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Part II: The Benefits of Tax Reform
The implementation of The New Tax System is a major reform that will bring both more robust government finances and substantial efficiency gains throughout the economy. The main features of The New Tax System are the abolition of a range of inefficient indirect taxes and the introduction of a goods and services tax (GST), significant personal income tax cuts, reforms to social security benefits and reforms to Commonwealth-State financial relations.
Narrowly Based Inefficient Indirect Taxes Replaced with a Broadly Based GST
A GST will be introduced from 1 July 2000 to replace the Wholesale Sales Tax (WST) and a range of inefficient State taxes, such as accommodation taxes (on 1 July 2000), Financial Institutions Duty (FID) and stamp duties on marketable securities (on 1 July 2001) and debits tax (by 1 July 2005, subject to a review by the Ministerial Council for Commonwealth State Financial Relations). The Ministerial Council will also review the need for retention of a range of other business stamp duties by 2005.
Cost Reductions for Producers
The removal of the existing inefficient indirect taxes will significantly reduce business costs. This is because these taxes become embedded in the cost structures of business (see Box 1), imposing a hidden burden on Australian exporters and import competing businesses in particular. Over half of the existing WST is paid as tax on inputs used by businesses. These embedded taxes also cascade, as the tax paid by businesses becomes embedded in the price on which WST subsequently becomes payable further down the chain. The existing tax system discriminates against manufactured goods, while favouring service industries on which WST is not payable.
Less Distorted Relative Prices Increase Allocative Efficiency
In contrast to WST, the GST is not a cascading tax. GST registered businesses at each stage of the production chain receive a credit for the GST paid on inputs at earlier stages of production. The effect is that the GST imposes a uniform 10 per cent effective tax rate on taxable supplies to final consumers. This effective tax rate does not vary according to the production chain involved and applies to taxable supplies of both goods and services.
Providing the States with a More Secure and Growing Revenue Source
The introduction of The New Tax System provides for the transfer of all GST revenues to the States and Territories, affording them a stable and growing source of revenue. Access to the GST revenues will allow the States and Territories to abolish a range of narrowly based indirect taxes that impede economic growth. It will also remove their reliance on financial assistance grants and revenue replacement payments from the Commonwealth.
Box 1: Embedded Taxes
The final prices of all goods and services (commodities) can be split into production costs (such as wages and the cost of materials), distribution margins (such as transport costs and wholesale and retail margins), capital costs (such as rent, interest and a profit margin) and indirect taxes (Column A).
However, the distribution margins and cost of materials, along with some capital costs, may include an indirect tax component (Column B). The industries in Column B may also have paid indirect taxes on their inputs or their distribution margins and so on (Column C,...). Since all of these `hidden' taxes (denoted by the shaded boxes) are embedded in the final price of the item shown in Column A they are appropriately described as `embedded'.
The prices of most goods and services contain at least some element of embedded taxes. Under The New Tax System, the WST and several other cascading taxes will be abolished. This will reduce the cost of producing these items, regardless of whether the final item is currently taxed or not. Competition, along with Australian Competition and Consumer Commission (ACCC) monitoring (discussed in Part III), will ensure that these savings are passed on to consumers.
GST revenue will be distributed to the States and Territories according to horizontal fiscal equalisation principles. These principles take into account differences in the capacities of the States and Territories to raise revenue and in their expenditure requirements to ensure that all jurisdictions have a broadly equal capacity to provide an average standard of government services (see Budget Paper No. 3).
Lower Effective Marginal Tax Rates and Improved Work Incentives
Reductions in personal income tax, increases in family assistance and assistance for low income and older Australians will ensure that low and middle income people, in particular, will keep a higher proportion of their before-tax earnings, providing greater rewards and incentives to work and save. These changes will see significant reductions in effective marginal tax rates faced by many low and middle income families, which have been a disincentive to workforce participation.
Lower Income Tax Compliance Costs
The New Tax System replaces all existing income tax collection and reporting systems, including Pay As You Earn (PAYE), prescribed payment system (PPS), reportable payments system (RPS), provisional tax and company instalments, with one new, comprehensive Pay As You Go (PAYG) system.
It will be a flexible system with taxpayer obligations transparent and easily managed as a by-product of other business activities. In this way, paying income tax and collecting other taxes will become simpler and less costly.
Under PAYG, both individuals and companies will pay tax on their business income at the same time. PAYG will make it possible for business to make one net payment, or to claim one net refund, quarterly and will abolish provisional tax and the uplift factor.
Individuals who now pay provisional tax will benefit from these changes in many cases since, unlike provisional tax, PAYG instalments will be paid after income has been earned and will be based on actual income. Companies will pay tax earlier than now, but a deferral of company instalments due for the 1999-2000 year after PAYG commences will assist companies to adjust to the new arrangements.
The Government has also introduced the Australian Business Number (ABN) as a single business identifier. The ABN will facilitate the introduction of a single tax compliance statement and streamline business interaction between taxpayers and the Commonwealth.
Benefits Enhanced by Business Tax Reform
The New Tax System reforms will be enhanced by the improvements to business tax arrangements that were announced as part of The New Business Tax System. Key elements of The New Business Tax System are a lower rate of company tax (reduced from 36 per cent to 30 per cent over two years) and reduced capital gains tax. The New Business Tax System will provide Australia with an internationally competitive business tax regime.