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ECONOMICS REFERENCES COMMITTEE
Structure and distributive effects of the Australian taxation system
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ECONOMICS REFERENCES COMMITTEE
Structure and distributive effects of the Australian taxation system
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ECONOMICS REFERENCES COMMITTEE
(SENATE-Tuesday, 29 July 2003)
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Content WindowECONOMICS REFERENCES COMMITTEE - 29/07/2003 - Structure and distributive effects of the Australian taxation system
CHAIR —Welcome. I invite you to make an opening statement, at the conclusion of which we will go to questions.
Mr McCallum —Thank you for the opportunity. There are five main points I would like to go over in reference to our submission. Our submission to the reform of work force age payments being conducted by FaCS and DEWR would also probably shed some light in terms of social security reform. I think some cross-referencing needs to be made in that regard. We have five main points in our submission on taxation. Australia is a low-tax country, a point that was being elaborated and debated by the previous submission. Research undertaken in 2000 by the OECD indicates that we are the sixth lowest taxing country in the OECD, with only Ireland, the US, Japan, Mexico and South Korea coming in ahead of us.
Australia's taxes on income are lower than those in most OECD countries, despite our top marginal tax rates. If we concentrate on headline marginal income tax rates, we miss the main story. Most OECD countries impose social security taxes, which fall heavily on low- and middle-wage earners. Many also have state income taxes. When these taxes are taken into account, Australian workers on average earnings pay less overall tax on their income than their equivalents in most countries surveyed by the OECD, including the US. The story is different when we add family payments as tax offsets, as the OECD does in one of its comparisons. We are around the middle of the pack in this table, but the reason is not high tax rates in Australia; the reason is that our family tax benefit is less generous for families on average earnings than is the case in other countries.
Our third point is: ACOSS considers that concerns that bracket creep is pushing large number of people into the top bracket are exaggerated. Less than 20 per cent of workers in Australia earn more than $60,000, and only 25 per cent of families have incomes higher than this. Bracket creep has lost many of its teeth due to low inflation, and taxpayers can no longer expect big tax cuts every five years—unless governments severely cut community services.
Our fourth point is: health, education and welfare services are in dire need of public investment, and the public knows this. The budget had some very regressive and deleterious effects on Medicare; public health services are in decline; standards are slipping in public schools, TAFE colleges and universities; and child and youth payments are well below the level needed to make serious inroads into child poverty. We have seen the user-pays system creeping in rapidly into many of the public institutions and public services that were regarded as being universal in the past. If we want a window into the future of Medicare, we only have to look at what is being proposed by some large medical practices in Melbourne and Sydney, where there is not only a two-tier system but a three-tier system unashamedly based on the ability to pay. I think that is an indication of the lack of investment in public infrastructure.
The public reaction to this year's federal budget exposed a shift in public opinion that has been under way for some years—away from cutting taxes and in favour of social investment. More people now understand that if taxes fall they will pay for essential services anyway, through higher fees and charges. As the population ages over the next 40 years, the cost of health and aged care services will rise by at least two per cent of GDP—around $14 billion in current dollar terms. This need not lead to a fiscal crisis or big hikes in user charges for these services, as long as the public accepts the necessary increases in taxation. Yet the political debate in Canberra has not caught up with these realities. It is still lost in never-never land—the place where taxes always fall and never rise, yet services always improve and are never cut back. The taxpaying public might dream of such a place but no longer believes that it exists. The debate in Canberra is falling behind public opinion.
I think the debate has become one around who can tax the lowest rather than who can provide the most impressive service structure. I think that is a particularly unhelpful public debate—to go around the notion of who can tax lowest and who is taxing the highest. The fallout from the last budget shows that people would rather have given their $4 back if they could have invested more in Medicare or public education. I think the public is no longer blinded by the notion of a minimum tax cut.
The fourth point: it is possible to raise more revenue without increasing inequality, and to improve equity without raising marginal income tax rates. Some commentators accept that taxes will have to rise but assume that the only way to do this is to ramp up regressive taxes such as GST or fees and charges for the users of community services. There is another way to strengthen public revenue without increasing income tax rates. The key is to be found in the slogan that the government took into the tax debate in the l990s—'Broaden the base and lower the rate.' The solution is to shut down the income tax shelters used by people on high incomes. The top income tax rate might be 47 per cent, but it is no secret that high-income earners with smart accountants can easily reduce that to 30 per cent or less.
On page 21 of our submission, we list seven deadly tax rorts, at a cost of $7 billion in revenue annually. Even partial progress in shutting them down could yield billions of dollars in additional revenue every year. No. 1 on the list of the seven deadly tax rorts is salary sacrifice for executive shares on options. To this we would add the cost of concessional tax treatment of some of the termination payments that have recently attracted bad publicity. No. 2 is salary sacrifice for cars. No. 3 is salary sacrifice for superannuation. Although there is public support for savings through superannuation, the present system skews the benefits of these tax breaks toward those who least need the public support—that is, high-income earners. No. 4 is income splitting with family members. No. 5 is negative gearing, which we have had a fair bit to say about of late. It is damaging to our economy and the affordability of first homes, as well as costing $2 billion per year in loss of revenue. No. 6 is family trusts and No. 7 is private companies. These last two well-known tax avoidance devices are still open for business despite six years of public debate and attempts to close them off.
Our fifth point is that genuine tax reform is doable. The main thing that stops the government from closing off these loopholes is the perception that it is politically impossible. That perception is carefully nurtured by the industry lobbies with a vested interest in the status quo. For example, the real estate industry has for many years recycled the false claim that the abolition of negative gearing in the mid-eighties led to the big rise in rents. The only research into this has found that the main causes of the housing investment slump at that time were high interest rates and a boom in share markets.
Genuine tax reform—broadening the base by closing the loopholes—is possible. It was achieved in 1985, for example, when very few commentators considered that capital gains tax was politically viable in Australia. The recipe for successful tax reform is to convince the public there is a serious problem—as was done with the bottom-of-the-harbour schemes—and trade off the closure of tax loopholes for reduction in tax rates and improvement in services. Then the industry lobbyists are no longer perceived as defenders of legitimate tax breaks; they are perceived as the people who are standing in the way of tax cuts and improved services for the average taxpayers and their families. Peter will elaborate on a couple of those points in more detail.
Mr Davidson —Negative gearing has been in the news a lot lately and it is interesting that an increasing number of commentators agree with us on this. As one tax professional has noted, ACOSS has been on this bandwagon for years. We thank him for that comment because it is true. Some of the reasons we have been on this bandwagon are now becoming evident. If deductions were not allowed for negatively geared property investment, it is very likely that first home prices, interest rates and household debt would be lower than they are. Negative gearing does not create property booms, but it fuels them. For those who profit from real estate transactions and those who get lucky during housing booms, there are benefits in negative gearing, but the losers include first home buyers, the economy and many investors as well.
I would like to quote from a statement by David Potts in the Sun-Herald of 28 July 2003. He is a veteran financial journalist, one of a growing number who agree with us on this issue. He says:
... beware if someone tries to tell you any of the following:
1 Negative gearing is good
He is putting the punter's point of view, the investor's point of view.
Negative gearing, where you invest at a loss hoping the eventual capital gain will not only dig you out of the poo but make you a millionaire, is mainly for mugs and lucky punters. And I fear there are more mugs than lucky punters who are negative gearers.
The pollies have now given their imprimatur for a very dangerous investment habit.
So long as you're aware of the risks you might blow your money gearing or borrowing isn't always bad. But it usually is.
If the investment stacks up after interest and other costs and makes a profit, then gearing is the greatest thing since sliced bread. Then it's positive, not negative, gearing. And yes, you'll pay tax. I don't know about you, but I'd rather be paying tax because I made money than getting a deduction for losing it.
But when the concept is perverted by property spruikers to mean that you can pay too much for something that will one day come good, forget it.
Negative gearing means you're losing on the investment, a loss that compounds. You might be sharing the loss with the Tax Office, your partner for life, but you're still going backwards.
That is a comment from a seasoned financial journalist, who is essentially saying that many of the punters who invest in these schemes are going to be disadvantaged as well. We are going to see a lot of that within the next two years.
Advocates of negative gearing argue that the rental market would collapse, without it, as they say it did in the mid-eighties. This is a good example of how a claim repeated often enough takes on the guise of fact. The only independent research that has examined this issue specifically, research that was funded by the Australian Research Council, was conducted by Adelaide academics Badcock and Browett.
I would like to table a paper by Badcock and Browett published in volume 6, No. 3 of Housing Studies, a British housing journal. They argue that the main reasons for the decline in investment in housing, in particular rental housing, in the mid-eighties and for the drop in vacancy rates at that time was not the decision to abolish negative gearing for rental property investment but the high interest rates and booming share market of that time—the high interest rates for obvious reasons and the booming share market because it drew investment out of rental housing. That position was reversed when the share market crashed in 1987 and, one month later, the negative gearing tax break was restored. We saw a boom in rental property investment but, once again, the principal cause of that boom was not the restoration of negative gearing but the share market crash and the hot money shifting out of equities and into rental property, as it has done once again in recent years. Negative gearing for passive investment in assets that appreciate in value—property, shares and collectables—costs the revenue approximately $2 billion each year. It damages the economy, without tangible benefits for the low-income tenants we are concerned about. We advocate replacing it with a tax rebate targeted towards low-cost housing.
I would like to quickly make a point in response to Treasury's submission, which we only saw today. I was puzzled by their table of the distributional effect of direct and indirect taxes. It seemed to be painting a picture very different from that in the graph in our submission, graph 5, which is on page 17 of the version that I have in front of me.
Senator MURRAY —Which Treasury table are you referring to? Is it table 1 on page 86?
CHAIR —By the way, it is on page 16 of our version of your submission, Mr Davidson.
Mr Davidson —Thank you. It is table 4 on page 13 of the Treasury submission. The percentages are higher for the top quintile than for the bottom quintile for indirect taxes, as well as for direct taxes and total taxes. Our graph 5 indicates that the bottom 20 per cent pay a higher proportion of their income, on average, in indirect taxes than the top 20 per cent. Those are shown by dark shaded bars on the graph.
Senator CHAPMAN —They are measuring different things.
—I then realised that they are measuring a different thing; they are measuring the proportion of all taxes that are paid by different quintiles. Of course, if you are measuring that, the top quintile are going to pay most of them, whether through a direct tax or an indirect tax, because they have more income and they spend more. But that is not the conventional measure of progressivity or regressivity in tax analysis. The conventional measure is what proportion of your income you pay in tax, and that is what is presented in our graph 5—taken, I think, from exactly the same data source, the ABS survey. When you look at it from that point of view, the indirect taxes are clearly regressive, because low-income people pay a higher percentage. The direct taxes—that is, the income taxes—at least are progressive. The overall effect, though, in that graph is not greatly different from a flat tax regime.
There are some swings and roundabouts. As Treasury indicated, the bottom 20 per cent underestimate their income, so this graph makes the tax system look a little less progressive than it is, from that point of view. Against that, the ABS survey does not model a number of indirect taxes, including company income tax and payroll tax, the incidence of which are likely to be regressive. They are regressive to the extent that they are passed forward to consumers. The extent to which that is the case is, of course, open to debate, and no thorough Australian study has been done of this. But I think if the analysis were fully and properly done we would find that the overall incidence of taxes, as distinct from social security and final income, is not that far from being flat.
CHAIR —I thank you for your submission and note that in your recommendations you have made quite significant policy recommendations. I know, just from looking at them, that some of them will have captured Senator Murray's imagination, for starters. Certainly they have captured mine. Can you give us a little information about your costing mechanism for those recommendations?
Mr Davidson —For all of them?
CHAIR —Just how you went about it. Is it possible to get a little more information about your costing model?
Mr Davidson —It might be best to take that on notice, because it would take a while. We used a combination of taxation statistics—which unfortunately are out of date, so there was some attempt and project those forward—and a number of estimates that were developed by the government's review of business taxation. In one case, we used NATSEM's microsimulation model, called STINMOD, to model the costings for easing of benefit traps. It is a combination of things, but we can provide more detail in writing. With regard to the superannuation proposal, it is revenue neutral. We have a specific revenue neutral proposal that was modelled using ABS superannuation data and taxation statistics data.
CHAIR —Thank you. The committee would certainly welcome some more information on that.
—As you have probably gathered, I also have some concerns about the regressive nature of indirect taxation, but we will probably leave that until a later date, when we meet with Treasury again and have a look at some new information. One of the other concerns that has come from both people who visit me in my office and the witnesses that we have heard from in the last day or so is whether or not the support that the government tries to offer families who are doing it hard, through the family tax benefit, is actually effective in meeting its stated aim.
One of the concerns that has been raised with me is that, when we come up with an initiative like the family tax benefit, we do not look at all the other policy changes we are making in other sectors of government, so it is very difficult to judge whether it is going to be effective—for example, the changes that the government makes to the labour market. It has been put to me is that it is very difficult for families to estimate their income a year in advance with the increased casualisation of work. How do they then avoid falling into debt to the government, rather than accessing decent support for family income? Do you have any comments on that?
Mr Davidson —The first point I would make is that in international terms our family tax benefit system is probably one of the best designed and targeted anywhere in the OECD from the standpoint of alleviating child poverty. And that is not just a feature of the present family tax benefit; that was a feature of previous reforms such as the family allowance supplement on which it built. It is actually much simpler than many overseas systems that have separate payments for working parents and jobless parents. With the FTB, those are rolled into the one payment, based on need and the costs of the children.
The second point is that you have pinpointed one of the Achilles heels of the family tax benefit system—namely, the income test. We actually supported the integration of family payments and tax allowances into a single system in 2000 because it ended the argument over tax breaks for children, because those who wanted a tax break for children could choose to receive their family payments through the tax system. It is simple, it is equitable, and at the end of the day 90 per cent choose to receive it as a direct payment anyway. However, in the process—unfortunately—a number of taxation principles intruded into the family allowance system, which since 1976, when Malcolm Fraser brought it out of the tax system and into the social security system, has been paid on income support principles.
One of those taxation principles which have caused a great deal of trouble is end-of-year reconciliation. Traditionally, social security payments do not have that end-of-year reconciliation, partly because information on incomes is collected more frequently than once annually. We actually advised the government through the bureaucracy at the time that it would be better to collect the income information more frequently and to avoid this end-of-year reconciliation process. We still think that that is the case, for exactly the reasons you raise. It particularly affects sole-parent families and 1[half ] earner families where the primary earner is on a low wage and where the family income hovers around $30,000 to $40,000 a year in that income test range. There are a lot of families in that range.
—I am glad you raised the point of sole parents. One of the cases I have dealt with is a sole supporting parent who is trying to do the right thing in that she has gone back to work during school hours while the child is at school. She earns about $19,000 per financial year. She also receives child support from her former partner. Depending on how much child support she receives—and that is something that is beyond her control in terms of his access to work, his decision to pay and a whole range of things—in one year she can pay an effective marginal tax rate of 50 per cent through her loss of family tax benefit and the income tax that she then pays on her child support. But if she had actually taken the same amount—that is, the child support—as part of her own earnings, she would have only paid 17 per cent as a tax rate and would have therefore still qualified for the maximum level of family tax benefit. There does seem to be a real administrative problem.
Mr Davidson —You are raising two issues at once there—one being the problem of end-of-year reconciliation and debt in relation to maintenance payments, which is a very real problem for many families at risk of poverty, and the other being the income test stacking problem, which leads to some very high effective marginal tax rates. The latter problem was eased somewhat by the 2000 tax and benefit changes but, as the same study by Gillian Beer which the Treasury quoted mentions, in 2000, post ANTS, 20 per cent of workers in married couple families and 50 per cent of those in sole-parent families—and I think this is mothers—lost more than 60c in every dollar they earned. So it might be around eight per cent of all workers, but if you concentrate on mothers, especially in low- to middle-income families, it is much higher. So there is still a lot more work to be done in that area, as I think everybody acknowledges.
Mr McCallum —Added to that, the suggestion that underestimating income is a way to avoid a debt defeats the purpose of having the support in the first place and I do not think it is a particularly realistic way of actually solving a problem.
Senator WEBBER —Indeed. Another problem that occurs to me with the system is that it is not flexible enough to allow for the way families who are in financial need and who need that support organise their lives. Another case that has been raised with me—and this will probably go back to Mr Davidson's point of the full-time worker and someone else who is working part time—is that, if that family chooses to structure itself in such a way that there is always someone at home with the children, and the mother, as it is in most instances, chooses to access work either in the evenings or on weekends or what have you so that someone is always at home, family and families such as that often find that they miss out on their part B entitlement. But, because they do not make any use of child care, they do not qualify for the child-care benefit either. So the system is not flexible enough to give them the support they may need to be a well-functioning, viable family unit—they are still missing out.
Mr Davidson —That is an issue we have also been raising with a range of people and which we have been developing policies to address, especially for families with younger children.
Senator WEBBER —So what are your recommendations for how we can best target assistance to these families?
Mr Davidson —They are not yet fully developed. You are right—the system could be a lot more flexible than it is. However, in our view the solution is not to throw all the existing payments into a pot and replace them with a flat payment. That represents false equity, because the needs of different families differ. For example, if you have two kids in child care it costs more than having one child in child care. The needs and costs of families where a parent stays at home also vary. So a single flat payment may look fair and equitable on the surface but there would be either a lot of losers or a big cost to government. At the end of the day, it is not fair at all, because different families face different costs. A fair and flexible system will recognise those costs as they change over time and adjust itself. That is the kind of system we think is required.
—In evidence we heard yesterday, the first witness made the very general statement—and I think it was corroborated later on—that young families these days effectively had to make a choice between having children or generating wealth, and that the current structure did not allow you to do both.
Mr Davidson —I think that those most disadvantaged by the present system are those who combine both. They have a loss of income from a parent staying at home part time and child-care expenses that are nowhere near covered by the child-care benefit. I think that is right. Yet that is the option favoured by most primary caregivers of very young children.
Senator CHAPMAN —The table that you have presented on page 16 of your submission, which combines income tax and indirect tax, is a table from 1998. Would you except that it is grossly out of date given the major tax reform that occurred in 2000?
Mr Davidson —I think that is fair to say, as we point out further on, one of the effects of that tax policy change in 2000 was to increase the overall level of taxes on consumption by around $5 billion per annum—those numbers are taken straight out of budget papers. So in that sense, at least, we would expect that the system would be somewhat more regressive than it was in 1998. Against that, the family tax package was highly progressive, but then again the income tax cuts were regressive. When you compare the overall costs of the income tax cuts, the family tax package and the increase in indirect taxes, I would say that the regressive effect of the increase in indirect taxes and of the income tax cuts is likely to overshadow the progressive effect of the family income support improvements, notwithstanding the benefits derived from that for many families right at the bottom end.
Senator CHAPMAN —Wouldn't you in fact accept that the change to the GST would be less regressive than the pre-existing wholesale sales tax structure given that, I suspect, low-income people tended to spend more of their income on goods whereas higher income people would spend more of their income on services and, of course, the overall rate of the GST was substantially lower than the average rate of the wholesale sales tax?
Mr Davidson —I do not think the distributional analysis that was conducted, for example by NATSEM and Neil Warren, would bear that out. Firstly, the overall level of taxes on consumption at the end of the day was $5 billion higher. Even though the rate was lower, the overall burden was higher. Secondly, the incidence of the wholesale sales tax is probably broadly similar to the incidence of a GST without food—that would be my guess. So I would say that, if the WST had simply been replaced by a GST without food, the change would have been neither progressive nor regressive. We had some modelling done by Neil Warren way back in 1998 which bore that out.
It was the overall ramping-up of taxes on consumption in order to pay for income tax cuts that in our view made the system less progressive than it would have been previously. As soon as you change the tax mix in a big way—away from income and towards consumption—the cost of most goods and services is by definition going to rise and that is going to affect the bottom end more severely than the top end.
—The safety net for low-income earners was built around a compensation package, and compensation packages by their very nature erode quickly and, unless there is some vigilance about keeping them contemporary, it is not very long before those people really do fall further and further behind. I think that was probably one of the flaws: we could not build it in without having compensation because compensation means the acknowledgment of loss.
Mr Davidson —We conducted our own analysis based on Warren and Harding's figures post the introduction of the GST, which we can furnish to the committee. This is a very complex debate and it is a difficult one to conduct verbally because there were so many factors in the mix.
Senator CHAPMAN —I note your table with regard to various tax loopholes and shelters on page 18. In particular, you refer there to high-income contractors or consultants being able to divert their earnings into private companies or family trusts. Don't you think that has been severely limited by the government's legislation to require that personal services income cannot be run or diverted through business structures and therefore that only genuine business income or investment income in fact can be earned through entities other than the individual?
Mr Davidson —We welcomed the proposals to tax personal services income at personal income tax rates when it was recommended by the Review of Business Taxation at the time. Unfortunately, there was a slip `twixt cup and lip'—between those recommendations and the final legislation. You will recall there was some opposition to these measures in the small business community, or elements of it, and some substantial changes were made to the initial proposals. I should preface that by saying that capturing the personal services income and taxing it at marginal rates is only part of the problem. It does not address the problem of investment income—
Senator CHAPMAN —I will address that in a question later.
Mr Davidson —sitting in corporate structures where it is at 30 per cent and then being transferred to the owner by way of loans, dividends and so on. We welcomed the RBT's proposals to crack down on the personal services area which the tax office had identified for some years as a serious area of concern. The final legislation is along these lines: where a taxpayer derives 80 per cent or more of their personal services income from one source—that is, you might suspect they are shifting their personal services income through a company structure—they may seek a determination from the commissioner and, thereby, avoid taxation at marginal rates of personal income tax. The tests are: if they have their own business premises separate from their home; or they employ anybody other than, I think, an associate such as a spouse; or they meet any one of three tests—they deal with a number of unrelated clients, they have employees or they have business premises—or they produce goods or services for a result; or they are required to supply tools and have to rectify work. If they pass any one of those tests they are home and hosed, and I would suggest that you could drive a fleet of courier trucks through those loopholes in the legislation; therefore, it is defective and unlikely to capture the lost revenue which the Review of Business Taxation had identified and was attempting to capture.
Senator MURRAY —The trouble is we can only get the figures which will tell the truth in two years time—that is the difficulty.
—I suggest it might be more difficult than you suspect to drive a truck through, given the number of representations I have received from people who believe they are now caught under these provisions.
Senator MURRAY —Those are the blokes who cannot drive.
Mr Davidson —They must have cheap accountants.
Senator CHAPMAN —Can I move onto the issue therefore of what might be regarded as genuine business income or investment income being earned through trusts or companies. Given that structures other than trusts or companies—that is, holding the asset in the individuals' names; spreading it through the individuals who are the beneficiaries of those trusts, companies, partnerships or whatever—would achieve exactly the same result in taxation terms, is it not reasonable to argue that the major purpose of trusts is asset protection? It certainly has that tax benefit but that tax benefit—exactly the same tax benefit—could be achieved legitimately by other means, but the additional benefit of the trust is the asset protection benefit. Therefore, are they not paying a legitimate form of holding those assets?
Mr Davidson —We have a submission on the record, which we can also furnish the committee with, on exactly that issue: the tax treatment of trusts. It is our submission to the Board of Taxation when they reviewed the legislation a year and a half ago or two years ago—it seems like a long time.
That is partly true but not wholly the case. It is true that people can split their income, with a spouse for example, in ways other than trusts. They cannot do it through partnerships—and incidentally most family farms are managed through partnerships rather than discretionary trusts, despite all of the concerns raised by rural lobby groups about the trusts crackdown—but investors can split their income legally with their partners without using any structure at all. It is much more convenient to do so through a discretionary trust because of the asset protection, as you pointed out, and also because he or she who ultimately controls the trust has a great deal more control over the asset than they would have if they used different kinds of structures. It is a way of having your cake and eating it.
Senator CHAPMAN —It is an aspect of the asset protection.
—Of course the government's trust-busting measures were not designed to address income splitting in the first place. We would have liked them to but they were not intended to address that. They were intended to address a range of other tax avoidance issues surrounding discretionary trusts. In that regard, the tax treatment of those trusts is very different to any other entity including companies and fixed trusts. In the case of companies there is a general withholding tax at 30 per cent so discretionary trusts are taxed quite differently to companies. With regard to fixed trusts, any income that passes through the trust to a beneficiary that has not previously been taxed or has been taxed at a concessional rate, such as capital gains, is caught up in the capital gains tax system. That was a measure introduced back in 1985 to address the perennial problem of tax avoidance through discretionary trusts. The problem was around way back then. Through a legislative loophole—that is, an accident—discretionary trusts were interpreted by the tax office as being outside the ambit of the CGT legislation and so income can pass through to the beneficiaries without attracting capital gains tax. That was an important protection for the revenue against some of the very schemes that the tax office was identifying, again in the mid- to late nineties. Compared to any other structure you could name—private companies, public companies, fixed trusts or partnerships—discretionary trusts are on their own and are treated very generously, and so it is not surprising that they have been a common source of tax mischief. We do not believe that the recently proposed measures will fully address those problems. We think we have some partial answers, which are in our submission.
Senator CHAPMAN —I am sorry, I am not clear on what you mean by the capital gains loophole. Isn't the capital gains tax in the hands then of the person receiving the distribution?
Mr Davidson —If you are a beneficiary of a fixed trust then trust income which has not been fully taxed, for example, which has been subject to a tax concession such as a depreciation allowance, attracts capital gains tax; That is, under the present tax system, at least half of it is going to be taxed before you get it. That is the law in relation to fixed trusts. That does not apply to discretionary trusts, so the beneficiary obtains the full benefit of tax concessions and preferences in the hands of the trust. That was deliberately introduced into the capital gains tax legislation in 1985 to gather up any income that might be slipping through the net and reaching beneficiaries without having been taxed properly in the hands of the trust.
Unfortunately, the law was challenged. The tax office found in favour of those who challenged it in a tax ruling—I cannot remember the tax ruling number offhand—and that left a loophole which applies not to fixed trusts but only to discretionary trusts. Some tax professionals, when debate around the tax treatment of trusts re-emerged in the late nineties, were actually suggesting publicly that this was the way to resolve the problem—'Let's close that loophole'—rather than going down the track of taxing them as companies. We have put forward both alternatives as a way of dealing with the problems. It is all in our submission.
Senator CHAPMAN —Thank you.
Senator MURRAY —I have suggested to Senator Chapman that that is perhaps a question he might want to put to Treasury just to get some clarification of their view on it. Your submission and the previous ACOSS paper No. 307—the two are related—are impressive, principally because, apart from the thoughtfulness in them, you have asked what we need to spend money on and where we can get it from, without being unfair. That is my summary of your approach. It seems to me you have concentrated on raising revenue rather than taxes, although some of your members who have appeared as witnesses I do not think understand the difference and talk about the need to increase taxes. I think ACOSS's submission recognises that it is in the tax concession area that there is a very substantial pool of money that could assist needs.
However, I think there is a conflict between where that money should go—in the sense that you either deliver it to the public sector, which might transfer it to the private sector to spend for people, or you give it to people directly to spend themselves. One of the issues facing this committee and the Productivity Committee is the real disposable income needs of low-income people. You could, for instance, spend a great deal more of that money by focusing on tax rates—tax thresholds in particular for low-income people—combined with examining the welfare side.
It seems to me that far too much pressure is applied to the wages system to accommodate the disposable income needs of individuals. That has great inefficiencies and great consequences to the economy, in terms of costs and productivity, whereas making a substantial portion of the income of low-income people tax free—or supporting them through a tax credit system; there are many ways you could do it—would be beneficial.
With that long introduction, what is the basic philosophy of ACOSS? Would you prefer to see as much real increase as is feasible in the hands of low-income people or do you take more of an interventionist view such that you would prefer to spend it for them, with much more expenditure in areas of health, education and so on?
Mr McCallum —I will say a few words and then Peter might answer more directly. There are a couple of things. One-third of Australian households do not pay any tax at all, so tax cuts of $4 a week do not apply to those people. We said in our introductory remarks that the erosion of some of the universal social safety nets, such as Medicare and money going into public education, are areas of priority. We would like to see the universality of some of those key fundamentals maintained via the use of government revenues.
I will turn to our submission around the single work force aged payment in social security. There are a number of anomalies when you go from youth allowance to Newstart to pensions and so forth. Differentials exist, for no good reason on many occasions, and there needs to be some raising of the lower levels of benefits. That needs to be addressed in terms of equity and income for low-income people. Those are some of the areas. There is a mix of direct income for people plus the provision of essential infrastructure which mitigates their need for expenditure. The Pharmaceutical Benefits Scheme, Medicare and the costs of education all come into that area. They are adding to household income in the sense of provision of services.
Mr Davidson —I am going to have two bob each way on this.
Senator MURRAY —I was sure you would, Peter.
Mr Davidson —On the one hand, our expenditure on cash benefits for people is very low by OECD standards. That is the main reason our social expenditures are low by OECD standards. That is partly because the system is more tightly targeted, but it is also because the maximum rates are a lot lower than they are in, for example, most of Europe. If you were concerned about income poverty, especially child poverty, then one of the first things you would do is improve payments. That has the benefit that people can then choose how they spend their money; that choice is not being made for them by government.
I think I am on a unity ticket with the Centre for Independent Studies on the issue of the tax-free threshold, because it is the single most important element of progressivity in our income tax system. It offers the same flat exemption from tax for low-income earners as it does for high-income earners. Of course, it is proportionally of much more benefit to those at the bottom end. While some people would ask why that $6,000 exemption is offered to millionaires, my answer would be that it is not worth that much to them but it is worth a hell of a lot to someone on $10,000.
That is the main reason our top marginal tax rates are higher than in most other countries—because of the cost of having a relatively high tax-free threshold. It is usually those who want lower tax rates at the top end who advocate getting rid of it, income testing it or whatever so that the higher marginal rates can drop. There have been many proposals along those lines advanced from time to time.
But I think the biggest difference in the progressivity between, say, our income tax system and that of the US is that the first dollar of income is taxed at 10 per cent in the US through their federal income tax, then by another four or five per cent by the average state income tax and then by, I think, an even larger amount through their social security taxes, which are quite regressive. That is one of the main reasons they have low top rates. They can afford to do that without having a higher overall tax burden than Australia by taxing the pants off those at the bottom end. It is one of the reasons they have needed to introduce those earned income tax credits to offset the effect of the income tax slugs imposed on the bottom end. But I am digressing.
My other two bob is to say that there is also a strong case for investment in universal and semi-universal services which are, in a sense, part of the social glue that holds the community together. It is about people being able to attend the same public schools, as public education still exists in this country, or people being able to obtain free treatment in public hospitals. If you take that away, you not only erode social capital but you erode public support for benefits and services for the bottom end. If you target those services exclusively to the bottom end, you do that even more, because the middle class can see no direct benefit for themselves. I do not want to take that argument too far, because if you take it too far you have very expensive welfare states and income tax rates and consumption tax rates that are much higher than the ones we have.
But there is a core of services, especially in the health and education area, that should be universal and semi-universal. I think the same applies to some of the transfers that are linked to services like the PBS and child-care benefit, where the governments are having two bob each way and linking a transfer to a service. There are yet other services that can only be effectively targeted and delivered as services—for example, child protection. If you cashed out child protection services and gave, for example, low-income families an extra two or three dollars a week to spend on child protection services, you can guess what would happen to those services. So there is also a role for services that are targeted towards social problems that benefits and income tests cannot possibly target in that way. So we need a bit of everything. I think Australia strikes that balance better than most other OECD countries.
Senator MURRAY —As you know, I would agree with much of what you argue. I have a view that for Australia to be competitive internationally we need to hold our wage rate increases below the level of productivity increases. I also hold the view that we need to increase the real opportunities available to low-income people to advance themselves, which means they need to increase their disposable income. The only way you can do those two things is to take off the tax burden. I have costed the consequences of increasing the tax threshold from $6,000 to $20,000. It is a rough costing, but it would be about $18 billion. The effect of that—if you look at your table 1 and use your average tax rate of 12 per cent as a guide—would be a $2,400 addition to disposable income for a person earning $20,000, which would obviously mean that a small business employing them would not have to raise wages—there are winners all round.
Except, where is the $18 billion to come from and how is it to be funded? From listening to witnesses and reading submissions, I find there is not a willingness, apart from yourselves, to consider a fundamental redesign of essential elements or to change the settings, if you like, rather than redesign—because frankly the design is not bad—so that we can accommodate the need to be competitive, to raise disposable income, to increase revenue and so on. I am disturbed by that, because frankly there is a lack of courage. You hear political parties talking about the Treasurer as the highest taxing Treasurer in the country, and people claiming we are overtaxed and others claiming we are undertaxed and so on. It does not help.
Mr McCallum —That becomes a useless circular debate. One aspect that gets thought about occasionally and then forgotten is the knock-on costs, the generational social costs, of not doing something—of not having adequate service delivery levels and adequate levels of payment. It then becomes necessary to invest in social control as opposed to social policy. Many countries seem to be happy to build infrastructure associated with incarcerating people in the future at ever increasing cost. There is a crossover point—where income falls to a certain level and when services fall to a certain level you then put people on a path to other ways of supplementing their lifestyles and living arrangements. That then requires government to adopt a social control response rather than a social policy response. They are costs that, once you set off down that road, you cannot retreat from; they become self-fulfilling. They also become the mantra of governments which want to get elected—especially state governments around the nation. Talking about privatisation, we get the situation in places such California where people are building prisons on spec.
Senator MURRAY —Here they do it on negative gearing!
Mr McCallum —Yes. We will probably negative gear a prison—that would be a good idea! Those are the sorts of things we need to look at longitudinally in terms of costs in the future. They are all about life choices and lifestyles. Do we want to go down the road where people who have the means can provide security for their lives—and I mean security in its most fundamental and concrete form—or do we want to have a society that embraces everyone and makes sure that we all feel a level of security that is appropriate across the board? The punitive approach will cost more in the long run and that is something we do not cost into things—we cost in the here and now, not intergenerationally, and I think we need to do that.
CHAIR —Thank you for your attendance today. I would remind you that you offered to make available the trust's paper. If you could forward that to the secretary, that would be appreciated.
Committee adjourned at 12.15 p.m.