Senate Economics References Committee
Appendix 8: Why governments tax and the attributes of a good tax system
The primary objective for governments to levy taxes is to finance their operations and functions. Taxes are also powerful economic and financial tools, altering the distribution of income and the levels of spending in an economy. In addition, they have significant social impacts impacting on individual and corporate behaviour (e.g. excise on tobacco reducing smoking).
Governments require a wide variety of tax instruments to fulfil their revenue requirements. A broad base ensures the taxation burden is not carried by a particular sector, or activity within the economy. It also goes some way to reducing the incentive to evade the responsibility of paying tax.
In addition to taxes, governments also raise revenue by directly charging consumers. Governments need to choose the balance between taxation for a general revenue pool, and direct charging for services. This requires a judgement on what is:
- efficient
- equitable
- effective
The effective financing of government requires access to a:
- robust
- Stable
- growing source of revenue
An effective taxation system (in the whole of a country) should exhibit the following attributes:
- administrative efficiency
- fiscal (horizontal and vertical ) equity
- transparency and accountability
A nation's tax system must be administratively efficient, ensuring the costs of collection and compliance are kept to a minimum for both the taxpayer, and the government collecting the tax. There are fixed costs associated with the collection of any tax, as a result the assignment of taxes between spheres of government must take into account various efficiency issues.
Australia has progressed in the direction of a highly centralised taxation system. This is appropriate response for a country with such a dispersed population across a large area. Whilst some forms of tax competition are good for the economy, local government prefers to prevent predatory tax competition between jurisdictions. An extreme example is the Canadian GST and sales tax, where ten provinces administer five different sales tax regimes.
Fiscal equity occurs horizontally and vertically and relates to the distribution of the tax burden in the economy.
Horizontal equity ensures that people in similar financial positions are treated in an equitable manner in regard to taxation. Vertical equity ensures people pay tax according to their capacity to pay (this is commonly referred to a progressive taxation regime).
To ensure transparency and accountability, revenue means should be matched as closely as possible to expenditure needs. Tax instruments intended to further specific policy objectives should be assigned to the level of government having the responsibility for such a service. This needs to be traded off against the efficiency of such a system. In a country such as Australia where taxation is highly centralised a vast amount of redistribution is required to match revenue with expenditure needs.
The Commonwealth Treasury defines effective government taxation arrangements as follows:
"Taxation measures should meet revenue objectives (or other public policy objectives) and have regard to the principles of economic efficiency, horizontal and vertical equity, certainty and transparency whilst minimising compliance and administrative costs. By meeting these aims, taxation measures contribute to the wellbeing of Australians, either directly or by providing the revenue base to finance government services."1
