Source: https://treasury.gov.au/publication/economic-roundup-winter-2006/a-brief-history-of-australias-tax-system
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A brief history of Australia's tax system | Treasury.gov.au
This paper was presented to the 22nd APEC Finance Ministers’ Technical Working Group Meeting in Khanh Hoa, Vietnam, on 15June2006. It provides an overview of Australian taxation history, identifying trends and discussing key reforms to Australia’s tax system at both federal and state levels of government.
Consistent with most industrialised countries, Australia’s tax take (measured as the tax to GDP ratio) grew significantly over the twentieth century, in line with the expanding role of government (see Chart 1). At the time of Federation Australia’s tax to GDP ratio was around 5 per cent. This ratio remained reasonably constant until the introduction of the federal income tax in 1915, which was used to fund Australia’s war effort. Between the two World Wars, government expenditure and tax revenues grew significantly and by the beginning of the Second World War, Australia’s tax take was over 11per cent of GDP.
Between 1915 and 1942, income taxes were levied at both the state and federal level, leading to complexity and inequitable taxation of income across states. The Second World War saw fundamental changes to Australia’s taxation system. In 1942, income taxation was consolidated by the federal government to increase revenue as a war-time measure. As a result, the states’ tax base was reduced (see Chart1), replaced by federal government grants. The states’ tax base was supplemented in 1971, when the then federal government ceded control of payroll taxes to the states.
By the end of the Second World War, taxation revenue had grown to over 22percent of GDP. The further increase in taxation largely reflected Australia’s involvement in the war and the introduction of government support programmes, such as the widows’ pension in 1942 and unemployment relief in 1944.
The ‘gold rush’, which began in Australia in 1851, offered a new opportunity for governments to raise revenue, with some small scale alluvial miners making large amounts of money. New South Wales and Victoria introduced a gold licensing fee for the right to mine allotted sections. This was considered the most feasible option for collecting revenue because of the ease of administration. The licence fees were the trigger for a significant uprising by Victorian miners against the colonial authority — the Eureka Stockade. The primary reason for the uprising was the high leve
l at which the licence fees were set, but other contributing reasons included: that the fees had no link to gold discoveries of miners; miners rarely saw any of the benefit of public expenditure; and the inequity of the taxes compared with the light taxation of wealthy land owners. Following the riots and rebellion of the Eureka Stockade, gold licence fees were replaced with a gold export tax and a much reduced miner’s right, which were easier to collect and more equitable (see Smith 1993).
Based on views about common citizenship rights, the drafters of the Constitution adopted an ‘assumption of “convergence”: that Federation would bring about an equalisation of the states’ economies and fiscal capacities’ (Hancock and Smith 2001 page iv). The federal parliament had power to make laws with respect to ‘taxation; but so as not to discriminate between the States or parts of States’ (Australian Constitution, Part5, Section 51(ii)).
The federal government increased its income taxation in the early years of the Second World War to meet the costs of the war effort. Between 1938-39 and 1941-42, federal government income tax revenue grew from 16percent to 44per cent of total federal revenue. With reliance on income taxation rising at both the federal and state levels, differences in state income taxes led to concern about the inequitable tax burdens between taxpayers in different states.
In 1942 the federal government introduced legislation that increased the federal government income tax rates to raise more revenue. The legislation provided for reimbursement grants to
the states provided that they ceased to levy their own income taxes. Although a state could legally continue to impose its income tax, doing so would impose an increased burden on its residents and also disqualify that state from receiving federal government grants. In practice, this prevented the states from continuing to levy their own income taxes. The uniform taxation arrangements were initially only meant to apply for the duration of the Second World War and one year thereafter. At the end of the War, the states sought to regain their income taxing powers but were unsuccessful.
The federal government introduced payroll tax in 1941 to finance a national scheme for child endowment. The tax applied as a 2.5 per cent levy on payrolls. With the federal government assuming control of the income tax base, the states lobbied for access to payroll tax and in 1971 the federal government handed over payroll taxes to the states, acknowledging that this tax represented the sole possible growth tax available to the states (Mathews and Grewal 1997). During the following three years the states uniformly increased the rate from 2.5percent to 5percent.
At its inception, the federal income tax was modelled on the income tax systems applying in the Australian states and the United States example of a global income tax system, applying to all forms of income, rather than the British schedular tax system. There has, however,
never been a comprehensive definition of ‘income’ for the purpose of taxation in Australia. Amounts originally identified by the courts and administrators are now known as ‘ordinary income’. The concept of ‘ordinary income’ was developed both on the form of payment and whether the income could be traced to a source such as labour activities, business activities or use of property. Ordinary income is distinguished from ‘capital receipts’. The meaning of these constructs derives largely from English equity. At its inception, income tax was an Australian source-only tax and did not apply to the foreign source income of residents.
In 1999 a capital gains discount was introduced to promote more efficient asset management and improve capital mobility, by reducing the tax bias towards asset retention, and to make Australia’s capital gains tax internationally competitive. The indexation and averaging provisions were removed for assets acquired after 30September1999. Under the discount, individuals and the beneficiaries of trusts pay tax at normal rates on only half of any capital gain realised on an asset held for at least twelve months. Superannuation funds receive a one-third discount.
Fringe benefits tax is levied on employers, rather than employees, to simplify compliance and administration. Fringe benefits are taxed at the top personal tax rate plus the Medicare levy3 (currently 46.5per cent). The fringe benefits taxregime contains a number of specific exemptions and concessions for particular types of benefits such as work-related items and remote area fringe benefits. It also provides for concessional treatment of benefits provided to employees of particular types of organisations, including scientific and public educational institutions, charitable institutions, public and not-for-profit hospitals, trade unions and religious institutions.
With the 1988 reduction in the Australian company tax rate, it was considered that there was little to be gained in taxing foreign source dividends where the foreign country had a similar tax system to tha
t in Australia. As a result, the foreign tax credit system was scaled back significantly in 1990, with dividends from non-portfolio interests6 and the profits of branches of Australian companies flowing from comparable tax jurisdictions7 excluded from the income tax base.
The Pay-As-You-Earn (PAYE) system, where employers deduct tax from employees’ pay, was introduced by the South Australian government during the depression and universalised by the federal government in 1942. This system allowed income tax collection from wage earners in lower income groups, which had been impracticable without a system of taxation at source. The PAYE system was more convenient for taxpayers, created a more even flow of revenue for government, and improved compliance as evasion was more difficult with income taxed at source (Groenewegen1985).
Following the assumption of income tax powers and introduction of the PAYE system by the federal government in 1942, the scope of the personal income tax was progressively broadened such that by the early 1980s the share of personal income tax paid by the top income quintile had fallen to around half, a level that has since been broadly maintained. This expansion in the scope of the income tax base has generally coincided with a reduction in marginal tax rates applying at higher levels of income. Australia’s top marginal tax rate has decreased over the past 50 years from over 75percent in the 1950s to 46.5percent (including the Medicare levy) as of 1July2006 (see Chart3). Notwithstanding the increase in the proportion of personal income tax paid by lower income quintiles, Australia’s average effective tax rate on the income of a range of household types is in the lowest eight out of the 30 OECD countries (Warburton and Hendy 2006).
Chart3: Personal income tax top marginal rate
As shown in Table 1, the company tax rate, like personal income tax rates, has been progressively reduced in recent times, decreasing from a high of 49 per cent in 1986 to the current rate of 30per cent. The rate reductions have largely corresponded with base broadening measures, such as the removal of accelerated depreciation.
Prior to 1983, the taxation levied on end benefits depended on whether they were paid out as a lump sum or an annuity. Lump sum benefits were taxed very concessionally, with only 5 per cent of the lump sum included in assessable income a
nd taxed at marginal rates. In contrast, annuities were taxed at marginal rates (with an exemption for contributions made from post-tax monies).
Krever (1986) notes that the taxation applied to superannuation prior to 1July1983 created a significant incentive for taxpayers to convert employment income to lump sum retirement payments. Reforms to the taxation of superannuation benefits were introduced in 1983 to address concerns that individuals whose remuneration package included superannuation contributions were accessing lower effective marginal tax rates than those individuals who received their remuneration exclusively as salary and wages.
The taxation on lump sum payments was raised to 15 per cent for amounts below a specified threshold, with amounts above this threshold taxed at 30percent. Contributions and earnings remained untaxed and the taxation of annuities was largely unchanged. The reforms were applied to service after 1 July 1983, while the pre-1983 arrangements were ‘grandfathered’.
Further revisions to the taxation of superannuation benefits were announced in 1988, when the Government imposed a 15 per cent tax rate on both contributions and earnings. To compensate for these changes, the Government reduced the tax rate on the taxed element of lump sum superannuation benefits. The rate was reduced from 15percent to zero (provided the benefit was preserved until age 55) for amounts up to the low rate threshold. Amounts above this threshold were taxed at the reduced rate of 15percent. While annuities remained taxed at marginal rates, the Government introduced a 15 per cent rebate when benefits were paid to the individual.
Productivity Award Superannuation was created in 1986 under industrial agreements which provided for up to 3 per cent of wage increases to be contributed to approved superannuation funds. While the initiative successfully increased superannuation coverage to approximately two thirds of the population, administration and implementation problems were rife, particularly with respect to the monitoring and enforcement of employer compliance. The Industrial Relations Commission cited these problems as the basis for its refusal of an application to increase the provision by a further 3percent in 1991.
The Superannuation Guarantee (SG), introduced in 1992, provides for a percentage of an eligible employee’s remuneration to be directed into a superannuation fund by means of a compulsory employer contribution. The motivation for the SG was twofold: to provide a mechanism through which employer contributions could be increased gradually, consistent with the Government’s retirement income policy objectives and the economy’s capacity to pay; and to extend superannuation coverage to a larger proportion of the population. The SG rate was phased up from 3 per cent to 9percent between 1992 and 2002. Superannuation coverage has broadened to about 90percent of employees under the Superannuation Guarantee. Although the rate of taxation is higher today than before the first suite of reforms were introduced in 1983, superannuation is still a highly concessional savings vehicle.
Indirect taxes have grown relative to economic activity, largely in response to increasing revenue demands brought about by periodic events, such as two world wars and the 1930s Depression, and the increasing role played by the public sector. The composition of indirect taxes has changed considerably over the past 100years, with Australia’s reliance on customs duties declining gradually, while the importance of alternative indirect taxes, particularly excises and more broadly based consumption taxes, has increased (see Chart4).
The WST was levied at the wholesale level to minimise the number of taxing points. It was introduced at a rate of 2.5 percent, but within a year the rate had been increased to 6 per cent, and by 1940 the rate had been further increased and a multiple rate structure introduced (see Table2). The WST was levied on many classes of consumables, but provided preferential treatment for food, primary produce and some primary industry inputs (Smith1999). In its first two years of operation, the WST base averaged 32 per cent of private consumption.
The WST was neither an efficient nor simple tax. The narrow base and differential rate structure created distortions to production and consumption decisions in favour of low taxed or unt
axed goods or services. Cascading of the WST through the production chain reduced economic efficiency and export competitiveness by increasing the cost of production in Australia. The arbitrary range of WST tax rates and exemptions imposed significant costs in terms of complexity and compliance.
Excise and customs duties have remained relatively steady as a revenue source, but have declined in importance as a proportion of tax revenue over the last century (seeChart4). In 1909 they accounted for three quarters of total tax revenue, while in 2003-04 they accounted for 8.5 per cent of tax revenue. Over this period, customs duties have declined in importance in comparison to excise duties, reflecting both increased domestic production of goods and a decline in the rates of duty applied to imports. Australian tariff levels have been substantially reduced across a wide range of import competing industries since the early 1970s to improve economic efficiency in the Australian economy.
Taxable profits are defined to be net of the recovery of all project related exploration, development and ope
rating expenditures. Where expenditure is carried forward to be offset against future income, its value is compounded at an annual rate intended to broadly reflect the required rate of return for undertaking such expenditure. These compounding rates vary according to the type of expenditure incurred, being highest for exploration and least for general overhead expenditure. In essence, a project will only become PRRT assessable once the owners have earned a ‘normal’ rate of return. As a tax on ‘above normal’ profits, PRRT is levied at a relatively high but constant rate of 40 per cent. Payments of PRRT are deductible for company income tax purposes in the year assessed.
Australian Treasury 1974, ‘Company income tax systems’, Treasury Taxation Paper, No.9, November, Australian Government Publishing Service, Canberra.
3 The Medicare levy is imposed at 1.5percent of taxable income, and applies above a threshold that excludes low-income earners.
4 Under 5/3 depreciation, eligible plant that could otherwise be depreciated at a rate in excess of 20percent using a straight line method, could instead be written off at a rate of 331/3percent (3 year write-off). Eligible plant otherwise depreciable at a rate of 20percent or less, could instead be written off at a rate of 20 per cent (5 year write-off).