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Part III: Competition and Indirect Tax Reform
The New Tax System is being introduced into a highly competitive environment. This environment will be fundamental to ensuring that the full benefits of The New Tax System flow throughout the economy and that the combination of strong growth and low inflation is maintained.
Prices and Competitive Markets
The Australian economy is reaping the rewards of a broad agenda of structural reforms. A common goal of many of these reforms is increased competition and improved market dynamism (see Box 2). As a consequence, competition in the Australian economy is now much stronger than it has been at any time in the post-war period.
One characteristic of a competitive market is that purchasers can readily choose between a range of sellers to find the best combination of quality and price. In such a market, the most successful sellers are those who best judge market conditions when setting their prices. Those who set excessive prices are forced to pull their prices into line or risk losing business. Competition drives dynamism because the speed of change in offering alternatives to the customer is of fundamental importance. The competitive nature of markets for most goods and services in Australia today means that vigorous, dynamic competition is now the driving force behind market prices.
Competitive markets have a range of other benefits. On the supply side, producers wishing to increase their profitability are forced to focus on alternatives to charging higher prices. For example, they may seek to reduce their costs, find more efficient and innovative production methods or pursue new markets. Australian businesses are proving that they can respond to competition by continuously improving their performance in all of these ways.
Demand side factors have also added to competitive pressures in Australian markets. For example, firms that have improved their marketing techniques have made it easier for consumers to compare quality and price, thus making markets even more competitive. Increased consumer awareness and `shopping around' have played an important part in the transformation of the Australian economy to one characterised by highly competitive markets. This trend will continue as new technologies, such as the internet and e-commerce, make consumers better informed and further reduce the effective distance between consumers and potential suppliers.
As well as these direct benefits, competition improves the efficiency of the use of resources, including the allocation of those resources across sectors. (See Box 2 for more details.)
A wide range of economic reforms has transformed the Australian economy. These reforms have increased competition and helped to create more efficient and dynamic markets. They have also helped to increase the capacity of the Australian economy to respond to new opportunities and challenges.
The New Tax System is part of this ongoing reform agenda and will deliver significant efficiency benefits to the marketplace by replacing a range of narrowly based indirect taxes with a broadly based GST. This will reduce the distortion of production and consumption choices by differing tax treatments.
Other significant reforms are catalogued below.
- Tariffs on imports, often with rates of more that 50 per cent, formerly provided protection to local producers by restraining competition. For most goods, tariffs have now been reduced to 5 per cent or less. This has increased competitive pressure from imports, to the benefit of consumers.
- National Competition Policy (NCP) has extended pro-competitive laws to all businesses, and reformed regulations that unnecessarily restricted competition. NCP has also introduced competition to the provision of services traditionally provided through public monopolies. Arrangements to provide access to essential infrastructure (public or private) have been established where this will assist competition in related markets. In this way, competition in traditional public and (so-called) natural monopolies is reducing business costs, and bringing benefits to consumers and producers alike.
- The corporatisation of government-owned businesses has subjected them to commercial disciplines. In many cases, government-owned businesses have also been privatised, thus bringing the capital market disciplines (including the threat of takeover) of private ownership and private sector management expertise.
- Reform of financial markets has facilitated the flow of financial resources for investment in new and expanding businesses, fostering a more efficient and competitive business environment. Increased competition has also delivered benefits to households via reduced interest margins and the introduction of innovative new financial services and products.
- Corporate law economic reforms have reduced regulatory burdens on business while enhancing investor protection and the corporate governance framework so fundamental to the workings of a modern economy.
- Enterprise bargaining has replaced the centralised setting of wages and conditions of employment. As employers operate in more competitive markets, wage rises must be underpinned by productivity rises.
Box 2: Reforms Promoting Competition and Market Dynamism (continued)
The increased competition and more dynamic markets resulting from these reforms are benefiting consumers, exporters and other businesses.
- They have contributed to lower inflation by reducing the prices paid by consumers and by constraining business costs.
- Since they allow resources to flow to activities where they produce the most value, competitive markets have helped to lift the productivity of the Australian economy so that it now compares more than favourably with other Organisation for Economic Co-operation and Development (OECD) countries. Australian productivity growth lagged well behind the OECD average up to the 1980s, but has exceeded the OECD average over the 1990s. The lift in productivity growth has, in turn, brought the benefits of higher real incomes and greater job opportunities for the whole Australian community.
- By encouraging innovative thinking and facilitating the free flow of resources, greater competition has been the driving force behind increased entrepreneurship, innovation and the introduction of new technologies. Businesses are encouraged to take up the opportunities presented by microeconomic reform by continually seeking efficiencies, product improvements and new markets.
- By enhancing the scope for business to seek and exploit new opportunities, more competitive markets have also made the economy more resilient to developments in the world economy.
The direct impact of increased competition on prices is most easily seen in those sectors where significant structural reforms have taken place, such as telecommunications and electricity. The marked impact that increased competition has had on prices in these industries is noted in Box 3.
Box 3: Examples of Increased Competition Affecting Prices
The effect of increased competition on prices is evident in the key sectors of telecommunications and electricity.
- The Australian telecommunications market was further liberalised in 1997 and there are now no restrictions on the number of carriers. There are currently 38 licensed carriers in the market, where there was formerly a monopoly. Some provide a full suite of telecommunications services. Others provide specialised services to niche markets. This increase in competition has allowed users to choose the company and services most suited to their individual needs. The clearest evidence of benefit is in price reductions for national long distance and international calls. For example, the price of a 15 minute peak call from Melbourne to Brisbane has fallen from $6.27 in June 1997 to $2.40 in April 2000 and the price of a 15 minute off-peak call to the United States has fallen from $13.77 in June 1997 to $2.70 in April 2000.1 More recently, increased competition has led to reductions in the price of local calls.
- In the electricity industry, Governments have corporatised - and in some cases privatised - their electricity assets and have divided the generation, transmission and distribution/retail functions into separate businesses. This has led to an increase in the number of competing entities and retailers in the market and a broadening of the ownership of these entities. The National Electricity Market has been established in Queensland, New South Wales, the Australian Capital Territory, Victoria and South Australia to foster inter-state trade and increased competition in the electricity industry. These reforms have benefited electricity users through lower prices. For example, residential consumers have received average savings of around $45 on their annual electricity bill, compared with 1993-94 prices. Commercial customers have received average savings of around $1,940 on their annual electricity bill, compared with 1990-91 prices.2
Significantly, the benefits of competition in these industries extend beyond the immediate consumers of these services. Telecommunications and electricity are essential inputs to many other sectors. Price reductions in these services constitute a reduction in the costs of other businesses, enhancing their competitiveness. These cost reductions in turn cascade through to other businesses and final consumers.
A broader indicator of the degree of competition in the tradable sector of the Australian economy is the ratio of gross trade (imports plus exports) to GDP, which provides a measure of trade intensity. Chart 1 highlights the increase in competition that has occurred since the mid-1980s. During the 25 years to 1984, trade intensity rose only slowly from close to 20 per cent of GDP to around 25 per cent. In contrast, the increase in trade intensity over the past 15 years has been much greater, as can be seen in the steeper trend over this period in Chart 1.
Chart 1: Trade Intensity(a)
(a) Trade intensity is exports plus imports relative to GDP.
Source: ABS Cat. No. 5206.0 and Treasury.
The Interaction of Tax Reform and Competition
As noted above, the highly competitive environment in which The New Tax System is being introduced will put pressure on excessive prices and maximise the benefits to consumers.
The indirect tax changes associated with the introduction of The New Tax System mean that most individual prices will change. The price impact will vary from item to item, with some prices rising, some falling and some unchanged. These relative price changes must occur to bring about the more efficient allocation of resources flowing from the more neutral (less distorting) indirect tax system.
The ACCC has been monitoring the early stages of The New Tax System implementation. So far, the ACCC has monitored the reduction in WST on a range of goods from 32 per cent to 22 per cent on 29 July 1999 and the cigarette excise changes on 1 November 1999. The ACCC has reported that both the actual decline in prices to consumers, following the reduction in WST, and the increase in cigarette prices compared favourably with their prior calculations. Extrapolating from this experience provides the basis for confidence that price rises will not be excessive and that cost reductions will flow through as the remaining elements of The New Tax System take effect.
A further example is provided by the recent behaviour of car prices. The replacement of the existing WST on cars with the GST means that new car prices will be significantly lower than otherwise under The New Tax System. Although the tax changes have not yet occurred, competition has meant that car prices have already fallen considerably in anticipation of The New Tax System.
These examples suggest that the highly competitive environment will resolve most concerns about price exploitation and also prevent businesses trying to use the tax changes as an excuse to raise prices or rebuild margins. Firms that have been under pressure to squeeze their margins or seek cost reductions due to competition before the introduction of the GST will continue to face the same competitive pressures under The New Tax System.
While competition will be fundamental to limiting price rises in the transition to The New Tax System, the ACCC will monitor price changes to provide a safety net against excessive price increases. The ACCC has been given strong powers under the Trade Practices Act 1974 to monitor prices and prevent price exploitation during The New Tax System transition period. There are substantial penalties if profiteering is proven.
The ACCC has already undertaken extensive price surveys across metropolitan and regional Australia to ensure that businesses do not unreasonably raise prices in anticipation of the GST implementation date. It expects to continue this extensive survey activity throughout the transitional period, which expires on 1 July 2002.
1 Communications Research Unit (Department of Communications, Information Technology and the Arts) and Phonechoice website ( www.phonechoice.com.au).
2 Treasury estimates based on Electricity Supply Association of Australia Electricity Australia (various issues).