At the 2025 Economic Reform Roundtable, the federal treasurer committed to “a better tax system”. In that spirit, my recent paper models reform packages for property, corporate and household taxes to reduce economic harm from those taxes, while raising the same revenue. In the long run, these reforms are simulated to boost annual consumer welfare by $43 billion.
Efficiency of the major taxes
Consumers make choices about: (i) the composition of their consumption; (ii) leisure versus consumption; (iii) present versus future consumption; and (iv) portfolio allocation.
Taxes can distort these consumer choices, as well as business choices, thereby reducing consumer welfare. This cost to consumers from a tax, over and above the amount of tax that is paid, is known as the excess burden.
The average excess burden (AEB) of a tax is its excess burden relative to the amount of tax that is paid. The marginal excess burden (MEB) refers to the effects of an incremental change in the tax rate and is useful in assessing the desirable direction of tax changes.
The 2010 Henry Review provided estimates of the excess burdens of the major Australian taxes. That modelling was undertaken by a team at KPMG Econtech that was led by me. Since the Henry Review, the Australian economy and tax burdens have changed, and the modelling of excess burdens has improved.
Table 1 shows how estimates of MEBs for four key taxes have evolved. There is a common pattern. The most efficient tax, with the lowest MEB, is a broad-based tax on land, such as municipal rates. It is followed by the goods and services tax (GST), personal income tax, and company income tax. This ranking mainly reflects the assumption that land is in fixed supply, while the GST discourages labour supply, personal income tax discourages it more because of its progressive rate scale, and company tax discourages investment and labour supply.
Table 1: Marginal excess burdens in selected Australian studies
The MEB estimates in my latest paper were prepared using the CGETAX2025 model (Table 1, bottom row). They are broadly similar to the estimates in the 2021 Tran and Wende study.
My latest estimates incorporate four improvements compared to the original Henry Review modelling. They better interpret a survey of economists on the sensitivity of the labour supply to real wages, they recognise the existence of oligopolies, they distinguish between rented and owner-occupied housing, and they take into account international profit shifting.
The overall effect of using the latest information and the four advances in the modelling is to raise the estimates of the MEBs, except in the case of municipal rates.
Three reform packages
To design the packages for reforming property taxes, corporate taxes and labour taxes, I use the more detailed estimates of MEBs presented in Table 2. The tax system can be made more efficient by relying less on taxes with higher MEBs and more on taxes with lower MEBs. I now construct three reform packages that follow that principle.
Table 2: Marginal and average excess burdens from CGETAX2025
1. Property taxes
Conveyancing duty is applied when property ownership changes hands. Its narrow effective tax base makes the effective tax rate high. Conveyancing duty discourages households from moving when their circumstances change, resulting in poorer utilisation of the housing stock. This inefficiency leads to a very high AEB of 77 per cent (Table 2). Conveyancing duty is abolished as part of my constructed package.
State land tax introduces inefficiencies by exempting owner-occupied housing and agricultural land. These inefficiencies lead to a high AEB of 59 per cent (Table 2). Thus, state land tax is also abolished.
Compared to state land tax, municipal rates are broadly-based and efficient, with a MEB of -4 per cent (Table 2). Hence, my constructed package makes up the loss of state government revenue from abolishing the previous two taxes by raising municipal rates (Table 3, property taxes column). The extra rate revenue would be directed to state governments.
2. Corporate taxes
The corporate tax base of company profits includes normal returns to capital and location-specific economic rents. This presents a dilemma for corporate tax policy.
Table 3: Annual Budget effects of reform packages (deviation from baseline, $ billion)
It is highly efficient to tax economic rents, including natural resource rents and oligopoly rents. Hence a hypothetical cash flow tax (CFT), which is a form of economic rent tax, has a very low MEB of –8 per cent (Table 2). This value is negative because part of the incidence of a CFT falls on foreign shareholders.
However, it is highly inefficient to tax normal returns to capital. This has the double disincentive effect of directly discouraging investment and indirectly discouraging labour supply. The additional revenue that the existing corporate tax raises by taxing normal returns to capital, rather than only economic rents, has a high MEB of 85 per cent (Table 2).
My corporate tax package introduces a hybrid tax base, with a weight of two-thirds on the existing tax base and one-third on a CFT base. To achieve this, one-third of investment is expensed immediately and one-third of net interest expenses are no longer deductible. If a company’s net interest income is positive, it remains fully taxable.
The hybrid tax base moves only one-third of the tax base to a full CFT for three reasons. First, by only partially removing deductibility for interest expenses, it makes the transition easier for more highly-indebted businesses. Second, it maintains sufficient compatibility with tax regimes in other countries, including by Australia continuing to apply more than the OECD global minimum corporate tax rate of 15 per cent on a standard base. Third, it takes into account that there are diminishing marginal benefits from reducing the tax rate on normal returns to capital.
To cover the budget cost of the shift to this hybrid tax base, franking credits are issued at a reduced rate of $2 out of $3 in corporate tax paid (Table 3, corporate taxes column). In any case, as Boadway and Bruce point out, foreign investors are arguably the marginal investors and they cannot utilise franking credits.
3. Household taxes
The three main taxes that ultimately fall largely on real labour incomes are personal income tax, payroll tax and GST. Personal income tax has a progressive rate scale. While this makes it more redistributive, it also contributes to a higher MEB of 48 per cent (Table 2).
Broadening the base of the GST to cover categories that are currently GST-free removes a distortion to consumer choices. Hence, this has a low MEB of 13 per cent compared to an MEB of 30 per cent from raising the GST rate.
Similarly, broadening the base of payroll tax by reducing the average payroll threshold from $1.2 million to $0.3 million reduces a tax distortion to the choice of business size. This measure has an MEB of 24 per cent compared to 42 per cent from raising the payroll tax rate.
This broadening of the tax bases for GST and payroll tax funds a cut of 11 per cent in personal income tax (Table 3, household taxes column).
Economic effects
When the three packages are combined, there is a large permanent gain in annual consumer welfare of $43 billion (Table 4). While the tax system raises the same amount of revenue as now, $91 billion of that revenue is raised in a different way that less distorts economic choices.
In this more efficient economy, there are gains in real GDP and household consumption of 5.8 and 4.1 per cent respectively. There is greater investment in business capital and housing, and greater mobility in the housing market (reflected in much higher ownership transfers).
Table 4: Economic effects of reform packages
Further work and policy co-ordination
Future work will be aimed at addressing some limitations of the current approach.
First, a new Dynamic CGETAX model will address vertical equity by distinguishing between consumers with low, mid and high wage-earning ability. This model will also trace the year-by-year path of the economy following tax reform. With that new information, the three packages can be tweaked to manage equity and transitional effects.
Second, further model development work will make it possible to add a fourth package that covers asset income tax reform. As highlighted by Bastani and Waldenstrӧm (2020), the main guiding principles for taxing asset income are efficiency, vertical equity and horizontal equity, while pension policies are the best tools for intergenerational redistribution.
In recent work for the Productivity Commission, I used CGETAX to model the effects of alternative corporate tax policies. In the second phase of that work, I will use the new Dynamic CGETAX model.
Finally, it is critical that tax reform is properly coordinated with other important economic reforms. For example, we should address artificially high land prices by increasing land supply even if that reduces land tax revenue. Similarly, we should address oligopoly power with competition policy even if that means less company tax revenue is collected from oligopoly rents.
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