the little known unfair treatment of tax deductions
Posted by Gordon on August 18, 2010
From Centre for Policy Development item on why a vaguely flat tax may be OK – so long as there is a large tax free threshhold & a higher tax rate at the top.
Paul Loring identifies a little talked about unfairness in the tax system, that current proposals don’t do much to address
I don’t think either the Henry Review or other reviewers since have given sufficient consideration of Deductions.
For a short while I worked as an H&R Block tax consultant, and from the amount of time I spent every day on deductions, and also as seen on their TV ads with the man smothered in receipts, you realise just how big an issue this is for tax payers, but also the impact it has on tax paid, and equity amongst tax payers.
A simple example is the best way of getting to the crux of the matter. Two workers, low paid whose marginal rate is 15% and high paid who is 45%, each buy a work related diary for $10. The low paid gets 15% reduction, ie, effectively pays $8.50, the high paid gets a 45% reduction, effectively pays $5.50 for the exact same work related expense, ie, a Deduction.
In reality this is compunded many fold as gross income rises. Eg, the high income earner actually buys a laptop depreciates it over two years, the low incomer earner can’t even afford the laptop let alone get it at a discount, a much smaller discount than the high paid.
The high paid doesn’t just have a laptop but also an investment property or two, a share portfolio, negatively geared loans, etc.
A flatter system may flatten this descrepency, but it still remains and very much for the benefit of the higher paid.
A system that I think meets several of the Henry Reviews needs, eg, simplier, still gives benefits across the board but with assistance giving the greatest benefit to low paid, reducing progressively with gross income is:
Effectively calculate gross tax on gross income, then reduce gross to net tax, applying a common system to everyone. The expense transfer would start with everyone receiving the same highest rate on the initial band of expense, with succeeding lower rates for subsequent bands, eg, say first $1000 at 40%, $1001 -$2500, 30%, $2501- 10,000 15%, zero beyond!As now this would apply to all income expenses, work, investment, property, negative gearing, etc.
In this example both would get the same benefit for the $10 diary. If the high income earner wanted to buy a laptop, property, shares, then the decision would increasingly become one based on genuine viability of the investment, not merely the tax benefit. That would better for a sustainable economy.
I think this approach, would also work well with a flatter and lowering of all marginal rates. Acturaries would need to calculate the balance of gross income rates and the expense transfer rates, to both fill the coffers, and distribute wealth.
There are other benefits. Still maintains a graduated taxation approach, a stronger one in fact. It effectively caps negative gearing. It also reduces the need for the massive expenditure currently wasted on tax consultants/accountants, as once the ceiling level for Expense Tranfer is reached, there is no point considering additional expense.
Ben says:Thanks Paul.
I agree the system of deductions needs significant reform. Adam and I have done a little work on this in relation to the super tax deductions (which follow the same logic as work expenses). I also agree that a system that provides some uniformity in the rebate it offers would be much fairer. One option is the one you outline, another is to have the percentage rebate decrease with income (rather than expenses), for example those on $40k might get 30% back while those earning $100k might get only 10%. Or we could extend the approach taken already by the Government, which is to offer a standard deduction to all regardless of their claim.
The advantage of this last approach is that it would reduce complexity and administrative costs as only a few tax payers would need to then lodge a tax return. The disadvantage is that workers with large expenses might be disadvantaged, especially compared to those doing similar work set up as small businesses or contractors and therefore able to deduct work expenses as business expenses. It also raises the question of charitable donations, because it eliminates the tax incentive to donate. Personally, I’d prefer this incentive to be given to the institution, not the individual, along the flat-rate line. That is if you donate to a charity, then the government will match 30% of it to the charity (not you). This gets rid of the administration for individuals and cuts it down for the state (it only needs to deal with a few thousand charities not several million tax payers. And it means everyone’s money gets the same benefit.
It is an area well worth reform. I tend to favour a flat rebate – but the issue of equity between workers and business/contractors remains a real one. Your option could be a good way forward.
