Dale Boccabella

There can be no dispute with last week’s call from the Business Council of Australia for meaningful tax reform. This is a larger issue than both the looming budget and September’s election.

However, it is harder to reach agreement on precisely what areas need reforming, and what that reform should be.

The reason for dispute comes back to two basic things; namely, what is a fair allocation of the tax burden and how should the tax system promote economic growth? It’s which of these goals should be the top priority that is at the centre of substantial tension.

If economic growth is the main criterion, most observers accept the continued presence of a number of inefficient and highly distortionary state and territory taxes is unacceptable.

The Henry Review was scathing of many of these. Stamp duties on real estate are the most damaging, mainly because of their magnitude. But removing these or reducing their current levels will prove very difficult because the revenue raised is badly needed by the states.

It needs to be remembered that the poor state of federal-state financial relations will continue to influence the states’ approach to their revenue raising. The fiasco around some states increasing their mining royalties in light of the credit mechanism under the mining tax, is a recent example.

Addressing this poor relationship is not just about getting a fair division of the GST revenue between the states. Finding a long-term solution also requires a fair way of sharing income tax between the states and the federal government. It should also be remembered that the parlous financial position of local councils is also a sub-theme of federal-state financial relations.

A relatively high corporate tax rate is also said to make Australia a less desirable place for foreign investment, thereby dampening economic growth. And relatively high personal tax rates are said to discourage work and effort, and in some cases, lead to a “brain drain”.

Fairness in the tax system is a major area of focus for many. The “tax mix” switch is probably the major point of dispute. The GST rate is set at 10%, and changing this requires rare political consensus across party lines.

By international standards, the GST rate is relatively low. This means that Australia’s main consumption tax has reduced capacity for revenue raising, which in turn means that the income tax has to shoulder more of the revenue raising burden. The tax base of the GST is also less than comprehensive, as basic food is excluded.

But many argue we need to keep income taxes down to promote overseas investment in Australia and provide incentives to work. Our corporate tax rate is much higher than that of many other countries in our region.

Increasing the GST rate and thereby allowing income taxes to fall would partly address this. At the same time though, increasing the rate of the GST compounds the unfairness of the flat consumption tax, and one can never be certain of the sustainability of compensation measures.

Within our income tax, there are a number of areas that can be seen as an affront to fairness. The main ones are largely open-ended tax concessions for superannuation; open-ended exemption for gains on the family home and the 50% discount for capital gains of individuals.

Also, I would argue you could include in this list the income splitting of property and business income that is readily available through the use of family discretionary trusts, and to a lesser extent through family partnerships and companies.

I welcome the BCA’s call to start with “everything on the table”. This is the only way to subject all tax measures to scrutiny so that tax preferences are justified. I am not so sure though that we need another “tax review process”; there is sufficient data available through the numerous tax reviews and other commissioned work to support a genuine and honest community debate and discussion about our tax system.

The obvious problem is that the “everything on the table” debate does not start with a clean tax slate (with the tax system being designed from scratch). Instead, we have had, and need, a functioning tax regime in place.

This means we all come to the debate “with baggage”, and in particular, aspirations for the continued preferential treatment of an area and/or removal of preferences in some areas.

The history of tax reform in Australia is that sectors do not readily come to an “everything on the table” debate, and in particular, giving up preferences previously won.

We do not have to look too hard for examples of this (such as the unwillingness of the mining and forestry sector to give up accelerated depreciation for a lower corporate tax rate, or the hysteria whenever tax on the family home – or death duties – are raised).

If organisations like the BCA really want an all-inclusive, open and honest debate about tax reform, their focus should really be on bringing divergent sectors to an “everything on the table” debate.

Part of this is thinking of a way or ways of taking the politics out of tax, or at least reducing the effect of political operatives on the debate. This may be asking too much.

But, taking the misinformation and some of the emotion that seems to necessarily go with taxes out, would increase the chances of an all-inclusive, open and informed debate on tax reform. This is necessary for a long-term sustainable and stable tax system.

Dale Boccabella is an Associate Professor of Taxation Law at the Australian School of Business.

Dale Boccabella

As currently couched, the self-education deduction capping measure is not targeted at the claimed mischief and it therefore overwhelmingly looks like a revenue raising measure. To dispel this, the government needs to target the measure.

As part of the government’s National Plan for School Improvement (NPSI), a $2,000 per year cap will be placed on deductions for self-education expenditure related to production of a taxpayer’s income. It is planned to start in 2014-15 and is expected to save the government around $520 million over the forward estimates (3-4 years).

Two justifications were given. First, this measure will generate savings towards the cost of the NPSI. Secondly, some taxpayers are spending too much on their self-education and/or their expenses involve “luxury” self-education. The Treasurer suggested that without a cap, some taxpayers are able to enjoy a significant “private benefit” at the expense of taxpayers.

Denying these deductions to raise revenues for an expenditure program is using the tax system for a “foreign purpose”. And, this point holds even if the topic of tax deductions bears some relationship with the expenditure program. In this case, this is debatable.

The Treasurer has some basis for arguing that the capping can be justified by the “private benefit” aspect. There are many tax cases involving claims for overseas and interstate travel where the taxpayer attaches leisure to attendance at a relevant conference. The tax tribunals have been rather generous when it comes to apportioning expenditure on air travel between the deductible conference attendance and the non-deductible leisure pursuit. This capping measure may put a ceiling on “suspect claims” but it will not address the private element of expenditure where it is below the $2,000 cap because it is not targeted at “private items” of self-education expenditure.

The cap more broadly can be seen as an equity measure as it puts a ceiling on a category of otherwise deductible expenses and therefore can reduce the detrimental “upside down” effect (i.e. taxpayers on higher tax rates get bigger tax break from a given deduction amount) that comes with all deductions. But, many people incurring non-private benefit and expensive self-education are in the earlier stages of their careers and are on lower tax rates. For them, the capping appears inequitable.

Although bluntly targeted, this measure will in part deny deductions for taxpayers with high “luxury” income-related expenditure. The short and legitimate question is, why is the capping only relevant to self-education expenses? Why isn’t it considered where other “luxury” deductible spending occurs? After all, isn’t there a large private benefit to a taxpayer undertaking business or first class air travel or five star accommodation for their work, outside the self-education context?

The extra problem is that the measure also operates to deny deductions for taxpayers with high “non-luxury” income related expenditures of self-education; again, the targeting of the private benefit appears to be missing. This tends to undermine the denial of the private benefit rationale and brings the government admitted revenue-raising rationale to the fore.

The deductibility of self-education expenses is one of the most troublesome areas under the general deduction provision and an area where the error rate is very high amongst taxpayers and their advisers. At times, this uncertainty encourages unscrupulous taxpayers and tax agents to make iffy claims knowing full well they may not be called to account. This announcement doesn’t address complexity because the focus is on capping. However, the government could use the opportunity to set out some bright lines on the circumstances where self-education is deductible. After all, it will have to do this to identify expenditure subject to the cap.

Perversely, the introduction of the cap may actually convince some taxpayers to claim an amount of self-education deductions just under the cap as deduction caps can send the “wrong message” (i.e. it is viewed as giving a deduction). Such practices need robust compliance follow up from the ATO.

Finally, many will argue that denying/capping deductions for income related self-education expenses is sending the wrong message and that some may be discouraged from engaging in education. Time will tell, but the argument puts considerable faith in the power of a tax deduction.

Dale Boccabella is an Associate Professor of Taxation Law at the Australian School of Business.

Geoff Weir

There is no doubt China wants the renminbi (RMB) to become a major global currency. While there is no public timeframe, one thing is clear: the ongoing move towards internationalisation of the RMB will have a huge influence on global volumes, currency denomination and location of financial flows and financial market activity over the coming decades.

China will within the next decade be both the world’s largest economy and the single most important driver of global trade.  The move towards internationalisation of the RMB will require ongoing relaxation of capital controls on China’s inward and outward investments, and full currency convertibility.

These factors will see a massive increase in investment and trade-related flows into and out of China, and in the associated provision of RMB denominated financial products and services in trade financing and investment.

There will be winners and losers. For instance, local and offshore investors have used Australian dollar and Australian dollar denominated assets as proxies for exposure to the Asian growth story. As the RMB becomes fully convertible and capital controls are gradually eased, these “proxy” trades will decline.

So how is Australia positioned to ensure it benefits from these enormous changes?

To date the process of building up RMB liquidity offshore has focused on encouraging RMB trade invoicing. While only a small proportion of Australia’s trade with China is currently invoiced in RMB, a recent Bank Customer Survey of Australian companies trading with China showed that it is likely to increase, potentially resulting in a build-up of RMB liquidity and RMB-denominated financial products and services in Australia.

Looking beyond trade invoicing, there are good reasons why Australia has the potential to become an important part of the offshore RMB network. For starters, Australia is ideally positioned, being the first major financial market to open after the US closes, before Singapore, Tokyo and Shanghai, and remaining open for much of the Chinese trading day.

Australia has a world class payments settlement system and a predictable, efficient and well-regarded legal framework and regulatory regime, with strong prudential oversight.

Australia already has critical mass and liquidity in funds management, and equities, derivatives and foreign exchange markets.  This is allied with a robust banking system and efficient distribution platforms, providing both liquidity and confidence.

While the extent to which in practice Australia develops as an offshore RMB hub is very much in the hands of the Chinese authorities, Australia has reasons for optimism. Firstly, in 2012 China and Australia entered into a bilateral currency swap agreement. The swap facility is the fourth largest after Hong Kong, Singapore and South Korea.  Last week it was announced the AUD has just become the third major currency outside of USD and JPY to have direct trading against CNY. And perhaps most importantly, the recently announced strategic partnership between China and Australia will provide an annual forum at which policy issues can be discussed.

So there are encouraging reasons for thinking that China may be willing to encourage and support Australia’s development as a location for the expansion of the network of offshore RMB hubs.

Nonetheless, more work needs to be done on understanding the key issues, drivers and impediments for developing RMB business in Australia. They will be the subject of a joint research project to be conducted by the Centre for International Finance and Regulation (CIFR) and the Shanghai University of Finance and Economics. This important project was announced last Friday by the Treasurer at the RMB Trade and Investment Dialogue in Sydney. It will incorporate a survey of both Chinese and Australian companies regarding constraints to RMB invoicing; the implications of RMB internationalisation for regional and global financial markets; and the market conditions and policy framework that may need to be in place to encourage development of an offshore RMB market in Australia.

Australia benefits enormously through its trade links with China. We now need to ensure that we have both the market conditions and the policy framework in place to also benefit from the massive changes that are just beginning in global financial markets as China eases its capital controls and moves towards a more market determined exchange rate.

Geoff Weir is a consultant for the Centre for International Finance and Regulation. A version of this article was previously published in The Australian Financial Review.

Professor Chris Styles

Former British Prime Minister Margaret Thatcher has died at the age of 87.  Famously the daughter of a grocer she was in the top job for 11 years.  She was also a highly divisive figure who was to some the saviour of the British economy, but to others responsible for decimating industries and communities.  Irrespective of which side of the fence you sit, it’s hard not to recognise her as a strong and highly effective leader.

What kind of leader was she?  In modern parlance she might be described as a values-based leader.  Whether you ascribe to her values or not, her model of leadership was about articulating her core values, and making decisions consistent with them, even in the face of strong opposition.

How do today’s leaders stack up to the Margaret Thatcher model?  Sheena Lyengar, a Professor at Columbia Business School, told an audience of over 1000 senior business school academics gathered in Chicago this week that we are facing a ‘leadership crisis’ that applies to business as much as politics.  Whether we are indeed in a crisis is debatable, but there are legitimate concerns over short termism, popularism (whether its politicians reacting to the voter polls or CEOs pleasing market analysts), and revolving door leaders. To better understand Thatcher’s approach to leadership, consider her three biggest achievements. First, with Ronald Regan, she was credited with ending the Cold War.   Their approach was to negotiate from a position of strength, which controversially included deploying nuclear missiles across Western Europe (including in Britain).  While Mikhail Gorbachev was a man she said she could ‘do business with’, she had a deep distrust of communism and saw its end as a moral imperative.

Second, she fought and won a war in the Falkland Islands that no one seriously thought she would enter into. Although a group of Islands where sheep outnumbered people, she said that it was a matter of principle that she not sit by and see British citizens invaded by ruling military junta in Argentina.

Finally, she transformed the British economy.   When Margaret Thatcher came to power in 1979 inflation was rife and the economy in poor shape.  She tackled inflation head on, cut spending and took on unions to move the economy towards the more flexible, market driven system that essentially operates today.  She was hated by many for the hardship her measures caused, but was resolute in reshaping an economy that in her mind would reward the efforts of local grocers like her father.

All three of these achievements are defined by a strong set of core values that were translated into strategies and action.  For example, her commitment to free and flexible markets led to strategies that reduced union power and privatised state industries which ultimately led to actions such as the miners’ dispute.  And once she went down a path, she did not waiver a position made famous by her remarks, “the lady is not for turning”.   Many of her decisions led to short term pain, including job losses, and indeed 255 British servicemen and three Falkland Islanders, as well as 649 Argentineans, lost their lives as a result of the Falklands conflict. She saw leadership as actions reflecting principles rather than basing decisions on popular sentiment.  She also displayed what many now see as a critical leadership quality, resilience.

When selecting leaders, whether on election day or for senior positions in business, we would do well to focus on a person’s core values and beliefs, and assess their record of delivering against them, particularly when the going gets tough.   If values are well articulate and we buy into them, then decisions and actions are better understood, respected and followed, even if not always liked.  Values-based leadership has much going for it and Margaret Thatcher was a great exponent.

Professor Chris Styles is Deputy Dean and Director Australian Graduate School of Management (AGSM).

Peter Swan

On Thursday the Gillard Government launched Phase 2 of their High Speed Rail study that was produced as part of a political agreement with the Greens.

The very optimistically projected cost is $114 billion for 1,800 kms of rail to link Melbourne to Brisbane via Canberra and Sydney. Approximately 8% of the route requires exceedingly expensive tunneling, giving huge scope for costs to blow out.

The projected (internal) financial return is 0.8% compared with a minimum of 15% to be considered for a commercial project. Hence it could never be financially viable and is likely to require on-going subsidies even if the Government provided the entire capital cost.

Can the project be justified in cost-benefit terms? Certainly, the Report claims that there is a positive benefit/cost ratio at low discount rates with the benefits roughly equal to the costs with a 7% discount rate.

These benefits consist of consumer and producer surplus. It is my belief that these benefits are likely to be vanishingly small in practice with the costs far outweighing the benefits.

These benefits are assumed to arise largely from time savings due to better access and egress compared with airports such as Tullamarine. A high-speed rail connection between Tullamarine and the City could be built for less than $114 billion with considerable time and convenience savings. There might even be some spare change.

Such assumed time savings also presumably drive the 55% of passengers who are assumed to switch from air to rail and the 19% induced passenger increase.

It is hard to imagine that the 23% of passengers that are assumed to switch from cars will gain sizeable subsidiary benefits to motivate a switch. In fact, many who currently drive will face car-rental and other out-of-pocket costs that are likely to be sizeable.

In my view, these passenger estimates are likely to be even more upward-biased than the pie-in-the-sky estimates that led many toll-road providers to the bankruptcy in both Sydney and Brisbane. Projected toll-road/tunnel usage exceeded the reality, typically by 100% or more.

At least one would think that private providers taking and equity stake would be cautious in accepting ludicrous estimates of traffic projections. Governments looking for juicy election bribes have no such hip-pocket concerns. All of these failed projections tended to give excessive weight to traveler time-saver benefits.

The first question to ask is what is a high-speed rail network? It is largely duplication of air passenger routes provided for ‘free’ by nature. Unlike air-routes high-speed rail is exceedingly capital intensive with an exceedingly long gestation period.

The Report projects that cash-flow will be positive for the first time around 2060, about 45 years after commencement. Once of the few routes that is commercially viable is in major Japanese city pairings with population density about 1,000 times higher than major pairings in Australia.

Even Japanese bullet trains received a bailout in 1987 and Taiwan’s line needed rescuing only two years after commencement. In China the high-speed network is highly problematic with severe speed limitations imposed on some lines. One line was even reduced to 45 kms an hour. Even in much denser Europe, only a few city pairs are financially viable.

There is no indication that any success will be achieved in North America. The Californian line that commenced in 2008 had spent $630 million within three years without constructing even one kilometer of track.

Thus the benefits of high-speed rail are largely illusory, especially in Australia with its exceptionally low population density and existing network of relatively efficient airports. Removal of curfews could greatly improve airport efficiency, especially in Sydney. Unfortunately, the costs are not illusory and are likely to be massively understated in the Report.

There have been quite few very-fast train schemes in Australia, mostly centering on the Sydney-Canberra-Melbourne corridor.

The first one was proposed by the then head of the CSIRO who carried the appropriate handle of ‘Wilde’. Hence the ‘Wilde scheme’, of which the latest incarnation from the Gillard Government is yet another example of an exceedingly white elephant.

It is also well timed as a tempting election bribe where it joins the Gonski Report into school funding, the National Disability Scheme and numerous other unfunded projects.

Professor Peter Swan is the Professor of Finance at the Australian School of Business.