Treasurer Joe Hockey speaks about the tax discussion paper in Melbourne.
AAP: Tracey Nearmy
Australia is currently a nation of over-indebted tax-dodging landlords with an underclass of renters - but with a better tax system, it could be a country where hard work and financial prudence is rewarded, writes Michael Janda.
The Treasury's discussion paper highlights two key issues around taxation that need to be front of mind if this Government is serious about genuine reform.
The first is how much tax Australian governments - federal, state and local - need to raise.
On the evidence available, "more" should be the answer - not that you'd know it from the foreword, clearly more the Government's creation than Treasury's, which states the aim of the "Re:think" tax review as being to "deliver taxes that are lower, simpler, fairer".
The aim of "lower" taxes seems more ideological than empirical.
Australia's budget deficit is ballooning mainly due to revenue write-downs rather than surging spending, with slower economic growth and slumping export prices seeing multi-billion-dollar cuts in expected income and company tax receipts every six months (as explained by regular Drum columnist Greg Jericho ).
The weight of economist opinion leans firmly to the view that the Howard government's tax cuts, the last of which were matched by the Rudd government, went too far in returning the benefits of the mining boom, creating a structural deficit that is now all too apparent as economic conditions turn down.
Furthermore, Treasury's discussion paper states that Australian taxes aren't high, at least by developed nation standards:
Australia's aggregate tax burden is relatively low compared with other developed countries, but higher than some of our major regional trading partners, at around 27.3 per cent of GDP in 2012.
A single average wage earner in Australia faces an average tax burden of 27 per cent. In comparison, the average tax burden in Canada, the UK and the US is around 31 per cent.
Assuming then, as the evidence suggests, that lowering an already relatively low and fiscally insufficient overall tax take should not be a focus of the current tax inquiry, the key issue to look at is the distributional and behavioural impacts of the tax system.
It just so happens that these two key issues often coincide, through differing tax rates that encourage many people to behave and structure their finances in particular ways - methods that are often only viable for those on higher incomes.
The report terms this "tax planning", and defines it thus:
'Tax planning' refers to the use of legitimate, legal strategies to reduce the amount of tax paid.
'Legal', yes, otherwise it would be classed 'tax avoidance'. But 'legitimate' is, I think, something that this inquiry, and the community, have to carefully consider.
For example, one note of caution that Treasury sounds over lowering the corporate tax rate is the additional incentive for tax minimisation that it would create:
A reduction in the corporate tax rate would exacerbate the existing disparity between the corporate rate and the highest marginal tax rate. this would increase incentives to engage in tax planning.
Overall, Treasury still sees a potential benefit to the whole economy from cutting corporate tax because of the extra investment and economic growth its modelling suggests would be generated.
However, while trusts, income splitting and using lower-taxed companies to cover many day-to-day living expenses are still widespread tactics by which better off Australians avoid paying tax at higher individual tax rates, it is understandable why PAYG taxpayers are loath to see company tax rates cut further.
Such tax planning not only reduces the progressivity of the income tax system, but also adds to economic inefficiency because of the amount of time that goes into finding the loopholes and setting up the trust and company structures that facilitate these schemes.
Some tax planning is also downright dangerous for the economy.
Nowhere is this more obvious than in
the taxation arrangements around savings which not only encourage huge levels of personal debt but also simultaneously discourage the domestic bank savings that could more safely fund these loans.
At one end of the spectrum, savings held in the family home are taxed at average effective tax rates approaching zero.
At the other end of the spectrum, savings held as financial deposits are taxed at full marginal rates, without any recognition for the costs of inflation.
(Of course, an extra tax on savings accounts to fund the bank deposit guarantee would further increase this disparity).
Somewhere in between is investment property, a relatively new Australian investment obsession of the past two decades, where Treasury's paper estimates an effective marginal tax rate roughly half that paid on bank deposits.
Photo Nominal effective marginal tax rates by savings vehicles
Tax discussion paper
Negative gearing cops most of the flak in the press, but Treasury shows how it is actually the 50 per cent capital gains tax discount that results in taxation savings.
However, it is negative gearing that makes the investment possible for many people in the first place, and also negative gearing that encourages many people to take on far more debt relative to their income and assets than is prudent.
As highlighted in the discussion paper, rental expenses (including interest payments) are the second biggest type of deductions after business expenses.
Unlike business expenses, which are unsurprisingly lower than business income, rental deductions in recent years now comfortably exceed total rental income.
Photo Major sources of income and deductions, 2011-12
Tax discussion paper/ATO
This highlights what the current tax system is doing in housing - facilitating a loss-making investment class that relies entirely on capital gains taxed at a discounted rate for its returns. In short, it's a Government-sponsored Ponzi scheme.
For now, the interaction of these two policies, probably more than anything else, has also encouraged the capital gains that keep the pyramid from crashing down on those at the bottom.
"Any additional savings in housing would amount to additional investment in housing and, given housing supply constraints, lead to increased house prices," Treasury concluded.
However, while keeping the scheme afloat for now, these two policies are also overwhelmingly benefitting higher income earners, nearly a quarter of whom have negatively geared investment properties versus less than 15 per cent of taxpayers on average incomes (a figure which probably understates the disparity ).
Photo Proportion of tax filers with negatively geared investment properties, split according to taxable income
Tax discussion paper
Not that the well-off actually need a lot of help.
While it is true that the top marginal tax rate in Australia is currently 49 cents in the dollar (45 per cent, plus the 2 per cent Medicare levy and a temporary 2 per cent budget repair levy), that rate only applies to every dollar earned above $180,000.
The Treasury paper shows that even someone earning $200,000 per year only pays just over a third of their earnings in income tax - and that's assuming they haven't engaged in any 'tax planning' to further lower that bill.
When you look at Treasury's graph on average tax rates, it is noticeable how much steeper the gradient is in average tax rates for low and middle-income earners than it is for high-income earners.
Photo Average and marginal tax rates
Tax discussion paper
This should be a key focus for the tax review, as it is surely this group where workforce participation can most be boosted by decreasing disincentives to work more.
By focusing on the intertwined issues of incentives and income distribution, this tax review could start turning Australia away from being an economically precarious nation of over-indebted tax-dodging landlords with an underclass of renters into a country where hard work and financial prudence is rewarded.
Michael Janda is an online business reporter with the ABC.