14 November 2024

Tax expenditures


A tax ‘concession’ refers to cases where a form of income or spending is taxed at a lower rate than other forms of comparable income or spending. The tax revenue foregone due to the lower rate can be viewed similarly to a government expenditure. These are referred to as ‘tax expenditures’, because they are similar to direct government spending. They tend to receive less direct scrutiny because no actual money is exchanged.

For example, the GST imposes a 10% tax on goods and services, but with exemptions on some food, health and education, which are concessionally taxed at a zero rate. An alternative system, which would deliver a similar result, would be for the government to tax all goods and services by 10% and provide all households payments equivalent to 10% of the value of those goods and services exempt from GST. The net impact, ignoring compliance and administration costs, would be almost identical to the current system, but with more GST raised and more government transfers to households. In this example, the tax expenditure can be thought of as the value of the GST foregone due to the concession, or as the amount that would be required to provide the same impact through a transfer payment.

The Charter of Budget Honesty requires the Australian government to report on the size of tax expenditures in a separate report, called the Tax Expenditures and Insights Statement (TEIS), and to also provide a summary of similar information in each annual budget. 

The total amount of tax expenditures in 2023-24 was over $200 billion. If these concessions were administered by governments as additional tax and spending, the Australian government’s budget would be over a third larger, though the budget balance would be unchanged if there was no additional administrative burden.

The largest group of tax expenditures itemised in the TEIS are the concessional tax rates on superannuation contributions and earnings. That is, the employer provided superannuation guarantee, any additional contributions - like salary sacrifice or deductible contributions paid into superannuation funds, and the subsequent investment earnings, are taxed at 15% (or zero in retirement), rather than the individual’s marginal tax rate. The associated revenue foregone by the government was around $49 billion in 2023‑24.[31]

The second largest tax expenditure relates to the exemption of main residences (owner-occupied housing) from capital gains tax, which represents revenue foregone of around $48 billion in 2023-24.[32] While estimates are not available, if taxes levied by States were also included (such as land tax), the exemption of owner-occupied housing from most taxes would, cumulatively, be the largest tax expenditure, with the amount likely to be around $100 billion of foregone tax revenue.[33]

The third largest group of tax expenditures was the exemptions from GST, totalling around $30 billion[34]. This includes some food, health care and related services, financial supplies, education, water, sewage and a collection of other smaller exemptions.

All 3 of these tax expenditures have increased significantly over time because all have increased faster than the size of the economy. For example, superannuation balances have increased from the equivalent of 38% of GDP in 1991[35] to 137% in 2023[36], with the associated tax expenditure increasing proportionately. Similarly, house prices and spending on GST-exempt consumption have increased faster than GDP causing a similar proportional increase in the associated tax expenditure.

The largest share of tax expenditures relates to revenue forgone in the personal income tax category. The impact of these tax expenditures on revenue collections is exacerbated by the increasing reliance on this revenue source (Figure 2-2).

Figure 2-2: Australian government tax and tax expenditures, 2022-23

Australian government tax and tax expenditures, 2022-23

Source: 2022-23 Tax expenditures and insights statement.

 

A good example of the operation of taxes, transfers and tax expenditures is Australia’s retirement saving system, which aims to provide individuals with an adequate standard of living in retirement. 

The retirement system is typically depicted as 3 ‘pillars’: the age pension, compulsory superannuation savings, and voluntary personal savings (including home ownership).[37] Only the age pension, a transfer payment, appears on the Government’s own books. 

The superannuation system, which provides a vehicle for individual retirement saving, is underpinned by the superannuation guarantee, which sets out a rate that employers must pay to a nominated superannuation fund in addition to employee wages.

Contributions to superannuation funds are largely concessionally taxed, resulting in a tax expenditure of the value of the difference between the tax paid and the tax that would have been paid had the amount been taxed with other personal income.[38]

Box 2 discusses how different countries achieve similar policy outcomes through different mixes of taxes, transfers and tax expenditures, making comparisons between them more difficult.

In designing policies, governments consider a number of trade-offs between various mechanisms for collecting revenue and delivering outcomes, including simplicity, equity, efficiency and compliance. These are discussed next in Chapter 3.

Box 2: Taxes and tax expenditures: International comparisons

Many countries fund a similar social insurance objective in a different way. One scheme common across Europe and the United States is social security contributions. Social security contributions are compulsory payments paid to general government that confer entitlement to receive a future social benefit. For instance, the UK funds retirement through a National Insurance scheme, which is a tax on employee earnings and self-employed profits. The amount of State Pension received by an individual in retirement is determined by their total National Insurance contributions. These social security contributions are recognised as taxes, while Australia’s compulsory superannuation guarantee is not.

As a result, these countries would record both higher tax revenue and higher transfers than in Australia. Both methods achieve the same goal: funding individuals in retirement, though the way these are reported in government budgets is very different.

Similarly, in Australia family benefits are mainly provided through transfer payments, where individuals pay their full amount of personal income tax and are handed back some money as a regular family payment where qualifying conditions are met.

In the United States, however, family benefits are provided in the form of Federal tax credits, reducing the amount of income tax paid. This mechanism reduces the tax take but also removes the need for the government to subsequently provide the benefit, so the net position is equivalent.[39]

Australia maintained a similar system in the past. In 1950-51, a single person earning £1,000 for the year would pay tax of £135, while someone with a dependent spouse and 2 children would pay only £83.[40]

These differences between how governments achieve their policy objectives complicates direct comparisons between taxes levied in different countries. 

The International comparison of Australia’s taxes, published in 2006, was a comprehensive statement on how Australia’s taxes compare with those in other countries.[41]

[31]        TEIS 2023-24: Concessional taxation of employer superannuation contribution - C2, Concessional taxation of superannuation entity earnings - C4.

[32]       TEIS 2023-24: Main residence exemption discount component – E8, Main residence exemption – E7. The calculation does not consider the impact on tax if home-owners could deduct their interest repayments or other property expenses from their taxable income.

[33]        Combining the $50 billion of tax expenditure for the exemption of CGT for owner-occupied dwellings with another $50 billion for exemption from land tax, based on estimates of actual rent and imputed rent consumed by owner-occupiers, reporting the Australian system of national accounts.

[34]        TEIS 2023-24: Food – H25, Health – medical and health services – H17, Financial supplies – input tax treatment – H2, Education – H14, Health – residential care, community care and other care services – H18, Financial supplies – reduced input tax credits – H13, Water, sewerage and drainage – H6, Health – drugs and medicinal preparations – H15, Private health insurance – H19, and a collection of smaller tax GST tax expenditure.

[37]        Superannuation Policy for Post-Retirement, Productivity Commission (2015).

[38]        The relative sizes of the total age pension in the absence of compulsory superannuation and the tax expenditure incurred in reducing the total age pension depends on how much people would have saved anyway. PBO analysis was reported in Would taxpayers be better off if superannuation never existed? (Michael Read, Australian financial review, 17 June 2022)

[39]        The OECD’s Taxing wages report adds Australia’s superannuation guarantee payments to tax when comparing different tax systems between countries. 

[40]        Year Book Australia, 1957, Commonwealth Statistician (page 813).

[41]       International comparison of Australia’s taxes RFE Warburton and P Hendy, 2006.