1901 to 1950: The early years of Australia’s tax system

Prior to Federation in 1901, each colony administered their own tax system, with excise, customs duties and income taxes as the primary sources of tax revenue. Income tax represented a relatively small proportion of tax revenue.

At Federation, customs duties between the states were abolished. The power to collect customs duties on foreign imports and excise was passed to the Australian Government, but three-quarters of this revenue was paid back to the states over the next 10 years. Only the states imposed taxes on income.

In the decade following Federation, a range of excise and customs duties provided Australian Government’s sole source of tax revenue. These played roles in shaping the behaviour of Australians, in addition to raising revenue. Some taxes played a significant role in Australia’s policies to ‘protect’ local industry from foreign competition. Other taxes targeted behaviours considered undesirable, such as smoking, drinking and gambling, as well as items considered to be luxuries, such as taxes on musical instruments, jewellery and ‘fancy goods’.

Similarly, the Australian Government introduced a federal land tax in 1910, with the intent of breaking up very large holdings of underutilised arable land.[1]

The Australian Government introduced its own personal income tax in 1915 to meet the rising costs of the First World War. This created a 2-tier system in which individuals paid income tax at both a state and federal level. To minimise the impact of ‘double-taxation’ (and to prevent the states from increasing their rates), the federal income tax rate was low and only applied to incomes above a certain threshold (£156 for adults). This ‘tax-free threshold’ is an example of a central component of our current tax system that originated in a particular historical context.[2] 

Another major change in tax revenue was prompted by the rapidly increasing need for income support during the Great Depression. “Faced with a large budget shortfall, the government introduced the wholesale sales tax in 1930. Raising indirect taxes was favoured because the incidence was disguised, making the tax more politically palatable.”[3]

The Second World War saw the Australian Government increase personal income tax rates to fund the war effort. In 1942, the states relinquished their personal income tax powers to the Australian Government. By the end of the war personal and corporate income tax revenue had tripled, to around 12% of Gross Domestic Product (GDP) in 1945 (Figure 1-1).

Initially intended to be a temporary measure to support the war effort, the states did not receive their income tax powers back when the war ended. Instead, the states were partly compensated by 2 actions, ‘reimbursement grants’ which lasted until 1959 and the Australian Government withdrawing from land taxation in 1953. The states also increased stamp duties, motor vehicle taxes and estate taxes to fill the revenue gap.

Figure 1-1 depicts the evolution of Australia’s tax revenue, showing the mix of tax between income taxes (or direct taxes) and indirect taxes, a common way to distinguish between the two major channels for charging taxes.

Income taxes are levied on many different forms of income, such as wages, business profits and investment income, including interest and capital gains. In the 1950s Australia’s income taxes distinguished between different forms of income. Income from ‘personal exertion’ was subject to lower rates compared to income from investments.[4]

Indirect taxes are generally applied to particular products and paid by businesses, with the value of the tax passed on to the consumer through higher prices. Chapter 3 discusses the relative advantages of different income and indirect taxes.

By the 1950s total tax revenue as a share of GDP had increased markedly and shifted away from a reliance on indirect taxes to a roughly equal reliance on indirect and income taxes, which were paid by both individuals and companies.

Figure 1-1: Australian Government tax revenue

Source: Australian Academy of the Social Sciences in Australia (ASSA), Australian Bureau of Statistics (ABS) and Parliamentary Budget Office (PBO) analysis.