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Structural changes to the economy will change the composition of Australia’s tax base and place pressure on revenue, the Intergenerational Report warns.
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Structural changes to erode Australia’s tax base: IGR
28 August 2023
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12 minute read
Changes to the structure of the economy over the coming decades will see shifts in the composition of Australia’s tax base with indirect taxes expected to fall, the 2023 Intergenerational Report (IGR) reveals.
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The report, handed down last week, outlines that indirect sources of revenue are expected to decline as the decarbonisation of the transport industry and changing consumer preferences erode fuel and tobacco excise bases.
Global demand for bulk commodities, and therefore reliance on them as a source of company tax revenue, is also expected to fall.
Personal income tax receipts, on the other hand, are expected to increase due to income and wage growth and continued population growth.
“Governments will need to make choices about how they respond to these shifts in the economy and tax bases while maintaining sustainable public finances and funding essential services,” the IGR said.
The report estimates that indirect taxes (excluding GST) will decrease from 2.2 per cent as a share of GDP in 2022-23 to 1.4 per cent in 2062-63
The decline reflects projected increases in the uptake of electric vehicles and a decline in per capita smoking rates.
“However, the rate at which these indirect tax bases erode is highly uncertain,” the IGR said.
“Governments will need to understand the potential implications of these trends on the efficiency, equity and sustainability of the tax system when considering what policy responses would be most appropriate.”
In the absence of policy change, the IGR estimates that personal income tax receipts will grow from 50.5 per cent of total tax receipts in 2022–23 to 58.4 per cent in 2026–63.
“Company tax receipts are projected to fall from 23.5 per cent of total tax receipts in 2022–23 to 18.0 per cent by 2033–34, and remain at that share until 2062–63,” the report stated.
“GST receipts are expected to stay broadly level, moving from 13.9 per cent in 2022–23 to 14.0 per cent in 2062–63."
Personal income tax receipts are forecast to be 11.7 per cent of GDP in 2022–23 and are projected to increase to 13.5 per cent by 2033–34.
They are also expected to grow as a share of GDP due to the progressive nature of personal income taxes and ongoing income and wage growth.
Personal income taxes are projected to be 14.3 per cent of GDP at the end of 2062–63.
The IGR said that increases in nominal wages will drive up average personal tax rates over time as a higher proportion of an individual’s taxpayer’s income is paid at the highest marginal tax bracket applicable to them.
In the absence of policy change, the projections in the report show increasing reliance on personal income tax.
Personal income tax base to narrow further
The report also noted that taxpayers have declined as a share of the total population since peaking in 2005–06 despite a similar employment-to-population ratio.
“This is the result of an increase in the effective tax-free threshold, driven by policy decisions to raise the threshold itself and associated increases to low income and age-related tax offsets, coupled with population ageing over the period,” the report said.
“As the population ages, the personal income tax base is projected to continue to narrow in line with the projected decline in workforce participation. Only 12 per cent of Australians aged 70 and overpay income tax and this age group now makes up 12.2 per cent of the total population.”
This age group is expected to increase to 18.1 per cent of the total population in 2062–63.
Company tax receipts are particularly exposed to volatility, the IGR said, with many factors influencing how much tax is collected for the same amount of profit.
“In recent years and over the near term, temporary business support measures and significantly elevated commodity prices have increased volatility in company tax receipts,” the report said.
“Commodity prices are assumed to return to long-run levels by 2024–25 resulting in a projected decline in company tax receipts to 4.4 per cent of GDP in 2033–34.”
The IGR predicts tax receipts will remain at this level over the remainder of the projections period to 2062–63, consistent with company profits maintaining a constant share of GDP.
“Fluctuations in global commodity prices and company tax receipts will likely continue to be a major source of volatility in total taxes,” the IGR said.
“History shows the distribution of profits across different companies and industry sectors can significantly impact how much and when profit translates to company tax and history shows.”
Super, PRRT and fringe benefit taxes to stabilise
Other income taxes, which include fringe benefits tax, petroleum resource rent tax (PRRT) and superannuation fund taxes, are projected to stabilise at 1.0 per cent of GDP beyond the forward estimates, remaining at this level until 2062–63.
“There are risks that this varies in the shorter term with the uncertain timing of expected receipts from newly paying projects,” the report said.
“Conversely, longer-term risks include decommissioning expenses and any decline in sales of offshore petroleum due to the global energy transition,” it said.
Budget deficits to widen in the longer term
While the budget will likely deliver a surplus in 2022–23 off the back of a stronger-than-expected economy, elevated inflation and high commodity prices, the outlook for the budget in the longer term is not as positive.
“Government debt-to-GDP remains high by historical standards, long-term spending pressures are growing, and the revenue base is narrowing as the population ages,” the IGR said.
Budget deficits are expected to widen from the 2040s due to growing spending, the report said.
Gross debt-to-GDP is projected to decline from a peak of 39.3 per cent in 2020–21 to 22.5 per cent by 2048–49, before rising again to reach 32.1 per cent of GDP by 2062–63.
Commenting on the IGR, AMP deputy chief economist Diana Mousina said these projections indicate budget repair is likely to be a key policy focus in the next few years.
“There are five main areas that are driving higher government spending: health, aged care, the National Disability Insurance Scheme, defence and interest payment. These 5 areas will rise from currently a third of government spending to half in the next 40 years and that’s already assuming slower growth in NDIS spending,” said Ms Mousina.
“Long-term government revenues will be under pressure as the economy transitions away from fossil fuels which have been a major revenue source, a loss in the fuel excise as we transition to electric vehicles and lower tobacco excise revenue as the rate of smoking declines.”
These old revenue sectors will partly be replaced with new areas of hydrogen and critical minerals like lithium, rare earth elements, cobalt and manganese, she said.
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