Saturday, December 06, 2008

TAXING TIMES: Beware the cash flow tax

Surely he couldn't have been serious?

Three weeks ago - making it clear that he wasn't "endorsing it," the head of the Treasury Ken Henry raised the idea of replacing most of Australia's existing taxes with with so-called "cash flow" models based on the difference between money coming in and money going out.

He said it had been put to him by "Jim", a central Queensland businessman whose real name turns out to be Roy, who he met in a pub on his way back from caring for northern hairy nosed wombats over the winter break.

Ken Henry already knew of the idea of course, it had been the subject of much "academic discourse," but he had "never seen it argued so well, nor with such understanding". He told the audience at the National Press Club it was an idea his Henry Tax Review would "need to consider".

And there the idea might have rested - a concept best thought of as academic curiosity, beloved by legions of ivory tower theoreticians including Australia's Mark Latham, but never seriously implemented anywhere and with loads of transitional and actual problems.

But it hasn't. The Review has been taking it seriously...

It's eagerly awaited consultation paper, to be released next week, may keep it as a genuine option.

The Treasury received a briefing from a champion of the idea, University of California Berkeley Professor Alan Auerbach, days after the Henry Review was announced.

Auerbach has conducted two studies that have concluded that moving to a cash flow tax in the US could boost its national income by 9 per cent over time. A 1970s US Treasury report and a report by the Meade committee of inquiry into tax in Britain found the same sort of thing. Three decades on another inquiry in Britian, headed by the Nobel Prize winner James Mirrlees, an expert in the role of incentives, is examining it again.

What is it about this elegant but impractical idea that for decades has been capturing hearts across a spectrum that takes in socialists in Britain, low-tax lobbyists in the United States, Australia's one-time leadership aspirant Mark Latham, Jim/Roy in central Queensland, and now quite possibly the head of the Henry Review Dr Ken Henry?

In Latham's case it seems to be a dislike of conspicuous consumption. By adding up all of the money that comes in (such as salary and withdrawls from the bank) and then subtracting only money that didn't go "out" (money put into the bank, mortgage repayments, certain types of approved investments and so on) the Tax Office would get at our consumpion - the bit we hadn't saved. It could tax this on a progressive scale minimally at low levels, and then quite heavily at high rates of consumption, allowing each of to enjoy the things we need but making us pay more heavily to spend on the things we don't.

As he says in his book Civilising Global Capital, high tax rates would no longer discourage people from working, but from consuming. "If high income earners choose to save or productively invest a solid proportion of their revenue, and thereby add to the growth of the economy," they would escape heavy taxes. But the new system would ensure that "the realisation of affluence, expressed in the form of excessive consumption, is accompanied by a progressive contribution to the tax system.

Put more bluntly, what Latham, Jim/Roy and all the rest are proposing is a massive - a complete - tax break for saving; for businesses as well as individuals. Corporations would be taxed only on that part of their net profit that they spent and so would their workers.

It's certainly elegant. The former Prime Minister Paul Keating used to eulogise what he called "long clean lines" of policy. His battle-hardened advisors, closer to the real word had a response: "neat idea, forget all about it".

Beautiful policies aren't always good ones, and right now can be downright dangerous.

Consider for a moment Latham, and perhaps Jim/Roy's, laughable idea that money isn't used until it is spent. Try telling it to someone without money. Ask whether that person would rather have the options, the security, that went with having a $50 note in his wallet or her purse or whether it would only benefit them when it was spent. Saving might be a good idea, but let's not kid ourselves that high-wealth individuals need tax breaks to encourage them to do it.

And what about workers or investors from overseas? Even if Australia's new cash-flow tax system was the best in the world, no-one else in the world would be doing it. How could we measure saving overseas to subtract from income made here and visa versa?

And how would we move to the new system? Australians with money in the bank right now have paid a lot of tax to get it there. The new system would tax that money again when it came out. The transitional arrangements to stop this happening would be complex (and not very "clean").

The idea will never get up. And that's its real danger.

Australia's tax system isn't perfect. The Henry Review has been presented with a once-in-a-generation opportunity to recommend tangible, doable measures that will help fix it up.

If instead it recommends a massive revolutionary change that could never be easily adopted, the Prime Minister might accept its recommendation and send the report away for further consideration.

The opportunity to actually fix things now will have been lost. It's what a timid Prime Minister might want: a bold recommendation.

Ken Henry was speaking boldly at the Press Club three weeks ago. This week we will find out whether he meant it. All manner of practical people with genuine hopes for making Australia's tax system work are hoping that he didn't.