Chart of the Day: Taxes are all wrong

There is nothing more certain in life than death and taxes: today’s chart will focus on the latter.

I consider taxation reform as the “only hope” for future productivity/microeconomic enhancements (as we’ve botched the macro as highlighted by House and Holes (and others here) regarding the MRRT and SWF), and these two charts, taken from the 2008 Taxation Review highlight the problems.

First, consider how 90% of all revenue is drawn from just 10 taxes – the “usual suspects”, whilst the remaining 10% comes from 115 taxes.

There are two major problems with this structure. On the one hand, the gross inefficiency and hazards involved in business and government having to deal with so many overlapping, complicated and such minor revenue raising red-tape. Fringe Benefits and Luxury Car Tax being a particular complete waste of time – the solution is a small increase in higher marginal income tax rates to “punish” the higher earners who want that Porsche. There are countless (actually 115) other variations of this ridiculousness.

On the other hand, the gross reliance on personal income tax (the largest bar of the 10) imbibes the system with fragility. This could be arrested by doubling the GST and increasing company and capital gain tax rates. (also in a future post I’ll show how wasteful the collection of most of this income tax is – in fact, for those earning up to $50,000 a year, it should be abolished)

Secondly, this combined chart of sources of tax revenue for States highlights a problem raised by Delusional Economics and The Unconventional Economist. A reliance on housing transactions (stamp duty) puts great pressure on State budget finances (who cannot rely on internal money creation and must resort to public asset sales (e.g QLD) or selling bonds directly (e.g NSW)).

Again, another problem – whilst a quarter of revenue comes from transactions, thus reducing capital productivity (and increasing speculation) and labour mobility (increases the cost of moving), another quarter of revenue comes from labour-killing payroll taxes.

A tax for employing more people…how interesting. Again, simply increasing the corporate rate of tax (especially for non-SME, i.e big business) would be a much more effective solution and would “free up” the countless brigades of tax accountants into more productive endeavours.

There are a myriad of solutions to these problems, with increased Federalism (i.e more revenue raised via Federal governments) the most likely outcome. The Tax Summit this year will also likely come up with no real solution, as business, labour, the public and politics on both sides have shown these last few years an intransigence against meaningful progress.

The other side of the coin is the wasteful and inefficient welfare/tax transfer system (which comprises nearly half of personal income tax), but that’s for another chart or two to discuss.

Comments

  1. Where do mining royalties get represented as a land tax ?

    Great charts, the more I read about the Ken Henry tax review, the more angry I get in regards both parties and the misplaced idealogies. They both parrot about productivity but push IR reforms or rollback of IR as the only method of productivity increases

  2. Walt Disney's Frozen Head

    We need a constitutional amendment banning payroll taxes.

    Do we have numbers on how much is spent on preparing tax returns?

    Do we have numbers on how much is spent on administering tax …presumably this would be the ATO budget plus various state revenue raising payrolls?

    Just wondering how much is spent on collecting the taxes from those 115 “other” categories.

    • I’ll be having a closer look at the report and doing some other research Walt to ascertain those figures.

      The reforms that required are relatively easy to come up with (and I think a Negative Income Tax should be the centre), but almost impossible to implement as they aggravate almost every sector, ideology and special interest group going.

      • You can’t do anything with a negative income tax that you can’t do with a basic income. For example, a flat 30% income tax with a threshold of $30,000, allowing the “tax” to be negative when income is below the threshold, is equivalent to a flat 30% tax with NO THRESHOLD combined with a basic income of $9000; either way, the graph of after-tax income vs. pre-tax income is the same.

        A negative income tax implemented through employers is available only to people in the workforce. You can similarly restrict a basic income by means of an activity test. But you can also use a different activity test if you wish. A basic income with a flat income tax has the further advantage that employers are not required to distinguish between “first” jobs and “second” jobs.

        Of course you can also combine a basic income with a consumption tax — as in the U.S. FairTax proposal.

        BTW, IANAL and TINLA, but requiring employers to collect PAYE income tax at their own expense is prima facie unconstitutional; see http://is.gd/erqeD .

      • Agree that in the end its better to have a flat rate and a basic income payment Gavin. Certainly easier on employers, and would ensure that people got TFNs sorted.
        Politically it might be a tougher sell. A simplified basic income also opens the opportunity to review the purpose and structure of minimum wages.

    • Agree on the payroll tax WDFH, not only is it distortive to business but also politically, state governements have an incentive to promote labour intensive immobile businesses. I seriously think replacing it with a 10% Co tax would be relatively simple especialy since Co registration is still a state function.

    • Re “We need a constitutional amendment banning payroll taxes”: IANAL and TINLA, but it is my longstanding opinion that payroll taxes, in so far as they fall on labour embodied in goods, are duties of excise in violation of s.90 of the Constitution.

      From http://is.gd/gstptu :

      In the last relevant High Court case, namely Ha v. NSW (1997), the majority held that an excise is “an inland tax on a step in production, manufacture, sale or distribution of goods”. If paying the workers is such a “step”, that definition would sink payroll tax.

      (The same definition, by the way, would also scuttle the existing State stamp duties on new cars and sales of livestock. The States like to live dangerously.)

      The three dissenting judges preferred a narrower definition of excises. In their view the purpose of s.90 was to “prevent impairment by the States of the common external tariff,” so that “A State tax which fell selectively upon goods manufactured or produced in that State would be an excise duty …” They added: “Whether a tax which falls upon locally produced goods discriminates against those goods in favour of imported goods is a question of substance, not form.” In substance, domestic payroll tax on labour embodied in goods manifestly discriminates against locally produced goods because it is not levied on the corresponding labour embodied in equivalent imported goods.

      Does it matter that payroll tax affects services as well as goods?

      Not under the majority definition, because the GST also affects services, and nobody is suggesting that the States could have imposed the GST; that’s why the Commonwealth imposed it and handed over the revenue. Under the minority definition, the question is whether a law forbidding discrimination against local goods can be circumvented by discriminating against local services as well. One should hope not.

  3. One thing that is worrying me is the lack of death tax in Australia.I find counterproductive to see heirs getting control of strategic media empire/businesses/mines or receiving houses and letting them empty as there is very little cost keeping them.coming from the right spermatozoid/vagina should not be a reason for fortune especially when it is against national interest

    a proper death tax would renew some ownership and should at least be equal to capital gain.

    • This is another argument in favour of a consumption tax (see http://is.gd/prog4ct below). Under an income tax, inheritances get exemptions or concessions, because it is accepted in all polite company that riff-raff whose parents die poor should pay higher tax rates on their wages in order to relieve the poor darlings whose parents die rich. At least a consumption tax is indifferent as to whether taxable consumption is financed out of earned income or inherited income.

    • I don’t agree with a death tax, but I am biased as my father is 4th generation farmer and I will be 5th. A death tax would often mean cutting the farm up.

      I think that instead should be a blanket wealth tax, of 0.5% to 1.0% of all one’s wealth each year. This is an alternative to a 20% or 50% tax on all of one’s wealth, once only, when they die. (This is not my original idea – I read it once, can’t remember where).

      I don’t know whether it would be better to tax one’s capital or one’s equity (capital minus debt). Probably equity would be fairer, although this may perversely encourage debt.

      It is unfair that some capital may attract a wealth tax of over 2% (such as land tax plus council rates if one owns a sizeable property portfolio in one state), whereas other capital attracts no wealth tax (such as shares). Both get taxed on income, but that’s separate.

      • Gavin R. Putland

        The assets subject to a “wealth tax” must be indestructible, irreplaceable and immobile. Otherwise the tax will be avoided to some extent by destoying the assets, or by failing to produce or maintain or replace them, or by moving them offshore. You can’t have a “non-discriminatory” tax on assets if the tax is avoidable for some assets but not for others, because the asset owners will respond to the tax in a discriminatory way.

      • Same problems apply to a death tax.

        Most assets that people own, apart from uninsured consumption items, are on a public record somewhere (shares, property, bank balance, the amount that the car or the contents are insured for).

        I suppose it is difficult to accurately value a business that is not publicly traded, and gold bullion buried in the back yard would difficult to detect and tax too. Again – same problems for the death tax.

        People moving assets to Switzerland via the Cayman Islands will continue to be a problem, but it is a problem now too, and is already illegal. The ATO just needs to get better at catching people (as evidenced by TPG’s daylight robbery of CGT avoidance when selling Myer in its IPO).

  4. Great post Prince…dont agree with all your suggestions, but your willingness to confront tax reform and put forward some practical ideas on how to fix this mess is admirable.

    That breakdown of State revenue is crazy…State Governments are addicted to housing bubbles – and even with the bubble producing them insance amounts of revenue they have failed to provide the services they are responsible for.

  5. Prince, off this topic, but I want to trade on the TSX, but if I go through CommSec I have to pay 15% withholding tax, on any dividend no matter in the world the trade is to the IRS as CS broker (Pershing) is US based. Is there a better way to trade TSX?

    Thanks in advance.

    • It would certainly assist in sorting out agriculture and forestry. Although the transition would be very painful.

    • Ohhhhh! If only we had a government willing to listen to the best advice of Treasury! Gillard! Abbott! Ken Henry was offering you economic reform that would propel economic efficiency into the stratosphere and with profound social justice benefits.

      Remove 125 activity-sapping taxes and draw government revenues from economic rents: a federal Land Value Tax and the Resource Super Profits Tax.

      But both major parties genuflect before the rent-seekers, terrified of their material clout.

      Australia isn’t a genuine democracy, not yet.

      • And again, what happens to RSPT revenue when commodity prices fall? As i’ve said to you before the entire concept of ‘economic rent’ from which the RSPT is based has been completely debunked over a century ago. It is a completely unnecessary tax.

        A land value tax, however, should be implemented. My preference is certainty a combination of land and consumption taxes (ie a significantly increased GST), a simplified income tax system (no deductions, no tax free threshold and only 3-4 bands) and a reduction in corporate taxes as our corporate taxes are high and inhibit industry. Remove all the rats and mice taxes that do nothing but reduce efficiency.

      • Maybe it should just be a super profits tax. Why not have marginal tax rates for business as well?

  6. Having failed to interest the MSM in the following, I find The Prince’s timing opportune.

    As the Tax Forum is to be overshadowed by recession, participants should remember that all taxes suppress productive activity, except holding taxes on indestructible, irreplaceable, immobile assets, the returns to which are economic rent.

    A tax on any other factor of production can be avoided by destroying the factor, or by failing to produce or replace it, or by moving it out of the jurisdiction. A tax on transactions can be avoided by avoiding the transactions. All these modes of avoidance amount to lost production within the jurisdiction.

    Taxes that can be avoided in any of these ways are costs of production and must be recovered through prices if production is to continue. Hence they are inflationary. Hence they raise the non-accelerating-inflation rate of unemployment (NAIRU), the maintenance of which is the target of monetary policy.

    The most obvious tax on production is income tax. On the macroeconomic scale, income is production: national “income” is net national “product”.

    It follows that income tax raises prices. The widespread belief that income tax doesn’t feed into prices, while a consumption taxes does, is based on the assumption that if a consumption tax replaced income tax, GROSS wages/salaries would be held constant. Under that assumption, the personal income tax presently withheld from wages/salaries would instead be paid to employees, and the consumption tax would need to come from another source, namely higher prices. But if NET wages/salaries were held constant, the total funds presently paid to the government as PAYE income tax would instead be paid to the government as consumption tax; there would be no need for enterprises to find extra revenue, hence no overall price rise.

    In either case, prices charged by unincorporated sole traders would behave similarly to those charged by employers (due to competition for customers, and arbitrage between working for oneself and working for an employer).

    On the macro scale, income is production. But on the micro scale, on which income tax is assessed, one entity’s income can be another’s production. Such is economic rent. So an income tax, with appropriate inclusions and exemptions, can target economic rent and spare the returns to production.

    In practice, however, income taxes invariably do the opposite, because economic rent buys political influence.

    Thus capital gains get concessional treatment, although they overwhelmingly represent economic rent rather than capital formation (and although CGT resembles a holding tax in that the taxable gain accumulates while the asset is held). Meanwhile income from capital, which really does contribute to capital formation (and is a transaction or series of transactions), gets no such concessions.

    Thus, in Australia, current losses incurred in pursuit of capital gains (“negative gearing”) are deductible against wage income although they are not incurred in pursuit of wages, while commuting costs incurred in pursuit of wages are not deductible against them.

    A consumption tax by its very nature is indifferent to whether consumption is financed out of production or economic rent. So it is not so easily rigged in favour of rent-takers. This is an advantage not only in efficiency, but also in equity, because the flow of economic rent is highly concentrated towards the rich (e.g. in Australia in 2005-6, the top 1% of income earners got 5.3% of wage/salary income and 38.6% of net capital gains).

    The belief that consumption taxes are less equitable than income taxes is another symptom of the assumption that GROSS wages/salaries would be held constant in the transition. Under that assumption, the abolition of the progressive personal income tax would overcompensate high income earners for the price rise, and undercompensate low income earners. But if NET wages/salaries were held constant, there would be no price rise and no change in wage relativities.

    Using the industrial relations power (which is mostly in Federal hands under the corporations power), governments can ensure that net wages/salaries are maintained for existing appointments. New appointments can be subject to a new IR regime, preferably with an additional per-shift payment as an implicit loading for part-timers and casuals. This “shift bonus” would replicate the progressiveness of the existing system with respect to working hours, so that (e.g.) a worker on 18 hours/week would take home more than half the pay of an equal-ranked colleague on 36 hours/week. The shift bonus would also eliminate the need for minimum-shift rules.

    As the producers of “necessities of life” are not exempt from income tax, there is no need to exempt them from a consumption tax that replaces income tax on a price-neutral basis.

    All this could be done while leaving the existing narrow-based GST untouched, as the Government has decreed.

    Unlike income tax, a consumption tax does not reduce the return on saving and investment (expressed as the ratio of future consumption to present consumption). Thus it is more conducive to capital formation and less damaging to production.

    Of course a consumption tax suppresses production by reducing effective demand for products. But this effect, unlike the suppressive effect of income tax, is diluted by trade: as a consumption tax applies only to consumption within the jurisdiction, it discourages foreign production for importation, but does not discourage domestic production for exportation. Neither does it drive away capital used in production for global markets.

    Because other countries can impose their own consumption taxes, the trade advantage is a first-mover advantage, which makes action all the more urgent. The other advantages of a consumption tax are permanent.

  7. Eye-opening Prince. I have been aware for some time that the individual (and therefore family) is the most penalised entity in our taxation system but haven’t seen actual numbers like this before. One point to add or rather a question to pose – is it fair that individuals pay tax OUT OF INCOME, while companies are allowed to pay tax OUT OF PROFITS. It may be something of a practical necessity for business, but is there an underlying reason why it should be so for families? We also have to remember the historical origins of the company as simply a means of imparting limited liability to the already wealthy whilst retaining the potential for unlimited profit – most of these structures are there for legacy reasons and unlikely to be optimal.

    • Witchsmeller Pursuivant

      Just to clarify- “families” do fine. it is the individuals, without kids, that get flogged like the proverbial dead horse.

    • Sorry Georgie, but in the pie chart above its clear that gambling only (sic) generates 8% of revenue vs. 24% for stamp duty.

      I’d prefer they get none at all from either, but only on moral grounds from the former, and robustness/anti-fragility on the latter….

  8. As much as the idea of a land value (and resource rent) tax only (i.e Georgism) has a lot of merit, the reforms that need to be considered have to be, by virtue of politics (from the Greek “poly” meaning many, and the Roman “tics” meaning parasites), compromised and transitory, i.e a slow sluglike path to actual effectiveness.

    There is also a legacy complication (i.e the three tiered system of government) to deal with as well as trying to educate an apathetic public, whilst a very powerful business/politico-housing complex controls the tenor of debate.

    Starting with a wide ranging “We can fix this all with a land tax” is not the way to make initial progress.

    Nibbling at the edges isn’t either – but I fear we will end up with just that if more reasonable reforms are not put forward.

    I don’t mean to shut down that debate, as I think it has tremendous merit – but land/resource rent taxation actually goes to heart of our economic systems….

    • Prince, I think if you start with the wealth transfer system and move towards some sort of negative income tax / citizenship dividend (with rates potentially linked to the company tax rate) the politcal ability to conduct some of these later reforms will become easier.

      In the current environment all tax / welfare reform has become pork barrelling.

    • Gavin R. Putland

      A moderate level of “land-value taxation” enriches land owners by giving governments the incentive to invest in infrastructure that adds value to land, as explained at http://lvrg.org.au/ (yes, the front page).

      But in the present climate I tend to agree that “Starting with a wide ranging ‘We can fix this all with a land tax’ is not the way to make initial progress.” When falling land values are dragging the economy into recession, one doesn’t want to do anything that would force sales of property or repel buyers. “Land tax” by itself would indeed have that effect.

      But “land tax” is not the only way to recycle uplifts in land values in order to finance infrastructure. Another way is to abolish existing transfer taxes on property (purchaser stamp duty, developer/infrastructure levies, etc.) in favour of a vendor stamp duty on the real capital gain. The initial change could be revenue-neutral. Future infrastructure projects would then pay for themselves by expanding the revenue base without further increases in tax rates.

      Property owners should prefer a duty on the real capital gain to a duty on the purchase price, because the former would be guaranteed not to turn a profitable purchase-resale cycle into a loss-making one or magnify a loss.

  9. Nice post Prince – these charts are nothing new to those in the industry, and sometimes it’s almost comical that the punters don’t get more annoyed.

    I hate to be cynical but as you point out it’s not worth holding your breath waiting for meaningful tax reform – the system is a rat’s nest of vested interests and pressure groups. And to top it off, the fees and salaries generated at the upper ends of the profession are very very healthy (bankeresque) – there’s a lot worth lobbying for!

  10. Whilst you touched on the point about the resources tied up with tax accountants you didn’t mention the govt administrative costs to manage the system (which runs into many billions) and other allied professionals like tax lawyers etc.

    A higher consumption tax on everything including food and education is the way to go – even though I don’t find the idea personally very palatable.

    Prince, you should consider politics.

    • Yes well accountants are the first step, then after that the lawyers and bureaucrats.

      As AJ said above, there’s a lot of vested interests to lobby against reform.

      Politics?

      That’s almost a bannable offence mentioning that!

  11. FBT is not about revenue raising – its about protecting revenue from income tax. If the government abandoned FBT salaries would be slashed and we’d all be paid (tax free) in houses, cars and groceries.

  12. What do Ausies think it’s most important to watch:

    a) The State of Origin
    b) Their backs from the Nanny State

    As long as its a) (with the honourable exception of MB bloggers) Parkinsons Law will prevail and the number of daft inefficient fees, levies, imposts, charges, surcharges, duties etc will rise in proportion to the rise in associated civil servant numbers.
    The day China invades Australia, Canberra will announce an invasion levy surcharge..

  13. The biggest issue i have with the consumption tax is the fact that small business bears a high cost in its collection. Would love to see some form of Swiss solution adopted, in having local government be the tax collector for GST so that they are rewarded for efficency and increasing the GDP and competing for business. Get rid of the states and have regional govts made up of reps from each local govt (after some forced almagamations), no political power only administrative and we would probably get more efficent service delivery as well.

    • +100

      Jack – how do the Swiss local cantons collect the GST?

      For mind, getting rid of States (I would also get rid of lower house of Reps…but that’s another story), having Fed’s collect 90% of revenue, whilst its administered locally by regional councils/cantons, is the most robust, effective solution geo-politically.

      We can learn a lot from the Swiss, particularly their healthcare system (although it has some faults too) and their economic and geo-political robustness.

      e.g we could have funded a SWF by cutting the ADF down by 50-80% in the last 20 years, saving the wastage and expenditure on outmoded, overrated weapon technology and putting into a sovereign fund.

      Anyway, the ADF has failed in its mission: over half the natural resources (that which the ADF is supposed to protect) is now owned by foreigners. And any sovereign reaction to protect our citizens from a debt bubble or over-inflated currency will be met by swift economic retaliation…

      But maybe I’m overstepping the mark here a bit…..

      • Based on where they are stationed the ADF’s role is to defend everything SE of the Townsville, Singleton, Ballarat line. ie All the valuable australian housing that any invading nation is clearly looking to annex.

      • Tongue in cheek I know Prince – but it’s a fair point.

        Whenever we try and get investment in or cash out of countries it ain’t nowhere near as breezy as it is for them in Aus – and the toughest player is the big one buying up all the Aussie resources!

  14. simple solution –

    lets call the corpoations people just like our hero’s across the sea do (well, we do like to please them so)… and tax them likewise … so bhp for example would surely be happy to pay say 45% on all income over $150k just like every other person, no ifs no buts no deductions –
    would we still need any other tax then? – ok maybe a wealth tax at a higher rate for the super rich persons who earn over $500k/pa say, and who could no doubt afford it – mr & mrs h norman inc. for example –

    and resource rent? – well i pay for water – i’m sure that they, as responsible citizens, would be happy to pay for water and dirt just like i do at the shop

  15. Cutting tax is popular. Adjusting the tax system to remain revenue neutral produce a new set of winners and losers, which is why reform is difficult.

    If the GST goes higher, we’ll see a significant movement toward the black market economy. Ireland is a good example : with VAT at 22% and company tax at 12%, their ‘black economy’ is estimated to be around 16% of GDP.

    http://businessetc.thejournal.ie/culture-of-nixers-helps-drives-irelands-black-economy-says-isme-164024-Jun2011/

    Cutting some tax while increasing others will not work. We need a different way of taxing. Especially important is getting rid of negative gearing.

    My proposal to the Tax Forum (which they probably sent straight to the recycle bin) is as follows : Australia should allow businesses to pay out tax-free bonuses to their employees in lieu of paying franking dividends.

    At first glance, it the same as changing the highest tax rates to 30%. Employees shift their salary to be paid out as bonuses, and businesses will have their ‘tax before profit’ increased from a ‘lower labour cost’. However, as the company now pays the tax instead of the employee, the employees can no longer claim a tax deduction!! That means no more negative gearing or other ‘tax efficient’ investments. The employee also have a effectively decreasing marginal tax rate, while the company’s marginal tax rate remains the same. There will be some revenue loss, however that can be achieved via rolling back the ‘middle class welfare’ government schemes. After all, when you pay no tax, you can’t demand a handout from the government anymore.

    Lastly, businesses that make a loss cannot pay out tax free bonuses, so we’ll no longer have the spectacle of a CEO paying himself millions while the company lost billions. A company will now have to make a profit to pay bonuses, and every employees will now work harder to generate a profit for the company so their bonuses can be paid ‘tax free’.

    • There is a slight problem with that, when the railways were privatised in the UK,the CEOs were paid purely on profit. It didn’t take long for them to collectively realise that buildng shopping malls on stations was profitable, whereas track and signal station maintenance wasn’t. Several fatalities later…

  16. Great post, Prince
    Taxes on income act as a disincentive to produce income. Taxes on consumption serve as an incentive to save — or join the black market economy.
    One practical problem: abolishing income tax and not company tax would result in corporate earnings being channeled into the hands of shareholders through mechanisms such as trusts, inflated salaries to directors, etc. If you abolish one income tax you need to abolish them all. Replace them with consumption taxes, excise taxes, land rents, etc.
    Cost of collection (including preparation and submission) would be a small fraction of that required for the present income tax system.
    Regards, Colin

  17. The taxes keep increasing because the public service is increasing, and the costs of idiotic programs and welfare are increasing. We need to reduce public servants from around 160,000 (thats just federal and not counting uniforms) to about half, and cut out transfer payments altogther (only possible with a simplified tax system on Everybody). We then could make a very major saving by reducing ATO staff numbers from over 22,000 to about 500.
    thats my contribution!
    Terry