The Abbott Government will shortly release a discussion paper on the Australian tax system. It will be the first step towards the much anticipated tax white paper. International factors should figure prominently in the white paper — specifically, how to ensure that Australia has a resilient tax system given the challenges of globalisation.

Treasury Secretary John Fraser recently said our tax system looks 'remarkably like it did back in the 1950s – but our economy looks very different'. How true.

Among the most significant changes are the internationalisation of the Australian economy, and the influence of technology. Australian exports and imports as a share of GDP have increased from 30% in the early 1960s to around 45% now. But this figure does not do full justice to the extent to which Australian business and consumers operate across national borders and participate in the global economy. 

The integration of economies and a global rather than a national approach to doing business is challenging our tax system.

For example, the underlying principle of corporate tax is that firms pay tax where economic activity takes place. This was fine when goods were entirely produced in Australia. However it is not so clear when inputs – both goods and services, such as R&D, advertising, marketing and intellectual property rights – are sourced from many countries. Increasingly, this involves companies operating production across many national borders. When there are such intra-company operations it can be difficult to determine the value-add and tax liability in each jurisdiction. Companies can readily manipulate prices in intra-firm operations.

The Government has countered with transfer pricing rules which seek to apply an arm's length principle to value related party trading. But this is increasingly difficult when intangibles, such as unique intellectual property rights, are a major part of the production process. As a guide to the rising importance of intangibles, in 1978 the asset distribution of S&P 500 companies was 95% tangible assets, 5% intangible. In 2010, the breakdown was 20% tangible and 80% intangible.

The breakdown of the production process across many countries and the increasing importance of services and intangibles in international trade makes it easier for firms to shift profits to zero or low tax jurisdictions. Combating corporate 'base erosion and profit shifting' is a G20 and OECD priority. But the resilience of the corporate tax base is particularly important for Australia given its high reliance on corporate tax. From 1983 to 2011, the OECD average corporate tax rate as a percent of total revenue remained around 8.5%. But Australia's corporate tax revenue rose from 9% of total revenue to 20% over the same period.

Another aspect where international developments will loom large is the competitiveness of the Australian corporate tax rate.

Australia's corporate tax rate is 30% compared with an average 23.5% in the Asia Pacific and an OECD average of 25%. The UK has recently cut its rate to 21%. If the international community is successful in combating base erosion and profit shifting, and taxes are actually paid where economic activity takes place, then economic activity (investment) will increasingly shift to countries with low corporate tax rates. The 2009 Henry Report on the tax system recommended that Australia's corporate tax rate be lowered in order to ensure that Australia remains an attractive place for investment.

The breakdown of national borders is also impacting the resilience of the GST. Online shopping has grown rapidly, with 75% of Australians who shop online making purchases from overseas sites. The total value of overseas online purchases falling below the threshold of $1000 when GST is to be applied was more than $7 billion in 2012-13. Australian retailers have argued that the low-value threshold should be lowered, although both the Productivity Commission and the Board of Tax concluded that the cost of collecting GST on overseas purchases below the threshold is prohibitive.

The challenges from online purchases from overseas are likely to grow. While Australia's online purchases have grown significantly, they still lag the US and UK markets.

In addition, it is one thing to impose GST on goods purchased from overseas; the GST is paid when the goods are released from customs. It is not so easy to impose GST on services and intangibles that are purchased overseas and delivered via the internet. This challenge is also likely to increase. For example, the spread of 3D printers could increasingly see patent rights purchased overseas and delivered via the internet , with the goods 'printed' in Australia. 

The global integration of the Australian economy and the spread of technology will not stop. More likely it will accelerate. As such, they must figure prominently in the tax white paper if Australia is to have a modern tax system for the 21st century.

Photo courtesy of Flickr user Tony Abbott.