First of all, a bit of history. The Coalition Government in its first budget after being returned to the Treasury benches in 1975 introduced the indexation of the scale used for taxing personal incomes.

The then Treasurer, Mr Howard, in his August 1976 Budget Speech lauded tax indexation in the following terms:

"It represents perhaps the most significant reform of the personal income tax system in our time."

STOCK VALUES

A limited system of stock value adjustments was also introduced. Despite the fact that the legislation then in place did not really deal adequately with the taxation of business transactions the move was widely welcomed. A first step appeared to have been taken towards ensuring that only real profits rather than illusory nominal profits were to be subjected to tax. BRACKET CREEP

As the then Prime Minister, Mr Fraser, pointed out at the time, tax indexation was meant to keep governments honest, forcing them to go to Parliament when they wished to increase tax collections.

He said that they would no longer be able to rely on a graduated scale of personal income tax to produce increased yields each year without this being obvious to the bulk of the electorate. It was felt undesirable that each 10 per cent wage rise should automatically produce a 20 per cent tax rise.

Tax indexation, by eliminating such windfall gains to the authorities, was also seen as a useful device to strengthen the resolve of governments to fight inflation.

In subsequent years the Coalition became less enthusiastic about tax indexation - the desire to keep budget deficits low seemed then to be more important than having an equitable tax system. The Coalition chose to overlook the fact that the correct way to increase personal income tax collections was to increase the rate of tax in the dollar, rather than to abandon or downgrade tax indexation.

CHOICE OF INDEX

Consideration should also be given to introducing a more appropriate index for tax indexation purposes than either the Consumer Price Index or the device used at the time, namely, the Consumer Price Index discounted for various items. The best available index would appear to be Average Weekly Earnings, as this has maximum regard to inflationary movements in taxable incomes.

THE TAXATION OF BUSINESSES

For commercial transactions it is most important that the tax base should be correctly chosen so that only real profits are assessed. A business enterprise cannot be considered to have made a true profit unless the net worth of the proprietor at the end of an accounting period exceeds the proprietor's net worth at the beginning (apart from moneys put in or taken out).

The taxation of illusory profits amounts to a levy on capital and not on income.

An inequitable tax system also encourages companies to adopt inadequate bookkeeping procedures and in effect to pay dividends out of capital. In this way the nation's capital base is being eroded, leading to serious long term consequences for the nation.

A BACKWARD STEP

The tax reform relating to stock values did not last very long. The then Treasurer, when announcing the withdrawal of the trading stock value adjustment in 1979, said:

"There is evidence that many businesses, taking the view that the stock valuation adjustment was an outright tax concession, have applied benefits from it to increasing reported profits."

There is little doubt that he was justified in this particular criticism. Far too many companies chose to maximise their published net profits by taking full advantage of the lower tax derived from a correction to conventional profits, while not being willing to make the corresponding adjustment to the gross profit figures themselves - an inexcusable inconsistency.

BOARDS OF DIRECTORS

Many company directors seem unwilling to adopt inflation accounting on the grounds that taxation is levied on conventional profits and that no change in presentation is appropriate until the tax legislation is amended.

This is a "back to front" argument. The Government would be much more likely to correct the tax injustice of the present system if the published profit results of business enterprises demonstrated the unfairness of the high rate of tax per dollar of real profits being paid by many businesses.

INEQUITIES IN THE PRIVATE SECTOR

Inflation affects different industries in different ways and the tax approach in current use is also quite inequitable as between different industries. The trading stock value adjustment referred to above was not an arbitrary tax concession - it was a genuine attempt to achieve tax neutrality.

If a government feels that it must raise a particular sum of money from company taxation then it should adjust the rate of tax rather than persevere with an incorrect tax base.

The trading stock value adjustment should never have been removed. It should now be restored, but using a 100 per cent figure rather than the 50 per cent rate which formerly applied.

TWO OTHER NEEDED REFORMS

A depreciation value adjustment to reflect the increased cost of replacing fixed assets at a time of inflation should also be introduced.

Furthermore, a tax deduction should also be made available to the holders of net monetary assets in recognition of losses from inflation suffered by them. Correspondingly, gains from having net monetary liabilities would need to be made assessable.

SUMMARY

The changes recommended above should be introduced to ensure that only real increases in net worth become subject to taxation. The present system, involving the payment of tax on non-existent profits, is most unjust.

Inflation cannot be eliminated and it is therefore most important that its effects should be made more tolerable for the community. All the reforms discussed in this paper are long overdue.