Some taxing challenges for the Henry Review
by Peter Davidson
Senior Policy Officer, Australian Council of Social Service,
the national peak body of organisations working with low income groups
Treasury Secretary Ken Henry said recently that compelling reasons were needed to pursue major tax reform. Here are three: To raise the revenue future Governments will need to meet the costs of an ageing population; to raise tax on the basis of people’s ability to pay; and as far as possible to reduce the effect of taxes on people’s decisions about how much to work and how much to save.
ACOSS has developed benchmarks to assess the Review Panel’s proposals on this basis (see box). Governments already struggle to ensure that all Australians have a decent income, secure housing, and access to a doctor when they need one. Treasury has estimated that in 40 years time, the Federal Government will need $40 billion more just to maintain existing health and aged care programs and to fund age pensions. Fortunately, Australia would not have to lose its low taxing status to achieve this – our overall tax take is $60 billion below the OECD average. So our first benchmark is that public revenue should rise as a proportion of GDP as the population ages.
Fairness is the currency of tax reform. Most people don’t understand the tax system well but they do have a view on what’s fair and know when they’ve been taken for a ride. On paper, we have an income tax system that taxes people according to ability to pay – the well off pay tax at higher rates than those who struggle to pay the bills every month. In reality, the tax scales are a façade behind which people bargain down their tax bills.
To illustrate, let’s compare the tax affairs of Richard on $200,000 a year and Susan on $50,000. If both received a bonus, then in theory Richard would pay tax on this at 45% plus the Medicare Levy and Susan would pay 30%. But Richard is well advised. He can ask the company to transfer the bonus to his private super fund where it’s taxed at a flat 15%. Or he can borrow to invest $100,000 in an emu farm at 10% interest and make the tax on $10,000 disappear. He wouldn’t be taxed on the capital gains until he sells up many years later, and even then at the discounted rate of 23 cents in the dollar. Or he could contract his services through a private company and pay tax at a flat 30%, or split income with his partner through a private trust.
The tax on Susan’s bonus is deducted automatically from her pay and as a sole parent she has mouths to feed, so can’t afford to invest for the future right now. She sticks to the letter and spirit of the tax law and pays tax at 30 cents in the dollar, more than Richard in most of the above examples.
Both Richard and Susan also pay tax when they buy things. Around 27% of tax revenue comes from taxes on consumption. Susan has to spend most of her income to live, so she pays more consumption tax as a percentage of her income than Richard does. When these are added to the mix, we have something close to a flat tax regime. ABS data indicates that the bottom 40% of households pay 26% of their overall income in taxes, compared with 33% for the top 40%.
We have an income tax that doesn’t tax income consistently and consumption taxes that are regressive in practice. So our second benchmark is that different forms of income should be taxed more consistently, so that all pay their fair share.
This should lead to an overall increase in the share of tax collected from high income earners and overall reductions in the share from low and middle income earners.
Some argue that it would be fairer if we gave up on taxing income and taxed spending instead. The basic difference is that incomes from savings and investments would no longer be taxed. The argument is that it’s unfair to tax returns from saving because this penalises those who choose to save. But we share the commonsense view that those with the greatest capacity to save also have the greatest capacity to pay tax. Share ownership may be widespread but the top 10% of taxpayers receive over 60% of all dividends and capital gains. Removing taxes on these incomes would be a windfall for the better off, which would be paid for by the rest of us.
Another argument for exempting income from savings from tax is that this would encourage people to save more. Evidence for this is thin. Economic researchers have been unable to provide clear and consistent estimates of the effect of income taxes on household saving. Australia exempted superannuation from income tax for many years but it was only when people were compelled to save via the superannuation guarantee that contributions rose substantially. Similarly, our slightly-above-average company income tax rate has not stopped foreign investment in Australia from rising from 80 to 150% of GDP over the last 15 years.
How the top personal marginal rate (above) and the company tax rate (below) have declined 
Source: ‘Australia’s future tax system’, Australian Treasury, http://taxreview.treasury.gov.au/content/Paper.aspx?doc=html/publications/papers/report/section_4-01.htm, accessed 28 January 2010.
Tax doesn’t seem to have a big impact on overall levels of saving, investment or hours worked. But it has a profound impact on where people choose to save or invest, and how they package their salaries. This is where serious economic harm is done. A good example was the surge of borrowing to finance investment in rental property earlier this decade, which at one stage grew by a third each year. Australian investors have an addiction to property speculation during economic booms. This is due to many factors, including easier access to credit. The tax system also played a part, through the halving of tax rates on capital gains from 2000 and the ability of investors to deduct all of their annual investment losses against their wages (which are taxed at higher rates) or other incomes. So there is a mismatch between the tax treatment of income and deductions. The outcomes of the recent surge of speculative investment in property included steep increases in housing prices, a sharp rise in household debt, and higher interest rates. The rise in rental property investment was mainly focussed on inner city and coastal resort apartments, so it did little to improve access to low cost housing. It arguably made matters worse by exaggerating the housing cycle – we experienced a stronger boom followed by a deeper trough.
Dr Henry points out that income from savings and investments are already taxed less than wages. He suggests that there may be a case for continuing to do so to take account of the effects of inflation on investment returns. This may be so, but no-one has presented a convincing argument for taxing overall investment incomes even less than they are now. For example, owner-occupied housing is hardly taxed at all, tax concessions for superannuation cost around $25 billion each year, and capital gains are taxed at half the normal rates.
Even if we are unable to tax all incomes at the same progressive rates, at the least we should remove the shelters and loopholes that encourage people to shift their money around in search of the lowest tax rate. One way to tax income more consistently is to reduce tax rates on investments to the lowest common denominator, for example by taxing bank interest and dividends in similar fashion to capital gains. But if Susan pays tax at 30% on her wages, then she is unlikely to think it is fair for a high income earner to pay less than this on his investments. Such a “levelling down” of tax rates could also be very costly. The challenge ACOSS is posing for the Review is to come up with ways to “level up” the lowest tax rates faced by the well-off, starting with such areas as capital gains, superannuation contributions and housing. If the report is to provide a template for fair and efficient tax reform for the next decade or more, it should tackle some of the hard issues.
ACOSS: Benchmarks and strategies for progressive tax reform
|
ACOSS released a paper in November outlining the key benchmarks for an equitable tax system to be put to the Henry tax panel:
Progressive tax reform: Reform of the personal income tax system - go to http://www.acoss.org.au > Publications > Papers > Economics & Tax.
Further information on tax reform for the community sector can be found at http://www.taxwatch.org.au/communitytaxforum
Source: Australian Options, Issue 60, Autumn 2010, pp. 3-5.