The economic case for tax reform

Our top rate of almost 50 cents in every dollar is pernicious and is increasingly out of line with other Western countries. The wealthiest people in the country don't even pay it: they take advantage of the much lower 30 per cent company rate, and they further reduce their tax liability by exploiting myriad loopholes and concessions scattered through 9,000 pages of tax legislation. There are now so many special allowances and exemptions (another 100 have been added since 1996) that tax law has become almost indecipherable.

Another problem is tax on retirement savings. Australia is the only country in the world that taxes superannuation when money is put into a fund, when the fund earns profit, and when the money is withdrawn. By raiding people's super in this way, the Government is shooting itself in the foot, for retirees who could have been self-reliant will end up with inadequate savings and will then have to be supported with a government age pension.

Professor Ross Garnaut, no right wing ideologue, nearly a decade ago showed how Australia could achieve serious tax reform by a gradual move down in marginal rates of income tax. Garnaut in 1997 presented a paper called Investing in full Employment to a meeting of the Business Council of Australia. In this important paper he pointed out that:

... the social security system has become increasingly comprehensive, with a relatively small number of Australians outside employment now being denied benefits, and with many people in employment now receiving benefits.

Furthermore:

Australia is approaching the stage where personal income tax and social security transfers together can almost be seen as one system of income redistribution, with one being applied almost entirely to the financing of the other, and together contributing little revenue to finance the general purposes of government.

This issue of tax and welfare “churn” is widely seen as a major area for reform. The consequences are considerable.

Ad hoc and separate growth and change in social security and tax have led to a total system that is now highly damaging to economic growth and to full employment. Integrated reform of the tax and social security systems is now centrally important to any program to restore full employment and to raise economic growth on a sustained basis.

In particular:

High marginal income (including capital gains) tax rates at all levels in the income range inhibit productivity growth in Australia. At higher levels in the range they inhibit personally risky innovation. They reduce the competitiveness of Australia as a base for footloose, high-skill industries. In addition, the divergence between corporate and income tax rates introduces uneven opportunities for avoidance that reduce community respect for the taxation system

High effective marginal tax rates (EMTRs) at lower incomes inhibit productivity growth, are a major deterrent to labour force participation, and block the labour market deregulation that is necessary for full employment. Here the problem of high effective marginal tax rates derives from the interrelationship of the tax and social security systems. This inter-relationship generates severe "poverty traps". It is a tribute to the foresight and work ethic of Australians that low-skill people enter the labour force at all, since for some millions of Australians the short-term net financial benefits of doing so are small and often negative when the additional costs of going to work (including transport and clothing) are taken into account. High EMTRs also introduce large incentives for tax evasion through employment in the "black economy".

We must acknowledge that the government has tried to do something about high EMTRs, mainly by reducing means test tapers. It reduced FTB Part A taper at bottom end of income range from 30 per cent to 20 per cent at the last budget, and Parenting Payment taper has been reduced from 50 per cent to 40 per cent. But this only creates problems elsewhere, for flattening the taper necessarily extends the range of incomes over which it applies, thereby dragging more affluent people into high EMTRs trap. This shows just how difficult this problem is to deal with in our current system with such widespread tax/welfare churn.