e&y - ensuring australia’s economic sustainability report: 2014 government agenda

Government Agenda — 2014

Ensuring Australia’s economic sustainability

ii Ensuring Australia’s economic sustainability Government Agenda — 2014

Ensuring Australia’s economic sustainability Government Agenda — 2014 1Ensuring Australia’s economic sustainability Government Agenda — 2014

Executive Summary 02COAG 04Carbon 06Defence 09Economic Management 12Education 16Health 20Human Services 24Infrastructure 27Productivity 30Tax 34 Superannuation 40

I’m pleased to share with you EY’s report Ensuring Australia’s economic sustainability — Government Agenda — 2014.

This report highlights the critical issues that need to be firmly on the Government’s agenda post election and into 2014 to ensure Australia remains competitive and economically prosperous in the future.

Australians are acutely aware of the challenges facing our economy and the need for major reform — from coordination across all levels of government to major tax reform — that must be driven by a courageous and visionary federal government.

How the incoming Government will be remembered will be how it meets these challenges and develops and implements policies that support Australia’s long-term economic sustainability.

When government and business work together, confidence increases, employment rises, there is greater consumer spending and increased business investment in communities. This is about building a better working world.

I hope you find this report useful and insightful.

Contents

Rob McLeod Oceania CEO & Regional Managing Partner

2 Ensuring Australia’s economic sustainability Government Agenda — 2014

No excuses

The incoming Government must act immediately to implement major government and economic reforms.Australia is about to hit the perfect economic storm, caused by the intersection of the: new realities of a global economy, cost pressures of an ageing population and loss of Gross Domestic Product (GDP) growth as the mining boom declines. In the challenging months ahead, we need an incoming Government with the courage and vision to introduce the major government and economic reforms required to create a sustainable economy.

Many of the drivers of Australia’s precarious situation are demographic. Our ageing population creates multiple issues for government: increased demand for expensive social services, a declining revenue base and slowing GDP growth. While the past 40 years have seen annual average growth in real GDP of 3.3%, in the next 40 years growth is projected to slow to 2.7%, as a direct consequence of an ageing population.

But others are of our own making. One of the biggest challenges for the incoming Government is to restore confidence. The policy backflips that have been the hallmark of minority government have devastated confidence at all levels, for businesses, consumers and global investors. It is extraordinary that, at a time when Australia has one of the most resilient Organisation for Economic Co-operation and Development (OECD) economies, foreign direct investment actually declined by 13% from 2011 to 20121.

To begin restoring confidence, the incoming Government needs to take decisive action.

• Set out a clear and credible fiscal policy that charts a path back to surplus Australia needs to balance its books within the next three to five years, with a fiscal policy based on controlling the size of government, rather than actions that dampen demand, such as tax increases or placing cost imposts on the business community.

• Refine and reorient Australia’s tax system to support growth and participation Our current tax system is unsustainable but the tax policy process is the first priority for improvement. Our current tax policy process and resultant uncertainty hinder growth of jobs and Australia’s future. A more strategic approach to Australia’s tax system also needs to be adopted to support growth and help resolve our national budgetary challenges.

• Develop a total economy and the infrastructure to support it With the mining boom declining and manufacturing dying, Australia needs to work out ‘what’s next’? We need a reform agenda to proactively develop a total economy based on productive employment across the country. Economic infrastructure projects in roads, rail, ports and utilities, which have a positive cost benefit and improve productivity, should be the top priority.

The Government no longer has the funds to fully finance such projects. The Government needs to develop policies that create certainty, set priorities and influence State Governments to follow the national plan to encourage private investment in infrastructure.

To this end, the incoming Government needs to act to simplify the Council of Australian Governments (COAG) agenda and clarify roles and responsibilities, so it can achieve its vital objective of supporting policy reforms of national significance, or where we need co-ordinated action by all Australian governments.

COAG must be allowed to focus on long-term projects, which drive a sustainable economy, lay the foundations for increased productivity or contribute to the overall betterment of the lives of citizens, such as transport and infrastructure, or environmental and sustainability issues such as climate change. Projects like these take years to roll out and measure. They require a champion outside the electoral cycle.

1 FDI in figures, April 2013, OECD

Executive summary


• Increase productivity Lift the economy by increasing productivity, both within the public sector and in Australian businesses, to help drive growth, competitiveness and living standards.

• Remain competitive on carbon policy The incoming Government must act decisively to firm up a carbon policy that respects existing investment to avoid disruptions to business, while supporting efficient long-term investments that reduce carbon emissions and honour existing commitments. The central feature of carbon policy should focus on achieving the carbon emissions reduction target in a least cost approach.

• Make wholesale changes to the business of Defence This will include: improving capability lifecycle management; developing enterprise and strategic planning and risk management frameworks; and changing Australian Defence Force (ADF) behaviour, culture and operational tempo.

• Change the funding model for human services delivery The role of Government is to be an enabler of infrastructure, but a supplier of health and education. However, this doesn’t mean it has to deliver services. To support our ageing population, the incoming Government needs to build an efficient market for NGOs to deliver Australia’s $70 billion human services through a fee for a value-based service arrangement, rather than grant payments in advance. This new funding model should create better outcomes for fewer dollars — putting Government in the role of price maker.

• Develop the right skills to support our future economy To remain globally competitive, we need to find a sustainable way to fund improved education outcomes and develop the skills we need in our new economy. Australia is slowly slipping behind our region in every area of education. In particular, our early childhood education care, in Kindergarten to year 12 (K–12), where Australia continues its fall behind our OECD peers.

• Restructure Australia’s balance sheet It’s time for policy makers to take a long hard look at the balance sheet and identify businesses — perhaps Medibank, Snowy Hydro or Air Services Australia — that the Government could simply regulate, rather than own. Then, the capital from selling these assets can be recycled and invested in infrastructure, health and education initiatives that don’t have attractive economics for private providers — but will deliver valuable economic and social outcomes over the long-term.

History will remember the September 2013 election as a pivotal moment for Australia: either the start of our national decline into recession or the catalyst for reforms that established a sustainable economy for the long-term. EY and its clients strongly urge the incoming Government to take the steps required to make it the latter — as outlined in the following document.

History will remember the September 2013 election as a pivotal moment for Australia: either the start of our national decline into recession or the catalyst for reforms that establish a sustainable economy for the long-term.


COAG

Issues

• COAG has disempowered spending Ministers The current construct of COAG has effectively diminished the authority of spending Ministers and given power back to the centre of government. Although the focus is aimed at outcomes, spending Ministers are still accountable for inputs. The aspiration of giving States more control by focusing on outcomes is good, but it’s not clear that the States have lived up to their end of the deal.

• COAG has become a political construct, with a short-term focus When COAG’s power shifted from the spending Ministers to the centre, its focus moved from big picture, long-term projects, to details, accountability and short-term outcomes, which can be easily measured and scrutinised publicly. Short-term outcomes are also the key drivers during the relentless election cycle, as the ability to measure them provides easy metrics to generate votes in an election campaign. With Australia’s Federation model, there is rarely a time when an election, either at Federal or State/Territory level, is not on the horizon. This makes it even harder for COAG to keep a long-term focus or agree on strategies without political inferences.

• Size of the COAG agenda The agenda is suffering from overload, with items that cannot be resolved at the Ministerial level being pushed up to COAG. This is further compounded by a minority government, which has seen COAG dealing with increased agreements and agenda items due to deals done with the Greens and Independents to form Government.

Since COAG doesn’t meet very often, it is effectively hamstrung by trying to deal with the volume of items on the agenda which has taken its focus away from the things that COAG is good at, such as compliance, regulation, manufacturing and competitive advantages for our country.

• Lack of clarity around the roles of the Commonwealth and States and Territories It is not clear where the Commonwealth’s power lies and how the Commonwealth and States operate together. Often the Commonwealth has no on-going relationships with the communities which it targets, through some of the National Partnership Agreements or grants, and this has a tendency to create conflict with the States as the Commonwealth is playing in areas which are a State responsibility.

Recommendations

• Simplify the COAG agenda to allow it to focus on issues of greatest impact for our country, such as manufacturing, health, regional infrastructure, and productivity.

• Clarify the roles and responsibilities of the Commonwealth and States in line with the constitutional powers of the Commonwealth.

• Delegate more to Ministerial Councils and spending Ministers with limited funding decisions made by COAG.

• Reduce the bureaucracy of managing agreements by streamlining Ministerial Councils and working groups. AG

Conclusion

COAG has the potential to achieve consistency across boundaries, as demonstrated by successes in the areas of regulation and standardisation. However, COAG is an imperfect model, which blurs the lines of power between the Commonwealth and States.

Fundamentally, COAG’s agenda has been clogged which has largely made it ineffective and prevented it from focusing on issues of national importance and competitive advantage to our country.

Although COAG is not currently effective, it can work with the right focus and clarity of accountabilities. Irrespective, if it’s COAG or something else, there needs to be some mechanism which allows the Commonwealth and States to come together to discuss issues of national importance to aid the future prosperity of our country.


National goals

Simplify the COAG agenda by focusing on issues of national importance and pushing responsibility to Ministerial Councils and spending Ministers.Clarify roles and responsibilities between the Commonwealth and States, so COAG can achieve its vital objective of supporting policy reforms of national significance or that co-ordinated action by all Australian governments.COAG must be allowed to focus on long-term projects, which drive a sustainable economy, lay the foundations for increased productivity and contribute to the overall betterment of the lives of citizens, such as transport and infrastructure, or environmental and sustainability issues.


Carbon

Issues

The Opposition has stated a full repeal of the Carbon Pricing Mechanism (CPM) is one of the first actions it will initiate if elected, while the Government has suggested it will accelerate the CPM to its flexible pricing scheme earlier than originally planned.

It’s no surprise then that businesses find themselves in a ‘holding bay’, delaying strategic decisions or investments because they are uncertain about the future existence of a carbon price or the structure of any alternative carbon policy — particularly in the short-term.

While there is a live debate about the respective merits of the two policies, one point is clear: the ongoing debate means ongoing uncertainty about the future policy environment in which businesses will have to operate. This uncertainty is damaging, especially in the electricity sector, as businesses require a level of certainty to plan and invest for the future. Australia urgently needs to agree on a policy framework for responding to the challenge of climate change.

Appropriately designed, carbon pricing is the most effective way of achieving least-cost abatement, particularly in the long-term. It can drive the cheapest abatement options across the economy, and avoid many of the administrative burdens and inefficiencies found with more interventionist government policies.

As a matter of urgency, the incoming Government, will need to clarify the new carbon rules for business. It will also need to consider how it will achieve Australia’s commitment to meet the agreed 2020 emissions reduction target.

In addition, both parties must commit to supporting companies that have already taken or are currently taking abatement activities.

It is also critical that any changes to policy leverage off the effort already invested by the business community in assisting the set up of the CPM (and in some circumstances the previously proposed Carbon Pollution Reduction Scheme).

Amending the CPM

An acceleration of the CPM to a fully flexible pricing stage, one year ahead of schedule, will see the carbon price subject to market mechanisms that will function more freely and allow companies to make investment decisions based on least cost.

Should the incoming Government initiate this acceleration, it will need to do so as quickly as possible to meet the start date of 1 July 2014. By doing so, businesses are more likely to participate in the advance auctions (currently scheduled to take place in the first half of 2014) or broader carbon market activities, such as domestic trading, trading of international units or entering into forward contracts and swaps — all of which will aid the ability to meet liability at least cost.

Updates required to the Australian Registry for the development of the link with the European Registry need to include controls protocols to improve security and respond to incidents involving misuse or criminal activity in relation to the registries.

Repealing and replacing the CPM

Should the Opposition come into power and follow through with its commitment to repeal the CPM and implement the Direct Action Plan (DAP), it needs to leverage what businesses have already done as part of responding to existing legislation and any investments that will result in carbon abatement.

We strongly support the proposed process of releasing a white paper, providing greater detail on the DAP and Emissions Reduction Fund, where business have the opportunity to provide input and give guidance on the development of the policy. Due to the often competing outcomes of climate change policy for particular parties, we expect significant divergence in the views that will be expressed in response to a white paper. However, we recommend setting some overarching policy principles to underpin the key elements of the DAP.

Specifically we recommend:

• The time period for which baselines are set for businesses should be retrospective, to avoid penalising businesses that have recently undertaken abatement projects.

• That strict controls be put in place for calculating baselines and abatement reductions, so they are truly verifiable, yet don’t stifle innovation or penalise businesses that can deliver strong commercial outcomes.

• That flexibility be provided in the ways in which business can access funds under any scheme.

• That any funds previously approved for abatement projects be transitioned into new support structures wherever possible.

• That projects with low risk of delivering high abatement potential are prioritised.

• That funds should be allocated to support research and development of new solutions to emissions reduction and energy efficiency.

Outside of the above boundaries, the Opposition might consider seeking specific feedback on the policy details — set out in the table on page 8.

What does it mean long-term?

Beyond the short-term uncertainty and above-mentioned issues surrounding carbon policies, both parties have committed to a minimum target of a 5% reduction in emissions by 2020 from 2000 levels with Australia a signatory under the Kyoto 2 commitment period.

Financing mature carbon abatement and energy efficiency technologies and developing new energy efficiency and carbon abatement solutions remains challenging and complex, with large up-front costs and limited capital resources.


National goals

Provide longer-term regulatory certainty in the pricing of carbon, incentivise business to reduce carbon emissions in the most economically efficient way, support the transition to a low carbon economy, and meet Australia’s target of a 5% reduction in emissions by 2020.


Scope item of DAP Possible areas of consultation

Setting of emission baselines

• Breadth of emissions baselines — Industry specific, company specific or facility specific: An industry baseline will reward companies that are more energy efficient compared to a company or facility specific baseline.

• Unit of measurement of baselines — emission intensity or absolute emissions: Emission intensity allows for business expansion and contraction without penalty or exemption.

• Length of historical period used in baseline setting: Longer historical periods will reward companies that have implemented past energy efficiency improvements.

Mechanics of the Emissions Reduction Fund

• Arrangements to guarantee cash flows on abatement delivery: Arrangements for guaranteeing the Government purchase of abatement units on delivery will need to be developed to increase funding options for potential Carbon Farming Initiative proponents.

• Future price indications: Price indications of abatement units prices will need to be thought about as businesses will require guidance to make financial investment decisions.

• Scheduling and size of auctions: The timing and size of auctions will be important aspects when companies perform financial analysis of projects. Consideration of advanced auctions to increase future certainty should be considered.

Expansion of CFI methodologies

• Additionality of abatement: Methodologies may be created for projects that would go ahead regardless of the Emissions Reduction Fund, eg. NPV positive projects

• The inclusion of projects that commenced under past abatement schemes: This may help projects that have received previous assistance but may also create the opportunity for projects to double up on Government assistance.

If the CPM remains in place and converts to an international emissions trading scheme, it is likely Australia would reach the minimum 5% emission reduction by 2020. The Australian industry sector will be incentivised to reduce its carbon intensity, which will improve its efficiency and relative international competitiveness. However a large portion of the abatement associated with such a scheme is expected to predominately occur offshore, since the purchase of international credits is the lowest cost form of compliance.

General consensus by the scientific community is that if the Direct Action Plan is implemented, it will be difficult for Australia to meet our Kyoto commitment and difficult to achieve more aggressive longer term reduction targets. This may leave Australia vulnerable to international demands from our trading partners to reduce our emission intensity or place restrictions in emission intensive exports. It could also leave Australia with an uncompetitive and inefficient industry sector less prepared for the transition to a low carbon global economy. In this situation, businesses may need to invest, independent of the Direct Action Plan, to remain internationally competitive beyond 2020.

Innovative financing programs, including a combination of low-interest funding and up-front loans for renewable energy and energy efficiency projects, are required to support liable companies, impacted companies and investors.

We are not alone in our commitment to reduce carbon emissions — our largest trading partners have or are looking to put in place measures to do the same. The USA has announced tough new rules to cut carbon pollution, China is implementing seven pilot emission trading schemes commencing later this year (with the intention of introducing a national trading scheme by 2015/2016) and Korea will launch its emission trading scheme next year. China has also become the largest investor in renewable energy and its incoming president has proposed other measures to reduce emissions and pollution such as putting a cap on coal consumption by 2015. This is in addition to existing emissions trading schemes already in place in the EU, New Zealand and California.

Under either scenario outlined above, the incoming Government cannot ignore the long-term requirement for businesses to remain competitive in an international carbon policy context.

Conclusion

The Federal Government must act decisively to firm up a carbon policy that respects existing investment to avoid disruptions to business, while supporting efficient long-term investments that reduce carbon emissions and honour existing commitments. The central feature of carbon policy for incoming Government should be a focus on achieving the carbon emissions reduction target in a least cost approach.

Carbon


Defence

2 ‘Defence and money: how to manage in an era of austerity?’ Peter Layton, ASPI Strategist, Jul 20133 ‘The Cost of Defence: ASPI Defence Budget Brief 2013 — 2014’, Mark Thomson, ASPI Report, 30 May 20134 ibid 5 ANAO Report No.15 2012–13, 2011–12 Major Projects Report

Issues

The recent Defence White Paper (2013) outlines Australia’s strategic policy approach and highlights the need to sustain a strong Defence industry, that the Australian Defence Force (ADF) will need in the coming years. It also touches briefly on some aspects of human capital management, particularly the challenges of managing the pending drawdown from major operations overseas.

Commentary since the White Paper and Federal Budget in May this year has suggested that there is ‘insufficient cash to buy all new capabilities’.2 The Australian Strategic Policy Institute’s (ASPI) Mark Thompson3 has been suggesting for four years that the cuts to Defence have brought the percentage of GDP for Defence to its lowest point in decades. While he acknowledges that the 2013/14 Defence budget shows an improvement in spending, ”regrowth” in Defence’s budget is occurring from a low base, and in absolute terms funding remains well below what was promised in 2009.’4 Against this background of fiscal constraint, we believe the key issues facing the ADF in next 12 months and beyond, include:

• Funding reforms and what is needed to determine the future shape and requirements of the Defence Materiel Organisation (DMO) and the wider Capability Lifecycle.

• The need to address the enterprise level of strategic planning and risk management.

• The wider, well published aspect, of changing Defence culture and behaviour, including the implications of a reduced operational tempo.

Recommendations

Issue 1: Budgetary Constraints and Wider Capability Lifecycle Management

Even though Defence spend has reduced in real terms, it still draws more than $24 billion out of Government revenues every year. A significant portion of this is allocated towards funding major Defence equipment acquisition programs/projects through the DMO. Historically, the DMO has managed the majority of these projects well, however major larger projects continue to prove challenging in terms of their completion within budget, on time and to the required level of capability.

| “The management of Major Projects is complex and, for this reason, it is a major challenge for the DMO to deliver the required capability on schedule and within budget. Consistent with previous years, schedule slippage remains a key focus for the DMO.”5

Australian National Audit Office (ANAO) Report No.15 2012–13, 2011–12 Major Projects Report

Over the next 15 years, even allowing for a reduced operational tempo, the Government will need to replace or upgrade up to 85% of the ADF’s equipment, including purchasing equipment in all of the major elements of ADF Land, Air, Sea and Joint capabilities — at an estimated cost of up to $150 billion in the next decade alone. It is vital that these projects avoid the slippage experienced in previous years.

There is also a wider discussion occurring in relation to the interface and balance between (and required improvements of) Capability Managers, Requirements Definition and Acquisition and Sustainment within these projects. Currently, the critical components of

the Capability Lifecycle are not operating as cohesively as they should and an imbalance exists as a result of increasing asset acquisition lag times and inappropriate asset sustainment cycles. As a result, some critically important assets may not deliver their ‘military effect’ within targeted timeframes, the consequence of which may threaten Australia’s sovereign security and potentially put our war-fighters in harm’s way.

Capability Managers must become more adept at understanding their asset demand profile which assists in downstream planning across the capability lifecycle; and ultimately achieving the assets intended ‘military effect’ to enable our war-fighters to fight and win.

The large number of on-going individual reviews must be consolidated and dealt with at a systemic level. Decisions that support capability needs in a constrained fiscal environment will assist in addressing the imbalance of key components of the Capability Lifecycle.

Issue 2: Enterprise Level Strategic Planning and Risk Management

Improvements in enterprise and strategic planning and risk management frameworks could realise significant benefit for the ADF. While some work has been completed and there is a sense that a number of services and divisions are doing good work to address this issue, a more strategic holistic approach will realise greater benefits. These include better alignment of strategy, more appropriate accountability for outcomes, improved performance management, and the creation of a significantly enhanced and informed decision-making environment.


National goals

Review funding reforms and determine future shape and requirements of the wider capability lifecycle, address the enterprise level of strategic planning and risk management and focus on changing Defence culture and behaviour including the implication of a reduced operational tempo.


6 LTGEN David Morrison, AO, Speech to the Sydney Institute, February 2012.7 LTGEN David Morrison, SBS Observer Effect Interview with Ellen Fanning, July 7 2013

This transition will require careful planning and management to avoid adverse impacts on capability (such as that experienced following the ADF’s withdrawal from Vietnam). Hard-won expertise (gained in counter-insurgency) and key operational learnings (such as the consequences of not maintaining appropriate levels of operational capability), must not be lost.

Specific issues associated with the transition to lower tempo operations include:

• Repatriating returning troops into society, with the recent memorandum of understanding between the Department of Defence and the Department of Veterans’ Affairs a good example of the ADF’s focus in addressing this issue.

• Managing people’s expectations in respect of systemic culture issues, and creating an environment which encourages people to ‘want’ to stay in the ADF during inevitable upcoming changes.

• Retaining and enhancing war-fighting and security skills and capability, in light of the changing operational tempo.

The recent Defence White Paper recognises these challenges, the changing shape of our region and the broader capability developments required to adjust to these circumstances.

We believe the incoming Government has a unique opportunity to transform the nature of Defence employment by implementing more flexible service arrangements and optimising the contribution of ADF Reserves to ‘Total Force’ capability. Such initiatives will support the transition of repatriating troops, help retain and build on existing skills capability and will deliver a more agile, capable force to mitigate future risks and changing security threats and demands.

Appropriate planning and risk management will underpin numerous aspects of the ADF’s operations and business, including the prioritisation of investments, the alignment and execution monitoring of strategic and operational plans, the measurement and accountability of resultant targeted benefit, the capture of longer-term impacts of changes in government policy positions (such as changes arising from budget cuts, often linked to political expediency) and ultimately the way the ADF manages its business risks.

This is often an overlooked component of large organisations, which when addressed at the strategic level (and coupled with a broader benefits identification measurement and realisation programs) will generate significant improvements in the execution and delivery of ADF KPIs.

Issue 3: Changes in ADF Behaviour, Culture and Operational Tempo

A key to future ADF success, irrespective of operational posture or tempo, is the their ability to assure the appropriate behaviour of its members (often within diverse and wide-ranging community environments).

In the words of Lieutenant General David Morrison, Army must ‘have a strong culture built on values of courage, initiative and teamwork.’6, and to this he recently added a 4th principle, one of ‘respect’7. These initiatives are at the forefront of CDF General David Hurley’s mind and are broadly supported across the ADF executives as a whole. Their importance is reinforced by reviews such as those recently conducted by Australia’s Sex Discrimination Commissioner, Elizabeth Broderick.

After a long phase of high operational deployment, the ADF is now returning to a period of more moderate activity. It has already commenced the operational drawdown from Iraq, Afghanistan and other areas of regional conflict.

Conclusion

The current fiscal environment dictates that significant changes to the business of defence (especially around the 2013 White Paper, Budget Guidance and wider Capability Lifecycle requirements), will be inevitable. The effects of these will impact all aspects of the ADF’s operations not just DMO but Capability Managers, Capability Development and all ADF support functions in terms of demand for improved cost efficiency and the more effective use of resources.

A strategic approach to enterprise planning and risk management will inform and direct the ADF as it seeks to address these challenges. It will deliver substantial benefit, not only within the current Defence environment, but also for wider government policy initiatives.

The demands of a change to operational tempo should be seen as an opportunity to reshape the ADF’s employment environment, to create a model which is more flexible and agile; one which sustains and improves capability; which provides blended and flexible career options that allows long term connection and engagement; and one which encourages and fosters diversity, inclusiveness and a culture which delivers both behaviour and performance in accordance with the ADF’s and our broader communities expectations.


Economic management

Historically, governments have been able to use the twin levers of monetary and fiscal policy to influence the economy. The Hawke/Keating reforms changed this paradigm. Responsibility for monetary policy moved to the independent Reserve Bank (as it has in other Western countries), leaving the government with fiscal, tax and regulatory policy levers.

Issues

• Ongoing structural deficit The more recent budgets have resulted in Australia being left with a large structural deficit, and this is expected to continue into the future. The long-term impact of this is exacerbated by expenditure being directed to areas that have not improved productivity or increased future cashflows to the Government.

The business community is equally concerned about the difficulties of returning the budget to surplus in the medium-to long-term, as the current forecast relies on achieving savings over the forward estimates period, along with an improved economy. Continuing budget deficits, at both Federal and State levels for the foreseeable future, will also only serve to increase Australia’s debt levels, eroding our future capacity to invest in appropriate infrastructure projects.

Government debt should only be used to fund public investment that, through rigorous assessment, demonstrates it will increase community incomes (and taxation revenues) by more than the cost of the debt. Previous governments have frequently failed to recognise this, resulting in ‘bad non-productive’ debt.

| “The extent of the anticipated cumulative deficits over the next three years, amounting to $48 billion, is sobering news. This is a turnaround, in only six months, of close to $55 billion in forecast budget bottom lines. Even more sobering is the prospect that further revisions are in store. Economic reality has bitten.”

Innes Willox, CEO, Australian Industry Group

| “Far from delivering a budget surplus on average over the medium-term, we now have in prospect an outcome of seven consecutive years of fiscal deficits — four in the past and three to come.”

Jennifer Westacott, CEO, Business Council of Australia

• Deep budget cuts could further weaken the economy However, the Federal Government needs to find a path to surplus that protects its fragile economy. Australia is burdened with a high dollar (despite recent reductions), waning GDP growth, declining mining investment and widespread private sector indebtedness. With these weak economic fundamentals, and despite recent substantial deficits, now is not the time to quickly re-balance the budget. Embarking on a large savings program may do significant short-term damage to the economy, especially if those savings directly reduce

household incomes and hinder business growth (as demonstrated by the recent IMF conclusions on the failure of the austerity measures in Europe). Rather, we need a measured response with a defensible pathway to surplus.

In a slowing economic climate, there is a case for governments to increase investment. However, this investment must satisfy rigorous cost-benefit analysis: its productivity benefits (or other worthwhile objectives, such as social or environmental outcomes) must outweigh the costs to taxpayers. According to AIG8, given our relatively low level of Government debt compared to other western economies, the 2013-14 Budget should focus on helping to support jobs and growth and not risk excessively detracting from aggregate demand.

| “The federal budget does little to take cost pressure off the private sector, especially small business, and fails to wind back government spending to rid the nation of deficits and allow future investment in the economy.”

Peter Anderson, CEO, Australian Chamber of Commerce and Industry

8 Ai Group Survey: Business Priorities for the 2013-14 Federal Budget Measures to build business competitiveness favoured over balancing the budget, May 2013


National goals

Enable economic growth by establishing overarching settings, such as taxation, regulation, property rights and infrastructure provision, to support productivity and encourage the required restructuring of the Australian economy. Adopt a fiscal policy that supports these actions and smooths economic variables with a clear path to a budget surplus. Ensure the Government only delivers the services required and those services are delivered in the most effective and low cost way.


| “Reducing the company tax rate is the single most important objective for business for the 2013-14 Federal Budget. This is particularly important for manufacturers, exporters and businesses competing against imports in the domestic market who are caught on the wrong side of the high Australian dollar.”

Ai Group Survey9

According to the Business Council of Australia’s (BCA) Budget Submission 2013, this refreshed fiscal strategy should include:

• Explicitly outlining the extent to which major new spending commitments will affect Australia’s fiscal position over the medium-term

• Delivering on its commitment to a 2% real cap on expenditure growth — considered the only substantive discipline on fiscal policy

• Offsetting any new spending commitments

• Adopting fiscal rules to place a hard cap on the size of government, build capacity to recharge fiscal readiness (to allow Australia to deal with the next major economic shock), and begin to provision for intergenerational pressures

Fiscal policy should be bound by government revenues, where government income is treated as a scarce resource to be allocated to the most beneficial areas for the community. To support this aim, all government expenditures must be evaluated by rigorous cost-benefit analysis. Government should recognise that ‘money’ does not equate to ‘success’. Models for service delivery can be just as important as funding levels.

Recommendations

The incoming Government should prioritise actions that carefully balance the need for fiscal prudence with the need to encourage economic activity, while also helping to build business community confidence. These include:

• Presenting a credible fiscal strategy, based on cost control, to chart a path back to surplus in the medium-term The incoming Government should seek to balance the budget over the medium-term — within three to five years. Australia may remain one of the few western countries with low overall debt, but we still need to use debt correctly within fiscal policy. This means using debt to fund long-term infrastructure — not short-term deficits. Governments don’t have to deliver surpluses in every single year, but they do need to have a credible strategy for returning to surplus.

| “We need a plan to build sustainable surpluses for the future so we can pay down debt, build resilience to future economic shocks and put aside money to cover the rising costs, which will be coming as our population ages in the years ahead.”


To this end, the incoming Government needs to develop a clear and convincing fiscal strategy for balancing the budget, based on controlling the size of government, rather than actions that dampen demand, such as tax increases and placing cost imposts on the business community.

Also, in presenting its new fiscal policy, the incoming Government should communicate its clear objectives and measurable outcomes to the community.

| “Budget deficits indicate that fiscal policy needs overhaul. This should begin with a ‘root-and-branch review’ of government spending, a detailed plan to restore the budget to balance and reform to regulatory, tax and workplace policy so that the burden of adjustment does not fall so strongly on monetary policy.”

Peter Anderson, CEO, Australian Chamber of Commerce and Industry

When required, fiscal policy should be applied in concert with monetary policy, which should be used to manage consumption and saving over the medium-term, smoothing economic growth over the business cycle and reducing the risk of a bust. Government should also consider the application of total fiscal policy — the net effect at the Federal and State level.

Other levers, such as tax and regulatory reform, should be used alongside monetary and fiscal policy and assessed, individually and collectively, to ensure they are meeting clear and worthwhile objectives at the lowest possible cost.

• Funding the right infrastructure projects to boost economic growth and improve productivity The incoming Government should fund, or facilitate, more investment in critical infrastructure to support GDP growth, provided these investments can be started quickly and satisfy cost-benefit analysis. Virtually all major industry groups see increasing infrastructure spend to drive productive capacity as a major priority.

9 Budget Ignores Small Business and Hard Savings Choices, ACCI, 14 May 2013

Economic management


Economic management

• Helping the economy adjust to a higher Australian dollar The incoming Government could seek to lower the Australian dollar, although recent independent Reserve Bank monetary policy shifts along with global changes have started to address this issue. Irrespective, exchange rates are likely to remain high, driving the need for the incoming Government to focus on helping the economy adjust to the higher dollar. This will require measures to aid economic re-structuring, such as training assistance and labour mobility.

• Reviewing State/Commonwealth relations and roles in service delivery COAG’s current model has increased the already high fiscal imbalance. The current trend to centralisation, inherent in the COAG process, is driving inefficient and costly changes in service provision responsibilities. This can only be addressed through reviewing State/Commonwealth relations, including clarifying the distribution of roles and responsibilities and considering potential areas of duplication.

| “Whichever government is in place after September is left with no excuses. They will have to properly restructure budget priorities through an independent review of the size, scope and efficiency of government, and address the failings of an uncompetitive tax system. What is needed is a concerted effort to fundamentally change the cost structure of government spending, by permanently changing programs or getting rid of expenditure items.


Conclusion

The incoming Government needs a clear strategy to return the budget to surplus. The strategy needs to review services provided by the public service and how they are being delivered. The incoming Government also needs to only use debt funding for capital projects and they need to ensure they invest in projects that deliver value to the Australian people.


Education

Our early childhood education engagement is also considerably below the OECD average, in terms of both participation and funding. On average across the OECD, 80% of 4 year olds participate in ECE&C. In Australia, despite intense and growing demand for places, this figure is just 50%. Similarly, Australia only invests 0.1% of GDP in ECE&C, compared with the OECD average of 0.55% and top performers investing 1.01% of GDP.

This under-performance in ECE&C has a ripple effect across the economy. In the short-term, lack of access to ECE&C is preventing many parents from returning to work, reducing household incomes and hampering national productivity. In the long-term, low participation in ECE&C hampers individual performance in K–12, affecting future workforce capability.

Issues

• More funding doesn’t equal better outcomes — much of the media debate has been around how to increase funding, with the underlying assumption that more funding automatically improves educational outcomes. Yet, those involved in the daily cut and thrust of education policy are acutely aware that simply increasing funding doesn’t necessarily boost learning. This depends on how the funding is structured, where the funding goes and who is accountable for getting a return on its investment.

• Different funding models across the education system — the funding models for each level of our education system reflect quite different philosophical and practical approaches. Universities and, progressively, our vocational and TAFE sectors, are adjusting to a market-based funding model, while K–12 funding models are outmoded.

Current performance

In higher education, we continue to perform well, with half our universities in the world’s top 500. But the trends for early childhood education and care (ECE&C) and Kindergarten to year 12 (K–12) are heading in the wrong direction.

The Better Schools Review of K–12 education — Australia’s first since 1973 — found growing gaps in student achievement. While Australia remains a high achieving nation in education relative to OECD peers, our overall performance has fallen in the last decade. In both absolute and relative terms, Australia has slipped behind in terms of reading, maths and scientific literacy. For example, our reading performance, which was already behind Finland, Hong Kong and Canada in 2006, slipped further and in 2009 was also behind Shanghai, Singapore and Korea.

Of great concern, we are way behind other OECD countries in terms of equity. We have an unusually large and growing gap between our lowest and highest performing students, with a long tail of low performers. In Australia, good educational outcomes appear to be ‘a lucky dip’: they depend on where children are born; the socio-economic status of their parents; the physical ability or disability of the student; their language background; and whether they are Indigenous. The resulting inequity in education outcomes becomes compounded during a life time, feeding further inequities in income, health and general well-being.

• Early Childhood Education and Childcare — full cost paid by users, offset by Federal Government support for low socio economic status (SES) groups.

• K–12 Government Schools — largely fully funded centrally by State Governments, at little/no cost to parents, including selective schools, which offer higher quality education to elite students.

• K–12 Non Government Schools — largely paid for by parents, augmented by fixed Federal Government subsidies to school systems, and schools — not to parents.

• Universities/TAFEs/VET — funding support follows the student, with fixed, subsidised prices that vary by course, and by institution depending on the course structure and special allowances for low SES profiles.

• Inequities for students with disabilities — in the current system, students with disabilities are limited in their choice of where to go to school. They are constrained to the public system. Often the public sector does not have the capacity to recognise much less accommodate those with special needs. There is no incentive for private institutions to accommodate children with special needs, beyond the non-commercially driven advantages derived from living in diverse school community.

• Outmoded management systems — school principals do not have the authority to make local decisions regarding budgets and staffing that improve the quality of education provided by their school although most State Governments are working towards increased autonomy.


National goals

Establish more effective, equitable and sustainable funding and operational models to reverse Australia’s falling educational performance.


• Little incentive for quality graduates to enter the profession — teachers face diminished status and remuneration, not to mention increasing stress from growing classroom management issues.

• Patchy access to early childhood education and quality childcare — although child care services are transforming into early childhood education services, in Australia education at an early age is not accessible to all, even though demand is growing rapidly. The problem is that childcare services is a ‘cottage industry’ in which the quality is variable and provision inefficient, making fees increasingly — often prohibitively — expensive. The resulting lack of participation is both dragging down educational outcomes and keeping parents out of the workforce — two alarming outcomes in a time of declining national productivity.

• State and Federal Governments at loggerheads — over control of the State school system and particularly over what represents appropriate curriculum and who should pay for what.

• Public-private divide — wealthier parents, who have become sophisticated ‘consumers’ of education, are increasingly abandoning the public education system, intensifying the disadvantage of those left behind.

• Slowing economic growth — this is putting pressure on funding, together with a wave of public sector reform sweeping across all State and Federal Governments.

Recommendations

To protect our national competitiveness, Australia urgently needs national education reform, for which we have workable and largely accepted guidelines at the K–12 level in the form of the Better Schools Review recommendations. There is widespread agreement that Australia’s K–12 education system needs:

• A well trained and motivated teaching profession — the only way to improve learning outcomes is to improve teaching quality. This will require better collaboration between the universities, the teacher’s union, school management and the community to better prepare, support, monitor and reward performance of educators.

• Adequate infrastructure — including appropriately supported and utilised IT, in every classroom, for every student.

• The right level of autonomy at a school/community level — allowing principals to better align resources with local needs, select the best teachers and manage their performance, and improve community engagement to raise the status of the teaching profession. This will require additional support for principals to manage that increased responsibility, including: training in financial literacy and a support mechanism around hiring and firing staff. Principals will also need to be assessed in terms of new KPIs around financial management, teacher performance and community engagement.

• Clearly articulated pathways between the various stages of the system — early childhood, primary, secondary, tertiary and across the States.

• The right metrics — used appropriately and transparently, to assess student learning and outcomes.

However, there is a real danger that this important work will either be derailed by the States quibbling over funding issues or perceived lack of control, or labelled a ‘Gillard platform’ and sidelined by the incoming Government. We therefore recommend:

• Embracing the Better Schools principles — move the States beyond their current funding squabbles by addressing actual or perceived inequities. Act decisively to create a national momentum and structure to implement the principles of the Better Schools Review, which are broadly supported by all major interest groups in education.

Education


Education

• Changing the national funding model — to achieve greater transparency, fairness, efficiency and equity, across State, Catholic and independent schools as set out by the Better Schools Review.

• Fixing Australia’s Early Childhood Education — ECE&C is a sleeper that requires similar attention to our K–12 system. We need a Better Schools-type review looking at how to make the sector more efficient and affordable, rapidly increase supply and regulate for quality educational outcomes. While additional funding may be required, this is not the only — or even the most important — answer. There are innovative ways to make ECE&C more efficient, including centralised procurement, so providers can benefit from economies of scale, and comprehensive databases of trained staff.

Conclusion

Turning around Australia’s educational performance is critical to our economic sustainability. The review work of Better Schools Review has been done — now we need to implement its broad recommendations across K–12 education as a matter of priority.

At the same time, we need to urgently address the next target, ECE&C, which needs a similar national review and followed by reform and not the other way round.


Health

| “An unsustainable and fragmented health system is one of the biggest threats to Australia’s productivity and long-term prosperity.”

Jim Birch, Lead Partner, Health and Human Services Asia Pacific, EY

Performance

Australian health outcomes are frequently cited among the best in the world, in terms of our population living long, healthy and productive lives. However, long life expectancy is often more related to levers other than health care services. Quality of food, clean water, sanitation and urban planning, a high quality education system and low unemployment more directly support this outcome. In other measures of health care provision, especially equity, safety, access and coordinated care, Australia lags behind countries like the UK, Germany and the Netherlands.

For example, we have growing disparities between different population groups, with little real advances in health outcomes for our Indigenous populations and poor access for people from low socio-economic backgrounds. In addition, we have high levels of personal co-payment relative to many other countries, with the exception of the US. Finally, although our per capita spend on healthcare is relatively low, it masks significant opportunity to improve the level of efficiency and unnecessary variability in our public hospitals. Targeting this and other measures more aggressively will reduce the overall level of cost burden and make our health care system more sustainable.

Issues

• Rising expense — health care is one of the fastest growing areas of government expense, costing taxpayers approximately $100 billion per year, or 9.5% of GDP.

It is likely that, in the future, health expenditure will grow faster than GDP. Within 20 years, the Federal Treasury expects Australia’s health care bill to top $250 billion, as our population ages, and the burden of chronic disease levels increase — at a time when Government revenues may be falling due to a shrinking working population.

• Chronic diseases — now account for a large proportion of illnesses in Australia, yet they are also some of the most preventable of health issues. Chronic disease is taking an increasing toll on all age groups, not just the elderly, lowering educational outcomes, limiting workforce participation, driving early retirement and restricting involvement in the community.

| “Chronic disease costs about $30 billion a year (3% of GDP) in direct costs and lost productivity. Yet up to one third of this is preventable.”

Australian Institute of Health and Welfare

• Inefficient, federated system — the Australian health care system has multiple moving parts, with little incentive to integrate or coordinate care delivery. Yet most patients, particularly those with chronic or complex diseases, need a range of medical, nursing and allied health services to manage their conditions.

The current federated system leads to significant efficiencies, through duplicated payments, complex administrative and operational processes — with many patients falling through the cracks. The result is often errors, re-work and higher cost and a poor consumer experience.

• Focus on in-hospital solutions — the current system funnels patients into higher-cost venues, such as hospitals. For example, patients often present at emergency department because they lack community care alternatives or are unaware of them. Similarly, 65% of Australians spend the last days of their life in hospital, compared with 35% in Europe, because most States lack high quality, home-based palliative care.

• Disproportionate costs for frequent users — a small percentage of patients use a high proportion of a hospital’s resources. These frequent users repeatedly end up in emergency rooms and hospitals for medical crises that could be prevented with more targeted, timely and appropriate, ongoing care.

• Ageing health care workforce — as the need for health services increases, our health care workforce is nearing the retirement cliff. In future, although we will have enough doctors, we face major gaps in the supply of nursing professionals. This issue will be exacerbated by the need to accommodate the additional demands of National Disability Insurance Scheme (NDIS), and the aged care sector. Workforce shortages, including for doctors, will also remain particularly acute in rural and remote areas.


National goals

Create a high performing health care system directed towards preventing illness and empowering citizens to sustain their health. The health system must be more directed to support the productivity and quality of life of people of all ages, in an economically sustainable way. It should proactively aim to deliver lower rates of hospital admissions and lower growth in cost of acute care, while achieving better health outcomes and a higher level of consumer satisfaction.


This will require the incoming Government to revisit its multiple payment systems, including health insurance, and move to a single, integrated health insurance system covering all aspects of care. Such a system could still be supplied by multiple, private providers, but it will need consistent standards and regulations to incentivise holistic care and reward positive health outcomes.

• Adoption of E Health and mHealth technologies — these technologies will be vital in lowering costs, increasing access and improving outcomes. They include: cloud computing, providing mobile access to health information and applications; use of social networks, which are already providing patient centric information sharing and peer support; and big data analytics, providing anywhere, anytime diagnostic insights.

| “Smart mobile devices and applications, working in concert with cloud computing, social networking and big data analytics, will be at the core of global health care transformation. These transformative technologies will help rein in cost, broaden access, change behaviours and improve outcomes.”

Jim Birch, Lead Partner, Health and Human Services Asia-Pacific, EY

| “In NSW alone, by the time NDIS is fully up and running, we will need 130,000 additional staff.”

NSW Policy Advisor

Recommendations

Australia needs to alter its health care paradigm, with a holistic approach incorporating the following disruptive concepts:

• Integrated care delivery — with a strong focus on long-term condition prevention and management. Care from disparate providers needs to be coordinated around the consumer. This will help to reduce the incidence of chronic disease and allow people already with chronic disease to be managed more often outside of hospitals.

| “If access to coordinated multidisciplinary care is improved then patients will benefit, the number of avoidable hospital admissions can be reduced, and long-term savings to the health system will be generated.”

AMA Chronic Disease Plan 2012

• New financing and payment model — that supports appropriate high quality care, including single funding. Australia needs to change its pay- for-service model, and introduce a value-based, pay-for-performance model that rewards quality outcomes, not throughput, and seeks to keep individuals out of expensive hospital facilities.

• Focus on out of hospital solutions — new remote monitoring and mobile technologies mean we can move health care out of hospitals’ and doctors’ offices to patients’ homes. Over time this will lower health care costs, improve consumer experience, while extending access beyond the reach of traditional health care. The NBN, together with mobile monitoring and detection devices will be important enablers, supporting post-operative and chronic care in the community and early detection. For example, sensing devices such as blood pressure cuffs are being connected directly or wirelessly to, or actually built into, smartphones.

• Citizen empowerment — patients empowered with their own information, via smartphone apps and rapid remote access to clinicians, could trigger huge efficiencies throughout the health system. Empowered citizens will take more preventive actions, engage in real-time monitoring, choose better and more cost-effective options and live healthier lives. This change would also be welcomed by Australians, who are looking to the health care system to adopt efficient and productive models from other industries that are more in tune with the hectic pace of their modern lives.

Health


Health

Conclusion

Australia needs a new system for delivering, consuming and paying for health care. All the technology enablers exist to support such a system. Now we need an incoming Government with the vision and decisiveness to put world’s best practice into action.

• Use big data analytics to drive investment and services strategies — just as the banking system uses analytics to predict customer behaviour and understand service provision, health care should use predictive modelling to shape service provision. Detailed and robust data about people’s current and future health can, in some instances, accurately predict future health events, informing intervention. Predictive modelling will be particularly important in identifying and diverting frequent users from the hospital system, by providing them with early care and, if necessary, interventions.

• Open up service provision to other professions — health care provision is very professionally demarcated and highly industrialised, resulting in many clinical groups and professions performing medical tasks that easily fall within an alternative practitioner’s capability. We need to open up aspects of health care provision to other sectors, taking the pressure off our dwindling supply of doctors, nurses and allied health practitioners.


Human services

A new funding regime has already been implemented within the children and family sector in some jurisdictions, and is now being considered in remote and regional programs. Over time, this will evolve to be the new funding model for the National Disability and Insurance Scheme (NDIS), the largest transformation of the Human Services sector in Australia’s history since Medicare, with some $12-14 billion being spent over the forward estimates.

Issues

Radical change to the traditional funding model

This is a fundamental shift in how non-government organisations (NGOs) operate their businesses and maintain service levels to some of the most vulnerable members of our community. Governments at all levels have traditionally funded NGOs through block grant funding, paid in advance. The new fee-for-service arrangement aims to drive to a more cost effective market by creating a specific fee for a service, rather than giving an upfront block of money for the provider to deliver the services. Previously the NGO made the price and the government paid. Now, the government will become the price maker.

NGOs will need to change their business models

Traditionally, NGOs have received block grant funding from Federal and State Governments, usually paid three months in advance. This funding model has provided NGOs with budget certainty. Now, many NGOs are anxious about the future fee-for-service model and its cash flow implications.

Smaller NGOs unprepared for the change

Feedback from some smaller NGOs has been that they will need to borrow more capital to underpin their operations to maintain cash flow for staff, overheads and infrastructure payments. This has interest cost implications and requires more sophisticated processes, better technology and greater financial capability for NGOs to cope with the delay between outgoing payments and incoming cash.

Government officials agree that NGOs will require more sophisticated systems to meet the future challenges. However, they also point out that respective governments have invested heavily in developing the workforce, and past grant funding should have allowed for infrastructure and systems establishment.

In contrast, NGOs say that in many instances, grant funding had to be ‘pooled’ to meet the individual needs of persons with disability, similar to a commune arrangement, and philanthropic donations had to be used to meet the payment gaps for services. Therefore, NGOs have forgone investing in infrastructure, business process and workforce capability/capacity to meet this funding gap.

Particular challenges for NDIS

NDIS is a paradigm shift in how disability services are delivered in Australia, moving from a rationing of untailored services to services tailored for the individual. Persons with a disability will pay for services on a fee-for-service basis either from NGOs, the private sector or specific individuals.

However, NGOs are concerned that the fee-for-service regime will require a greater knowledge of the disability market, in terms of service requirements, demand volume and the location of persons with disability.

| “We will welcome the empowering of persons with a disability to directly purchase services, but we just simply need to understand the type of services required, demand and where this demand is now and in the future. If we are going to a free market where demand and supply meet, then we need to understand the demand drivers.”

CEO of a small NGO

Government has responded by stating that the NDIS will be launched in a number of sites around Australia until these types of transition risks are mitigated.

According to former Prime Minister, Julia Gillard10: “$122.6 million over four years has been allocated to start preparing the disability sector for the new way of delivering disability services. Building the capacity of disability organisations to adjust to an NDIS is critical to success, particularly in the launch locations in the first stage of roll out.”

However, asked where this money would be invested, senior government officials were a little vague on what type of capacity building would be undertaken for the NGOs.

10 NDIS Budget Media Release, 2013


National goals

Build an effective and efficient market for NGOs to deliver Australia’s $70 billion human services (child care, housing, disability, families, community and aged care) through a fee-for-service arrangement, rather than grant payments in advance. This new funding model should create better outcomes for fewer dollars — putting Government in the role of price maker.


Human services

Australia, supports NGOs to prepare for the new funding paradigm via:

• Demand analysis — identify the different service types and volume of service requirements in different regions, current and future, and make this data available to NGOs

• NGO maturity assessments — develop an assessment tool to assist NGOs in building their capability and capacity for strategy, governance and cash management, allowing them to sustain their operations now and into the future

Recommendations

Based on our experience in the sector, we believe small-to-medium sized NGOs will struggle to operate in a fee for service payment regime. To address this issue, we recommend Government does more to prepare the market for the new funding model. This is not just about building workforce capability, but rather building the capability and capacity of NGOs to deliver under the new funding model.

To help NGOs transition, we recommend Federal Government, via DisabilityCare

• Accreditation schemes — implement an accreditation scheme beyond the current respective state accreditation frameworks, ensuring quality services are delivered consistently to some of our most vulnerable community members.

Conclusion

Fee-for-service is an optimum funding model for NGO delivery of services, with the potential to deliver better outcomes more efficiently. However, even mature NGO markets will need substantial support to transition to the new regime.

Case study

NGOs in a mature market struggle to adapt to a new funding model

Despite a government agency investing in developing a market over four years, NGOs failed to transition to the new funding model. Interviewed afterwards, NGOs stated the government had not prepared them to be a price taker and deliver under a fee-for-service arrangement.

This is concerning, especially as the test market had the following advantages:

• Investment in industry development — the new funding model was introduced to a mature NGO market, which had been delivering services on government’s behalf for four years.

• The market welcomed the new model — each of the NGOs welcomed the service categorisation and

associated unit costs because it created greater pricing transparency, equity in funding and better service outcomes. The NGOs signed up to new contracts for several years.

• Transition support in place — the government agency and EY worked with the NGOs to ensure a smooth transition to the new funding model. Fees were paid in advance for the first two quarters and after the third quarter were paid in arrears.

Yet issues arose as soon as payments in arrears started:

• Poor cash flow management — the NGOs began to fail because they could not manage their cash to meet their short term liabilities. Many did

not understand how to properly align fee for service payments with internal costs such as salary, overhead and indirect expenses. They simply lacked the ability to deliver services within a fee-for-service regime.

• Failed business model transition — NGOs could not adapt their business model to the new funding regime. When interviewed, the NGOs stated they had become ‘corporatised’ and could not pool their grant money across other services as they had to acquit the specific fee for service.

As a result, payments returned to being made in advance, and a number of NGOs dropped out of the market for providing services.


Infrastructure

Issues

Australia’s demographics make it difficult to match our infrastructure supply to the needs of a constantly-changing population:

• Declining revenue base (as a consequence of our ageing population) — this is creating a growing chasm between the need for new or improved infrastructure, and the actual level of current investment.

• Urbanisation — around 90% of people in Australia live in urban areas, and about half the population can be found in five state capitals. Of the immense population growth expected in the next 40 years, three quarters is anticipated to be in our capital cities. This will generate growing demand to expand city infrastructure, including: transport, sewerage, water and energy supply, telecommunications and waste disposal.

In addition, Australian political cycles are short when compared to the lengthy lead time for large infrastructure projects, making pipeline development problematic.

Role of Government

Broadly, the incoming Government should set priorities, influence State Governments to follow the national plan and work collaboratively with them to encourage private investment in infrastructure. Occasionally, it may have to partly fund essential projects that the market will not take on. For example, in the absence of Commonwealth support, some of the major transport schemes we so desperately need, such as the Melbourne Metro, will simply not proceed. The reality is, the Federal Government has limited power to influence infrastructure unless it is prepared to invest in projects. At the very least, it should assist in establishing long-term finance for infrastructure projects.

In executing this overarching role, the incoming Government has several levers to pull:

• Funding contributions to State projects — this is a very powerful lever, which can send a side-lined project to the top of a State’s list. However, the danger is that dual funding leads to inertia, with States delaying projects because they are ‘waiting for Federal funding’. The Federal Government needs to be clear on how much capital is available for infrastructure and how it will be applied. After that, the States should be certain that they’re on their own and need to harness private sector investment and expertise to execute projects.

| “We have this inertia where everyone is pointing to each other. The Commonwealth is pointing to the States; the States are pointing to the Commonwealth. Meanwhile we haven’t achieved anything.”

Jim Miller Macquarie Group Executive Director

• National vision — it’s essential to develop and stick to a national plan for Australia’s infrastructure to ensure that State plans are properly focused and integrated. Infrastructure Australia (IA) has brought discipline to national infrastructure planning, helping to prioritise projects and create consistency across the States. Its contribution to the planning and execution of a pipeline has been one of the most positive developments of the last few years. However, the IA blueprint is only followed if projects are allocated Federal funding and if there is alignment with the States. State Governments remain responsible for determining public transport priorities, planning for growth and providing infrastructure. IA’s role in driving a national infrastructure agenda should be maintained and

strengthened. For example, the IA process for assessing and prioritising projects should be rigorously enforced — without political interference.

| “Economic infrastructure projects in roads, rail, ports and networks (power, gas, electricity and water), which have a positive cost benefit and improve productivity, are the top priority.”

Tony Shepherd, AO Transfield Services Chairman

• Certainty — private sector appetite is enormously high for infrastructure projects; the issue is the lack of certainty and the complexity of the procurement pipeline. To make infrastructure investment attractive, the incoming Government needs to smooth out the boom/bust cycle and avoid the extremes of risk. For example, moving towards a more consistent and transparent deal flow would give institutional investors, the certainty they require to take on the risk of bidding for and investing in infrastructure projects.

• Funding solutions — finance is not a problem for brownfield infrastructure projects; the problem is funding greenfield projects with market risk. The incoming Government should work collaboratively with State Governments to establish clear, deliverable PPP funding solutions that balance appropriate risk transfer with leveraging the incoming Government’s funding capacity. Establishing a long-term corporate bond market would also assist by providing an alternative source of capital for projects.

| “It is not a shortage of participants, skills or capital. It is a shortage of projects.”

Jim Miller Macquarie Group Executive Director


National goals

Australia needs to stay ahead of the infrastructure curve, so gaps and bottlenecks are not allowed to hinder our economic growth, our quality of life, and our ability to capitalise on the opportunities generated by the march forward of China, India and our other regional neighbours. The incoming Government should take action to make sure nationally important projects go ahead, and mitigate the risk of delay or cancellation.


Conclusion

The role of Government in funding projects directly has been forcibly reduced by falling available capital. At the same time, the Government’s role in developing policies that create certainty, smooth the approvals path and attract private sector investment, has never been more important.

Even where the private sector bears a significant role in specific projects, infrastructure remains fundamentally a matter of public policy. But it is essential that the Federal and State Governments’ priorities are aligned, to provide the market with certainty.

• Approval process — projects can be accelerated by smoothing the approvals path, especially where there is a policy disconnect, such as in environmental impact mitigation, between the Commonwealth and the States.

| “The Federal Government should delegate to the States the power to grant environmental approval, thus avoiding the cost and time of duplication.”

Tony Shepherd, AO Transfield Services Chairman

• Tax incentives — the incoming Government can get the infrastructure pipeline moving by allowing projects to monetise any tax losses today. Although this appears to be a loss to revenue, we believe the resulting GST and income tax receipts will make it revenue positive — not to mention the multiplier effects from investing in the project.

• Traditional funding structures are no longer appropriate. Private investors need commercially-attractive projects. Government should work with them to ensure the risk and return profile or projects are structured to efficiently leverage the market’s appetite. This will include looking at new ways to partner with project beneficiaries in delivering infrastructure — both economic and social. In future, we expect more user-pays models, and new effort to find other revenue streams that can be monetised by capturing the value created for property owners, developers and different levels of government.

• Asset sales — Policy makers need to look at the balance sheet and identify businesses — for example, Medibank, Snowy Hydro or AirServices Australia — that the Government could simply regulate, rather than own. The capital from selling these assets could then be recycled and invested in infrastructure, health and education initiatives that don’t have attractive economies for private providers but will deliver valuable economic and social outcomes over the long-term.

Infrastructure


Productivity

| “Both government and business leaders should take joint responsibility for increasing productivity by ‘hand-on-heart’ declaring they will work together to address productivity. This should be followed by a bold statement of ambition on productivity setting out a 20-year plan to the year 2030 to provide the light on the hill.”

Neil Plumridge, Managing Partner, Oceania Advisory, EY

Context

Australia is coming off the back of a dramatic productivity growth decline. In the mid-1990s, average multifactor productivity growth was 2.3% p.a. In stark contrast, from 2003/04 to 2010/11, this fell to 0.4%. In 2012, Australia’s productivity performance finally started to improve, thanks to cost cutting and corporate restructuring in response to uncertain economic conditions and greater international competition driven by the high dollar. However, these gains are stalling and productivity has plateaued in 2013. Australia needs a new approach to productivity to realise its considerable potential. A recent EY study calculated that Australia has yet to unleash $305 billion in productivity potential, with 85% of workers believing they could be more productive11.

Issues

• Not just a government issue — Too often, productivity is seen as a problem for government. While the incoming Government has a vital role in adjusting policy levers, business leaders and the union movement have an equal responsibility to promote meaningful ideas to drive productivity within organisations.

• Slow pace of improvement — Without deliberate intervention from the Federal Government and business leaders, Australia will take 20 years to achieve its full potential, assuming productivity continues to improve at the same rate as it has over the past seven years. With intervention, this time could be halved.

• Lack of measurement — As a country, we lack national productivity targets and fail to measure, or even take into account, the productivity benefit or cost of policies. Until Australian policy makers and business leaders understand the metrics they are managing for, they will not pull the right productivity levers.

• Public sector productivity performance — Australia’s public services sector is dragging the productivity chain, with annual labour productivity growth at -0.6%, in contrast to the private sector, which stands at 1.4%.

• Low value jobs — Australia continues to foster low value jobs through both its cultural resistance to offshoring and remaining tariffs, which are propping up an industry’s least productive businesses and confuse market signals.

We need to be more accepting of ‘creative destruction’, where the demise of less successful firms enables the more innovative and productive use of the released labour and capital in other companies or industries.

| “The decline and exit of the weakest performers is an important mechanism for delivering aggregate productivity growth. Indeed, international studies attribute between one-fifth and one-half of (labour) productivity growth to such changes in industry composition.”

Greg Banks, (then) Chairman Productivity Commission, November 2012

• Industrial relations tension — This is fraught with difficulty because of the fairness/productivity trade off. Unions are hostile to the idea that such regulations should be required to demonstrate that the public interest benefits exceed the economic costs.

• Low female workforce participation — Over the past decade, Australia has made some gains in female workforce participation, with the rate rising by just over 4%, largely due to older women joining the workforce. However, there is still considerable room for improvement. In fiscal 2012, the Australian Bureau of Statistics (ABS) recorded male labour force participation at 79%, 14% higher than the female rate of 65%. The labour force participation rate was higher for males than females across all age groups.

This issue alone is costing the nation billions of dollars in unrealised productivity, and high government benefit payments as interrupted careers result in greater reliance on family support and lower retirement savings.

11 EY Australian Productivity Pulse, May 2013


Productivity

To this point, the Productivity Commission recommends periodically reviewing all major human services programs to ensure they are delivered cost effectively.

• Transparency — Measure and report annually on the productivity performance of individual agencies at local, state and federal levels. If government believes productivity is important, it has an obligation to publicise its own performance and compare it to previous years. This is not about cutting costs, but about tax payers getting ‘more bang for their buck’.

2. Use policy levers to remove productivity hurdles

Other chapters of this paper cover many of the policy preconditions for productivity growth. They include: creating a stable macroeconomic environment, investing in infrastructure, investing in education and training and sustaining a balanced and predictable regulatory environment — particularly with regard to tax, industrial relations and foreign investment rules.

Beyond these essential elements, government has the following range of levers to support businesses in unleashing their productivity potential.

• Set a productivity target for the country — As recommended by the House Economics Committee in 2010, the incoming Government needs to introduce a national aggregate productivity growth target to 2030. In addition, as started by the Government in 2008, we need specific targets in each policy area directly contributing to productivity.

Recommendations

The incoming Government has two roles in supporting productivity:

1. Improve productivity performance in the public sector

The public sector needs to put its own house in order and improve the productivity of its employees. Across Australia at all levels of government there are 1.9 million employees or 16% of the Australian workforce, so it is critical that this group of workers is tasked, measured and held to account for annual productivity improvements just like workers in all other sectors. To date, such efforts have largely revolved around incremental improvements. In future, government agencies, at all levels, need to be far more ambitious, targeting:

• Demand — Remove any programs, reports, committees or regulations that don’t add value to the country. This needs to be an effort across local, state and federal levels of government and can start with an online campaign calling for ideas and submissions from any organisation or individual tax payer to create a “National List of Waste” to remove from the country.

• Supply — Make more radical use of technology and automation and take another look at privatisation, or at least at outsourcing functions to the commercial sector. If government processes and functions were subject to market testing, many would fall behind best practice. While policy should remain in the hands of government, the vast majority of service delivery could be performed more efficiently by the private or not-for-profit sectors.

• Controlled removal of remaining tariffs, terminate selected industry subsidies and test competition restrictions — As a nation, we need a much higher level approach to developing quality work. This will include policy changes to abolish tariffs and only allow industry subsidies that deliver demonstrable net social benefits (which should be subject to transparent reporting of costs and social benefits). It will also mean evaluating competition restrictions where economic conditions have changed. According to the Productivity Commission, two obvious priorities include:

• Pharmacy ownership restrictions — which add to healthcare costs

• Taxi licence quotas — which raise transport costs and make it harder to reduce urban congestion

Government should also publicly recognise that some existing jobs are holding the country back, and encourage companies to transition out of them by using technology or moving them offshore.

• Review workplace regulation with an eye to productivity — Testing whether the fairness/productivity trade-off is justified. Encourage flexibility and modernised awards.

• Declare war on wasteful regulation — Organisations are wasting a vast amount of resources to comply with unnecessary regulation. For example, universities estimate government red tape costs them $7 million each year. The Government recently removed 1,000 items of redundant regulation, but this is just the tip of the iceberg. The Opposition estimates regulatory costs can be reduced by $1 billion.


National goals

Lift the economy by increasing productivity, both within the public sector and Australian businesses, to drive growth, competitiveness and living standards.


• Promote innovation — The incoming Government has an important role in providing a policy framework for innovation, especially in terms of creating incentives for and removing barriers to technology investment. However, according to the Productivity Commission, beyond the tax concession, the challenge is to allocate support that yields a net payoff to the community. The Commission therefore recommends:

• Rigorously evaluating innovation programs

• Focusing support on basic and strategic research — where the market failures are greatest, rather than commercialisation activities, which are more likely to be privately profitable

• Facilitating greater cooperative research between business and academia — with more nimble mechanisms

| “Productivity is virtually synonymous with innovation.”

Greg Banks, (former) Chairman Productivity Commission, November 2012

• Engage business leaders and the union movement in tackling productivity — An initial step in this direction could be a Productivity Summit of business and trade union leaders in the first six months of the new government to discuss productivity ideas and to agree on a national productivity target out to 2030 and a framework for removing barriers to productivity improvement.

• Encourage participation — Make childcare more affordable, as per the recommendations in the Education chapter. Maintain and broaden the compliance requirements that encourage employers to introduce or extend diversity and flexibility strategies. This will both increase participation and productivity as women with a high level of job flexibility have been found to waste less time and are more productive12.

Conclusion

Pro-productivity policies are rarely popular, and therefore a hard sell politically. Hopefully, the incoming Government will have the resources to advance unpopular reforms that will yield the highest productivity payoffs, via a broad and consistent policy that tests proposed solutions, measures performance and adjusts to new market and economic conditions.

12 Untapped opportunity: the role of women in unlocking Australia’s productivity potential, EY, June 2013

Productivity


The Reserve Bank Governor Glenn Stevens noted the adverse effects on business confidence in July 201314 in comments that apply strongly to the tax environment:

| “The business community’s confidence has been quite subdued... we have to rely on:

• clarity of policy frameworks and objectives;

• constant application of policies towards well-understood goals; and

• attention to avoiding things that can dampen confidence unnecessarily.

... to make sure that the accretion of regulatory actions being undertaken does not inadvertently make it harder for businesses to plan with confidence, to achieve better cost and productivity performance, or to take a chance on a new product, a new investment or a new worker.”

Key challenges include the following:

• Lack of certainty about tax policy and interpretations leads to a lack of trust in the system As a small, open economy reliant on global capital, Australia must be an internationally attractive location for business investment. But Australia is seen internationally as having a complex and ever-changing tax system, with high compliance costs. As Glenn Stevens confirmed, uncertainty impedes business planning for new investments, also impacting productivity and jobs.

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Tax laws are announced without proper pre-analysis or against private advice. Unsustainable or over-ambitious tax announcements lead to post-announcement delays. As well, announced policies are sometimes cancelled or delayed. The unclear law and policy often allows the Australian Taxation Office (ATO) to take its own novel positions which lead to tax controversy. The tax ‘fog’ of announcements, u-turns and inaction creates uncertainty. It frustrates business capital investment decisions which could create jobs and growth: it diminishes Australia’s reputation.

As a result there are ‘deadweight costs’ and distortions for Australian economic activity.

The big issue: an end to uncertainty in tax policies

Six years after the Australia’s Future Tax System Review (AFTS, “the Henry Review”) was commissioned, and five Assistant Treasurers later, there is no certainty, no clear strategy for our tax system and no clear structure for its processes. Because our tax system is so complex, the uncertainty impacts business confidence and investment and thus affects jobs and economic activity.

The AFTS Review in 2009 identified our “unsustainable tax structure”13:

| “Australia has too many taxes and too many complicated ways of delivering multiple policy objectives through the tax system. The capacity of the legislative and operating platforms of these systems, and their human users, to deal with the resulting complexity has been overreached.”

13 Section 1.7 “An unsustainable tax structure” Australia’s future tax system, Report to the Treasurer, December 200914 Economic Policy after the Booms, Glenn Stevens15 Some desirable policies proceeding slowly include the Investment Manager Regime which was announced to be operational from 1 July 2011 but is still in development

and the tax reforms relating to Managed Investment Trusts.16 Recent retrospective changes affect tax consolidation, financial arrangements, and transfer pricing rules.

Australia’s current tax system is unsustainable, but the tax policy process is the first priority for improvement by the incoming Government. Our tax policy process and the resulting uncertainty hinder growth of jobs and Australia’s future.

The causes of tax uncertainty include:

• Many government tax announcements are made without consultation, often for political effect.

• When found to be unsustainable, some are cancelled or postponed: this even includes recent measures in the 2013 Federal Budget.

• Measures take a long time to implement15, because Federal Treasury tax policy resources have been cut to the bone.

• Treasury and government do not even produce a complete list of the many announced but unlegislated measures and their legislative status. This lack of transparency is very visible.

• Tax law changes and over-regulation weaken business confidence Tax law changes that retrospectively affect prior years’ investment decisions16 are being made without regard for the business impact, exposing business plans based on existing laws to additional risk. This adds significantly to business uncertainty, as businesses cannot even rely on existing legislation.

For example, the 2013 Budget saw a proposal to deny Australian companies certainty about tax deductions for borrowings to finance overseas subsidiaries, unless the subsidiaries generate assessable income for the Australian parent. However, the use of borrowed funds was expressly authorised in 2002 tax law. The 2013 announcement had no provision for


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• ► Lack of governance has contributed to process problems Australia has faced similar difficulties in the last few years regarding the never-ending changes to our superannuation system which affect the confidence of Australians in the entire superannuation system. Significantly, the government responded in a 31 July announcement that it:

| “will make no major changes to superannuation tax policy for a five-year period, promoting confidence and stability in the superannuation system… (to) give Australians the confidence to make investment decisions in the knowledge that the rules will not be subject to constant change… and that superannuation policy is removed from the political cycles for genuine confidence in the system to build.

The Government will… establish the Super Council (and)… an agreed Charter of Superannuation Adequacy and Sustainability... This robust institutional framework will give Australians confidence that there is a predictable and consistent stewardship of superannuation.”

Australia’s tax system deserves at least the same respect and robust institutional framework, to give “Australians the confidence to make investment decisions in the knowledge that the rules will not be subject to constant change... for genuine confidence in the system to build.”

Treasury consultation to fine-tune the policy impact. So companies relying on the 2002 law, with long-term financing structures locked in, have the risk of major permanent tax disadvantages as the changes apply to existing debt not just new debt.

There is no strategic approach to how to change government policies while providing legitimate transitional mechanisms for taxpayers.

The IMD World Competitiveness Survey ranked Australia only 29th for “ease of doing business” and noted:

| “Regulations cost money and time . . . something which is even more burdensome for medium-sized enterprises.”17

The frustration was expressed in a humorous 2013 contribution from the small business representative in the government’s 2011 Tax Forum.18

• Insufficient tax law maintenance leads to ATO taking controversial positions Lack of clarity around law, and issues emerging from the law, can lead to the ATO taking controversial positions, from the perspective of the business community, in relation to generally accepted tax law, principles and policy.

Whilst the ATO under its new Commissioner of Taxation is seeking to streamline its processes, we highlight that gaps in formulating tax policy and the lack of clarity around enacted laws contribute to tax controversy and uncertainty.

We need a more sustainable and competitive tax system

As well as the major improvement in our tax policy process, Australia must adopt a strategic approach to its tax system, to build community acceptance for a plan for a sustainable tax system built on growth.

• Australia’s corporate tax environment is not competitive Australia’s tax mix has an unhealthy reliance on corporate income taxes, inappropriate for a small open country looking to investment to drive growth. Australia has the highest percentage of corporate tax to GDP of any country in the OECD19 apart from Norway (where the percentage is influenced by the petroleum resource rent tax). Our ratio is over 60% higher than the OECD average, 45% higher than Canada, over 70% higher than the USA and over 50% higher than the UK. And that’s even before considering our Asian neighbours, which compete for foreign investment with Australia.

• High corporate taxes impede growth Australia’s high tax rate and broad base affect global companies’ investment decisions.

Australia’s effective tax rates are getting relatively higher as countries in Europe and the Asia Pacific region trend down their corporate tax rates. See for example the UK and Canadian moves to lower corporate tax rates20, and Vietnam competing with other Asian countries for investment by reducing its corporate tax rates21.

17 Remarks by Prof Garrelli of IMD quoted in Australian Financial Review, May 30 2013, op.cit.18 Small business chief Peter Strong releases rap Red Tape Nation — http://www.news.com.au/national-news/federal-election/small-business-chief-peter-strong-releases-

rap-red-tape-nation/story-fnho52ip-1226687502610#ixzz2b3TTPe2G19 data extracted on 27 May 2013 11:32 UTC (GMT) from OECD.Stat20 The UK main rate of corporation tax is 23% on 1 April 2013, 21% at 1 April 2014 and 20% from 1 April 201521 The Vietnamese tax reform strategy to improve the country’s business and encourage investments includes reducing the standard corporate income tax (CIT) rate

from 25% to 22% from 1 January 2014, and to 20% from 1 January 2016. In addition, favourable tax treatments have also been introduced in the new CIT laws


Attractive corporate taxes stimulate investment, and create jobs. That is clearly understood, and not just in the AFTS Review. The G20 Finance and Central Bank Deputies Meeting in February 2012 on Structural Reform in a Crisis Environment noted that:

| “Growth-friendly tax reforms could help strengthen the jobs content of a recovery… These include removing tax expenditures and shifting the tax burden towards tax bases that are less harmful to employment and growth, such as immovable property, consumption and environmental taxes”.

Australia’s uncompetitive tax rate trend sends the wrong signals in a globalised business environment, when businesses can freely relocate their activities. The risks for Australia are magnified by the increasing free trade and freedom of investment — such as the ASEAN Free Trade zone to commence in 201522. Increased free trade leads to new business investments (manufacturing or distribution or design locations). So the more that markets free up for investment and trade, the greater the competitive disadvantage or deadweight cost arising from an unattractive tax system.

Australia cannot continue to assert a high tax ‘benefits of the boom’ approach after the resources investment boom has passed and business investment is weaker.

• It’s not just about tax to GDP ratios It is too simplistic and in fact misleading to look just to the ratio of total taxes or even corporate taxes to GDP. This ratio is affected as the OECD identified, by government accounting for tax and expenditure programs23. Governments can keep down tax to GDP ratios by funding expenditure programs by borrowings, but borrowings need to be repaid out of future taxes or charges.

Our ratio of total taxes to GDP is lower than in the Howard government era: however that is due in part to the continuing world recession and the slow economy which has restricted tax revenues. We are concerned that as Australia’s economy grows, the ratio of corporate taxes to GDP will leap sharply due to the tax increase measures introduced in recent years.

The primary focus of tax policy should in our view be on the effective tax rate (ETR) including effective marginal tax rates on new investment in Australia, not on tax-to-GDP ratios. The ETR influences the next business investment by an Australian or foreign business, and whether the next investment should be in Australia or overseas24. ETRs depend on the nominal corporate tax rate, capital allowances and tax incentives, and comparing these with other countries. Measuring ETRs is not as easy as the tax to GDP ratios, and the AFTS Review considered ETRs in its policy thinking25.

• ► State taxation needs reform to fund State responsibilities Australia’s State tax finances need substantial reform, as also identified in the AFTS Review. States’ revenue bases are not consistent with their responsibilities, causing ongoing Commonwealth/State tension and overlap of functions. The lack of clarity results in escalating regulatory and public service costs, tax revenue pressures for states to fund their costs, and more red tape. States’ revenue gaps are becoming more acute with the declining yields from the GST. To fund their expenditure programs, States must rely on a range of taxes — many of which are inefficient — or seek funds from the Commonwealth.

• ► Expenditure programs cause tax pressures which impede growth Martin Parkinson of Treasury has identified that spending programs create pressure to raise taxes26:

| “Combined, the slowing economic growth, rising expectations of government, and a constrained revenue base, are likely to force an explicit debate about the size and scope of government, both at each level of government and between the levels of government.

I see this debate being shaped by a series of questions.”

Dr Martin Parkinson Secretary to the Treasury

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22 “The ASEAN Economic Community (AEC) will focus on regional economic integration by 2015. AEC envisages (a) a single market and production base… The AEC areas of cooperation include human resources development and capacity building, closer consultation on macroeconomic and financial policies, trade financing measures, enhanced infrastructure and communications connectivity, development of electronic transactions through e-ASEAN, integrating industries across the region to promote regional sourcing… In short, the AEC will transform ASEAN into a region with free movement of goods, services, investment, skilled labour, and freer flow of capital.”

23 The OECD, which provides the most comprehensive estimates of tax to GDP ratios in its annual “Revenue Statistics” report (http://www.oecd.org/ctp/tax-policy/revenuestatistics2012edition.htm), still notes the caveats in its 1999 report. Factors that can affect the level and trend of tax-to-GDP ratios for countries include social economic assistance via tax expenditures, rather than direct Government spending, relationship between tax base and GDP, the economic cycle and measurement of GDP

24 See Erwin Diewert and Denis Lawrence papers on Deadweight Costs of Capital Taxation in Australia (http://cdi.mecon.gov.ar/biblio/docelec/az1228.pdf); and The Deadweight Costs of Taxation in New Zealand (http://www.jstor.org/discover/10.2307/136126?uid=3737536&uid=2129&uid=2&uid=70&uid=4&sid=21102535558297)

25 For example, p149 mentions the importance of capital taxation given the increasing international mobility of that capital, p162 provides information on EMTR trends over time for OECD countries

26 Dr Martin Parkinson PSM, Secretary to the Treasury, ‘Challenges And Opportunities For The Australian Economy’, to the John Curtin Institute of Public Policy, 5 October 2012


National goals

Improve and clarify our tax policy process, as current tax policy processes create distortions and uncertainty which hinder growth and discourage investment. Adopt a strategic approach to Australia’s tax system to support growth and help to resolve our national budgetary challenges.


shows that without restraint on expenditure programs already announced, takes would rise very significantly as a percentage of GDP.

• ► Introducing a more balanced and less volatile indirect tax component in our tax mix Effectively, Australia’s high corporate taxes compensate for the low indirect tax base. This includes a GST at a relatively low rate — compared with most other OECD countries using GST or VAT — and a low base, as it does not cover all goods and services. This needs to be transparently reviewed: as mentioned, the AFTS Review was prevented from considering the GST.

As well, Australia’s over-reliance on income taxes also makes our tax revenues more volatile and affects the accuracy of our tax revenue forecasting. Exchange rate movements and small variations in the economic aggregates can significantly reduce income tax revenues, which are more volatile than indirect taxes. As a result, forecasts of increased revenues, which were used to fund spending programs, are not achieved and create additional economic distortions.

Recommendations

The flaws in Australia’s current tax processes and tax structure require action.

• A disciplined tax policy approach with transparency and integrity The first tax priority for the incoming Government is a disciplined process for developing tax policies, to achieve certainty and to rebuild confidence for businesses to invest in Australia. Actions include:

a) Regaining trust by releasing a transparent list of announced measures and their status.

| “The first is about what we… want or expect our governments to provide… we will increasingly demand better quality goods and services. While, at times, debate has presumed that these services will always be publicly provided, this is not a presumption we can afford to make. There are many very worthy and constructive programs that governments could potentially fund. Explicit prioritisation is required on what can, and what can’t, be funded by governments as opposed to individuals.

We then need to consider how governments should fund the goods and services they are to deliver. It’s a truism that any increases in spending need to be funded either via higher taxes, introducing more user-pays options, and/or reducing spending on other services.

This raises an important issue for governments at both the Commonwealth and State levels: the sustainability of the tax system.”

Dr Martin Parkinson Secretary to the Treasury

Parkinson also identified the stark concerns for discussion about the sustainability of our tax system given free-spending expenditure programs.

The incoming Government must organise a strategic discussion about our government expenditure programs and their relationship to the tax system and ultimately to Australia’s future.

The risk is, as confirmed by Parkinson, that Australia’s escalating government expenditure demands will require new taxes, these will discourage new investment and new growth — and Australia will have real tax sustainability risks.

This is confirmed in the Treasury pre-election Economic and Fiscal Outlook 2013, where Appendix F

b) Cancelling and deferring various announcements: The incoming Government must manage the many unlegislated announced tax measures. Even in July 2013 the Government deferred the proposed limits on deductions for self-education expenses to “allow for further consultation on how best to target excessive claims while ensuring the impact on university enrolments and genuine continuing professional development is minimised.” The proposed repeal of companies’ deductions for interest to finance foreign investments under s25-90 (mentioned above) is a prime candidate for deferral for at least one year if not more ‘for further consultation on how best to target excessive claims while ensuring the impact is minimised. A precedent for a comprehensive revision and culling of all previously announced tax measures was in February 2009, when the then Assistant Treasurer Chris Bowen released his Forward Work Program For Tax Measures, 12 February 2009.28

c) A structured approach to managing reforms: The New Zealand Generic Tax Policy Process should be considered, with a clearly expressed policy approach29 under which:

| “a major reform may pass through the five distinct phases of the policy process, moving from the conceptual to the concrete…:

• Strategic, including an economic strategy, fiscal strategy and three-year revenue strategy...

• Tactical, which involves the development of a three-year work programme and an annual resource plan to implement the revenue strategy. The process allows the initial scoping and development of broad policy

27 “The Government has decided to defer the introduction of the $2,000 cap on work related education expense deductions until 1 July 2015. This will allow for further consultation on how best to target excessive claims while ensuring the impact on university enrolments and genuine continuing professional development is minimised. This measure is expected to decrease receipts by $250 million over the forward estimates period.”

28 Forward Work Program For Tax Measures, 12 February 200929 How we develop tax policy — http://taxpolicy.ird.govt.nz/how-we-develop-tax-policy

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options, and may involve external consultation at this point, often by means of a high-level ‘green’ paper, or discussion document.

• Operational, which consists of detailed policy design, detailed consultation.

• Legislative, in parallel with the operational phases, speeds up the process. External consultation takes place through public submissions to the select committee considering the bill.

• Implementation and review, which include the post-implementation review of new legislation, after it has had time to ‘bed in’, and identification of remedial issues that need correcting for the new legislation to have its intended effect.”

d) External oversight is needed. The government promised, for different political reasons, a ‘five year freeze on superannuation changes’30 to address members’, employers’ and the industry’s frustrations with an unstable system which had led to widespread dissatisfaction and lower contributions: it promised also a ‘Super Council’ and ‘an agreed Charter of Superannuation Adequacy and Sustainability’. We do not suggest a five year freeze on tax changes, but Australia needs better governance around tax reform processes.

A tax policy governance board would be beneficial, to ensure a methodical and properly resourced process for our national tax infrastructure.

e) Methodical maintenance of the existing tax law There is a need for improved law maintenance to enhance certainty and business confidence. This includes the examination of the operation of key areas of tax law, particularly those impacted by new

developments, to identify concerns and anomalies before they become widespread and have a disruptive impact on the business community.

• A strategic review of our tax system and its interaction with jobs, growth and investment A strategic review of Australia’s tax policy directions is needed. The focus should be to encourage economic growth and recover Australia’s position as an attractive investment location, driving jobs growth. This is particularly important outside the resources sector.

As the chief of the IMD noted when launching the IMD World Competitiveness Survey:

| “The world’s most competitive medium-sized nations — such as Switzerland, Sweden, Norway and Canada — were flourishing despite high currencies because their economies were more diversified than Australia’s economy, more export-oriented and had ‘fiscal discipline’”.

The policies need to encourage businesses to invest and link to policies to encourage greater labour efficiency and productivity.

We believe the incoming Government should involve a consultative process to set the environment for the Australian tax system, and to fully expose the risks and challenges head. That can then include an updated consideration of policy directions.

The AFTS Review illustrated an element in that process. But the AFTS Review was not followed by an open consultation about the priorities: rather the choices made about priorities, without transparent consultation, led to the difficulties associated with tax reform.

A recent example of strategic tax analysis is in the Treasury scoping paper on potential risks to the tax system arising from the activities of multinational businesses. This scoping

paper did not involve tax policy adventurism. The scoping paper was carefully considered. It followed a consultation process, albeit limited. It confirmed that there is no clear and present danger to the Australian tax system from multinational business activities but identified some future risks. It then set out a series of actions including the need for Australia to act in concert with the multilateral initiative being led by the G20 in relation to the international tax system.

Because the first requirement is for due process, we do not present in this document a comprehensive fine-grained list of solutions. We note the useful contribution of the Business Council of Australia in its Action Plan for Enduring Prosperity31. That document also recognises the need for a strategic review.

We set out some elements that the strategic review should consider:

• Compliance efficiency The AFTS Review identified, as mentioned above, the excessive complexity of our tax system. The frustrations of small business, as well as larger businesses, require a streamlined compliance focus.

The Review should counter the continuing trend to legislate hugely complex integrity measures which add to the deadweight costs for business and indeed the ATO as administrator.

• Achieve better tax rules for international businesses in Australia and globally As the G20 secretariat for 2014, Australia will have a significant role in the G20 and OECD project to update the tax rules for global businesses in the 21st century. As well as the major tax initiative to combat tax evasion (usually by private persons, using tax havens and secrecy jurisdictions) the project to update the tax rules for multinational businesses is critical.

30 Five Year Freeze On Superannuation Changes 31 July 2013, http://ministers.treasury.gov.au/DisplayDocs.aspx?doc=pressreleases/2013/012.htm&pageID=003&min=cebb&Year=&DocType=

31 July 2013

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This is a major task and Australia needs to follow a disciplined approach. Importantly, Australia must act within the multilateral frameworks so as not to affect our competitive position. Unlike India, China or the USA, we do not have huge populations and strong economic attractiveness for new non-resources business investment.

As well the Government must influence global tax policy processes so that countries appropriately allocate their taxing rights and sharing of taxes. Otherwise, multinationals will be burdened with double taxation.

• Indirect tax and State tax reform Working with the States, the Government should consider indirect tax reform and fundamental State tax reforms, to help replace inefficient State taxes and to fund the responsibilities of the States. GST reform should address the base broadening and low rate gaps above.

State tax reform could also align and standardise the law and practice for existing taxes applying in multiple States. For example, on payroll taxes the States have already moved to align the concepts and approaches, but more can be done. Reform of stamp duties is another priority, to encourage greater economic activity. Currently, varying rules for stamp duty treatment of ‘land–rich companies’ are adding to the cost of doing business in Australia.

• Encourage workforce participation Australia needs appropriate tax incentives to boost participation, including by women and by older Australians. These will both improve productivity and reduce social welfare outlays.

Superannuation Australia faces significant stress on the public purse, as the cost of supporting our aging population continues to increase. One of our options for reducing this stress is the superannuation system, which was designed to address retirement savings challenges and help take pressure off the Federal budget by reducing outlays on the age pension. However, with Treasury estimates of the cost of super running at $32 billion per annum, we need to ask serious questions about our current system. What benefits do we anticipate super providing? Does the current system deliver these benefits? Is the cost sustainable over the medium-to long-term?

We need greater certainty around the future direction of Australia’s retirement funding model. The incoming Government must take a strategic approach to superannuation reform, successfully address the nation’s ticking demographic time bomb. Recent changes to super have done little more than tinker around the edges of a system in need of a much more robust and strategic review. Now we need new strategies that take into account longer life-expectancies, changes to retirement and pension access ages, and the prevalence of small account balances. This is the only way to ensure the existing superannuation system is doing enough to enable more self-funded retirement from those who would otherwise be dependent on the pension.

As compulsory superannuation contribution levels rise, the incoming Government should also consider trimming tax concessions on voluntary contributions, particularly for higher income earners who are already capable of supporting themselves in

retirement. It should also look at greater incentives to encourage voluntary contributions for groups who currently have limited opportunities to accumulate super, such as low income earners or carers.

The super guarantee should also be revisited, in line with changing work and demographic patterns and the increased cost of living. The system needs to be more equitable for low income earners and those with interrupted work patterns, such as casual workers and women. We may even need an opt-out system for low income earners, on the basis that removing 12% of the pay of such workers may be unduly onerous with little benefit.

When it comes to accessing superannuation funds, the current lump sum payment system is not sustainable. The means testing of the age pension actively encourages retirees to spend their superannuation lump sum, so they qualify for more of the age pension. If superannuation continues to be supported with tax concessions, there should be stronger parameters around lump sum payments to ensure more of the funds are actually used as retirement income to ease pressure on the pension system.

The incoming Government should also seriously consider lifting the superannuation access age. When the retirement age was set at 65 (for men) in 1909, the life expectancy (for men) was only 55. Today, Australians can expect to live into their 80s and the figures keep rising. Increasing the access age for superannuation would encourage a longer savings accumulation phase better suited to our longer life spans.

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Contacts

COAG Bruce Hunter +61 2 6267 3855 [email protected]

Carbon Mathew Nelson +61 3 9288 8121 [email protected]

Defence Tony Smith +61 2 6267 3997 [email protected]

Economic Management David Cochrane +61 3 9655 2551 [email protected]

Education Stephanie Fahey +61 2 6267 3820 [email protected]

Health Jim Birch +61 8 8417 1763 [email protected]

Human Services Mark Nixon +61 2 6246 1584 [email protected]

Infrastructure David Larocca +61 2 9248 4245 [email protected]

Productivity Neil Plumridge +61 3 9288 8957 [email protected]

Tax Craig Robson +61 8 9429 2271 [email protected]

Canberra Lucille Halloran +61 2 6267 3872 [email protected]

Adelaide Chris Sharpley +61 8 8417 1686 [email protected]

Brisbane Jenny Parker +61 7 3243 3673 [email protected]

Perth Michael Anghie +61 8 9429 2324 [email protected]

Superannuation Antoinette Elias +61 2 8295 6251 [email protected]

Sydney Lynn Kraus +61 2 9248 4244 [email protected]

Melbourne Annette Kimmit +61 3 9288 8141 [email protected]

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