1.Challenges for Australia’s tax system
This chapter sets out the major challenges that confront the Australian tax system.
Australia’s tax system faces challenges from a changing world.
The tax system needs to support improvements in productivity and encourage workforce participation.
Tax reform offers one of the biggest opportunities to improve productivity and foster jobs, growth and opportunities.
1.1:Australia’s tax system faces challenges from a changing world
In recent decades, changes in the global economy have put strain on tax systems around the world and Australia has been no exception. Key factors include technological change (particularly the rise of the digital economy), highly mobile investment and greater labour mobility. These developments pose two critical issues for tax systems: they can weaken the ability of tax systems to raise revenue from traditional tax bases and they can increase the economic costs of taxation, dampening economic growth.
Technological change is particularly significant for the taxation of income, especially corporate income. Multinational firms operate across many jurisdictions, much of their value is intangible and the location where value is added can be difficult to determine. The digital economy also facilitates greater personal importation of goods and services, placing pressure on the indirect tax bases.
As the mobility of capital increases, Australia’s high corporate tax rate can deter investment, ultimately leading to lower wages and prosperity. High effective marginal tax rates (including through the interaction with the transfer system) can also deter workforce participation or lead to tax planning activities as individuals seek to reduce their tax burden.
Australia also faces the prospect of a period of belowaverage income growth as the terms of trade decline and global economic growth remains subdued, relative to the years leading up to the global financial crisis. Tax reform offers an opportunity to significantly improve productivity and foster jobs, growth and opportunities.
2.Globalisation provides opportunities for a more prosperous future, but also challenges Australia’s tax system
Over the past 50 years, the economic environment in which the Australian tax system operates has changed dramatically. In the 1950s, Australia generated substantial income from wool and other agricultural commodities, the economy was encircled by a comprehensive tariff wall, the financial sector and the flow of capital were heavily regulated, and the manufacturing sector was a major employer.
Today, developed economies, including Australia’s, have become increasingly open to international trade and investment (see Chart 1.1). Financial deregulation, the growth of multinational companies utilising globally dispersed supply chains and the increasing digitisation of global commerce have opened the Australian economy to the world. This has had an overwhelmingly positive influence by increasing business efficiency and living standards and driving economic growth. However, these changes have also transformed the environment in which tax systems operate, especially for capital importing countries such as Australia.
Chart 1. Trade and foreign direct investment as a share of GDP
Source: Australian Bureau of Statistics (ABS) 2014, Australian System of National Accounts 201314, cat. no. 5204.0, ABS, Canberra.
Historically, large companies tended to be locally based and engaged in production (such as manufacturing) primarily for domestic or regional markets. Now, technology allows large companies to supply global markets using internationally integrated supply chains. This means that production can be located where costs are lowest. It is now normal for multinational companies to: have their investors reside in one country; manufacture products in another; locate their marketing and product development in a third country; and supply customers in a fourth.
A leading indicator of change is that multinationals are investing increasing economic value in intangible assets, such as intellectual property. Investment in intangible assets (such as patents, trademarks, copyrights, goodwill and branding) has been growing at around 1.3 times the rate of tangibles since 197475.1