May 2008

Taxation, reform and politics

Julie Smith, Australian National University

Miranda Stewart (ed.) Tax Law and Political Institutions, NSW, Federation Press, 2007 (204 pp). ISBN 9-781 86287-638-5 (paperback) RRP $39.95.

Richard Eccleston Taxing Reforms: The Politics of Consumption Tax Reform in Japan, the United States, Canada and Australia, Cheltenham UK, Edward Elgar, 2007 (208 pp). ISBN 9-78184542-120-5 (hard cover) RRP $163.73.

The Howard Government’s ‘A New Tax System’ (ANTS) tax reforms, including the goods and services tax (GST), are less than a decade old. Some of us thought ANTS had achieved what the 1985 Tax Summit and Fightback! had not—chronic tax reform fatigue. Yet, taxes are rarely off the political agenda for long. ‘Tax’, says leading Australian tax scholar Yuri Grbich, ‘is politics with a dollar sign in front’ (personal communication, quoted in Evans (2003, p. 214)). With the first Rudd Labor Government’s budget, an economically risky election commitment to major personal income tax cuts amidst a booming economy, and a 2020 Summit-related promise of ‘root and branch’ tax reform including federal finances, 2008 promises to be another taxing year for Australian governments.

Public and media discussion of tax policy invariably turns quickly to personal tax rates and the ‘hip pocket nerve’, but rarely consider ‘big picture issues’. The study of fiscal politics explores questions such as:

Why Australia’s tax system has evolved into what it is, and what forces will shape it into the future?
How does taxation affect political development and growth in democracy?
Does a country’s political ‘culture’ affect how well its tax system develops and functions?
Through what pathways does successful tax reform occur, and are some countries with particular political structures, institutions, and policy processes better placed to reform their tax systems than others?

Contributors to two recent Australian publications on tax policy explore issues like these. Miranda Stewart introduces Tax Law and Political Institutions with a summary of recent thinking on how tax systems link with politics, providing a readable and succinct backdrop to several methodologically diverse articles on tax policy. She concludes, accurately in my view, that the renewed emphasis on process in tax policy research ‘brings attention back to the budget as the political locus for government taxing and spending’ (p. 7). Richard Eccleston’s Taxing Reforms systematically compares consumption tax in four countries—Australia, the United States, Canada, and Japan—through ‘structured narrative’, to decide what the critical factors were in ‘successful reform’.

These books may not be avidly read at the ‘coalface’ of Australian tax reform—in the ATO, the federal Treasury or at Parliament House. Yet this sort of attempt to gain a deeper understanding of what underpins our tax system, and how and why it changes, is immensely valuable, not least because ‘The Fisc’—our tax and spending system—is fundamentally reflective of our society’s real priorities, as well as so important to resolving conflicts over who gets what at the material level.

UNDERSTANDING COMPLEX CAUSATIONS

Because taxes are paid reluctantly, and the public needs to be coerced or convincingly bribed into paying them, Levi (1988) and others have argued that taxation itself spurs and shapes political systems and the extent of democratic representation. The taxation authority must have a degree of popular legitimacy—‘no taxation without representation’—so growth of taxation leads to power sharing and more representative government.

The taxation authority must have a degree of popular legitimacy.

Theories of how ‘politics’ affects the evolution of tax systems range from the simple and appealing idea, associated with public choice theory, that government is a self interested leviathan which grabs the maximum revenues as and where it can, to more deterministic approaches which explain tax systems and tax reform as the product of economic forces and economic change (Buchanan & Musgrave 1999). Recent research on fiscal politics has taken a pragmatic approach to improving our understanding of the tax reforms of the past decade. ‘Historical institutional’ theory (Peters 1991; Pierson 1993; Steinmo 1998) explains different tax systems as the slowly evolving result of interactions of ideas and interests with social and economic forces, within existing institutions and political cultures. The Stewart and Eccleston volumes take this approach.

POWER SHARING, FAIRNESS AND THE LEGITIMACY OF TAX POLICY

In Stewart’s volume, Cullen and Krever ask whether governments are forced along the path to democracy by the need to impose taxes. Exploring the links between the slow progress of democratic political development and taxation in Hong Kong, they argue that tax reform is inevitable because Hong Kong’s tax system is, in their assessment, ‘outdated’. Taxes—mainly a profits tax, a salaries tax and a property tax—are close to the lowest in the developed world. Hong Kong’s successful experience with a public leasehold system of land tenure has provided substantial revenues from land rents. Cullen and Krever argue that over-use of land rents for revenue purposes has imposed a ‘de-facto’ goods and services tax on all consumers in Hong Kong, as inflated land prices may have been passed on by businesses to consumers in prices’ (p. 17). However, land revenues have enabled Hong Kong to provide its citizens with ‘public housing on a massive scale, [and] to finance excellent transport and communications systems and comparatively sound education and health systems’ (p. 16).

Cullen and Krever seem to be making the case that political development is hindered in Hong Kong by this politically painless revenue system. But perhaps the Hong Kong case is more interestingly understood as supporting the proposition that citizens rebel against ‘taxation without commensurate government services’ rather than against ‘taxation without representation’. A contrasting example is Canberra, where a poorly administered public leasehold system has led to poor land revenue collection (Neutze 1988a; 1988b), but reliance on more modern systems of taxation does not appear to have generated pressures for democratic representation. Self government was imposed on the Australian Capital Territory by the federal government in the late 1980s, and declining standards of public services, and rising taxes have only reinforced citizen’s disdain for the locally elected legislature since that time.

Fortescue’s account of Russian experience confirms that the link between democracy and tax systems is not simple, with corporations in the country’s supposedly democratic new institutions able to press their case on taxation through mechanisms unavailable in practice to its citizenry.

Political manoeuvring over the GST continues today.

Eccleston argues for the importance of policy learning and policy ‘entrepreneurs’ in the introduction of Australia’s GST. Strangely, for a political scientist, the narrative does not take into account the critical role of institutions such as the High Court in shaping Australia’s tax system and particularly in triggering implementation of indirect tax reform. For example, it was the Ha decision of the High Court in 1997—a decision that ruled several billion dollars of the states’ annual revenues to be constitutionally invalid after decades of debate—that provided the essential backdrop to the GST reforms (Smith 2004). A focus on the role of key players and policy elites also means that Eccleston’s narrative understates the significance of the institution of the Senate in modifying the GST to exclude basic food, a fundamental change in its design from the Coalition Government’s original ANTS package.

Political manoeuvring over the GST continues today. One of the most interesting tax policy proposals in the public arena in the lead up to the May 2008 Budget has been the ‘kite flying’ by business groups for a rise in GST as a means of funding a lower company tax rate. In the short term, this has been ruled out by the Rudd Government, but the proposal raises several issues about tax policy design and tax reform processes. For example, while some industry sectors, especially those competing for business in low taxing Asian markets, might favour a lower company tax rate, other businesses or industries may prioritise specific company tax concessions, say more generous depreciation allowances for their investments in manufacturing plant and equipment, or even greater capital gains tax concessions for small business or real estate.

Most importantly, there are major political complexities of increasing the GST. First, because of the Howard Government’s pretence that the GST was a state, not Commonwealth tax (see Smith 2004); altering the GST rate would immensely complicate current financial negotiations between the Commonwealth and the state and territories. Second, raising the GST would trigger demands for costly compensation to protect the real incomes of low income groups and families. On this latter point, Eccleston’s account of the introduction of the GST in Australia misses another interesting story. The Treasury had argued for a comprehensive GST, from a public choice perspective that understood exemptions from the wholesale sales tax (WST)—a tax, among others, replaced by the GST—were the result of ‘rent seeking’. My research has shown, however, that most exemptions from the WST, such as for food and medicines, were actually a reasonably coherent policy response to longstanding Australian values about equitable taxation during the 1930s depression and World War II (Smith 1999). These same influences, in my view, came to the fore during the ANTS debate on excluding food from the GST in Australia.

This provides a different perspective to Eccleston’s on the type of ‘policy learning’ that informed the final design of Australia’s GST. In New Zealand, which has no Senate and no states, GST was introduced in 1988 with virtually no exemptions and a minimal compensation package. Nevertheless, the GST in that country was increased just a couple of years later, to maximise revenue, and there was no adjustment in social security or family payments to offset this regressive tax increase (Smith 1998). This was because increasing means tested social security payments to low income families would have increased the number of families caught in the ‘poverty trap’ of high effective marginal tax rates and work disincentives. In Australia, basic food was exempted from the GST in order to gain a Senate majority for the tax reform package. Thus, arguably, a distinctive aspect of the GST reforms in Australia, reflected through its Senate, was that it applied the policy learnings from New Zealand, and did not adopt the ‘pure’ GST model preferred by the economic policy elites.

The revenue cost
and number of tax expenditures expanded during
the Howard years.

Further, Eccleston’s characterisation of the United States as having ‘failed’ to institute consumption tax reform is also interesting when that country’s tax reforms are analysed from an economic perspective. Reforms which exempt savings or investment from income taxation take the tax system towards a consumption tax base. Leading economists have argued that in the United States during the 1980s, a non-transparent ‘tax reform’ process of this kind allowed legislatures to bypass important questions about the desired distributional effects of taxation (Musgrave 1987). Arguably, the active role played by the Senate in the ANTS debates meant that Australia’s tax reform process ensured debate on the distributional effects of indirect tax reform, addressing equity concerns through embedding certain exemptions, such as for basic food, in the final design of the GST. This approach also provides greater assurance than in New Zealand that the existing income distribution will not be altered by future governments increasing the GST without compensation for its regressive effects.

LIGHTING UP THE TWILIGHT ZONE OF THE FISCAL SYSTEM

Another area for fruitful investigation of fiscal politics that remains unexplored in the Stewart and Eccleston volumes is that of tax expenditures. Tax expenditures, ‘the twilight zone of government expenditures’, are defined by the OECD as ‘a departure from the generally accepted or benchmark tax structure which produces a favourable tax treatment of particular types of activities or taxpayers’ (Organisation for Economic Cooperation and Development 1984, p. 7).

The politics of tax expenditures are fascinating, as President Clinton’s chief tax policy advisor Eric Toder understood:

Tax incentives are popular because they represent a way of increasing Federal support for social policy, while seeming to be tax cuts rather than increases in spending. Compared to direct outlay programs with similar goals, they better meet the need of politicians to appear to favour spending restraint and in some circumstances can be financed at a lower political cost (Toder 1999, p. 5).

In Australia, the revenue cost and number of tax expenditures certainly expanded during the Howard years (Smith 2003). Broome’s research, reported in the Stewart book, analyses patterns in media coverage of taxation issues during a recent New Zealand election. Broome nicely illustrates how media coverage sets the agenda for policy, in that case by generating and building momentum for tax cuts. The massive growth in fiscal concessions for private superannuation and private health insurance in Australia in recent years provides another clear example of how tax systems are shaped by both changing economic structures and prevailing fiscal ideologies, as well as how tax policy agendas are set by media campaigns. A similar process of policy agenda setting would be revealed by careful analysis of Australian media campaigns on tax concessions for superannuation and private health insurance in the past two decades. Over $20 billion a year is now provided to these two industries from the Commonwealth Budget. It is timely that the Commonwealth Auditor General has this month published a commentary on how well such fiscal charity is provided, measured and reported in public documents (Australian National Audit Office 2008). The issue of tax expenditures is surely worthy of more attention by Australian tax scholars and political scientists.

Societies where public trust is low are more likely to be corrupt.

Citizens’ trust in the tax system depends on their perceptions of its structural fairness and of the transparency and equity of tax policy processes. Richardson’s international comparative study in the Stewart collection suggests that societies where public trust is low, especially in poor and undemocratic regimes, are more likely to be corrupt. Lisa Philips’ article on gender aspects of tax policy shows how tax policy making by elites can exclude the perspective of significant groups of citizens and thereby leave the tax system vulnerable to criticism and lack of citizen trust in its structural equity. Especially in the light of the recently announced review of Commonwealth taxation, to be conducted under the stewardship of Treasury head Ken Henry, Phillips’ paper is one of the most interesting and relevant papers in the Stewart collection. Complex tax law and policymaking processes, she argues, may result in tax policy by experts only— that is, a political elite—resulting in lack of inclusiveness and poor recognition, for example, of the gender bias in conventional market and ‘economic’ perspectives. Tax policy could be improved if the unpaid economy mainly populated by women were incorporated into policy analyses. Likewise, a perspective which included class, ethnicity, and other characteristics of citizens would generate more defensible and legitimate tax policy decisions and tax structures.

At a time when governments are facing some urgent and difficult policy choices about how to regulate energy use and slow global warming, the environmental aspects of tax policy also need to be more closely scrutinised by political economists. The fringe benefits tax concession for business car use is a case in point, costing several billion dollars a year in lost revenues, and invisibly encouraging excessive production and use of large cars, especially those produced by the Australian car industry.

A comparable example warranting further scrutiny by scholars of fiscal and environmental politics is the 2001 decision of the Howard Government to abolish indexation of the fuel excise during the Queensland state election campaign. This has facilitated declining rates of taxation of petrol, relative, for example, to tobacco or alcohol, and even compared to taxation of goods and services, such as books, processed foods, and children’s clothes. It is difficult to defend this as sensible public policy, in view of current environmental concerns and fuel scarcity. The revenue costs of such politically generous decisions on fuel excise totals around $2 billion a year, and has left under-utilised an important tool for encouraging more fuel efficient cars and transport decisions. In the face of the current political campaign to lower petrol prices, is it too much to expect that Queenslander Kevin Rudd will revisit the Trebeck Inquiry into fuel tax indexation finding (Fuel Taxation Inquiry Committee 2002) that ‘the strong relationship between fuel consumption and greenhouse gas emissions make fuel tax an appropriate instrument for charging for the costs of climate change attributable to fuel use’ (p. 73), and act on its call to revisit the fuel excise issue when Australia signs the Kyoto agreement?

SUMMING UP—PROGRESS IN TAX POLICY REFORM

Despite my thirst for more and more sophisticated probing of the nuances of particular tax and fiscal policies, the interest of Australian political scholars in this field is welcome, and long overdue. Many of the papers in Stewart’s volume imply that greater transparency in tax policy process, and wider participation by citizens in tax policy processes, can lead to better tax policy and, ultimately, to better tax compliance and tax system functioning and efficiency. It is true that greater transparency alone may result in better policy. Nevertheless, influential participation by excluded groups requires their fuller knowledge and understanding of tax policy issues, policy processes, and fiscal politics. Enabling the wider public to better appreciate the role of taxation and fathom the links between key features of our fiscal system and the workings of our democracy, is commenced by these volumes and is the next task for scholars of Australian tax policy.

After all, as a visiting US scholar Willard Pedrick observed during Australia’s astonishing abolition of death and gift duties from 1976, ‘revenue acts are not the act of a hostile enemy of occupation. They are the means by which a community maintains itself as a community responding to the needs of its members’ (Pedrick 1981, p. 134).

REFERENCES

Australian National Audit Office 2008, Preparation of the Tax Expenditures Statement, 8 May [Online], Available: http://www.anao.gov.au/uploads/documents/2007-08_Audit_Report_32.pdf [2008, May 7].

Buchanan, J.M., and Musgrave, R.A. 1999, Public Finance and Public Choice: Two Contrasting Visions of the State, Cambridge, Mass., MIT Press.

Evans, C. 2003, Taxing Personal Capital Gains, Australian Tax Research Foundation, Sydney.

Fuel Taxation Inquiry Committee 2002, ‘Fuel tax inquiry report’, Commonwealth of Australia, Canberra, 28 March [Online], Available: http://fueltaxinquiry.treasury.gov.au/content/report/default.asp [2008, May 27].

Levi, M. 1988, Of Rule and Revenue, University of California Press, Berkeley.

Musgrave, R.A. 1987, ‘Short of euphoria’, Journal of Economic Perspectives, vol. 1, no. 1, pp. 59–72.

Neutze, G.M. 1988a, ‘The Canberra leasehold system’, in Report on the Canberra Leasehold System, (ed.) Joint Parliamentary Committee on the ACT, Canberra.

Neutze, G.M. 1988b, A Tale of Two Cities; Public Land Ownership in Canberra and Stockholm, Urban Research Program Working Paper No. 3, Australian National University, Canberra, May.

Pedrick, W.H. 1981, ‘Oh! To die Down Under! Abolition of death and gift duties in Australia’, Centre for Research on Federal Financial Relations Reprint Series, no. 44, Australian National University, Canberra.

Peters, B.G. 1991, The Politics of Taxation: A Comparative Perspective, Blackwell, Cambridge, MA.

Organisation for Economic Cooperation and Development 1984, Tax Expenditures: A Review of the Issues and Country Practices, Paris, Organisation for Economic Cooperation and Development.

Pierson, P. 1993, ‘When effect becomes cause: Policy feedback and political change’, World Politics, vol. 45, no. 4, pp. 595–628.

Smith, J.P. 1998 (1992), ‘Tax reform, the GST and women’, The Australia Institute Background Paper No. 11, Canberra, March.

Smith, J.P. 1999, ‘Is the only good tax an old tax? An historical perspective on the GST’, ANU Centre for Economic Policy Research Discussion Paper No. 398, Canberra, March.

Smith, J.P. 2003, ‘Tax expenditures: The $30 billion twilight zone of government spending’, Information and Research Services, Department of the Parliamentary Library, Research Papers No. 8, Canberra, May [Online], Available http://www.aph.gov.au/library/Pubs/RP/2002-03/03RP08.pdf [2008, May 27].

Smith, J.P. 2004 (1993), Taxing Popularity: The Story of Taxation in Australia, 2nd edn, Australian Tax Research Foundation, Sydney.

Steinmo, S. 1998, Taxation and Democracy: Swedish, British and American Approaches to Financing the Modern State, Yale University Press, New Haven CT.

Toder, E.J. 1999, ‘Tax incentives for social policy: The only game in town’, The Burns Academy of Leadership, University of Maryland, Paper No 5, College Park, Maryland.

Julie Smith is a Research Fellow at the Australian Centre for Economic Research on Health (ACERH) at the Australian National University (ANU). She was formerly a senior economist in Australian and New Zealand treasuries. She has a PhD in Economics (ANU) and, prior to joining ACERH, was a Visiting Fellow in the Economics Program at the Research School of Social Sciences and a postdoctoral fellow at the National Centre for Epidemiology and Population Health.