Tax lurks to cost the Budget $300 billion?

ScreenHunter_2531 May. 22 07.09

By Leith van Onselen

The AFR continues to target Australia’s tax lurks, arguing that tax concessions on superannuation and property could cost the Budget $300 billion in revenue foregone over the next three years, and are undermining the fairness of the tax system:

Updated forecasts from Treasury in the federal budget papers show the capital gains tax exemption on the family home, the 50 per cent CGT discount and superannuation concessions remain the biggest costs to the budget...

Since most household saving is concentrated in property and superannuation, the cost to federal revenue could grow as a percentage of GDP if no action is taken to tackle the budget sacred cows…

Treasury predicts superannuation tax breaks will cost $36.25 billion in 2014-15. The super concessions will in total cost $171 billion over the three years. The other big costs is the capital gains tax exemption on the family home (estimated to grow to $57 billion over the three years to 2017-18) the 50 per cent discount on capital gains (which could hit $70.5 billion over the same period) and the cost of CGT discounts for individuals and trusts (estimated at $28.3 billion).

Certainly, Australia’s tax lurks are world-beating. A report released earlier this year by the International Monetary Fund (IMF) estimated that Australia has the highest tax expenditures in the OECD when measured against GDP (see next chart).

ScreenHunter_1051 Jan. 30 17.39

According to the report, tax expenditures are:

…government revenues foregone as a result of differential, or preferential, treatment of specific sectors, activities, regions, or agents. They can take many forms, including allowances (deductions from the base), exemptions (exclusions from the base), rate relief (lower rates), credits (reductions in liability) and tax deferrals (postponing payments).

The IMF also believes that tax expenditures should be reformed since they:

…can have major consequences for the fairness, complexity, efficiency, and effectiveness of not only the tax system itself but, since they often serve purposes that might be (or are also) pursued through public spending, of the wider fiscal system.

Nevertheless, the claimed $300 billion cost to the Budget is likely exaggerated, since it does not account for changes in behaviour that would likely occur in the event that these tax concessions were closed. A classic example is the expected increase in negatively geared investment in the event that superannuation concessions alone were closed. It’s a complex area, making estimating likely revenue losses difficult.

Further, not all tax concessions should be closed, anyway. Take, for example, the capital gains tax exemption on one’s owner-occupied dwelling, which is said to cost the Budget $57 billion over the next three years. Removing it would have the same deleterious impacts as stamp duty. It would discourage housing turnover and unnecessarily penalise people that move to homes that better suit their needs. Obvious examples include baby boomers downsizing from large family homes and young growing families upsizing to bigger family-friendly homes. In turn, such disincentives would encourage a less efficient use of the housing stock, such as empty nesters occupying large homes with multiple spare bedrooms. Applying a capital gains tax on one’s home would also hinder labour mobility, since it would discourage workers from relocating closer to employment.

Rather than closing the capital gains tax exemption, it would make far more sense to apply a broad-based land tax (preferably in place of stamp duties). Such a reform would encourage a more efficient use of the housing stock and improve labour mobility, penalise land banking and vagrancy (increasing effective land supply in the process), and help to make infrastructure investments self-funding for governments (since any land value uplift brought about through increased infrastructure investment would be partly captured by the government via increased land tax receipts).

That said, there is a strong case to limit superannuation concessions, which have increasingly become a mechanism for richer older people to avoid paying tax, rather than a genuine means for Australians to pay for their own retirement and avoid drawing on the Aged Pension. There are very good reasons to quarantine negative gearing losses, so that they can only be applied against income from the same asset, as well as removing the capital gains tax concession on investments (why should they be taxed at a lower rate than income?).

These concessions do cost the Budget many billions of dollars (although the exact cost is uncertain), and they are skewed towards the wealthy and high income earners, undermining the progressiveness of the tax system.

Any genuine attack on entitlements must tackle these lurks head-on.

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Comments

  1. I’d like to also know about the revenue forgone due to family trusts. I’ve heard from several people that they love using these to escape some taxes. They also sound like just a gift for rich people.

    • They aren’t the tax advantages that they once were, in fact they don’t really save very much tax but they are a great way to ensure that asset ownership is retained by family members. Especially useful when ownership rights change after a remarriage.

      • @PF

        They aren’t the tax advantages that they once were

        This has changes mainly for dependents under 18. Otherwise all the lurks are still there.

        Alternatively companies offer 30% flat tax with income retention.

      • Yep ,and company tax is to reduce to 28.5% if the budget is adopted.

        I’m not saying they are not useful, they are but it’s not without it’s issues. For example I see below that AB is distributing money to his children who are presumably over 18.

        There is nothing to stop those children from one day asking for the ‘money’ that has been distributed to them. It has happened.

        What happens when those children inevitably become employed themselves? Then the benefits stop or reduce significantly, so the window of great opportunity only exists for a few years.

        I’m sure that there are people who benefit greatly but most that I see are close to being a waste of time and money. Kind of “this is the trendy thing to do so I should have a family trust too”

      • “For example I see below that AB is distributing money to his children who are presumably over 18.”

        Not children (mine are well under 18), but other relatives who don’t have an income for various reasons.

      • @ AB – apologies for misrepresenting you. I presumed which is always dangerous.
        I’m sure that your accountant will be giving you advice that is right for you.

      • “@ AB – apologies for misrepresenting you”

        No worries Peter – I didn’t take offence at all. The principle is the same no matter who the recipients (though I would suspect that adult children may be more likely to demand their share!)

        My wife and I also used income splitting just between us for several years as well. She’d work one year and split her income with me while I wasn’t working, then I’d work the next, etc.

      • “There is nothing to stop those children from one day asking for the ‘money’ that has been distributed to them. It has happened.”

        Sounds like a recipe to get cut of their parents’ wills.

      • @PF yes it depends on your particular situation and the tax departments (speaking from personal experience) do get narky about such things. But to be honest, you can income split between yourself and the mrs quite easily. In many cases the tax savings will outweigh the after tax salary that the other other partner would otherwise receive.

      • PF you’re being a bit obtuse here. Family trusts are still very much advantageous for minimising tax – particularly if you are self-employed or receive most of your income through dividends (like you’re an owning partner in a company). This is how a lot of owners in private employee-owned companies have their income disbursed.

      • dumb_non_economist

        Due to a recent case I believe the Family Court now has a spotlight on trusts for that very reason.

      • The money that has been distributed to those children is being spent on every cent that is spent for their benefit such as uni fees, trips, gap years etc.

        It gets much harder when the kids are/become high income earning adults with their own tax problems, which is why negative gearing and super with are so popular.

        Asset preservation from marriage breakdown and from problems with drugs, gambling, and perceived “no hoper”s and estate planning for cntrol from the grave are all relevant uses of companies and trusts often in combination.

        Anyone who imports might be using transfer pricing through a low tax country with trusts and companies. Blind trusts in Hong Kong were very popular for reinvoicing. It also gets over dumping allegations and import tariffs and sales taxes are no longer a significant potential cost in reinvoicing/transfer pricing situations.

        PS in the US family offices are setting up in States that have abandoned the Rule Against Perpetutities which used limit the life of a discretionary trust to a “life in being” plus 21 years which was likely to give about 110 years total, now it it’s perpetual trusts which overturns about 300(?) years of English law.

    • “I’ve heard from several people that they love using these to escape some taxes.”

      I use a discretionary trust largely to minimise income tax rather than to hold assets (at the moment – that might change after I have my mortgage paid down more).

      My income from IT consulting goes largely to the trust (though I do pay myself a token salary) and then is distributed between three or four people at the end of the year.

      I think last year it saved around $50-60,000 in income tax.

      Although I use one, I would fully support trusts being restricted or removed as part of a broader tidy-up of tax expenditures (including negative gearing and the capital gains tax discount).

      There’s no good reason why I should be able to reduce income tax like this while a salaried employee earning the same amount can’t.

      • Dne – it’s a bit more complicated than I can easily explain here, but basically the income is through a company to the trust and is result oriented and from multiple unrelated clients so PSI doesn’t apply.

      • Just a question – why not use the company instead of the trust? Wouldn’t it be the same end result?

      • “why not use the company instead of the trust? Wouldn’t it be the same end result?”

        Let me preface this with “I think…” as the arrangements were put in place a good few years ago and I can’t recall the exact details. I’m happy to be corrected if I’m wrong.

        A discretionary trust allows you to vary the distributions from year to year (hence discretionary) whereas a unit trust or company distributes income according to relative ownership of units or shares and you can’t vary that distribution without changing the ownership structure.

  2. Call me a fossil, but the original implementation of CGT, whereby real gains were taxed (with some provision for averaging), was much better than the farce we have now.

      • Stephen Morris

        Oddly enought it was a recommendation of the Ralph Inquiry which had (from memory) been asked to inquire into company tax in Australia.

        I recall some commentators at the time noting that the recommendations on personal capital gains tax were outside the terms of reference . . . and yet these were the ones adopted!

        The realpolitik [how that word keeps coming up!] behind the Ralph Inquiry was to do with the introduction of GST. By drawing services into the tax net, GST had increased the overall tax on the (largely Sydney) service industries relative to Victorian manufacturing and Queensland/WA mining.

        The Ralph Inquiry was instituted by the Kirribilli Prime Minister to rectify this unpleasant state of affairs by:

        a) lowering the company tax rate (which benefits service industries); while

        b) winding back accelerated depreciation (which benefits mainly mining/manufacturing)

        so as to leave Sydney unscathed by the introduction of GST.

        The CGT concession was an added gift to the wealthy.

    • Yes.

      The fifty percent blunt instrument discriminates against long term asset holders vs short termers. Someone holding an asset for thirty years would have much more than the fifty percent eaten away by inflation. The asset churner who holds only for twelve months would get the full discount in effect.

      It would be far better to look at how the effect of taxes on the economy is comparatively. For example, taxes on income have been more than indexed as a result of the Howard and Rudd giveaways. Cash interest has no discount for inflation pre-tax. CGT has this clunky half attempt to compensate for inflation. Trying to reform the system without unravelling that problem is likely to end up self defeating.

  3. Now you are talking. More articles like these please.

    I particularly like AB’s comment, showing how easy it is to escape paying tax when you utilise a Trust.

    It’s not all due to a too low GST rate you know…

    • “I particularly like AB’s comment, showing how easy it is to escape paying tax when you utilise a Trust.”

      Absolutely. Income-splitting is trivial assuming you can find other adults or others with zero to low income.

      They don’t even have to actually see the money – it’s all just accounting.

      • drsmithyMEMBER

        Absolutely. Income-splitting is trivial assuming you can find other adults or others with zero to low income.

        Though it does require you to be self-employed in some fashion, correct ? Ie: not a salaried worked ?

      • Yes, and as Dne points out above, the rules have been made stricter in the last couple of years.

  4. DodgydamoMEMBER

    Seems to me the CGT exemption on PPOR gets murky for property investors who move around i.e. live in and rent out the same property at different times, then selectively calculate valuations for CGT
    I’m not sure the answer is to penalise every homeowner who needs to move though.

    Please keep up the good work highlighting rorts which if addressed could be used to fund removal of the more daft and punitive budget measures aimed at the young and vulnerable.

    • “I’m not sure the answer is to penalise every homeowner who needs to move though.”

      I think the answer is to defer the tax liability if another PPOR is bought within a certain time period after the existing one is sold.

      I’m pretty sure this is done in Sweden for example and means that any tax liability will often only be realised when the person dies.

  5. Of course CGT should be applied to the family home. Not having it encourages over capitalisation, unnecessary renovations and so on. This is money that could be put into productive investments, but aren’t because they attract CGT while the family home doesn’t. It’s a mega distortion.

    The cash flow issue that might prevent people from moving id their homes attracted CGT can be fixed with rollover provisions. The government would simply get the cash later, but from a budget accounting viewpoint it would make no difference.

    The only pragmatic policy reason not to have CGT on the family home is that if there are widespread housing price falls, then those CGT losses could be offset against gains elsewhere.

      • “But the family home is paid for with after-tax income so CGT should not apply.”

        All assets, including those on which CGT is paid, are paid for out of after tax income. That has nothing to do with it.

        “there is no need to raise any taxes if existing lurks and benefits are dealt with.”

        The two biggest lurks and benefits are no CGT on the family home and superannuation. Fix them and we could all get an income tax cut, have generous welfare, health and education and run a budget surplus.

      • But the family home is paid for with after-tax income so CGT should not apply.

        This doesn’t make sense. A rise in the value of the family home is still a capital gain, and thus additional income when the property is sold. Why should this income not be taxed?

        Are you also saying that share gains should not be taxed if they’re bought with after-tax income?

      • It does raise the question of whether interest payments on the ppor should/would be tax deductible though.

    • So a family decides they want to move suburbs in order to put their children in another school or to move closer to work or for a change of scenery and their home purchased for $300k is now worth $400k. The suburb they want to move to is priced similarly. So they would be taxed on a $100k capital gain just to move houses, while they’ve received no real benefit. You think that is reasonable?

    • To tax owner occupied housing under a comprehensive income tax model you would tax the imputed rent and any capital gain (nominal, and ideally on accruals) and allow costs such as interest expenses to be deducted.
      This is too complicated (and has the lock-in effect that UE refers to), so in Australia we use a pre-paid expenditure tax model. This is simple but creates a distortion in favour of housing over other investments that receive income tax treatment.
      It is probably best to stick with this treatment but, as UE suggests, ramp up land tax.

  6. The irony is that if these tax lurks were stopped we could ALL enjoy much lower tax rates.

  7. The goal of tax reform should be to make the marginal rate of tax as similar as possible for all entities (individuals, companies, trusts) and all forms of income (salary, interest, capital gains, fringe benefits etc).

    There should be some concession for super, but it is currently far too generous, especially for high income earners.

    If you are paying the same marginal rate no matter how you structure your income you won’t waste your money paying an accountant to shuffle money around. It will also stop the tax system influencing investment decisions.

    A simpler, fairer, more consistent tax system is what we need. End the rorts now!

  8. The Patrician

    If the current budget emergency is such that it demands immediate and severe cuts to health, education and scientific research how does Hockey justify the continuation of these costly and unproductive tax expenditures?

  9. The AFR continues to…. [argue] that tax concessions on superannuation and property could cost the Budget $300 billion in revenue foregone.

    This sounds like a wild fabrication. Total commonwealth revenue is about $350 bill pa. Total income tax is about $150 bill pa and GST in the $50’s.

    People would be inclined to take Treasury more seriously if they stopped just making shit up.

  10. Alex Heyworth

    CGT on the family home is a wild pipe dream. For a start, if it was to be treated the same as other “investments” producing capital gains, not only mortgage interest but costs of maintenance would become deductible. Not only that, they would only be deductible when the asset produced income – ie when it was sold. Can you imagine the furor it would create if every householder in the country was required to keep the receipts for money they spent on light bulbs for their entire life in order to offset some capital gains tax when they sold to go into a nursing home?

    Pull the other one, AFR.