Facing the globalisation challenge
Illustration: Le Lievre
AS THE world's centre of economic gravity shifts towards Asia, the process of globalisation - the breaking down of barriers between countries - is speeding up. This means there's no shortage of challenges looming for our political leaders.
In a speech earlier this month, the boss of Treasury's revenue group, Rob Heferen, outlined those affecting taxation. He says our tax system, which relies heavily on taxing income - whether of individuals (48 per cent of total federal tax revenue) or companies (22 per cent) - will come under increasing pressure.
Since the introduction of full dividend imputation in the late 1980s - under which Australian shareholders get a tax credit for the company tax already paid on their dividends - the main purpose of company tax has been to tax profits earned by foreign shareholders.
But globalisation is increasing the ''mobility'' of capital (and to a lesser extent, labour), making it easier to shift to countries where tax rates are lower. Heferen says this is particularly true for multinational companies, which account for about a quarter of global production. Multinationals have considerable latitude in choosing where to locate their production, making them more sensitive than other businesses to the tax rates that apply to them. They also have some latitude in deciding in which country they'll declare their profits, notwithstanding rules that attempt to limit profit-shifting.
''So setting tax policy to deal with multinational enterprises is an increasingly difficult task,'' he says. ''Policy should support innovation and attract investment, but also help uphold the integrity of the corporate tax system.''
Because of the greater competition for foreign investment, policymakers must take into account how other countries tax multinationals, as well as the wide range of successful tax planning strategies available for companies to use.
Then there's the effect of financial innovation. It's now easier than ever to move funds between countries at little cost and to re-characterise financial assets from debt to equity or vice versa. These options place further pressure on the system and help firms seeking to minimise their worldwide tax. Another problem arises from the increasing role of intangible assets - such as brands, copyright and other intellectual property, customer lists and internal processes - which are often the result of much spending on research and development or marketing.
Investment in intangible assets is growing faster than investment in machines and buildings. Since intangibles have no fixed, physical form, it's much easier to relocate them to low-tax countries.
Going the other way is the taxation of natural resources. Unlike other resources, these are immobile. You can either develop the site or leave the stuff in the ground (where, in all likelihood, its value will grow). And the profitability of their exploitation often depends on natural factors: the quality of the ore, or how easily it can be got at.
Because world prices are still so high, (and likely to stay well above what we used to get), our largely foreign-owned miners are making profits far in excess of those needed to make these projects a worthwhile investment. Taxing the gap between profit and the level needed to induce investment won't discourage investment and this is part of the rationale behind the minerals resource rent tax.
Research suggests other small, open economies like us have configured their tax systems to rely less on income taxes and more on taxes levied on less internationally mobile bases, such as resource rents, land and consumption.
''However, raising taxes on some immobile bases, most notably consumption, may also have implications for the fairness of the system, its social acceptability and the ability of the government to redistribute income,'' Heferen says.
On the other hand: ''In the longer term, if we opt to keep relying on mobile bases for a high proportion of revenue, we may see increased risks for tax-base erosion and stronger disincentives for capital investment and for individuals to acquire productivity-enhancing skills''.
So, is there any way around this unpalatable choice? Heferen says one answer may be finding a different base for company tax.
The standard choice is between a ''residence'' base (you tax Australian companies on their worldwide income, but don't tax foreign companies operating in Australia) and a ''source'' base (you tax all companies just on their income from production in Australia, but don't tax Australian companies on their income from foreign production).
Like most countries, we've chosen the source base (though, strangely, not for capital gains). But some leading academics have suggested we move to a ''destination'' base, where we'd tax companies' profits on sales they made to Australian final consumers, regardless of where production occurred.
In practice, this would be a source-based tax, but with adjustments made for exports and imports. It would eliminate the incentive for companies to shift their location or their earnings to other countries.
This seems a strange approach with our mineral exports being so profitable, but maybe this could be fixed with adequate resource rent taxes. And Heferen says we shouldn't ''underestimate the power of structural change in the global economy to shape policy in new and unexpected ways''.