With Federal Treasurer Wayne Swan indicating carbon, mining and the GST are off the agenda for October’s tax summit, it’s been suggested there’s little left to talk about.
Of course that’s not the case. Our tax system desperately needs reform. The summit should focus on Australia’s most important tax: income tax. It should build on the substantial work carried out by the Henry Tax Review, released last year.
It is easy to forget, among all the noise about “big new taxes”, that the income tax raises 80% of federal tax revenues – estimated to be $216 billion in 2010-11. That is 60% of all taxes raised by local, state and federal government. The personal income tax raises two thirds of income tax revenues.
Here are five personal income tax reforms that should be on the table at the Tax summit, to make our income tax fairer, simpler and more sustainable for the future.
1. Reform income tax rates for the benefit of low and middle income earners
Reduce high effective tax rates that apply to low and middle income earners. Current tax rates range from zero (on a low tax free threshold) to 45% plus the Medicare levy of 1.5%. Overall, this progressive tax rate structure is fair, but it is complicated by an array of tax offsets and adjustments. More importantly, its interaction with the transfer, or welfare, system causes problems.
High effective tax rates are caused for low and middle income earners by phasing out welfare benefits as income is earned, combined with tax rates on low and middle earnings. This affects women caring for young children, the long-term unemployed, and older Australians who want to keep working. Women caring for young children especially face a tax-benefit squeeze when they go back to work, usually part-time and at low to middle wages.
One option for reform proposed by the Henry Review is to create a large tax-free threshold of $25,000 and flatten tax rates a little, while removing complex tax offsets. This is simpler, but other options should also be considered. The best value for my tax reform dollar would be for a progressive income tax to fund universal benefits for carers of young children. This would distribute the cost of care more fairly and end high effective tax rates applying to carers - mostly women - who return to work, generating a productive dividend as women apply their skills fully in the Australian economy.
Some commentators want to lower the top tax rate. But we’ve already raised the threshold for the top rate significantly, to $180,000. There is no evidence that a lower top rate would increase economic participation. It would undoubtedly make the system less fair. Research by economists AB Atkinson and Andrew Leigh strongly suggests that lowering the top rate would increase the share of total income owned by the richest 1 percent of Australians, further widening the economic gulf between a rich minority and the rest of us.
2. End work-related deductions for most workers
A key tax reform goal is to simplify drastically tax filing for most individuals. More than 12 million people file tax returns and more than 70 percent get tax agents to help. A key factor is work-related deductions. More than 8 million of us claim them every year.
The tax summit should end work-related deductions for most workers, by adopting a realistic Standard Deduction for individuals – more than the $1,000 per year already proposed by the government. Alternatively, this could be rolled into the tax rate reform. Most Australians would only have to file a short electronic pre-filled tax return, or no return at all.
3. Repeal the Fringe Benefits Tax
The summit should adopt the Henry Tax Review’s recommendation to repeal Australia’s massively complex Fringe Benefits Tax (FBT). We need to simplify the valuation rules for non-cash work benefits, and tax them in the income tax, using the Pay as You Go system. End the inequitable and perverse FBT concessions in the process – including the current subsidy for driving work-provided cars more miles.
Its important to make sure that Australia’s not-for-profit sector is not disadvantaged by FBT reform. Not-for-profit organisations depend on packaging FBT concessions – including the car subsidy - to generate attractive salaries for staff. A creative solution is needed: perhaps a direct subsidy to not-for-profit organisations to fund a new wage deal, or a tax credit for workers at not-for-profits.
4. Reform tax rules distorting housing and investment
Housing and investment choices are distorted by the income tax system. The combination of the capital gains tax 50 percent discount, the ability to negatively gear investment in rental property, and poorly designed State housing taxes, contributes to Australia’s lack of affordable housing.
The Henry Tax Review recommends keeping the main residence exemption, but reforming income tax rules for investments, including in rental property. The summit should adopt the recommendation of a 40 percent discount on net savings income. Investors would net off their income and gains on investments, against expenses and losses on those investments. A 40 percent discount would apply to net savings income.
5. Adopt a new federal-state income tax sharing deal
Finally, State taxes need reforming and it is time for a new federal-State intergovernmental agreement on taxes. The new agreement should aim to share a proportion of federal income tax revenue with the States. In exchange, the States would be required to carry out key tax reforms including the abolition of stamp duties. Land tax needs reform so that it applies to all real estate, including the main residence, at a low flat rate. State governments would, at a stroke, be funded by a fairer and more efficient tax system if this could be achieved. The current deal to share the GST should stay in place.
Does it matter that the carbon tax, the mining tax, and the GST are not on the agenda for the tax summit? No. Ross Garnaut has suggested that carbon tax revenue could fund income tax cuts for low and middle earners. But we have yet to see how much revenue a carbon tax will generate after compensating the big polluters. As for the mining tax, negotiations between the federal government, big miners and State governments should go ahead urgently, and need not wait for the summit. Excluding the GST from debate at the summit does mean that some big reforms are off the table. In particular, the substantial income tax cuts that some are seeking would likely need to be funded by an increase in the GST rate, say to 15%.
Nothing to talk about at the tax summit? You must be joking. Let’s get debating about how to make the income tax fairer, simpler and sustainable for 21st century Australia.
Associate Professor Miranda Stewart teaches and researches tax law and policy at the Law School, Melbourne University.