A comprehensive income tax base

One of the most important and obvious areas for reform of Australia’s system of taxation involves the removal of the many special exemptions and concessions to the measure of taxable income so as to broaden the tax base, or taxable sum, as part of a package with lower tax rates. Such an idea was behind the successful reform package implemented by the Hawke government in 1985, the US in 1986, and in many other countries.

Over time, politicians have succumbed to requests for special exemptions and deductions which advantage the rent-seeking pressure group at the expense of the rest of society.

A comprehensive and broad based income that treats a dollar as a dollar for income taxation, regardless of how and where it is earned, secures future revenues, removes distortions to decisions and promotes greater productivity, achieves horizontal equity in sharing the tax burden across society, and is simpler and less costly to administer and comply with.

Under a comprehensive tax base for labour income, all sources of remuneration would be taxed at the same rate as wages and salaries. In this vein, reform would remove the current concessional tax treatment of remuneration taken as fringe benefits, and this would have the further advantage of removing distortions with adverse environmental effects favouring the excessive use of motor vehicles, lower rates applying to some lump sum payments, and concessions for income earned in remote areas.

Another reform option is to remove the current ad hoc list of deductable work related expenses and use the revenue gained from taxing a larger taxable income to fund lower tax rates. Examples of the ad hoc features of allowable and non-allowable work related expenses include: deductible travel expenses from one place of work to another, but not from home to work; deductibility of child care if attached to the business, but not if in an independent location; deduction for uniform/clothing expenses in some occupations and industries but not others; and a deduction for self-education expenses if employed, but not if unemployed. Such a reform would greatly add to simplicity and reduce the need for over 75 per cent of Australian taxpayers to spend over $1 billion a year on tax professional advice.

The present flat rate system of taxation of superannuation is highly regressive. A tax of 15 per cent is imposed on wage and salary income allocated to superannuation, and the earnings on the fund are taxed at a 15 per cent rate (and down to 10 per cent on capital gains) regardless of the individual’s level of income and superannuation wealth. Two reform options which would tax superannuation similarly to the taxation of savings invested in owner occupied homes, and both are important ways of providing retirement incomes, are to tax all funds entering superannuation at the individual’s personal income tax rate with no further tax, or to tax all withdrawals from superannuation at the individual’s personal income tax rate.

Income earned as capital gains receive tax concessions worth billions of dollars a year relative to the taxation of most other forms of income earned on other saving and investment options.

Concessions include the halving of the tax rate, deferral of tax paid until capital gains are realised, and for small businesses there are a number of allowable capital gains where no tax is payable.

While taxpayers at all levels of income do earn capital gains, a disproportionate share of the aggregate dollar sum of declared capital gains is for those on relatively higher incomes. The lower tax burden on capital gains, relative to other saving and investment options induce the reallocation of investments in these options in order to reduce tax payable and away from more productive for society investment options.

While the business income reforms of 2000 based on the Ralph Committee Review went a long way to establishing a comprehensive business income tax, and funding reduction of the corporate tax rate from 36 per cent to 30 per cent, a number of special exemptions and deductions remain. Details are provided in the Treasury Tax Expenditure Statement 2008 (available at www.treasury.gov.au). Removal of the special concessions and deductions on measured business income would remove tax-induced distortions to business investment and production decisions with a resulting improvement in national productivity.

The second important part of an income tax reform package involving the removal of special exemptions and deductions from the taxable sum is the lower rates it can finance while collecting about the same aggregate amount of revenue. Since the base broadening measures are relatively more important for higher income tax payers, the rate reductions to retain current broad vertical equity of taxation will be greater as we move up the income tax rate schedule.

In the case of individual taxpayers, they gain from the carrot of lower tax rates and lose from the stick of lost special exemptions and deductions. Inevitably, within each tax bracket there will be some winners for whom the carrot exceeds the stick and some losers for whom the stick exceeds the carrot, but for many the stick and carrot of the reform package will approximately balance.

Overall, the package of a broader tax base with less special exemptions and deductions and lower tax rates is a positive sum game. Efficiency or productivity gains come from the removal of distortions to individual and business decisions associated with removal of the tax breaks and the lower rates, and from reduced incentives and rewards for tax avoidance schemes. The greater simplicity reduces the need for expensive professional tax advice and releases these skills for more productive employment.