Ken Henry AC in conversation with Leigh Sales

NAB Chairman Ken Henry AC discusses the future of reform, why the tax debate has become 'strange' and the challenges facing the banking sector.

Ken Henry AC keynote address at the 2018 Australian Governance Summit

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Thank you, Elizabeth, and the Australian Institute of Company Directors for inviting me here today. This is an important forum and I have valued hearing the contributions many directors and business leaders have made throughout the day.

I want to make some remarks today about two topics that seem to me to be especially important right now. First, the role of business in society. And second, genuine tax reform. These topics are closely related.

The role of business in society

Most economists subscribe to a conceptual framework in which businesses seek to maximise profits for their owners, consumers seek to maximise happiness for themselves and governments pick up the pieces.

This conceptual framework is simply a set of convenient assumptions. Yet, for many people, it has become a normative role assignment statement: the purpose of business is to maximise profit. Businesses should not have regard for the consequences of their profit maximising activities. They should have no moral or ethical obligation for the welfare of anybody other than those who provide them with their financial capital.

Ironically, businesses, even with this narrow purpose, do make a fundamental contribution to the welfare of the country’s citizens.

In pursuing profitable ventures, businesses produce the things that people want to buy and they create jobs; those jobs provide incomes that allow workers to enjoy the benefits of consumption and to save for the future. Some of those savings end up being invested in businesses that generate an income for retirees.

It is this role that businesses play, in inadvertently promoting social welfare, that Adam Smith explained nearly 250 years ago with his metaphor of the ‘invisible hand’; describing a man of commerce ‘led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was not part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.’

Yet it is also true that a narrow pursuit of profit might lead a business to negatively impact its employees, thus denying workers a source of income formerly available to them. And in pursuit of profit our businesses might generate negative externalities, including greenhouse gas emissions and other forms of pollution.

And when we are challenged to explain why we are doing these things we often say that we are simply going about our business. We say that it is for government to determine whether any of our activities have negative social or environmental consequences and it is for them, not us, to do something about it.

If that’s the best we can do, then we shouldn’t wonder that we find it so difficult to occupy positions of trust and respect in society. Neither should we wonder that politicians of all political colours have such an uneasy relationship with us. So what should we do?

Why we need a shared purpose

One of the more important things we in business can do at this time is accept responsibility for the social and environmental outcomes of our activities. Not unreasonably, this is what the community expects.

But I would go further. It is time we got really serious about the social purpose of business. We need to make Adam Smith’s invisible hand visible. And then we need to develop consensus on an ambitious role for government that goes well beyond picking up the pieces.

Over the past couple of years, we at National Australia Bank have spent a lot of time reflecting upon the purpose of our business.

We were not surprised to find that our bankers are motivated strongly by the contribution they make to the lives of others; especially those who have the courage, who are bold enough, to take on calculated risks in the pursuit of a better future for their families, their businesses and their communities. We have framed our purpose in these terms: back the bold who move Australia forward.

This purpose drives our people in our core banking activity. But it also has us looking for opportunities to use our skills to secure better social outcomes.

For example, we have backed the not-for-profit Good Shepherd Microfinance to develop Speckle – a fair, flexible and affordable lending alternative for Australians in need. Speckle provides small cash loans of between $200 and $2,000 at around half the cost of payday lenders.

And our purpose has us partnering with CSIRO and more than 50 other business, non-government and academic leaders to identify some of the ways we, as a nation, can respond to the challenges and opportunities facing us out to 2060. The Australian National Outlook project is aiming to discover how we can secure Australia’s long-term prospects.

NAB’s purpose statement reflects our corporate culture, embedded in a strong set of values. At NAB, we back one another to be bold. Our people show a passion for customers, a respect for people, a desire to win together, and they will back themselves, and their colleagues, to do the right thing.

We know that today many people outside of the bank will be sceptical of NAB’s purpose, and we understand why that might be. But we didn’t write it for publication. We wrote it for ourselves. It tells us a lot about who we are, and even more about who we want to be. It is beyond profit – an articulation of the reason why we exist. I believe that, in time, as we model our purpose, we will earn the trust and respect of the community.

Different businesses will articulate their social purpose in different ways. But there should be a common thread. I would hope that all of us in business would be motivated by a purpose that contributes to improving the wellbeing of our community.

And government? When business commits to improving community wellbeing, it creates room for government to pursue a higher ambition. We should want our political leaders to be motivated to ensure that all Australians have the opportunity to choose lives of real value, and that future generations have no lesser opportunity. I know numerous community groups in Australia share a similar purpose.

Tax reform

Australia’s economy is fundamentally in a good place with strong jobs growth and near-record high business conditions, likely to be supportive of strong business investment. We have a lot going for us, but not everything.

It’s nearly 10 years since my colleagues Jeff Harmer, John Piggott, Heather Ridout, Greg Smith and 50 tax policy professionals in the Treasury, led by Rob Heferen, and I were commissioned to conduct a comprehensive review of Australia’s tax and transfer systems.

Our deliberations were set against the backdrop of several major challenges confronting Australia; all of which present as even more serious today.

First, a strongly growing and rapidly ageing population, with implications for jobs, government budgets and the adequacy of retirement incomes.

Second, changes in the structure of the labour market, including increasing rates of female participation, a declining proportion of single income households and rising rates of part-time work. Today, these labour market dynamics are accompanied by weak wages growth.

Third, rising expectations of community living standards, deterioration in housing affordability, increasing urban congestion, and worsening access to high quality education at all levels.

Fourth, increasing globalisation, the rise of Asia and the shifting centre of global economic activity, presenting unprecedented opportunity for Australians, but also raising questions about Australia’s ability to remain an attractive place to work, invest and do business.

Fifth, an extended period of large current account deficits and the possibility of further international financial volatility, underpinning the case for a stronger national saving effort.

Sixth, growing environmental pressures, including land degradation, loss of fragile ecosystems, species decline, unsustainable water use and climate change.

Seventh, transformational technological developments, especially in digital electronics and communications. Today, businesses and workforces across virtually all industries are being disrupted by these new technologies.

And eighth, an unsustainable tax structure characterised by multiple, often conflicting, objectives; increasing complexity; very high compliance costs; base erosion; and low levels of consistency amongst jurisdictions. Ten taxes are responsible for about 90% of revenue. The other 10% comes from more than 100 other taxes.

When we were working on our review over the course of 18 months in 2008 and 2009, we assumed that future Australian governments would deliver on their bipartisan commitment to achieving a budget balance, or a small surplus, over the economic cycle.

We avoided taking a position on the size of government, instead taking the view that the tax system should be designed such that it would be capable of generating sufficient revenue to meet evolving fiscal requirements, without unacceptably deleterious consequences for economic efficiency, fairness and system complexity. We noted that ‘increasing the revenue-raising capacity of the tax system would require a greater emphasis on broad-based taxes’.

It is now evident that the size of government has grown significantly since the commissioning of the review. That will have to be paid for. It is also evident that the personal income tax system is being called upon to generate an increasing share of revenue, continuing to be propelled by fiscal drag. That is unsustainable.

As you know, few of our recommendations have been implemented in full. We also made a very large number of ‘findings’, in addition to our recommendations.

So what would Australia’s tax system look like today had both ‘recommendations’ and ‘findings’ been implemented in full? The following things would have been abolished:

• The complex ‘invoice-and-credit’ GST, payroll taxes, and all State taxes on consumption, including taxes on insurance;
• Resource royalties;
• Stamp duties on property transfers and motor vehicles;
• Fuel excise and vehicle registration taxes;
• Luxury car tax;
• The Medicare levy;
• Taxes applying to scholarships, pensions, allowances and other transfer payments; and
• Renewable energy targets and all other ad hoc schemes designed to achieve greenhouse gas abatement.

With those things abolished, today’s tax system would have the following principal features:

• A broad-based cash flow tax replacing the GST, payroll taxes and all inefficient State consumption taxes such as those on insurance;
• A uniform national resource rent tax;
• A 25 per cent company tax rate, for all companies;
• Progressive land taxes replacing stamp duties on property transfers;
• Cost based, comprehensive road user charges replacing fuel excises, stamp duties on motor vehicles, luxury car tax and vehicle registration taxes;
• A carbon emissions trading scheme; and
• A much simpler and more progressive two rate personal income tax system, with most people facing the lower of the two marginal rates.

Obviously, those engaging in today’s tax debates don’t see themselves delivering that sort of tax system. Their debates concern a small set of very narrowly cast propositions; such as when, by how much, and how broadly should company tax rates be reduced.

As my colleague Heather Ridout observed not so long ago, that is a polarising debate. It is the opposite of the sort of discussions we should be having. Heather got it right when she said that the country needs a 10-year plan built on a unifying proposition.

In respect of the company tax matter, I will simply say this. First, of course we will have to cut our company tax rate; in a world of mobile capital, countries don’t get to choose their own company tax rate in perpetuity. Second, there is good reason to think that a lower company tax rate will drive a faster rate of investment and labour productivity growth, and that should support higher wages growth over time. And third, cutting the company tax rate is only a small part of a required restructuring of our tax system, and that in turn is only a small part of the policy reform program that will be required if we are to ensure that all Australians have the opportunity to choose a life of real value.

And that is where my two topics today come together.

Demonstrating purpose throughout the tax reform debate

I’ve talked in the past about the need for the nation’s leaders to frame a compelling narrative that motivates and supports national development. The narrative must present a realistic assessment of where we are – but also an ambitious, clear vision for our future. And it must detail the strategies that will secure that vision against many challenges.

We have leaders in politics, we have leaders in business and we have leaders in the community sector. The narrative for Australia’s future has to be unifying across those three groups of leaders. It won’t be unifying if those different groups have inconsistent purpose.

For example, we in business should not expect to be taken seriously in tax reform debates until we demonstrate a serious commitment to a purpose that improves the wellbeing of Australians. Surely nobody needs to spell out why a businessperson motivated by nothing more than profit is going to have a hard time convincing anybody of the merits of a proposition to cut the rate of tax applying to profit.

Australia will get no progress on tax reform unless the community sees vested interest make way for the national interest.

In the spirit of maintaining a focus on the national interest, here are just a few things to keep in mind during this year’s tax debate.

The first thing to keep in mind is that our present tax system is not sufficiently robust to finance government spending on average through the economic cycle. It is not capable of supporting the medium-term fiscal strategy that both sides of politics have signed up to. It simply doesn’t have the buoyancy to generate enough revenue to achieve a balanced budget on average over the cycle. And its robustness is deteriorating through time. Our tax system is too narrowly based and relies too heavily upon tax bases that are subject to international tax competition, including the company tax; taxes that we will have no option but to cut over time.

Understanding those truths, our current tax debate appears very strange. We know the total tax take is too low, but that simple fact seems too horrible to admit. So instead, we have chosen to have an argument about which tax rate should be cut first: company tax or personal income tax.

The second thing to keep in mind is that the various challenges confronting Australia have implications for the structure of the tax system. For example, the fact we have the highest rate of population growth in the developed world has obvious implications for the utilisation of the nation’s infrastructure, including roads. Yet the revenue bases being relied upon to finance road construction and maintenance are falling relative to the total tax take, and we have almost no functional ability to manage congestion. This is unsustainable.

The third thing to keep in mind is the need for a much simpler tax system. Last year when we surveyed our customers, 44% of small businesses told us they don’t fully understand the tax system that applies to them. They’re spending, on average, over 250 hours a year on tax compliance. A complex tax system is not conducive to growth. In particular, it is not supportive of the important contribution SMEs make to our economy.

And lastly, but importantly, we have to keep in mind that the purpose of taxation is to raise revenue to fund government spending; to do things like build a social safety net that reduces inequality, and to fund world-class education and health systems. The tax system is a critical determinant of our social fabric.

Conclusion

We need a more considered debate on tax reform; a debate that is truly reflective of the challenges and opportunities confronting Australia.

Business must be fully involved in this debate. Just as we must be fully involved in thinking about the future shape of our cities and regional development opportunities; how to make the most of the digital revolution; how best to secure our future in the Asian century; and how best to address environmental degradation.

If we in business are going to be taken seriously in these debates, we will have to demonstrate that we are engaging not out of self-interest, but because we share a mission to improve the wellbeing of the Australian people.

We are going to have to demonstrate that our social purpose drives the way we operate. We are going to have to demonstrate that we are more than profit, much more. It’s a challenge that I’m hoping all of us want to embrace.