaning that losses to social welfare and the administration and compliance costs of taxation should be minimised
  • simplicity — meaning that the system should be easy to understand and simple to comply with, so that minimal resources are used to navigate it
  • sustainability — meaning that the tax system should enable governments to meet changing revenue needs without resorting to inefficient taxes
  • policy consistency — meaning that tax policy should be consistent with the broader policy objectives of government.19

While all these principles are relevant when considering State tax reforms, the principle of efficiency is often highlighted due to the relative inefficiency of some State taxes, when compared with possible alternative taxes and tax designs.

AFTS findings — State taxes

In relation to State tax reform, AFTS said that:

  • States should have autonomy over how their revenue is raised.
  • Existing State taxes are inefficient and increases in State tax rates are not a sustainable way of funding services in the future.
  • States would be better placed to meet future cost pressures if they had access to a more efficient and sustainable revenue source, such as a broad based cash flow tax.20 This may be used to abolish a number of existing State taxes. Tax base sharing options could also be considered, such as allowing States to levy a flat surcharge on personal income tax.
  • State tax reform should be coordinated through intergovernmental agreements between the States and the Commonwealth to provide the States with revenue stability and to facilitate good policy outcomes.21

As shown in Table 1.2, AFTS recommended a long term shift from existing taxes to a broader land tax, business cash flow tax, road user charges and resource rent tax.

Table 1.2: Summary of AFTS findings on State taxes

State tax

Reform direction

Payroll tax

Payroll tax should be replaced by a tax that better captures the value-add of labour. This could be a broad-based wages tax or, preferably, a cash flow tax.

Conveyance duty

The removal of duty should be achieved through a switch to more efficient taxes, such as those levied on broad bases (including consumption and land).

Land tax

Land tax should be levied using an increasing marginal rate scale applying to the per-square-metre value of the land. The tax should be calculated per land holding, not on an entity’s total holding. There should be no specific exemption for principal place of residence or primary production.

Insurance tax

All specific taxes on insurance products, including the fire services levy, should be abolished.

Motor vehicle tax

State taxes on motor vehicle use and ownership, including motor vehicle registration transfer (stamp) duty and taxi licence fees, should be replaced with efficient user charges where possible.

Gambling tax

Options for reducing conflicts in policy-making between regulation and revenue-raising should be explored.

Resource royalties

Most existing output-based royalty and resource rent tax arrangements imposed on non-renewable resources should be replaced by a single rent-based tax. The Commonwealth and the States should negotiate an appropriate allocation of the revenues and risks from the resource rent tax.

Source: Australia’s Future Tax System, Report to the Treasurer, Part 2, Detailed Analysis, page 680.

The AFTS review also made a number of observations in respect of the impact of the current HFE system on State tax reform, namely:

  • A multilateral tax change will change the relative revenue raising capacities22 of States, which will lead to a change in GST shares.
  • Tax reform might be revenue neutral in an aggregate sense, but may not be revenue neutral for individual States.
  • In theory, no State would have a financial incentive to resist or favour a revenue neutral tax reform if all States apply the same revenue raising effort.
  • In practice, States have, and are likely to continue to have, different tax policies. HFE will not compensate a State for revenue lost from a change in tax mix where it does not apply the average policy. States may experience difficulties if they do not have the same ability to raise marginal revenue from the new tax base as from the old.
  • The States will need to consider whether, and to what extent, differences from average policy should be reflected in their replacement taxes.23

1.7 The Tax Forum and beyond

The Commonwealth convened a Tax Forum in October 2011, to discuss priorities and directions for further tax reform.

The Tax Forum covered a broad sweep of topics across six sessions: personal tax, transfer payments, business tax, State taxes, environmental and social taxes, and tax system governance. Changes to the Commonwealth’s announced resource tax reforms and to the rate and base of the GST were excluded. Reforms also had to be consistent with the Commonwealth’s fiscal policy.24

More detailed consultation continues on many of the outcomes of the Forum:

  • The State tax reform plan is examining some of the more inefficient State taxes. The first iteration of the plan is due by the end of 2012.
  • The Not-for-profit Sector Tax Concession Working Group is examining how existing taxation support for the sector can be provided in fairer, simpler and more effective ways.
  • The Business Tax Reform Working Group is examining how the business tax system can be improved.
  • The Superannuation Roundtable has the Commonwealth working with industry, community groups and other stakeholders to implement reforms to superannuation.
  • There are ongoing consultations between Treasury, the Australian Taxation Office and the Council of Small Business of Australia on ways to reduce small business compliance costs.

Work is also being done by individual States to review their tax systems.

Two States have recently completed reviews of their tax systems — the New South Wales Financial Audit (the Lambert Report) and the ACT Taxation Review.

In relation to the tax system, the Lambert Report finds that:

    The revenue base of the State, particularly the tax base, is in the main narrowly based, volatile and economically inefficient. There are substantial opportunities to reform the tax base to achieve greater efficiency, equity and simplicity.25

The report makes a number of recommendations in relation to tax reform, including:

  • abolishing insurance duty (funded by a lowering of the payroll tax threshold)
  • broadening the payroll tax base and reducing the payroll tax rate
  • abolishing transfer duty and replacing it with a replacement tax on land value
  • a feasibility study on congestion charging, with road user charges replacing vehicle taxes
  • giving companies that develop new mines a choice between being charged royalties and being subject to a New South Wales resource rent tax.26

The ACT Tax Review contains 27 recommendations, including:

  • replacing (over 10-20 years) stamp duty on conveyances with increased land taxes
  • broadening the land tax base (achievable by abolishing the existing land tax and replacing lost revenue through higher general rates)
  • abolishing general insurance and life insurance duties
  • retaining payroll tax, pending a nationally agreed reform in this area
  • retaining motor vehicle transfer duty, pending a nationally agreed shift to a road user charge system
  • considering increasing gambling taxes, following the completion of the mandatory pre-commitment trial period being pursued in cooperation with the Commonwealth.27

1 2005, Australian System of Government Finance Statistics: concepts, sources and methods, cat.�no.�5514.0, ABS, Canberra, page 140.

2 Taxes on tobacco and alcohol, for example, are generally set at levels that discourage overconsumption of the commodity. In the past, taxes on imported goods were set at levels to encourage purchase of locally produced goods over imports.

3 Australia’s Future Tax System, Architecture of Australia’s tax and transfer system, page xii.

4 Of the Commonwealth’s 99 taxes, 67 are agricultural levies. Unlike other taxes, funds raised from these sources are hypothecated to industry research and development or marketing arrangements.

5 Section 51(ii) of the Commonwealth of Australia Constitution Act 1900 provides that the Commonwealth Parliament has the power to make taxation laws, but not so as to discriminate between States or parts of States. Section 90 gives the Commonwealth exclusive power to levy customs and excise duties, and Section 109 provides that wherever the law of a State is inconsistent with a law of the Commonwealth, the State law is invalid to the extent of the inconsistency.

6 Australia’s Future Tax System, Architecture of Australia’s tax and transfer system, page 199.

7 Commonwealth Government, Final Budget Outcome 2010-11, page 67.

8 Commonwealth Government, Final Budget Outcome 2010-11, pages 63 and 67.

9 New South Wales abolished land tax in 1906, but reintroduced it in 1956.

10 James, Denis, Federal and State Taxation: A Comparison of the Australian, German and Canadian Systems, of the Parliamentary Library, Current Issues Brief No. 5, 1997-98, 3 November 1997.

11 Walter Hammond and Associates v the State of NSW and others and Ha and anor v the State of NSW and others (1997) 146 ALR 355. Franchise fees were characterised by the Court as excises, which may not be imposed by States because of Section 90 of the Commonwealth of Australia Constitution Act 1900.

12 Victorian Government, 1998-99 Budget Paper 2.

13 The Commonwealth also legislated to protect States from paying refunds on past collections of business franchise tax.

14 The Commonwealth’s taxation power cannot be imposed so as to discriminate between States or parts of States, see Commonwealth of Australia Constitution Act 1900, s 51(ii).

15 Transitional support was necessary to fulfil the Commonwealth’s guarantee that no State would be fiscally worse off as a result of the tax reforms. A determination of each State’s Guaranteed Minimum Amount (GMA), including the impact of taxes forgone, was agreed. Any shortfall between GST payments and GMA was redressed through a Budget Balancing Assistance (BBA) payment.

16 Commonwealth Government, 2007-08 Budget Paper 3, Appendix E.

17 Intergovernmental Agreement on Federal Financial Relations, 2008, Schedule B, pages B-1 and B-2.

18 The AFTS review’s Terms of Reference excluded it from considering increasing the rate or broadening the base of the GST, changing the tax-free status of superannuation payments for over 60s or making recommendations that were not in line with the Commonwealth’s announced aspirational personal income tax goals.

19 Australia’s Future Tax System, Report to the Treasurer, Overview, page 17.

20 A business cash flow tax is broadly equivalent to an invoice-credit model GST or a payroll tax without exemptions.

21 Australia’s Future Tax System, Report to the Treasurer, Detailed analysis, page 669.

22 The concepts of effort and capacity in the HFE context that are essential to understanding the importance of these observations are discussed in Chapter 2.

23 Australia’s Future Tax System, Report to the Treasurer, Detailed analysis, page 685.

24 Joint press conference: Treasurer and Minister for Financial Services and Superannuation, 28 July 2011,

http://www.treasurer.gov.au/DisplayDocs.aspx?doc=transcripts/2011/110.htm&pageID=004&min=wms&Year=&DocType=, accessed April 2012.

25 New South Wales Financial Audit, September 2011, page 23.

26 New South Wales Financial Audit, September 2011, page 27.

27 ACT Tax Review, May 2012, pages 6-9.