Rudd Goverment’s cautious response to ambitious and visionary Henry Review

The Henry Review is an ambitious document, conceived early in the life of a new government at a time when budget surpluses stretched as far as the eye could see, surpluses which could be used to ease the tensions between winners and losers that are the inevitable consequence of any tax reforms worthy of the name.

Hence the Review aspires to a tax system which ‘is oriented towards supporting strong and sustainable economic growth’, one which has regard to the pressure which strong population and economic growth will put on our ‘increasingly fragile ecosystems’, and one which ‘fully exploits the opportunities of the new digital age’.

More specifically, it proposes that Australia’s tax system should rely primarily on four revenue sources – personal income, business income, private consumption, and ‘economic rents’ from natural resources and land – with all of these tax bases being as broad and comprehensive as possible. Apart from taxes which ‘efficiently address social or economic costs’ (such as those on tobacco, alcohol and gambling, environmental taxes and ‘efficient road user charges’), it suggests that other taxes (including payroll and insurance taxes, and stamp duties) should be abolished. And it recommends that all pensions and benefits should be comprehensively means-tested, but tax-free.

In contrast, the Government’s response to the Henry Review comes at a time when those budget surpluses have disappeared, and when, with around six months (at most) until the next election, vaulting ambitions inevitably take second place to ‘political realities’.

Indeed the Government has given no indication as to whether it embraces the Henry Review’s broad vision of what Australia’s tax system should look like in the future. Rather, its initial response has been to implement less than a handful of the Review’s 138 recommendations – and some of those only partially.

It has, to be sure, left the door open to changes ‘in a number of other areas’ in its second term, should it get one. But it has also explicitly rejected 27 other recommendations, as well as two further propositions which the Review would almost certainly have recommended (increasing the rate or broadening the base of the GST, and reversing the tax-free status of superannuation payments to the over 60s) had it not been specifically precluded from doing so in its terms of reference.

The ‘headline news’ in the Government’s response is the proposed introduction of a resource rent tax – which, consistent with its penchant for acronyms, it is calling an RSPT (for ‘Resources Super Profits Tax’), and which (net of rebating state-based royalties and a new exploration rebate) will pay for a 2 percentage point reduction in the company tax rate, instant write-offs for capital expenditures by small businesses, additional infrastructure spending (especially in the resource-rich States), and further government support for superannuation contributions. (Note that the 3 percentage point increase in compulsory superannuation contributions, to be phased in over the next nine years, will be paid for by employers, not the Government).

A resource rent tax is, as the Henry Review says, a better way of ensuring that the Australian community receives ‘an appropriate return on its non-renewable resources’ than the existing (predominantly output-based) royalties, which have collected a declining share of resources-related profits during a period in which the latter have increased substantially, and is consistent with the direction in which other advanced economies with significant resource endowments have been heading.

However the decision to give small businesses a two-year ‘head start’ on the proposed reduction in the company tax rate, and to give them (but not large businesses) an instant write-off for asset purchases, appears to be motivated primarily by tactical political considerations and runs counter to the Henry Review’s vision of a comprehensive and non-distorting business income tax base.

The immediate response of both political parties to the Henry Review suggests that a calm, measured, and mature debate over either its vision or its detail between now and the next election would represent a triumph of hope over recent experience. However it would be heartening to think that the Review will eventually provide a template for more far-reaching reform over the lives of the next two or three parliaments.

(This article was originally published in the Melbourne Age on 3rd May 2010)

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4 Responses to Rudd Goverment’s cautious response to ambitious and visionary Henry Review

  1. Corin says:

    Saul, I think the main issue you’ve missed is that in response to Henry and calls for more aggressive cutting of the company tax rate, they could have tied this to a revised ETS package to take to the election.

    Dumping the ETS was a strange option when the Henry review could have been used to improve its reform credentials – of both – even in a single package.

    In my view pricing carbon can also promote tax reform if this is grasped. The ETS always needed a business constituency in the ‘pro’ camp. Using the ETS to more aggressively cut the company rate would have helped both packages in my view to be more credible. Certainly Rudd’s credibility is on the line and he didn’t have to dump the ETS, nor did he have to go to a DD over it. He could have found a better policy than that negotiated with Turnbull and taken that better policy to the people.

    Tax reform is not seperate from the ETS. Garnaut realised this early and pricing carbon provides big opportunities to promote efficiencies in business taxation if part of carbon price is used for this. Obviously part of the carbon price is needed for compensating consumers, but there is room for far more aggressive cuts to company tax rates.

  2. Nicholas Gruen says:

    Yes, as far as the economic models go, switching a good chunk of ETS revenue for lower company tax, lots of models would have told you it would have increased growth.

  3. Saul Eslake says:

    Corin, I don’t disagree with you. The only quibble I would have is that the Rudd Government’s ETS would have been revenue-negative in its first few years, and thus there would arguablt have been less room to cut company tax, rather than more, if it hadn’t been abandoned. Of course, as my Grattan Institute colleagues have shown (see http://www.grattan.edu.au/pub_page/report_energy1.html) the ETS could have been revenue-positive if it hadn’t given away so many ‘free’ permits. Maybe – if a revised version of the ETS is put forward after the next election – further reform of other taxes will become more feasible

  4. Corin says:

    Saul, that is a fair answer. I think the piece would have really come to life with that as a prominent issue though. The Govt would have put together a broader coalition of support among key businesses if they had followed a better policy setting, like we are discussing, but they would have had more losers too. The Govt needed to start here as an optimal, rather than a sub-optimal start that got more and more sub-optimal. Like the GST ……. it got worse in evolution under political pressure to do a deal with the Dems but it started from a more ‘pure’ setting and this allowed for a credible package to be enacted even if it wasn’t the ideal. Currently the existing ETS is not only sub-optimal it has no cheer squad, whether in business or the other key constituencies. Sometimes ‘purist’ policy get a bigger division but that is not always bad electorally. Tariffs in the 1980s are a case in point, those who screamed loudest lost.

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