Fran O'Sullivan: Time to seize initiative on tax reform

Australian Treasurer Wayne Swan has some controversial options in front of him. Photo / Mark Mitchell

Once were leaders - it's sometimes hard to credit that New Zealand did indeed once occupy the pole position on taxation reform, while this country's policymakers wait lemming-like for Australia's Future Tax System Review to finally report before deciding what our own future platform should be.

Typically, Australia is framing its impending tax changes from a "national interest" perspective. Treasurer Wayne Swan has set out three over-arching goals for the review panel: The tax system must be made simpler, it needs to build in more incentives and has to be made more internationally competitive.

That's fair enough.

But the big problem that both Australia and New Zealand face is how the two respective countries avoid being caught in a "race for the bottom" as they try to move to more competitive taxation platforms at the same time as they have to service huge Government deficits as a result of the financial crisis, and also position themselves to deal with the impending pressure on health and welfare budgets from the ageing baby boomers.

Even before the two Governments announced their respective taxation reviews there was plenty of analysis around to suggest that ultimately tax rates (particularly at the personal level) might have to be hiked to deal with the impending fiscal pressures irrespective of the additional problems the global financial crisis has latterly imposed.

The Australian review has some potentially controversial options in front of it. According to media reports one possibility is to slap a 3 per cent surcharge on those earning more than A$150,000 a year. Other reports suggest options like applying a capital gains tax to family homes could be part of the ultimate mix.

But it should be pointed out that the so-called "root and branch" review is hardly that given the Rudd Government's highly political decision to quarantine the GST rate (currently 10 per cent) from consideration.

The final results won't be out till later this year. But Australian Treasury Secretary Ken Henry - who chairs the review panel - has already sent two signals which have considerable relevance for New Zealand.

First - that in this age of globalisation, Australia's 30 per cent corporate tax rate is not competitive. Henry pointed out to the recent Australia New Zealand Leadership Forum in Sydney that the most obvious manifestation of the globalisation effect has been the stark international trend of declining company tax rates.

Among OECD countries, the unweighted average company tax rate fell from around 47 per cent in 1982 to under 27 per cent in 2008. In Australia's case it has moved from having the ninth lowest company tax rate in the OECD in 2001 to having the 22nd lowest today. And Australia has to "seriously consider" lowering the rate.

He noted smaller economies in particular have lowered their headline corporate rate to maximise their share of the world's capital, or savings, invested domestically. Down the track there might be a case for abandoning taxing company profits and instead taxing business spending.

But the issues are complex.

The 30 per cent corporate rate does at least bring a large number of foreign investors within the Australian tax net. Shifting it lower - given the higher personal income tax rates across the ditch - could incentivise taxpayers to rearrange affairs to take advantage of the lower corporate rate.

Henry pointed out that in Australia today the gap between the top personal and company tax rates stands at 16.5 percentage points, more than double that in New Zealand. Mobility of labour is not such a big issue across the Tasman - given just 4 per cent of Australians live offshore compared to 24 per cent of New Zealanders.

The second issue Henry raised which has relevance here was imputation credits. Notwithstanding the fact that Australia and New Zealand are the only OECD nations to have dividend imputation schemes, the review panel believes Australia should retain the scheme, at least for the medium term.

The New Zealand Treasury and IRD have made a case to the panel for mutual recognition of dividend imputation credits, but Henry did not endorse this measure outright.

"For two small open economies where the cost of capital is largely set by the international capital markets, it is less likely that credits for foreign taxes will affect the cost of capital and production location decisions of firms - particularly those that are internationally focused. Even if mutual recognition could improve the efficiency of transtasman investment, it would also risk distorting investment decisions where the choice is between investing in Australia and New Zealand, or investing in a third country," he told the forum.

Frankly, there is enough on the table now for the National Government to order its own review team to press ahead rapidly with a set of measures that are appropriate to New Zealand's status as a small economy and introduce them ahead of the Rudd Government's policies.

Sure it was almost a quarter of a century ago, when NZ's taxation reformers savagely reduced the top personal taxation rate as a quid pro quo for moving to a broad- based consumption tax (GST), wiped myriad indirect taxes like stamp duty, and lowered the corporate rate.

At that stage New Zealand was feted as sporting one of the world's most neutral taxation platforms - notwithstanding Sir Roger Douglas's failure to notch things up again with the introduction of a "flat tax" regime.

Bumping up GST again is a no-brainer to fund a significant lowering of corporate rates. Taking our own unilateral action on dividend streaming - rather than waiting even longer for Australia to come to the party - would seem in order.

The reality is we are a small country trying to compete against our larger neighbour for capital, investment and labour. Time to frame our policies that way.