The financial system’s ability to allocate funding and risk efficiently is central to promoting a higher trend rate of economic growth. The financial system does this by: providing funding for business investment and innovation; enabling businesses, households and governments to smooth their cash flows and make large asset purchases; and facilitating the transfer of risk to give agents greater certainty to undertake certain economic activities.

Figure 3.1 shows a high-level representation of the supply and use of funds in the economy. Suppliers of funds provide savings to users of funds through markets and intermediaries. This chapter deals explicitly with the components in Figure 3.1 in bold type. They represent major issues raised in submissions to the Inquiry.

Figure 3.1: The supply and use of funds in the economy

This figure is a flow chart showing the supply and use of funds in the economy. Funds are supplied from overseas, households, non-financial corporations, unincorporated business and government. These funds flow to markets (loans, deposits, bonds, equities and other). Through markets, funds flow to and from intermediaries (ADIs, superannuation funds and other) and to users of funds (overseas, households, non-financial corporations, unincorporated businesses and government). Funds are used for consumption, gross fixed capital formation, second-hand asset purchases, research and development and cash flow management.

Assessing allocative efficiency

It is difficult to assess and quantify the effect any inefficient allocation of funding and risk has had, and is having, on economic growth. It is also difficult to identify what an efficient allocation of funding would look like. The best way to ensure resources are allocated efficiently is to allow relative prices to perform their allocative function. The Campbell Inquiry placed particular emphasis on this mechanism to facilitate a better allocation of funding and risk in the economy; this Inquiry sees no reason to change this emphasis.

The Inquiry has examined potential impediments to prices performing their primary function and has identified three main sources of distortions: taxation, regulation and other market imperfections. The Inquiry has explored these distortions by examining the saving, investment and funding choices of households, businesses, governments and financial entities, and the functioning of certain financial markets.

The Inquiry has identified a number of taxes that may distort the demand for and supply of funding in particular sectors, and may distort the broader allocation of funding and risk. This chapter explores these issues in more detail. The Inquiry has also identified other taxes that may adversely affect outcomes in the broader financial system. A summary of these tax issues is in Appendix 2 (Tax summary). Those issues that are not currently under active Government consideration should be considered as part of the Tax White Paper process.