Tax Mix Change John Freebairn
Outline General idea of a tax mix change Some detailed policy options Importance of casting assessment in the context of a small open economy Economic effects of a tax mix change Efficiency, or productivity, gains Equity, or redistributional, effects Some caveats to change
Tax Mix Change Two related ideas: Increase consumption tax to fund lower income tax. Reduces tax on saving. Increase tax on labour income to fund lower tax on capital income. Reduces tax on income earned on saving. Examples: GST for income tax, 1999 Fund retirement income via SGL rather than income tax, ongoing
A Note on Australia s Hybrid Income Tax System Labour income: close to comprehensive Capital income: hybrid treatment of different saving and investment choice options Capital income exempt-owner occupied housing Income taxed-financial deposits, equity returns distributed as dividends Mixed-retained equity returns, capital gains Law to itself-superannuation
Some Options to Change Tax Mix Increase indirect taxes (to fund lower income tax) GST Payroll tax, or SGL Direct tax options (to reduce tax on S or Y k ) Extend capital income tax exemptions Tax C = Y S The X-Tax (Modify GST to deduct labour costs, and tax labour at personal level)
International Economy Context Australia as a small country in a large global economy Labour is relatively immobile, with a low supply elasticity Capital is relatively mobile, with a high supply elasticity Key tax analysis implications In final tax incidence, labour bears most of any tax Tax efficiency says most tax on labour
Economic Effects of a Tax Mix Change (lower tax rate on capital income) For a given world after tax return, the required pre-tax return on Oz investment falls Increase investment and capital stock in Oz Increase income, including taxable income Increased capital to labour ratio increases labour productivity, and then through to higher wages
Economic Effects of a Tax Mix Change: Numbers from an Illustrative Model Simple small country model Labour in inelastic supply Capital in elastic supply Cobb-Douglas production function, with labour share of 0.7 Competitive markets Long run comparative static analysis Experiment Cut tax rate on capital from, say, 30% to 20% With initial pre-tax return of 10%, a 10% pre-tax return cut
Illustrative Model Comparative Static Economic Effects of a Tax Mix Change The required pre-tax return on Oz investment falls 10% Increase capital stock in Oz 14% Increase income in Oz, including taxable income 10% Increase Oz wage rate 10%
Efficiency Effects of Tax Mix Change Large investment boom, increased capital stock, larger GDP, increase in market wages. (Result of application of optimal tax idea in a small economy context.) Reduced distortions to the choices of different saving and investment choice options. Reduced distortions to intertemporal consumption decisions. Initial increased distortions to labour decisions reversed in longer run.
Equity Effects of Tax Mix Change Night after with no base changes (zero sum game) Labour lose with higher taxes Domestic savers neutral Oz investors gain Longer run when economy grows and wages increase (positive sum game) Labour (and other) tax rates fall Labour gain from higher market wages
Some Caveats to a Great Opportunity Time lags for investment and productivity growth to develop a positive sum game Sustainability of a single country maintaining the optimal tax idea in a global tax competition game Uncertainty about appropriate model and parameters in quantifying efficiency gains and redistributive effects So far, no country has successfully implemented a direct consumption base tax
Conclusions In principle, for Australia a tax mix change offers a significant win-win opportunity. But, implementation will require a mindset change in tax reform debates. Specifically, we have to look beyond the night after effects to a large positive-sum game pay-off over the medium and longer term.