Shifting the tax mix through policy

(a) from income tax to consumption tax

A large but relatively simple illustration of a change to the tax mix from policy is to increase the GST and decrease personal income tax, being the largest indirect and direct taxes in the mix.

For example, if the GST rate doubled from 10% to 20%, the amount of GST collected would increase from around $100 billion to $200 billion per year (although consumers would likely shift their spending somewhat to products not subject to GST).

The corresponding decrease to personal income tax would not be exactly the same because an increase to GST would also increase the consumer price index (CPI). The corresponding increases to a range of government payments, such as the age pension, would total around $14 billion. 

To maintain the same budget balance, the reduction to personal income tax would therefore be less than the increase in GST revenue.

As GST is the more efficient tax, the change from personal income tax to GST would also have secondary benefits to the budget. As described in Chapter 3, all taxes distort the efficient allocation of resources, but a broad-based consumption tax is less distortionary than personal income tax. 

The marginal excess burden for GST is around 8 cents for every dollar collected, compared to 25 cents for every dollar collected of personal income tax (see Figure 3-1). Shifting $100 billion of tax to GST would therefore improve the size of the economy, and therefore incomes, by around $17 billion. This equates to 0.5% of GDP (around $500 per person). This additional income would also generate tax, which we assume is split evenly across the various sources.

All up, the change would reduce personal income tax from making up 42% of all tax in Australia to around 30% (the same share as in the 1950s) and increase the GST share from 11.5% to 23% (Figure 5-3).

Figure 5-3: Impact of doubling the GST rate and reducing personal income tax

Source: PBO analysis

In addition to increasing economic efficiency, a change of this magnitude would decrease the average complexity in the tax system for individuals and make the tax system somewhat more responsive to economic shocks. 

In a scenario like this the impact on the equity of the system, and the inflationary effects as a whole, would depend on how cuts to personal income tax were applied across the income distribution. For example, a government could choose to provide smaller income tax cuts and increase government income support instead.

This scenario is for an enormous change. It illustrates that a policy of this magnitude would be necessary to produce a very obvious change to the tax mix.

(b) replacing all state taxes with a land tax

The second scenario ‘replacing all state taxes with a land tax’ is often discussed, including in the Henry review. The review recommended the replacement of many of the taxes levied by the states with an expanded land tax.[59]

The illustrative scenario here is to eliminate all state taxes and increase land tax by the same amount. This change does not involve any switching between direct and indirect taxes, so that the overall tax mix remains unchanged at that level. However, the scenario is a significant shift away from taxes with high efficiency costs to a single tax with a near-zero efficiency cost (see Chapter 3).

Total taxes paid to the states are estimated to be around $150 billion in 2025-26. The average economic cost of these state taxes is around 42 cents per dollar raised, or around $63 billion, which equates to over 2% of GDP (or the equivalent of $2,200 per person).

The taxes that contribute most to the economic cost are stamp duties, payroll tax, and taxes on gambling and insurance.

Raising the entire amount of state tax revenue through land tax would increase GDP by over 2%, but the states themselves may not see a large increase to revenue because land prices are not closely linked to GDP growth.

The Australian Government would benefit by around $15 billion of additional tax revenue because the increased economic efficiency would generate more income and consumption, and hence more tax.[60]

Land taxes (and municipal rates) are simpler, more efficient and less volatile than most other taxes. The impact of this switch in the tax mix on equity depends on the difference between the characteristics of those affected by stamp duties, payroll tax and taxes on gambling and insurance, as compared to those affected by land tax:

• Payroll tax affects a very broad population, through the prices of most goods and services.
• Insurance taxes (also known as insurance duties) affect a broad population, as insurance on homes, cars and possessions are all subject to the tax (except in the Australian Capital Territory). 
• Taxes on gambling and stamp duty have a narrower base. This switch is similar to where tobacco excise is replaced by personal income tax, where the same amount of tax is spread over many more people. For most ‘sin taxes’, the target population is effectively subsidising slightly lower taxes for the rest.

In this scenario, land tax is more obvious than many of the taxes it would replace.

Taxes on business payrolls, insurance and gambling are generally remitted by businesses and passed onto households in the form of higher prices, with the impact of the tax hidden. Partly reflecting this issue, many discretionary changes to tax policy to increase revenue have focussed on less direct taxes. The key example of that was the introduction of wholesale sales tax in 1930 (see Chapter 1).