Paul Tilley: Australian tax system is a ‘renovator’s delight’

Foundational tax reviews are rare and destabilising. Tax is “quasi-constitutional” in the sense that it implies a social contract between a government and its citizens, explained Paul Tilley, former economic policy adviser to the Australian government.

It is a “matter of judgment” whether a system has reached the tipping point at which major tax reform is warranted.

Some, like former Treasury secretary Ken Henry, believe that time has arrived. Others, including Tilley, see a tax review as “ideal” but hold out hope for incremental reform.

It is a question of degree, and, at any rate, Australia’s tax system would be, to a real estate agent, a “renovator's delight,” he said.

Accounting Times spoke with Tilley to learn what Australia’s less-than-inspiring tax reform record says about the current tax debate.

This question formed the subject of Tilley’s new book, Mixed Fortunes: A History of Tax Reform in Australia.

Winners and (transparent) losers

Asked why tax reform is a story of “mixed fortunes”, Tilley answered simply that “tax reform is difficult.”

“The starting point, when I was in Treasury, what I would say to the people I worked with, the divisions I ran, was that when you think about tax reform changes, you have to broadly constrain yourself to a revenue-neutral framework,” he told Accounting Times.

“Every time you see an advantage in having a tax break for a particular group, you need to think at the same time about how you have the tax increase to get the $700 billion the government needs.”

It’s a world of “winners and losers” and the government has to bet whether the costs of a tax increase will be more or less beneficial than an associated tax decrease.

The reason tax reform is so difficult, he said, is unlike other areas of policy, “the losers are so transparent.”

Most of the challenges are baked into the very nature of tax reform, though Australia’s political system has its unique challenges.

Australia has seen only three tax reviews that successfully met their aims, said Tilley. The first was the Curtin review of 1942 in which the federal government consolidated income tax to boost war-time revenues.

The second occurred nearly a half-century later under the Hawke government, which significantly broadened the nation’s tax bases, adding a capital gains tax, a fringe benefits tax, a foreign tax credit system, and a dividend imputation system.

The third, and most recent successful tax review took place under Howard, within years of the new millennium. Its centrepiece was the GST.

Setting the foundations

When asked what he had been most surprised to learn in researching for the new book, Tilley said it was the importance of foundational reviews in supporting subsequent determinative ones.

“I knew a fair bit of this, but it became a lot sharper for me … You need to allow the community to be exposed to these debates for a long period,” he explained.

“If you’ve got only a short political window to do reform, you need the arguments to have been made previously.”

The Curtin reforms had the benefit of two decades of public debate and two royal commissions before being acted upon. The Hawke reform, too, was based on recommendations made a decade earlier under the 1975 Aspey review.

Similarly, the GST had been 25 years in the making before being inked by Howard.

Reformers today would be relying on the 2008 Henry review to plead their case, said Tilley.

The lessons learned in that review, he said, including the need to further broaden the nation’s tax bases to take pressure off income taxes would prove “foundational” to a modern-day tax review.

Tilley said the Henry review was “politically compromised” by both the GFC and the Rudd government’s attempt to introduce a resource super profits tax.

“But it still sits there,” he said, including its insistence that the government should be using other tax bases like land, wealth, and stocks.

Where are we now?

There is a general set of criteria against which tax policy can be judged, including revenue adequacy, economic efficiency, social equity, and administrative simplicity.

The overall character of a tax era is defined by which considerations stand out most strongly. Revenue adequacy is always the overarching consideration, but trade-offs between the remaining criteria are constantly being made.

As tax systems developed in the 19^th century, revenue adequacy and simplicity considerations were paramount. In the first half of the 20^th century, equity took over as income taxes took centre stage.

Later in the century, he said, efficiency took on more importance as policymakers looked to broaden tax bases and lower tax rates.

Since the GFC, “[social] equity is probably where the game has changed.”

Tax reform is now as much about intergenerational equity as it is point-in-time equity, he said.

At the launch event for Tilley’s book, Henry repeated his claim that the current tax system is an “intergenerational tragedy” in the making.

The burden of funding Australia’s growing public expenditure bill will “have to be shouldered by a declining proportion of the population – principally young workers,” he said.

“The same people who have been priced out of the housing market; the same people who are going to have to adapt to the interrelated impacts of climate change and biodiversity loss.”

Apart from revenue adequacy, it is social equity that will be the guiding criteria against which any tax reform proposal would be most harshly judged.

A reformist government

Meaningful tax reform will only take place when a government assesses it has the “political and fiscal window” to pursue it. The current government is not that government, said Tilley.

While a crisis could change that, the way the Second World War created room for the Curtin review of 1942, “the right here and now doesn’t look good,” he said.