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Policies that remove impediments in the tax system to new investment will enhance productivity across the economy, supporting Australia's growth prospects and living standards. The Working Group's principles are intended as a framework for thinking about business tax reform in this context. Each principle is accompanied by explanatory text to guide its application.
The application of these principles will necessarily involve judgements about how a particular package of reforms performs against an individual principle and against the framework as a whole. In seeking to reform the tax system, principles can conflict and there will necessarily be trade-offs that need to be made in getting the balance right. A critical aspect of these trade-offs is that they be made transparently.
The terms of reference require the Working Group to have regard to the Australia's Future Tax System (AFTS) Review. In its final report to the Treasurer, the AFTS Review set out some core design principles for the tax-transfer system: equity; efficiency; simplicity; sustainability and policy consistency. Using these principles as a foundation, the Working Group has developed its principles for business tax reform.
Principle 1.Revenue adequacy: The business tax system should raise revenue that, together with other taxes, helps to pay for public services that the community relies upon.
The primary function of any tax system is to raise revenue to fund the provision of goods and services by the government. The Australian community will continue to demand efficient, responsive and relevant public services, funded by taxes.
Business tax revenues make a contribution towards funding these goods and services. This will continue to be the case, regardless of the particular reform options adopted.
The integrity of the system is important in securing predictable adequacy of revenue.
Principle 2. Economic efficiency: The business tax system should raise revenue in a way that minimises the effect of the tax system on business decisions except where this is needed to correct for market failures.
By distorting investment and production decisions, the business tax system can deter investment and lead to an inefficient allocation of resources within the economy. In this way, it can detract from Australia's productivity performance and future living standards.
Business tax should be applied in a way that minimises its impact on business decision making. It can be useful to think about the impact of business tax on the following set of decisions:
- What to invest in?
- Where to invest?
- How much to invest?
- How to finance investment?
- The organisational form through which to undertake the investment?
- Where to record profits arising from investment?
- How to distribute income?
- When to invest?
Efficiency gains arising from business tax reform will be realised as a result of changes in business decisions which in turn, over time, change prices and quantities. However, different tax reform proposals will affect these decision margins in different ways. All feasible options will retain some form of distortion, but the aggregate impact of some options will be smaller than others. Assessing these impacts is challenging, given the complexity of the overall tax system and the range of factors that influence business behaviour.
Efficiency enhancing reforms are more likely to be successfully implemented and sustainable if the rationale for change is clear and well understood by businesses and the public.
The tax system is one tool which the Government has at its disposal to correct for the failure of the market to take account of positive and negative spillovers or externalities. Tax concessions can be used to encourage socially beneficial activities in which there would otherwise be underinvestment. Similarly, tax can discourage activities that impose a cost on the community as a whole.
Principle 3. Distributional equity: The business tax system and potential reforms should be understood in terms of where the final incidence falls among capital owners, workers and consumers.
The size and openness of the Australian economy and the existence of economic rents suggest that in the long run most of the burden of Australia's company tax is probably borne by labour and consumers, but with some of the incidence falling on capital owners earning resource and other immobile rents.
In the short run, it is likely that a larger share of the incidence of a reduction in Australia's company tax rate (relative to rates applying elsewhere) would be captured by capital owners.
The company tax system raises revenue by acting as a final tax on foreign investors and, as a result of imputation, as a withholding tax on domestic investors. Proposed reforms need to be understood in terms of their impact on after-tax returns to different investors.
The interaction of business tax with elements of the broader tax-transfer system such as capital gains tax and personal income tax must be understood. Regard needs to be given to the distribution of share ownership among resident households and superannuation funds and non-residents and the different tax treatments of their income from companies.
Principle 4. Competitiveness: The business tax system should take into account Australia's integration with the global economy.
Australia has long been a net capital importing country, and will continue to be so, making it important that our business tax settings take into account the potential for the tax system to discourage investment by increasing the cost of foreign capital.
The growing importance of outbound investment means the competitive position of Australian business offshore is an important consideration for Australia's business tax policy.
The competitiveness of Australia's business tax arrangements also needs to be considered in the context of the range of other, non-tax factors that make Australia a good place to do business and invest.
Principle 5. Simplicity: Business tax reform should be aimed at making the system as simple and as easy to comply with as possible, having regard to an often complex business environment, the need to ensure the integrity of the system and the costs and benefits of transitioning to any new rules.
Businesses are more likely to make efficient decisions, and respond as intended to policy signals, if the business tax system is simple to understand and the processes necessary to comply are not unduly complex.
Simplicity can deliver productivity gains by allowing scarce resources to be reallocated away from tax compliance and administration.
However, the business tax system also needs to be able to cope with sophisticated business transactions
and arrangements.
That said, complexity can undermine the integrity of the business tax system. The ongoing integrity of the business tax system is essential to its role in collecting revenue.
Complexity in the business tax system can also arise from interactions with other parts of the broader tax system.
Even where a particular reform may ultimately lead to a more efficient and less complex system in the long run, these gains should be assessed against the costs of transition in the short to medium term.
Principle 6. New investment focus: Business tax reform should generally focus on new investment.
Generally, business tax reforms are forward-looking. However, retrospective changes will sometimes be desirable. It is important that any reform proposals include a clear pathway from current arrangements to the desired reform destination. Transitional arrangements can also raise issues of fairness and system design.
Changing the tax outcome of existing business ventures may deliver a windfall gain or loss to taxpayers. This needs to be weighed against any potential impact that tax reform may have on the revenue adequacy, efficiency and simplicity of the tax system.
Difficult decisions need to be made about the appropriate commencement of business tax reforms, taking account of the potential impacts resulting from these trade-offs.