Rethinking tax reform: The once-in-a-generation opportunity to unshackle Australian businesses

Australia has been presented with a once-in-a-generation opportunity to overhaul its tax and transfer system, with the long-mooted topic now firmly back on the national agenda due to COVID-19.

While the inefficiencies of our taxation system are nothing new, the latest wave of government debt and significant economic contraction should be ample reason for policymakers to finally enact change.

How did it get so bad?

In recent times we’ve seen Australia’s tax laws fail to keep up with changes spurred on by globalisation and an increasingly digital economy. Our current tax framework is characterised by a patchwork of amendments and administrators scrambling to ensure that a decades-old system operates as intended — in many circumstances that, quite frankly, it was never intended to cover.

Australia’s tax and transfer system is arguably one of the world’s most complex — which is surely of very little benefit to anyone other than tax advisers. Now add to the mix the economic curveball we’ve come to know as COVID-19, and we’ve got a system grappling with significant economic contraction and mounting government debt.

While substantial recovery from this crisis will require the pulling of many economic and policy levers, there has never, in our lifetime, been a greater need to focus on improving our tax system.

Getting back to basics

Taxation policy 101 teaches us that an effective system should be based on three key factors:

1. Equity – or ‘fairness’  between taxpayers, with respect to ensuring that taxpayers in similar positions bear tax at the same level, but also that tax is borne at a level commensurate with the taxpayers’ ability to pay;
2. Efficiency – that is, the system should not encourage the distortion of economic decisions; and
3. Simplicity – the system should be relatively easy to understand and place a low administrative burden on taxpayers.

It’s doubtful whether Australia’s current system achieves any of these criteria. In fact, our current regime is arguably the exact opposite — inefficient, technically complex and often distortive.

If we cast our minds back to 2015, the federal government’s discussion paper on tax reform, Re:think, noted that our current tax system was ‘holding Australia back’. However, we have seen little traction in achieving true reform since.

An example: the plight of SMEs

Taking a ‘back to basics’ look at the taxation of small and medium-sized enterprises paints a very clear picture. These kinds of organisations comprise a large portion of Australian businesses and make a significant contribution to the Australian economy — at last count contributing to around 57% of the nation’s GDP.

Ordinarily it would be expected that businesses of this size and scale should not have to seek specialist tax advice in relation to their everyday affairs, yet the complexity of the taxation regimes applicable to such businesses is astounding.

Out of all Australian tax legislation, some of the provisions relevant to small and medium sized businesses are the most complex. From the taxation of trusts to capital gains tax concessions, and even the process of extracting profits from private companies, the complexity of these processes and procedures is overwhelming. 

Complexity also stems from the differing tax treatment of legal entities (for example, trusts, partnerships and companies) used in the operation of small and medium sized businesses, meaning that the ability of a business owner to navigate this complexity can have a significant effect on the tax liability of a business and can lead to different tax outcomes for businesses which are economically similar and/or operate in similar industries.  

Put simply, the framework encourages distortion (for example, as between business structures) and does little to achieve equity between taxpayers. 

A wider lens

On an individual level, much can also be done to simplify the tax and transfer system and neutralise its distortive impact. For low income earners, or a second income earner within a family unit, our current system will often act as a disincentive to re-engage within the workforce. Surely in the current economic climate rebuilding the Australian economy will require all Australians in a position to do so, to be actively engaged in the workforce.

Much has been made of the recent reduction in Australia’s corporate tax rate and the fact this was needed to compete for international investment. While initially proposed as a broad-based initiative applicable to all companies, this was eventually watered down and, in practice, substantially complicates the regime.

Different layers of federal and state taxes also increase complexity — and we find ourselves with a vast range of inefficient taxes imposed largely by the state governments (and each subject to its own legislative regime and varying rules). Taxes such as stamp duty and payroll tax are incredibly distortive and will often discourage business transactions and wage growth respectively.

Where to from here?

If structural change is to be implemented this will require a fundamental change in the current modus operandi for our political parties. A shift in focus to a longer-term view of the Australian economic landscape and alignment of key decision makers in achieving both the redesign of tax policy and implementation of a new tax system will be key.   

It is time to take stock — and start from scratch if required. 

At both the federal and state levels, governments should be looking to capitalise on the recent bi-partisan approach that has been adopted to tackle a number of issues amid the COVID-19 crisis, and look to implement long-term structural change that will stand Australia in good stead — not just for the next 12 to 24 months, but for the next 50 years.

While I am not an economist, it’s clear that at least some or all of these measures should be considered as part of any re-design:

• Further changes to the corporate tax rate. Recent reductions have only served to increase complexity and aid in the distortion of the rate of taxation of income, and questions have been raised over whether these changes have achieved foreign investment and economic growth objectives.
• Abandoning the principle of entity taxation and taxing similar businesses in a similar way, regardless of entity type.
• Consideration of ‘flow through’ entities, similar to the ‘S Corporation’ system currently used in the US which works to replace cumbersome anti-avoidance provisions.
• Modernisation of state taxes, including land tax, stamp duty and payroll tax — or even abolishing state taxes altogether and taxing only at the federal level.
• Adopting a more consistent treatment of gains which currently differs across income and capital assets.

The all-important ‘recovery’

From the perspective of expanding the Australian economy coming out of COVID-19 and funding the stimulus required to keep the economy on life support, the fact that Australia places such a heavy reliance on taxes that can be easily manipulated, or are subject to significant shifts in a global economic crisis, surely means that Australia must re-visit the basis upon which our tax system is designed.

Although no system will ever be ‘perfect’, the potential risk of imperfections cannot be allowed to spoil the opportunity created by COVID-19. If a global pandemic and impending recession isn’t enough to drive tax reform, then I certainly don’t know what policymakers are waiting for.

NOW READ: Tax-time warning for SMEs: How always focusing on June 30 can blur your long-term vision

NOW READ: Billion-dollar but tax-free: Are SMEs paying more tax than Australia’s biggest businesses?