Sunday, September 20, 2009

Ken Henry's grain of mustard seed - what to expect

"Like the grain of mustard seed in the parable Rudd would have read about in his studies of Christianity - when planted, the Henry Review became impossible to control"

Staff at the Henry Tax Review have begun drafting the chapters of a final report set to surprise just about everyone who was there at its birth.

Gathered around butchers' paper stuck to one of seven pinup boards in the Great Hall of Parliament House 17 months ago the taxation group at the 2020 Summit decided the only thing it could sensibly recommend was a complete tax inquiry.

On that day the topics participants including former Reserve Bank Governor Bernie Fraser and businessmen Lachlan Murdoch and Fred Hilmer had in mind did not seem particularly grand. They spoke about about how to better mesh the tax and welfare systems and how to ensure that foreign companies could easily invest in Australia .

They might have been surprised by pay-as-you-drive road taxes policed by geosynchronous satellites, death duties, wealth taxes, higher capital gains and resource rent taxes, the withholding of superannuation until the age of 67 as well as the shaving of corporate tax rates and the slashing of taxes on insurance.

Wayne Swan might have been surprised as well. In announcing the review on the eve of his first budget he was clear about what it could not do. It could not recommend broadening or boosting the Goods and Services Tax, it had to preserve tax-free super payments for over 60s and it couldn't tamper with the government's announced "aspirational" tax cuts for high income earners.

Since then the government itself has ditched the aspirational tax cuts, the Henry Review has found other ways to restrict superannuation payouts and its report is set to at least give a nod to the long-term case for a higher consumption taxes...

Anyone who expected Treasury boss Ken Henry to do any different overlooked both his history and the way in which he spoke about his task.

In 2006 Prime Minister John Howard appointed Henry to a task group on emissions trading with terms of reference that required it to advise on a "workable global trading system". Instead it suggested a standalone Australian system.

In 2008 Communications Minister Stephen Conroy appointed Henry to a panel to examine proposals to build a fibre-to-the-node broadband network. Instead it suggested a fibre-to-the-home network.

Henry speaks about the review as a once-in-a-generation game changer. This is partly good news for Rudd and Swan because it releases them from the obligation to act on the recommendations quickly in what will be the lead-up to an election. Henry points out that the 1975 Asprey Tax Review had to wait 10 years for the capital gains tax it recommended and 25 for the goods and services tax . He told a conference in August some of his recommendations might only become possible "sometime in the future when technology is available".

But the sweeping nature of the once-in-a-generation rethink also means Rudd and Swan genuinely could have had no idea of what was to become of what they started. Like the grain of mustard seed in the parable Rudd would have read about in his studies of Christianity, when planted it became impossible to control.

A better analogy is that of a review conducted from the deck of an alien spaceship just arrived on earth. Some things we do are so obviously strange - such as imposing special taxes on insurance that we impose on no other socially useful spending - that the alien couldn't help but notice.

Cheaper insurance

Insurance stamp duties and fire and emergency service levies add as much as 50 per cent to the cost of a premium on which the 10 per cent GST has already been paid. Every other product-specific supertax is imposed on a good or service thought to be bad such as alcohol or gambling or tobacco. Insurance is not a vice and should be taxed at no higher rate than everything else under the GST according to a recommendation to be included in the December report.

The fact that these are state taxes and the Henry Review is a Commonwealth committee won't worry it. Like an alien on the deck of a spaceship it will feel free to recommend the unthinkable - that our existing ideas about which part of government does what can be reworked.

Australia's system of alcohol taxation can kindly be described as uneven. It too will get attention.

No relief for homebuyers

But the Henry Review has come to the conclusion that other state taxes - much complained about - aren't actually that bad. Stamp duties on conveyancing and land transactions are charged at a time when people are already borrowing and can afford to pay. They don't much seem to be slowing our relentless desire to trade up and they help claw back the untaxed profits we pocket from the capital gains tax exemption on our family home. The Review won't recommend an end to real estate stamp duties for as long as the capital gains tax exemption remains, and even it is unlikely to have the courage to recommend that the exemption goes.

Payroll tax to stay

Payroll tax is also widely abhorred, but from the review's standpoint is pretty harmless. Not only will it stay in defiance of the bulk of submissions on the topic but the review will recommend it be extended by withdrawing a range of exemptions.

There are taxes that do genuinely hurt employment, and the review believes they are those that discourage foreign firms from setting up here and staying here.

Company tax to slide

A nation's rate of company tax turns out to be pivotal to its ability to attract and retain foreign capital. The Henry Review is convinced of that beyond doubt. While earlier tax reviews suspected it they lacked hard evidence in the form of cross-country studies that have only recently become available. They suggest that the gains from even small cuts to a nation's corporate tax rate are so big that Australia would be doing itself a disservice by leaving its rate at an uncompetitive looking 30 per cent.

But they also suggest there's no need to cut the company tax rate to anywhere near zero. Beyond a certain point a low rate attracts the wrong sort of capital; extremely footloose money that bids up asset prices rather than builds employment.

The review believes that the ideal rate for Australia at the moment lies between 25 and 30 per cent, and so will recommend a cut - but not to below 25 per cent.

Higher resource and capital gains taxes

The review believes mining companies have been treated too generously. In an earlier discussion paper it noted that while mining profits raced ahead during the commodities boom the revenue to the nation whose resources were being mined failed to keep pace. It will recommend either a higher resource rent tax or a switch to a resource profit tax.

It also expressed bemusement at the 50 per cent discount applied to income taken in the form of capital gains introduced by John Howard at the start of this decade, noting that income earned from work attracts no such concession. The review has been told the cut fed the subsequent explosion in property prices and sallows high income earners to avoid tax.

Taxing income from capital gains in the same way as other income would have an economic rationale as well as recovering some of the revenue to be lost from a lower company tax rate.

Many of the report's recommendations are far from firm at the moment. And that's why the review's staff are drafting chapters. Panel members want the recommendations to firm up in the drafting process and want to use each draft chapter to see how its ideas mesh with those in other chapters to build an integrated vision.

In designing a system for the next 25 years the review has had to become a futurologist, effectively producing its own early version of the government's Intergenerational Report due for release next year.

Longer work and longer care

The review has seen that Australians are living longer and so will recommend not only that the pension age be lifted to 67 as the government has already announced, but that the age at which we can get superannuation payouts climbs to 67 as well. It has also discovered that we are living longer in unpredictable ways, meaning that private insurers have stopped offering lifetime annuities - a role it wants the government to perform so that retirees can be certain of getting a monthly cheque for the rest of their lives no matter how long they live.

Paying for using roads

The review can see that cars will soon no longer be powered by petrol. When that happens excise collections will collapse, and with it Australia's half-hearted attempt to use the pump to charge for road use. The obvious replacement revenue stream is from actual road use and the review is excited by the possibilities.

Its report will point out that other utility is charged for. Electricity, gas, water, telephones - we pay for each of them according to how much we use. When the committee asked "why not do it roads," it found no valid reason. It commissioned one study and the Treasury commissioned another and found benefits from road user charges extending way beyond the revenue stream. In the same way as charging for electricity use removes the need to build endless new power stations, and charging more for power at peak times makes better use of the power stations we have, charging for road use and charging more when roads are clogged should drastically cut the need to spend billions building more and more expensive roads.

Along with lower corporate tax rates, user charges for roads have long been an article of faith among economists, but they are now actually being trialled in Seattle and Singapore with in-car GPS devices that deduct money from accounts or pre-paid cards in real time. The review is convinced that privacy concerns can be properly addressed and will point out that the information collected by the in-car devices would remain in the cars with only bills being sent outside of them.

If it sounds futuristic, it's the type of thing the Treasury Secretary meant when he said that some of his ideas would have to wait until the technology became available.

It's probably light years away from the ideas that were going through the minds of the enthusiasts gathered around the butchers' paper in the Great Hall in April last year.

Death duties and wealth taxes

But other ideas won't surprise them. Estate duties and wealth taxes are both on the agenda, as they need to be to bring Australia into line with the rest of the world, but the review has put them there for completeness, not because it thinks they'll be big earners. Most estates and most piles of wealth would have to be exempted to make the system popular and easy to administer.

And a modest land tax

Land tax, another favourite of economists will get some sort of endorsement, but the committee has found that its benefits aren't as straightforward as claimed. It's often hard to distinguish the value of land from the value of the purposes for which it is used.

The top rate of income tax certainly isn't set for another cut regardless of the "aspirational" goals the review was told to keep in mind and its likely to spell out the obvious case for pushing up Australia's reliance on consumption tax.

But there'll be surprises as well. It'll be that sort of report.

Henry Review

Searchable submissions

Consultation papers

Published in today's SMH and Age

Graphic: The Mustard Seed Bookstore