Australian Financial Review, p 47   When did talking about tax reform turn into talking only about tax increases? An assumption that we solve our problems by taxing more is threatening to cripple our tax reform debate.

 

Instead, we need to step back, and think hard about what we want from tax reform. The starting point is to clarify how much tax revenue we need.

 

If we resume the spending growth of the last decade - close to 4 per cent real per year - the result is disastrous. With expected revenue growth below 3 per cent, tax rates will need to keep increasing over time just to keep up with spending growth. That means crippling cumulative increases in the GST or income taxes, or both.

 

This is essentially the message of the intergenerational report (IGR). The assumptions are credible (i.e. non-political) because they are based on actual experience before 2013. Underpinning this is a rapidly ageing population, combined with governments unwilling to do the hard work to contain rampant spending growth over the long term.

 

We have no choice but to contain spending at a rate below economic growth. So the first strategic objective of tax reform is to help contain spending growth. Taking pressure off the growth in pension payments, and encouraging more people young or old, male or female - to enter and stay in the workforce, is crucial. As the Australian Council of Social Service argues, better targeted superannuation concessions, without undermining the incentive to save for retirement, could help. So could smoothing out "poverty traps". That is, smoothing out the high marginal tax rates (once transfers are taken into account) for the unemployed and those out of the workforce, particularly women and older Australians.

 

Rapid federal spending growth has been necessary to support state expenditure, particularly for health and education. Why would states pursue difficult productivity gains when the begging bowl is always filled by the federal government?

 

We could solve this problem by giving the states more control over tax rates, and the revenues that flow from that. Malcolm Fraser attempted it and the Commission of Audit recently recommended it Reformminded Mike Baird is showing some interest Not such a crazy idea after all.

 

At the very least the states need to take responsibility for any tax hikes to fund their spending increases. That way the states can "internalise" the difficult political trade-off

between higher taxes and accelerating the innovations necessary to contain health and education spending. Better that they choose the latter.

 

A second strategic objective of tax reform is to encourage economic activity and prosperity. This will simultaneously raise incomes and fill government coffers. With sluggish consumption growth and mining investment collapsing before our eyes, few things could be more important. Tax reforms can help by encouraging innovation, investment and job creation.

 

Beginning to bring company tax rates into line with other small economies - our current policy- is a good start So is simplifying tax legislation and compliance wherever possible.

 

But with bracket creep bearing down on average-income earners, we are creating a big economic headwind. Bracket creep is insidious, thwarting innovation and penalising effort We need to fix this, but a strong budget position (and therefore contained spending growth) is a prerequisite. Which takes us to the third strategic objective: securing our tax base in an increasingly global world. Rapid digitisation is now extending well beyond just music, books and videos. Retail, taxis, education, finance and even manufacturing (with automation and 3D printing) are increasingly open to digitisation. Some huge and growing companies with unique intellectual property are driving this process across the globe. Think Google, Facebook, Amazon, Uber and many more to come.

 

We are right to work hard to prevent unprincipled profit shifting via transfer pricing, "thin capitalisation" and excessive cross-border fees and royalties. Simplistic silver bullet solutions such as mandated gearing (Labor's solution) won't work.

 

The ATO needs to have a deep and commercial understanding of the full toolkit of the tax avoidance trade, and needs to have the resources and capability to demand fair outcomes.

 

But we also have to face the reality that much of the profitability of these companies is made possible by legitimate research and development in other countries.

 

Part of the answer has to be encouraging more innovation to occur within Australia. Again, lower company taxes and better targeted deductions and concessions can support this outcome.

 

Australia will not tax its way to prosperity in a world where capital is mobile, and competition is fierce and getting fiercer. This is a world where the innovators - organisations and people we need to attract and motivate - exercise choice about where and how much they invest, work and create jobs every day.

 

Let's not turn the tax reform debate into class warfare. We cannot afford to simply focus on unfairly penalisingjob creators and wealth creators out of misplaced jealousy of their success.