Nance Frawley

Tax Reform:

Critically Examining the Leaks

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What’s so interesting about tax and tax reform?

So much more than revenue raising

• Social engineering• Product of political compromises

and the power of interest groups

Tax Reform After Henry

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Where are many of the leaks?

• 2 distinct types of provisions in tax legislation:

1. Tax technical provisions – dealing with tax base (what/who gets taxed),tax administration and collection etc

2. Tax expenditures- provide tax subsidies by way of deductions, offsets/rebates/credits, deferral allowances etc -> the leaks

Tax Reform After Henry

The usual focus of tax reviews

• On revenue raising• Not on reforming tax expenditures-

continually overlooked yet promise the greatest gains for increasing the integrity of the tax system

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How significant is the impact of tax expenditures on our tax

system?• VERY

• Approx 340 tax expenditures, costing approximately $102 billion (taken from the 2008-09 Tax Expenditures Statement)

• Approx. 100 new tax expenditures added in past 10 years, only 30 removed

Tax Reform After Henry

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Advantages and Disadvantages

Why are tax expenditures part of our tax system when such

provisions deal with government spending rather than revenue

raising?

-> increased complexity-> increased instability-> poor targeting

‘Cost savings’ questionable

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Can the costs of tax expenditures be accurately determined?

• ‘Revenue forgone’ approach• Different from budget costings• Questionable accountability

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On what criteria should tax expenditures be assessed?

• Usual tax policy analysis centres on concepts of FAIRNESS,EFFICIENCY & SIMPLICITY->

Concepts that cannot be used to assess spending programs

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4 stage enquiry (Professor Neil Brooks)

1. Does the tax expenditure serve a valid govt objective?

2. Does it meet budgetary criteria?3. Is it the appropriate policy

instrument or are there better alternatives?

4. If it should be delivered thru the tax system, what method ie credit, deduction etc?

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R&D tax concessions- a tax expenditure of questionable merit

• Currently 125% tax deduction, in certain circumstances 175% tax deduction for ‘eligible’ R&D- ‘eligible’ -> quite broad

• companies with t/o less than $2m refundable offset

• Changing to a two tiered credit system:- Companies with t/o $20m or less -> 45%

refundable tax credit- All others -> 40% nonrefundable tax

credit+ Eligibility of claimable activities much tighter

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Difference between tax deduction and tax credit

Income tax payable = (taxable income x tax rate) – tax offsets/credits

Taxable income = assessable income- deductions

Therefore tax offsets not affected by changes to tax rate

‘Refundable tax credit’ – can get a payment where not paying tax

Tax Reform After Henry

‘Tax reform’ but not a ‘Tax Review’

Tax expenditures can be reviewed/reformed by a process outside a tax review-

Better? Maybe... A closer look at the process for reforming the R&D tax concessions

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Reform process for the R&D tax concessions

- Independent review -> Cutler Report; Review of the National Innovation System- not just a tax review (tax incentives only 1 of 12 chapters)

- Govt response – 9 months later- Consultation- after govt response, 1st & 2nd

drafts but increasing rushed & less public; responses by interest groups only?

- Bills & EM rushed; full of typos-> EM rereleased. - Senate Report 15 June; must be passed by 25th

JuneStarted off looking good-> ultimately ????

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What questions that still need to be asked?

• Should the govt be subsidising R&D? Why not leave it to market forces?

• Will the new program distribute benefits fairly and be target efficient?

• Does the government have control over this spending and how will it be accountable for this spending?

• Are there more appropriate policy instruments?

Tax Reform After Henry

Broad suggestions for reform of tax expenditures

• Subject tax expenditures to formal & ongoing evaluations

• Attach sunset clauses• Cap amount of revenue forgone

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