This speech was delivered by BCA President Catherine Livingstone at the CEDA Economic and Political Overview event in Sydney on 8 March 2016.
Check against delivery.
Thank you Alf, and thanks to Stephen and to CEDA for inviting me to contribute to your 2016 Economic and Political Outlook series.
My thanks also to friends and colleagues from both the business and community sector for making the time to be here this afternoon, and to EY, a valued member of the Business Council of Australia, for sponsoring the event.
Setting the scene
Today, the Business Council is releasing a discussion paper on transforming the tax system, and I will be talking about that shortly.
But first, let’s step back and ask why we are even talking about this at all? What is the context?
The context is creating a sustainable future for the country.
The Business Council has always seen itself as playing the long game on what is right for Australia.
We will not resile from the commitment to Australia’s long term interests, and the demand for good policy design.
That is our core role. We seek to describe the conditions that will drive economic growth, remembering that it’s primarily business that creates wealth, jobs and the capacity for reinvestment.
We have a major stake in this:
- one in 10 working Australians are employed by a BCA member company
- 10 million people are employed in the business sector overall.
Our vision for Australia was set out in considerable detail in our Action Plan for Enduring Prosperity, which we released in 2013.
Key elements of that vision are:
- For Australia to return to 3.5 per cent average annual GDP growth, not because this is a magical number, but because if we are to maintain living standards, we should expect nothing less than the rate of growth Australia has experienced over the last 55 years.
- For labour productivity growth to return to 1990 levels because without it, as our terms of trade level off or continue to decline, there are few other levers to achieve GDP and wages growth. The productivity task requires a commitment to investment and innovation-led growth.
- For real income growth to increase to the historical average of 1.9 per cent per year, at a minimum.
- And for this combination to see this country being ranked in the top five comparable, industrialised countries, in the world, for real GDP per capita.
A growing economy is the only path to delivering social progress in areas such as job creation, health outcomes, educational attainment and quality of life infrastructure.
While the policy imperatives identified in the Action Plan remain as relevant today as when released, just prior to the 2013 federal election, our degrees of freedom for phased implementation have narrowed.
We developed our Action Plan with acute recognition of the profound changes underway, both in the global economy, and as a consequence, in the Australian economy.
As we have highlighted, these changes include:
- The disaggregation of global supply chains.
- The fact that 75 per cent of all trade is in intermediate goods and services and capital goods.
- The extraordinary impact of smart phones, only introduced as recently as 2007, and consequent access to the mobile internet, and what that has enabled in terms of disruption of traditional business models.
- And the increasing, if not accelerating, mobility of individuals and companies.
I can’t stress strongly enough the depth, scale and speed of these changes.
For as long as the tax debate is merely a daily commentary on individual tax measures, we risk losing sight of the core objective which is to underpin a transitioning economy.
It is, therefore, essential that we are systematic in our approach, and that we return to the tried and tested framework for the development of good public policy, which includes four essential steps:
- Having a vision, such as the one I have just outlined, that defines the desired future state
- Identifying clear policy objectives to deliver that vision
- Recognising the problems that need to be solved in order to achieve these objectives, and then;
- Putting forward a set of incremental, coherent, purposeful and feasible policy actions, to take the country past these problems, and towards the vision, with all of these actions anchored in first principles.
In a sense you could look at this process through the lens of the business model for the country.
Good businesses have a vision of where they want to get to. They put in place strategies to get there, and they implement those strategies through a detailed and coherent set of actions.
At all times, they maintain a view of the overall shape of the business model, which encompasses:
- How the business is going to generate revenue - how it’s going to grow
- The capabilities needed in the organisation to deliver that growth, and
- The reinvestment capacity of the business, needed to make the business model sustainable?
So let’s talk about Australia’s business model in the context of the vision we have articulated: there is strong agreement that the next wave of growth must be innovation-led.
This is acknowledged by both major political parties in key position papers, specifically the government’s National Innovation and Science Agenda and the Opposition’s Powering Innovation Agenda.
The importance of innovation-led growth was also endorsed at the August 2015 National Reform Summit by representatives from the community sector, trade union movement, and small and large business.
So, if we are agreed on the need for innovation-led growth – in business we would refer to this as top line revenue growth - what are the capabilities we need, recognising that in a globalised world, these capabilities need to reference the global context?
- We need to be globally competitive in terms of education and skills – we need capable people and we need them to be engaged in the economy.
- We need vibrant, agile, growing businesses because the country makes money when business makes money.
- We particularly need business to be competitive in key sectors where we have a comparative advantage, an approach that’s being advanced through the Industry Growth Centres policy framework.
- This policy followed the BCA’s July 2014 ‘Building Australia’s Comparative Advantages’ report, which called for a whole of economy approach to lifting those sectors where we had a comparative advantage.
- We need foreign investment, though with an emphasis on investment which brings mutuality and reciprocity of benefit, and
- We need regulatory settings which provide encouragement and incentive for the development of the capabilities I have just described.
One of these regulatory settings is tax. Our tax system is one controllable factor in a volatile, unpredictable global economy.
If our tax system is not conducive to people productively engaging in the economy, or businesses investing, innovating and creating jobs - and if it’s compromising the nation’s international competitiveness, then the system is undermining our national business model.
That’s why Australia is talking about tax.
And while my focus today is on tax, I will also refer to fiscal policy, because of the irrevocable interdependency between revenue and expenses.
Recognising the problem
If we follow the framework for good policy, and we are agreed that a tax system which reinforces and complements our national capabilities is essential to delivering on our national vision … the next step is identifying the problems with the current tax system.
The characteristics of a good tax system include that:
- it’s stable and predictable
- it provides incentive to work and participate,
- it creates the business environment for companies to invest and expand, and
- it facilitates initiatives around innovation-led growth, such as research and development, entrepreneurship and risk taking.
The problems we have now include major issues with the structure:
- We are overly reliant on a volatile, narrow base of income taxes, both personal and company.
- 12 companies pay 33 per cent of all company tax, and three per cent of individual taxpayers pay almost 30 per cent of personal income tax.
- Personal income taxes are increasingly inequitable due to bracket creep: if we are committed, as a nation, to a progressive tax system, nothing could be more regressive than the impact of bracket creep.
- Our rate of company tax is one of the most uncompetitive in the world, adding to our already failing competitiveness.
- The complexity and inefficiency of the system has 10 taxes raising 90 per cent of revenue, while the remaining 115 taxes impose significant compliance costs for very little revenue yield.
These problems have consequences …
Taxation can be either an accelerant or an impediment to economic growth – in our case it is increasingly an impediment. We see this in the decisions made, at the margin, by business and by individuals.
A lower rate of company tax reduces the after tax cost of capital, which lowers the hurdle rate for investments, and leads to an increase in business investments that drive innovation, alongside the productivity growth and job creation which flow from innovation.
In the course of consultations for EY’s new report, Tax reform: A better way, former Oceania Managing Partner and CEO Rob McLeod emphasised how much the headline rate of tax really And it matters both for individuals and for companies.
Roadmap for change
Remembering, therefore, the importance of applying first principles, therefore, every adjustment we make to the tax system, even if incremental, must be part of a staged, restructuring of tax arrangements which:
- lowers the overall burden on families and businesses
- decreases our reliance on a narrow base
- removes the most inefficient taxes, and
- improves simplicity, integrity and transparency.
The Business Council has always envisaged at least the following three elements:
- On personal income tax, changes to thresholds to tackle bracket creep, and to encourage workforce effort, participation and entrepreneurship.
- A lowering of the company tax rate to 25 per cent, noting that this will simply align Australia with the OECD average.
Let me pause here to make an important comment:
On integrity, the Business Council’s strong position is that companies must meet their tax obligations, and where arrangements do not keep pace with community norms, they should be reviewed.
Robust integrity measures are an integral complement to more competitive business tax arrangements, but we must support tax transparency that is fit for purpose.
We support the need to address the multinational tax issues, but to use this issue to characterise all companies as underpaying their tax is disingenous at best, and potentially very damaging if it obscures the importance of making our rate of company tax more competitive.
On Treasury’s assessment, two thirds of the benefits of company tax reductions flow to Australian households, primarily through higher real wages.
And for a small, open economy it is inconceivable, with our current company tax settings, that we can we return to a 3.5 per cent growth rate, and all the benefits that flow from it in terms of jobs, wages and living standards.
If we come back to our first principles, and our focus on growth in national income, a more competitive company tax rate is non-negotiable.
Back to our reform elements…
- At a state level, our suggested tax package would see a gradual shift from stamp duties and insurance taxes to carefully designed land taxes, and harmonised payroll taxes. There is unassailable evidence that stamp duties and insurance taxes are among the most damaging to the economy, and stamp duties are also highly volatile, given their reliance on the property market.
In summary, if Australia does not pursue a package of the kind we are advocating, the community deserves to understand the implications for the position we will be in by 2025:
- 43% of Australian taxpayers will be in top two income tax brackets.
- Incomes growth will slow to an average rate of 0.9 per cent per year, compared to the growth rate of 2.3 per cent Australians have enjoyed over the past 13 years.
- Our company tax rate will be increasingly uncompetitive internationally, given the strong indications from other countries that their rates will be further reduced from their already competitive position.
To choose not to embark on a process of restructuring the tax system in the way we, and many others, are suggesting is akin to then former Treasury Secretary Martin Parkinson’s description of “sleepwalking” our way into lower living standards.
The question is how to fund it.
In an ideal world, all of these issues would be addressed through an holistic transformation of the system.
The Business Council believes that the GST could have been a potential source of funding, with appropriate compensation to ensure low income households would have been no worse off.
Increased reliance on a consumption tax would also deliver an important structural benefit by reducing our reliance on more volatile direct income taxes, and by addressing the narrowness of our tax base.
Incremental, purposeful action
If the GST is not an option in the medium term, we need to find another path through, and thus we would support a pragmatic approach based on three clear Horizons of adjustment.
While the changes we have set out will set us on the right path and will boost economic growth, the long term structural work will still need to be done.
Over time, we will need to address:
- the balance of direct and indirect taxation
- the challenges of an increasingly digitised economy, with new classes of assets, and
- the challenges of an aging demographic which will see fewer working people paying tax.
But we have to start somewhere - we have to get on the right course.
The first two Horizons need to be tackled within one and five years respectively, and our paper includes a menu of options around how to fund them, through careful changes to concessions that improve policy design and provide structural correction of the system.
Horizon 3 moves us much closer to our destination, with the growth dividend from the lower rates in Horizons 1 and 2 starting to flow through, giving the nation choices.
Our paper sets this out in some detail, but let me provide a snapshot of what we are proposing.
Summarising the actions in Horizon 1 and 2 together:
Within five years, we suggest implementing moderate personal income tax cuts, and in Horizon 1 we should focus on low and middle income taxpayers affected by bracket creep, that is people earning between 37 and 87 thousand dollars.
Within the same five-year timeframe, we would move on a glide path to a more competitive company tax rate of 25 per cent, and in Horizon 1, we should immediately correct for the current anomaly of having two company tax rates by harmonising the rate to 28.5 per cent.
The current arrangement is distortionary and fails to come to terms with the ecosystem of interactions between businesses of different sizes. Britain tried this and has since corrected the mistake. It’s just bad policy.
The glide path to a rate of 25 per cent cannot afford to be a spurious promise. To have an impact on business investment decisions, it must be legislated, with the proviso, as is the case in the UK, that parliament has the flexibility to adjust if global circumstances change dramatically.
So, back to the question of how to pay for these changes.
We are not the Treasury, but we believe there are concessional arrangements which should be considered.
It is the job of Treasury to model potential adjustments and identify the five-year cash flow assumptions.
This is a complex task, and there will be choices to make about how we calibrate the pace of change, depending on how quickly the benefits from these adjustments flow into the economy.
It is also Treasury’s job to chart thoughtful transition over time, and across generations at a point of time, and to understand potential unintended consequences.
It is most important that, in redesigning concessions, even those which provide a revenue dividend, the objective must be to improve tax policy design and the structure of the tax system, not to fund additional spending.
In our paper, we have set out some of these design parameters.
Now, turning to Horizon 3 – which takes us to 2025 – actions would be underpinned by progress made in the previous two Horizons, and would include:
- An ongoing glide path to take the company tax rate down towards 22 per cent
- A restructuring of the personal income tax and transfer interface to address the marginal tax rate issue and provide greater incentives to work, and
- Steps to rebalance the mix between direct and indirect taxes, including a well-designed compensation package.
If we move through these Horizons purposefully and systematically, the growth dividend, over time, could be considerable.
While we can debate the impact of a company tax rate reduction - and all the modelling suggests it could be in the order of a $9 billion increase in GDP - it is important to consider the consequence of the counterfactual: that is; no change in the company tax rate.
Doing nothing doesn’t mean that nothing will happen.
- Increasingly mobile company investment decisions, attracted by more competitive rates in other jurisdictions
- An erosion of the intellectual property developed in Australia, and
- Less and less formation of new businesses, and
- Fewer and fewer employment opportunities for young, mobile people.
I’ve already quoted one former Treasury Secretary, Martin Parkinson, on living standards. Another, Ted Evans, made a similar point in saying that a nation can choose the level of unemployment it is willing to bear.
As you can see from this slide, the dividend from achieving a higher growth rate compared with accepting the rate we have now is substantial. Our nation’s economy can be one and half trillion dollars bigger, and represents an entirely different scenario from our current trajectory, in terms of resilience, reinvestment capability and living standards.
As I mentioned at the start, the other side of the tax story is our fiscal arrangements – as with any business model, there are deep interdependencies.
And, again, just to be very clear, the purpose of tax reform is not to raise overall levels of revenue simply to fund additional spending.
Australia has a structural over-spending problem and raising the overall level of taxation will not solve this.
- Over the last 10 years, spending has exceeded our rate of GDP growth, and the Intergenerational Report forecasts this will continue, with real annual GDP growth of 2.8 per cent and annual spending growth of 3.1 per cent.
- We have made poor spending choices - health and education provide the standout examples, and
- We have continued to make substantial expenditure commitments on new programs.
We have no choice but to face up to the deficit challenge.
It’s compromising our capacity to pay for the services people need today, and our capacity to make investments at the national level which will underpin future wealth generation - whether that’s in physical infrastructure or knowledge infrastructure.
Failing to address the deficit also makes Australia vulnerable to global economic shocks and, should these eventuate, we may find ourselves having to make unpalatable choices.
If our business model is social progress afforded by generating long-term economic wealth, such an outcome is unacceptable and would represent a failure of that business model.
Comparing our situation favourably against weaker economies is hollow comfort. No business experiencing difficulties would excuse inaction by pointing to another business that’s experiencing even greater challenges.
If I return to business model interdependencies – addressing these fiscal issues will increase our capacity to move through our three Horizons of structural tax reform.
All of this involves choices and trade-offs, and the politics is hard. That is self-evident.
Good process can provide strong protection for governments in tackling tough decisions. These decisions should not be rushed, and a government must be allowed to work through the otions carefully and systematically, based on the best available data.
The better of the major structural reforms to our economy, like the GST in 2000, came after years of intensive analysis.
We believe that the policy development framework we have set out, which clarifies the vision and purpose of change, and offers choices, will be a useful contribution to this.
The single issue or single tax focus of the current debate militates against taking a framework approach and worse obscures the real purpose of reforming our tax system and strengthening our budget position.
As the election draws closer, our politicians have choices about the mandates they seek.
For the last 10 years, we have emerged from federal elections with governments that have no meaningful mandate for structural reform - in tax, in workplace relations, in regulation or in fiscal policy.
When a business is facing a difficult decision, and you are sitting around the board table trying to grapple with it, it’s the person in the room who asks “what is the right thing to do here?” who sets the discussion on the better course.
The question has multiple dimensions to it – moral, ethical, reputational, fiduciary – but the answer is the course that furthers and protects the long term interests of the company, and its shareholders.
This is the national leadership model we require - a collective dynamic, involving the parliament as a whole, interest groups like ours, and the community, which asks: "What is the right thing to do in the long term interests of the country?"
My colleagues and I felt this keenly, last week, when Australian of the Year David Morrison addressed the Business Council, and spoke of what had shaped and motivated him as a leader.
So let me finish this afternoon with a quote from David:
“Leaders recognise that they are the recipient of a legacy left by those who have shaped them to this point in their lives: role models, teachers, mentors, agents of change. True leaders then ask themselves, ‘What is the legacy I am going to leave?”