ACTU Tax Paper 4: Paying our way - Personal income tax in Australia by Australian Unions

Paying Our Way Personal income tax in Australia ACTU Working Australia Tax Paper No. 4

australian council of trade unions

PAYING OUR WAY Restoring fairness to personal income tax ACTU Working Australia Tax Paper No. 4

October 2011

Contents The ACTU Tax Papers .................................................................................................................... 3 1.

Principles for tax reform ........................................................................................................... 4

Executive summary.................................................................................................................. 5

Introduction .............................................................................................................................. 6

Personal income tax: securing the fair go ................................................................................ 7 4.1

The flattening of the personal income tax system in the 2000s ......................................... 8

4.2

Who gained from personal tax reform in the 2000s? ....................................................... 10

4.3

International comparisons ............................................................................................... 14

4.4

Were the tax cuts well-targeted? ..................................................................................... 16

4.5

The composition of tax revenue ...................................................................................... 18

The AFTS Reviewâ&#x20AC;&#x2122;s flat tax proposal ..................................................................................... 19

The Clean Energy Future package ........................................................................................ 22

Future directions .................................................................................................................... 24

7.1

The tax system needs to be more progressive, not less.................................................. 24

7.2

Workforce participation should be promoted ................................................................... 25

Conclusion ............................................................................................................................. 28

The ACTU The Australian Council of Trade Unions is the nationâ&#x20AC;&#x2122;s peak body for organised labour, representing Australian workers and their families. Any inquiries about this report should be directed to the ACTU on (03) 9664 7333, or help@actu.org.au

The Working Australia Papers The Working Australia Papers are an initiative of the ACTU to give working people a stronger voice about social and economic policy. Although low and middle income Australians ultimately bear the costs of poor policy decisions made in relation to tax, infrastructure, retirement incomes, welfare, and services, their voice is too often absent from national debates about these issues.

This paper has been researched and written by ACTU Research Officer Matt Cowgill.

Working Australia Paper 10/2011 ACTU D 63/2011

The ACTU Tax Papers Tax is always a hot political topic, but the Government’s announcement that it will hold a Tax Forum has helped put the tax debate on the front pages. The tax debate in Australia tends to be one-sided. Well-funded business groups make a self-interested case for cuts to business tax, or regressive personal income tax changes, and are given extensive coverage by the media. Such proposals for “reform” are treated as self-evidently good things, with little evaluation of competing ideas. False or misleading claims about the tax system are sometimes presented as facts. There is a need to push back against the misleading claims and self-interested demands of the typical participants in the tax debate. As the peak council for working Australians and their unions, the ACTU is in a strong position to provide such balance, by advocating for tax reform in the interests of low- and middle-income people and for Australian society more broadly. After all, around half of all federal tax revenue is raised directly from individuals, with workers also paying GST and other indirect taxes. The tax system affects and belongs to all of us, so it’s important that working Australians have a voice on this important topic. This series of discussion papers represents one part of the ACTU’s participation in the tax debate. The papers will examine:

•

The facts about the Australian tax system, drawing comparisons over time and with other countries;

•

Australians’ preferences for their tax system and society;

•

The need for further progressive reform of the personal income tax system that supports and encourages workforce participation;

•

The truth about business taxation, and the need to ensure that the tax system supports jobs while requiring corporations to pay their fair share; and

•

The ways that loopholes in the tax system mean that ordinary working Australians pay higher taxes than those who can disguise their income through arrangements like sham contracting.

1. Principles for tax reform The Australian tax system belongs to the whole community, not just to the business sector. Real tax reform is one of the key ways that we can improve Australian society. Tax revenue funds the provision of services and infrastructure that are so important to Australians, and the design of the tax system can also play a key role in shaping and build a fairer, more prosperous Australia. Real tax reform is reform that is directed towards satisfying Australians’ needs and preferences, and that positions Australia well for the future. Real reform ensures that the tax system treats people of similar means equally, without allowing some to exploit loopholes to avoid their obligations (‘horizontal equity’). It means a progressive tax system, to ensure that all Australians pay their fair share (‘vertical equity’). Real reform will also ensure that the tax system is as simple and efficient as it can be, without sacrificing other aims in the name of simplicity or efficiency. ‘Reform’ should not imply an unending series of cuts to business tax and tax rates for high-income Australians. It should strengthen, not weaken, governments’ ability to provide the high-quality public services and social security that Australians want, need and deserve. Reforms to the Australian tax system should: 1. Ensure that the tax system raises sufficient revenue to fund the provision of high quality services to the Australian community; 2. Make the system more equitable and progressive, with taxes rising with individuals’ ability to pay; 3. Reduce the opportunities for individuals and businesses to avoid their obligations, particularly by disguising their incomes through contracting arrangements, trusts, and private companies; 4. Not reduce the proportion of tax revenue that is paid by business; 5. Ensure that superannuation delivers adequate retirement incomes to working Australians while making sure that tax incentives associated with super are focused on low- and middle-income earners; 6. Further reduce the effective marginal tax rates (EMTRs) that make it hard for low-income Australians to get ahead, and undermine workforce participation; 7. Reduce the distortions in the tax system that reduce the availability of affordable housing; 8. Promote jobs and investment in socially and environmentally useful projects; and 9. Ensure that Australians receive a fair share of the profits obtained by extracting our collectively-owned natural resources, including iron ore and petroleum.

2. Executive summary The tax system should be progressive: the higher your income, the more you should pay in tax as a proportion of your income. This cherished principle was undermined in the 2000s. The personal income tax, the largest source of revenue and the main progressive element of the overall tax system, became flatter, with the gap between the taxes paid by the well-off and those paid by average workers falling. In the 2000s, Australian high-income earners received larger tax cuts than their counterparts in almost all other OECD countries. OECD data shows that the tax rate for high-income earners (including personal income tax and other taxes) was cut in Australia by 6.5 percentage points, the third largest cut of any OECD country. The OECD average was a much more modest 1.8 percentage point cut. This paper finds that the personal income tax rate for a worker on average earnings fell by 2.8 percentage points over the decade, while the rate for someone on three times average earnings fell by 5.4 points. This flattening of the tax system exacerbated the trend of rising inequality and shifted more of the tax bill onto ordinary working Australians. Not only did these massive tax cuts for the well-off undermine the equity of the tax system, they were also poorly targeted if the aim of policy is to promote workforce participation. Marginal tax rates for high-income earners were cut by 10 percentage points in some cases, while those for low- and middle-income earners fell my much less, and rose at some income levels. This is despite the fact that studies show that lower income earners are more likely to vary their hours of work in response to a change in their net income. The Australia’s Future Tax System Review (“AFTS Review”) recommended a further flattening of the tax system, which would needlessly deliver further substantial tax cuts to the well-off at the expense of middle-income earners. It also recommended a substantially higher tax-free threshold, which would help to promote workforce participation by lifting millions of low-income Australians out of the personal tax system entirely and cutting effective marginal rates for others. The Clean Energy Future package builds on the positive aspects of the AFTS proposal: it delivers a much higher tax-free threshold, with tax cuts for low- and middle-income earners, but without the needless flattening of the system that AFTS recommended. Future reforms should build on the Clean Energy Future package by promoting workforce participation without undermining the equity of the system.

3. Introduction “The tax-transfer system is the principal means of expressing societal choices about equity. The tax-transfer system is a reflection of the kind of society we aspire to be.” – Dr Ken Henry, 2009 ACOSS National Conference. “The personal tax structure should be the sole means of delivering progressivity in the tax system” –Report of the Australia’s Future Tax System review (‘the AFTS Review’, also known as ‘the Henry Review’).1 If, as Dr Henry suggests, the tax-transfer system is the principal means of expressing societal choices about equity, and the Australian public favours more egalitarian public policy, then the tax system should reflect that choice by being strongly progressive.2 Personal income tax is the primary means of delivering progressivity in the overall tax system. The distribution of personal income tax liabilities therefore seriously affects the extent to which the overall system “express[es] societal choices about equity.” The personal income tax system over the past decade has become flatter, and has therefore moved away from Australians’ preference for equity. Some of the proposals of the AFTS Review, such as a flat marginal tax rate for 97% of taxpayers, would move the tax system further in the wrong direction. The income tax reforms announced as part of the carbon price package are a step in the right direction, but more must be done. It is time that the personal income tax system reflected Australians’ desire for equity and adequate revenue for social spending. Progressive tax reform has the capacity to improve participation at the same time as delivering greater equity in Australian society. This paper sets out the consequences of the tax changes of the past decade, compares these changes with developments overseas, examines the key recommendations of the AFTS Review, and evaluates the carbon price package. Finally, it sets out some future directions and principles for personal income tax reform, arguing that future reforms should build on the carbon price package by continuing to focus on promoting workforce participation for low- and middle-income earners without undermining the progressivity of the system.

Australia’s Future Tax System Review 2010, Report to the Treasure: Part One, Commonwealth of Australia, Canberra, p.29. 2 Australians’ desire for a progressive tax system and reduced inequality were examined in the first ACTU Working Australia Tax Paper, Myths and Realities. 1

4. Personal income tax: securing the fair go In a progressive tax system, higher income earners pay a larger proportion of their incomes in tax than low- and middle-income earners. This progressivity is largely delivered through the personal income tax, as many other taxes (like the GST) are regressive or proportional in their impact. The AFTS Review recommended that “the personal tax structure should be the sole means of delivering progressivity in the tax system”.3 Some indication of the overall progressivity of the Australian tax system can be seen in Figure 1, below. The income tax component of the tax system remains progressive, with households in the lowest quintile paying no income tax and households in the highest quintile paying 25% of their incomes in income tax, on average. However, when other taxes are included, the overall tax system is much closer to being ‘flat’, or proportional, than progressive.

40%

35%

30%

25%

20%

15%

10%

0% Lowest

-5%

Second

Third

Fourth

Gross household income quintile Income tax Other taxes

Taxes as % of household income

Figure 1: Progressivity of the Australian tax system

Highest -5%

Source: ACTU calculations based on ABS 6357.0

Personal income tax is therefore crucial to determining the overall fairness of the system. If the income tax system becomes ‘flatter’, then the overall tax system will also become flatter. Similarly,

Australia’s Future Tax System Review 2010, Report to the Treasure: Part One, Commonwealth of Australia, Canberra, p.29. 4 Derived from ABS, Government Benefits, Taxes and Household Income, Australia, 2003-04, Catalogue Number 6357.0, Table 9. Replicated from Davidson, P 2009, ‘Progressive tax reform: reform of the personal income tax system’, ACOSS Paper 158, Australian Council of Social Service. 3

if more revenue is raised via regressive or proportional taxes, and the personal income tax becomes less important as a source of revenue, then the overall system will also become flatter. Both of these things have occurred in Australia. These trends undermine the progressivity of the tax system, at a time when inequality has continued to grow. These trends are examined below.

4.1

The flattening of the personal income tax system in the 2000s

Much of the ‘flattening’ of the Australian income tax system has occurred not through reductions to the top marginal tax rate, but rather through increases to the top threshold and cuts to the secondhighest marginal rate. Figure 2, below, shows the top marginal tax rate from 1970 to 2011. While Australia used to have a significantly higher top MTR of circa 70 per cent, the rate has been between 45 and 50 per cent since the mid 1980s. Figure 2: Top marginal tax rate: 1970 to 2011 Per cent

Per cent

0 1970

0 1975

1980

1985

1990

1995

2000

2005

2010

Top personal marginal tax rate (incl. Medicare levy) 5

Source: Treasury

While the top marginal rate hasn’t changed much in the past twenty years, the threshold at which the top rate begins to apply has been lifted dramatically. In the 1990s and the first half of the 2000s,

5 Australian Treasury 2008, Architecture of Australia’s Tax and Transfer System, p.193, updated by the ACTU using Budget papers.

individuals faced the top MTR when they earned between 1.5 and 1.8 times average weekly earnings. Since 2005, the top threshold has been lifted on three occasions. First, from July 2005, the threshold was lifted from $70 000 per annum to $95 000 per annum, or from 1.7 times average earnings to 2.3 time average earnings. Then, in 2006, the top threshold was lifted again, this time to $150 000 or 3.5 times average earnings. The 2008-09 tax year saw another substantial lift in the threshold, this time to $180 000 or 3.8 times average earnings. Figure 3, below illustrates the changes in the top MTR threshold to average weekly earnings ratio over the past 15 years. Figure 3: Top marginal tax rate to average weekly earnings ratio

Top MTR to average earnings ratio

0 1984

1987

1990

1993

1996

1999

2002

2005

2008

2011

Source: ACTU calculations based on ABS, ATO

Until the mid-2000s, the top marginal rate applied to incomes greater than around 1.7 times average earnings. As at mid-2011, the top marginal tax rate only applies to incomes greater than 3.5 times average weekly earnings. This is a significant change. In 2008-09, only 2 per cent of taxpayers faced the top marginal income tax rate.7 High-income earners, whether theyâ&#x20AC;&#x2122;re in that top 2 per cent or not, have benefited immensely from the increase in this threshold and the cuts in the second highest marginal rate.

6 ACTU

calculations based on ABS, Average Weekly Earnings, Cat no. 6302.0 and historical tax scales obtained from the Australian Tax Office. Earnings figures are total average weekly earnings for all employees, seasonally adjusted. 7 Australian Taxation Office, Taxation Statistics 2008-09, Table 9.

The second highest marginal rate was 43% until July 2000, when it was lowered to 42%. It was then reduced to 40% in 2006, then 38% in 2009 and finally 37% in 2010. Many high-income earners have also benefited from the concessional treatment of capital gains and the flat rate tax on superannuation contributions.

4.2

Who gained from personal tax reform in the 2000s?

One way to evaluate the implications of these changes for the progressivity of the personal income tax system is to look at the change in the average tax rate (ATR) paid by individuals at various multiples of average earnings. The ATR is simply an individualâ&#x20AC;&#x2122;s tax liability divided by his or her income; for example, if a person earned $100 000 and paid $25 000 in tax, the ATR would be 25%. Over the past ten years, the ATR for individuals who earn an average wage has been reduced by 2.8 percentage points, from 20.9% to 18%.8 Individuals who earn 3 or 4 times that amount have seen their average tax rates fall by 5.4 percentage points over the decade. Table 1, below, shows the average tax rates faced by individuals at various multiples of average weekly earnings in 200001 and 2010-11.9 Table 1: Average tax rates paid at multiples of average weekly earnings in 2000-01 and 2010-11 Income (February

2000-01

2011)

Ave.

201011

Reduction in tax (dollars)

Reduction in ATR (percentage points)

$52,430

20.9%

18.0%

-$1,492

2.8%

2 x average

$104,859

30.0%

27.0%

-$3,168

3.0%

3 x average

$157,289

36.2%

30.8%

-$8,420

5.4%

4 x average

$209,719

39.3%

33.9%

-$11,272

5.4%

5 x average

$262,148

41.1%

36.4%

-$12,323

4.7%

10 x average

$524,296

44.8%

41.5%

-$17,575

3.4%

earnings

Source: ACTU calculations

The gap between the tax rates paid by middle-income earners and those paid by high-income earners has fallen, flattening the tax system. High-income earners have received larger tax cuts, in both dollar terms and as a proportion of their incomes, than middle-income earners.

Each figure has been rounded to the nearest decimal place. 2000-01 has been used as the baseline for this analysis, as it was the first tax year in which the GST was in place. 10 ACTU calculations based on ABS 6302.0 and Budget papers. This analysis includes Medicare Levy and the Low Income Tax Offset, but does not include other offsets, surcharges or deductions. 8 9

The analysis in Table 1 compares the tax rates paid by workers at specific points in the wage distribution in 2000-01 and 2010-11. Another way of examining the distributional consequences of changes to the tax system over the past decade is to compare individuals’ current tax liabilities with what their liabilities would have been if the system had remained unchanged in real terms. In the analysis below, the 2000-01 tax rates and thresholds have been adjusted in line with the Wage Price Index (WPI)11. The Low Income Tax Offset (LITO) and Medicare Levy thresholds, as well as the LITO amount, have also been adjusted. The 2000-01 tax structure, indexed to WPI, is then compared to the 2010-11 structure, to show the size of the ‘real’ tax cut accruing to individuals at various income levels. This gives some idea of the ‘real’ tax cuts given at particular income levels, above and beyond cuts that hand back ‘bracket creep’ that comes about as a result of growth in incomes. The results are stark. Figure 4 shows the income tax liability that individuals at each income level would have incurred if the 2000-01 thresholds had been indexed, and compare it with the 2010 liabilities. Figure 4: Income tax liability by income level – 2000 (indexed) and 2010 $100,000

Income tax liability

$80,000

$60,000

$40,000

$20,000

$0 $0

$50,000

$100,000 Gross income 2010

$150,000

$200,000

$250,000

2000 (indexed)

Source: ACTU calculations

WPI has been used to inflate the thresholds and LITO amount, as it is growth in wage rates (rather than the growth of prices as measured by the CPI) that affects individuals’ tax liabilities. The WPI controls for compositional change in the labour market and therefore provides a ‘purer’ measure of changes in wages over time than other measures of wages growth.

Many high-income earners have received real tax cuts, in excess of bracket creep compensation, of over $10 000 per year. Most middle-income earners have received real cuts of less than $2000 per year. The distribution of real tax cuts over the decade is depicted in Figure 5. Figure 5: Real tax cut (dollars per year): 2000-01 to 2010-11 $14,000 $12,000

Real tax cut per year

$10,000 $8,000 $6,000 Average wage

$4,000

Average full-time wage

$2,000 $0 $0

$50,000

$100,000 $150,000 Gross income

$200,000

$250,000

Source: ACTU calculations.

A full-time worker on average wages has received a real tax cut of around $1300, about $25 per week, over the course of the past decade. Someone with an income of three times the average full time wage received a real tax cut nearly 10 times the size, at around $12 170, or $234 per week. Of course, a large dollar tax cut to a high-income earner may represent a relatively small percentage of their gross income. Figure 6 shows the real change in the average tax rate curve over the decade. While the average tax rate fell in real terms at all income levels, it fell more sharply at higher income levels, and became flatter overall.

Figure 6: The flattening of the tax system: Average tax rates in 2000 (indexed) and 2010 50%

Average rax rate

40%

30%

20%

10%

0% $0

$50,000

$100,000 $150,000 Gross income 2010

$200,000

$250,000

2000 (indexed)

Source: ACTU calculations.

Figure 7, below, depicts the real tax cuts to various individuals, expressed as a percentage of gross income. It shows that people who earn between approximately $122 000 and $275 500 received real tax cuts of at least 5%. Some low-income earners also received real tax cuts equivalent to more than 5% of their gross income. Many middle-income earners received far smaller real tax cuts. Figure 7: Real tax cut (percentage of gross income): 2000-01 to 2010-11 7%

Percentage of gross income

6% 5% Average wage

4% 3% 2% Average full-time wage

1% 0% $0

$50,000

$100,000 Gross income

$150,000

$200,000

$250,000

Source: ACTU calculations.

This analysis shows that, in dollar terms, high-income earners have received significantly larger tax cuts than low- and middle-income earners. In percentage terms, low-income earners (largely parttime workers) have received real tax cuts of a reasonable size as a proportion of their gross incomes (largely from the LITO increases over the period), as have high-income earners, but most ordinary full-time workers have not.

4.3

International comparisons

As outlined above, Australian high-income earners received significant tax cuts in the 2000s. While this is also true of high-income earners in many other developed countries, few nations gave such sizeable tax cuts to their high-income earners. Over the course of the decade, Australia went from having the 13th lowest taxes on high-income individuals to the seventh lowest.12 This is shown in Figure 8, below.

In this OECD data, high-income earners are workers who earn 1.67 times the average wage in their country, and the tax rate is an inclusive measure of the difference between labour costs to the employer and the corresponding net take-home pay of the employee. 12

Figure 8: Tax rates on high-income earners in 2000 and 2010 in OECD countries

Source: OECD

The total tax rate for high-income earners was cut in Australia by 6.5 percentage points, the third largest cut of any OECD country. The OECD average was a much more modest 1.8 percentage point cut. Australian high-income earners’ 6.5 percentage point cut was larger the cuts received by their counterparts in the US (1.6 pp) or New Zealand (1 pp). Norway, which also experienced a commodity-fuelled boom, only cut high-income earners’ taxes by 2.6 pp, and Canada similarly reduced rates by 2.7 pp. Australia’s large tax cuts for high-income earners were not part of an OECD-wide race to slash rates. While Australia slashed rates for high-income earners by 6.5 percentage points, the OECD data show that average workers received a more modest cut of 4.1 points. While this was still larger

OECD Stat 2011, Average tax wedge for single adult with no children at 167% of the average wage. Based on Megalogenis, G. 2011, ‘How our rich were given some of the world’s biggest tax cuts’, The Australian, 21 September. 13

than the OECD average, it confirms that the Australian personal tax system became flatter in the 2000s, with larger cuts going to high-income earners than average workers.14

4.4

Were the tax cuts well-targeted?

One of the claimed benefits of tax cuts implemented during the 2000s was increased workforce participation. Standard economic analysis suggests that a reduction in marginal tax rates should induce an increase in the labour supply; people will want to work more, or seek work in the first place, as a result of an increase in their after-tax income. However, evidence suggests that the labour supply response of different groups of workers to a change is not equal. Many factors other than tax affect the decision to participate in the workforce, and the amount of hours of work to seek. Wages rates are important, as is childcare policy.15 There is evidence to suggest that people in higher-income households are less responsive to changes in their net incomes than low-income people. The most responsive group are single parents, followed by married women. Most studies suggest that married men, on average, do not vary their labour supply in response to changes in net income.16 Policies to promote workforce participation, including tax policy, should be targeted at low- and middle-income earners, as they’re most responsive to changes in their after-tax incomes. Tax cuts aimed at high-income earners, like those in Australia in the 2000s, are likely to yield far less ‘bang for the buck’ in terms of increased workforce participation than equivalent-cost policy measures directed towards low- and middle-income earners. Tax cuts for high-income earners don’t result in any material change in workforce participation: the individuals pocket the increased income and don’t change the amount they work. That is fine if the policy rationale is increasing the net incomes of high-income earners. If the policy is sold on the basis that it will increase workforce participation, then tax cuts aimed at the well-off fail to deliver on their promise. Of course, the tax cuts in the 2000s were not just aimed at high-income earners. Very low-income earners (mostly part-time workers) also experienced a reduction in their marginal and average rates of tax. In particular, the dramatic expansion of the Low Income Tax Offset in the past few

Note that the tax rates used in this OECD data differ from the average tax rates presented elsewhere in this paper, as they include other taxes on labour income. 15 Buddelmeyer and Kalb found that minimum wage increases can yield a greater labour supply response than equivalent-cost changes to tax policy. See Buddelmeyer, H. & Kalb, G., ‘The effect of minimum wage changes on labour supply and income distribution’, 2008 Minimum Wage Research Forum, Volume 2, October 2008, Australian Fair Pay Commission, 222-226. 16 The elasticity of labour supply for married men is found to be “mostly in the range between 0 (or slightly negative) to around 0.3 with average around 0” in a range of studies summarised by Dandie, S. and Mercante, J. 2007, ‘Australian labour supply elasticities: Comparison and critical review’, Treasury Working Paper 2007-04, Commonwealth Treasury. These Australian studies seem to accord with international findings regarding the variation of elasticity among demographic groups, eg. Saez, Slemrod & Giertz 2009. 14

years has seen the effective tax-free threshold increased from $7567 in 2005-06 to $16 000 in 2010-11. 17 Figure 9: Effective tax-free threshold: 2000-01 to 2010-11 $18,000

Effective tax-free threshold

$16,000 $14,000 $12,000 $10,000 $8,000 $6,000 $4,000 $2,000 $0 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 Source: ACTU calculations based on Budget papers.

The LITO has done much to help low-income Australians, and to encourage workforce participation by cutting effective marginal tax rates for low paid workers (these are examined in more detail in a later section of this paper). The expansion of the LITO has been one of the notable achievements of the Labor Government. Some elements of the tax reforms of the 2000s were clearly welltargeted to achieve an increase in workforce participation. However, the largest and most expensive tax cuts over the decade were directed towards highincome earners. As outlined above, Australian high-income earners received larger tax cuts than their counterparts in nearly all other developed countries in the 2000s. If some or all of that revenue had been directed towards policies to assist and encourage lower income people to enter the workforce, be it through tax policy or other areas such as childcare assistance, the workforce participation dividend would have been much stronger. In fact, the largest reductions in marginal tax rates over the decade were for individuals on double or triple average earnings, as shown in Figure 10. This is not the result that would be obtained if tax reform in the 2000s had truly been directed towards increasing workforce participation.

ACTU calculations based on Budget papers. Effective tax-free threshold is calculated here for single adults. It is calculated as the statutory TFT + (LITO amount / lowest MTR).

Figure 10: Marginal tax rates paid at multiples of average earnings in 2000-01 and 2010-11 Reduction Amount (February

in marginal 2000-01

2010-11

2011)

tax rate (percentage points)

$26,215

18.5%

16.5%

2.0%

$52,430

31.5%

35.5%

-4.0%

2 x average

$104,859

48.5%

38.5%

10.0%

3 x average

$157,289

48.5%

38.5%

10.0%

4 x average

$209,719

48.5%

46.5%

2.0%

5 x average

$262,148

48.5%

46.5%

2.0%

$524,296

48.5%

46.5%

2.0%

50% of ave Average earnings

10 x average 18

Source: ACTU calculations

4.5

The composition of tax revenue

The analysis above demonstrated that the personal income tax has become flatter, less progressive, in the 2000s. This, in turn, has undermined the progressivity of the tax system as a whole. The overall progressivity is also undermined by the shift away from income tax towards taxes such as the GST which are effectively regressive. The AFTS Review found that “Australia’s total taxation on personal incomes is among the lowest in the OECD,” taking into account the fact that we do not pay social security taxes, as the citizens of many other developed countries do.19 This has important ramifications, as personal income tax is generally the main progressive element of a tax system. Indeed, the AFTS Review recommended that the personal income tax system “should be the sole means of delivering progressivity in the tax system”.20 If personal income tax is the primary (or sole) means of delivering progressivity, and the share of revenue derived from personal tax is reduced, then it stands to reason that the overall progressivity of the system will fall. Successive changes to the tax system have reduced the role of personal income tax, and thereby undermined the progressivity of the overall system. Direct taxes on individuals have fallen from 13.5% of GDP in the late 1980s to 11.1% in 2006-07.21 There has been a move towards tax bases with a regressive impact, like consumption taxes.

ACTU calculations based on ABS 6302.0 and Budget papers. This analysis includes Medicare Levy and the Low Income Tax Offset, but does not include other offsets, surcharges or deductions. 19 Australia’s Future Tax System 2009, Report to the Treasurer, vol 2, part 1, p.3. 20 Australia’s Future Tax System 2009, Report to the Treasurer, part one, page xix. 21 Australian Treasury 2008, Architecture of Australia’s Tax and Transfer System, p.193. 18

5. The AFTS Review’s flat tax proposal Future tax reforms must not further undermine the progressivity of the tax system. Unfortunately, the proposal in the AFTS Review for a flatter personal income tax system would do just that. It is often suggested by economists that, in the interests of efficiency, the pursuit of equity should be confined to a progressive personal income tax system and a system of transfer payments. This is the position advanced by the AFTS Review in its recommendation that the personal income tax be "the sole source of progressivity in the system".22 And yet, when discussion turns to personal income tax and social security payments, equity seems to recede as a consideration. This, unfortunately, is the case with the AFTS Review’s proposal for a flatter personal income tax system. The AFTS Review suggested that the personal income tax system should be reformed to feature a “high tax-free threshold with a constant marginal rate for most people”. An indicative tax scale was given, with a $25 000 tax free threshold, a 35 per cent marginal rate for 97 per cent of tax payers, and a 45 per cent marginal rate for very high-income earners (those earning over $180 000 per year). The idea of a much higher tax-free threshold has substantial merit. A threshold of $25 000 would remove many social security recipients from the tax system, reducing the complex interactions between the income tax and payments systems that can discourage workforce participation and can make it harder for low-income people to make ends meet. As a medium-term goal, a higher tax-free threshold is something that policy makers should work towards. The Government has taken a substantial step in this direction with the Clean Energy Future household compensation package (examined in more detail in a later section of this paper) However, there is no compelling reason for this higher threshold to be accompanied by further flattening of the tax system and further tax cuts for high-income earners. This proposal would result in high-income earners receiving more tax cuts, on top of the substantial real tax cuts they have already received in the past decade. While the proposal would also reduce tax for some lowincome earners, it would increase the tax bills of middle-income Australians. Figure 11 shows the distribution of tax cuts and increases by income level.

22 The AFTS Review also recommends a progressive land tax, which does not seem to accord with its recommendation that personal income tax be the sole source of progressivity.

4000

3500

3000

2500

2000

1500

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500

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Figure 11: Tax cuts and increases by income level with the AFTS proposal

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All individuals with taxable incomes between around $36 000 and $93 000 would pay more tax under this proposal. A worker on an average wage would pay $133 more per year, while someone on three times the average wage would receive a $2206 tax cut. While the tax increases on middle-income earners arenâ&#x20AC;&#x2122;t large, this proposal would nevertheless continue the trend of cutting taxes on well-off Australians relative to ordinary workers, while flattening the personal tax system. The high tax-free threshold ensures that the AFTS structure remains progressive, but the degree of progressivity would once again be reduced. The AFTS structure would cut marginal tax rates for individuals with taxable incomes below $25 000, but would increase MTRs for individuals with incomes between $25 000 and $37 000 per year. In some cases this increase would be substantial â&#x20AC;&#x201C; from 16.5% to 35%. The 2010-11 marginal tax rates (including the LITO and Medicare Levy) are compared with the AFTS proposal in Figure 12.

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Figure 12: Marginal tax rates under the current system and the AFTS proposal

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Source: ACTU calculations based on Budget papers and the AFTS Review.

The structure proposed by the AFTS Review would further flatten the tax structure, delivering tax cuts to high-income earners, while middle-income earners would pay more tax. Some low-tomiddle-income earners would also face higher marginal tax rates, which could reduce workforce participation for them. There is no need for the increase in the tax free threshold to be accompanied by significant cuts to high-income earners. The 37% marginal rate should be retained. This rate has already been cut significantly over the past decade, and the threshold at which it applies has been increased in real terms. Abolishing this rate, such that 97% of taxpayers face a constant marginal rate, would be an unacceptable step towards a truly flat income tax system. Given the regressive effect of other taxes (such as consumption taxes), a flatter income tax system pushes the tax system as a whole towards being less progressive.

6. The Clean Energy Future package The Government has announced plans to move towards a higher tax-free threshold without undermining the progressivity of the system. Under the Clean Energy Future household assistance package, the statutory tax free threshold will be increased to $18 200, while the effective threshold (taking into account the LITO) will be $20 500. This is a substantial improvement on the current arrangements, which feature a statutory threshold of $6 000 and an effective threshold of $16 000. Marginal and average rates for taxpayers on greater than $80 000 will remain unchanged under the package â&#x20AC;&#x201C; no one will pay more income tax as a result of these changes, but low- and middleincome earners will pay less. Figure 13: Marginal tax rates under the current tax system and the post-CEF system 40% 35%

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While there is a slight increase in the MTRs faced by some low-income earners, it is a much smaller increase (from 15% to 19%) than under the AFTS proposal, and the MTR increases occur over a much smaller range of incomes. Average rates are cut for all taxpayers with incomes below $80 000 per year, as shown in Figure 14, below.

Note that these calculations omit the Medicare Levy, as it was not clear at the time of writing where the Medicare levy phase-in thresholds would lie after the implementation of the CEF package. As the ML is being preserved under the package, its omission does not make a significant difference to this analysis.

Figure 14: Average tax rates under the current tax system and the post-CEF system 25%

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Source: ACTU calculations based on CEF papers and Budget papers.

The Clean Energy Future package is a good first step in the right direction: it encourages workforce participation for low- and middle-income earners without adding to the excessive tax cuts high-income earners have already received in recent years. Future reform should follow in these footsteps.

7. Future directions Future tax reforms should build on the Clean Energy Future package: boost workforce participation by cutting effective marginal tax rates (EMTRs) for low-income people, while preserving and enhancing the progressivity and equity of the system. The arguments in favour of these principles are briefly outlined below.

7.1

The tax system needs to be more progressive, not less

The most well-off Australians have done very well over the past decade. Their share of national income is large and has risen substantially. Figure 15, below, shows the share of total income that is earned by the top 1% of taxpayers. Although there are some cyclical swings, the top income share has been rising since the early 1980s. Figure 15: Share of total income held by the top 1% of taxpayers 12

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Tax policy is made against this backdrop of rising inequality of incomes, yet in the past decade the majority of tax reform revenue has been directed towards high-income earners. The tax system needs to be more progressive, rather than less, in order to maintain an egalitarian Australia. If rising inequality persists over time, inequality of opportunity will become entrenched, and our relatively high degree of inter-generational social mobility may fall.

7.2

Workforce participation should be promoted

Promoting workforce participation is an imperative for public policy for several reasons. First, obtaining decent work is a key way for people to lift themselves and their families out of social exclusion. Decent work with decent wages is the best social inclusion strategy yet devised. Second, boosting workforce participation has economy-wide benefits. With an ageing population, the ratio of working-age people to seniors declines; to maintain economic growth and ensure fiscal sustainability, promoting workforce participation is a laudable and necessary goal of public policy. There are many aspects of public policy that can promote workforce participation, of which the tax system is only one element. Investing in skills and education is important. Getting childcare policy right can deliver a huge boost to participation, particularly given the fact that single parents and married women are among the most responsive to changes that make it easier for them to work and earn a decent living. Ensuring that the Job Services Australia system is functioning well, particularly in assisting long-term and disadvantaged jobseekers, can also help to make sure that no one is locked out of the workforce. However, the tax and transfer systems do have a significant role to play. People are more likely to work, or to seek additional work, if they keep a larger proportion of an extra dollar they earn. While the size of this behavioural response is close to zero for higher income earners, low-income earners are particularly response to changes in their net incomes. Future tax reforms that aim to promote workforce participation should be aimed where they get the biggest ‘bang for the buck’: with low- and middle-income earners. Low income earners who are not in the labour force or who work part time can face high effective marginal tax rates (EMTRs), which can discourage workforce participation.25 EMTRs are the sum of the tax paid and social security withdrawn as a result of earning an additional dollar of private income. An EMTR of 60%, for example, means that a low-income person will retain only 40c out of an additional dollar that he or she earns by working. Social security payments (such as Newstart and Youth Allowance) are typically withdrawn at 60c in the dollar: for each additional dollar that a payment recipient earns from work, they lost 60c of their payment. It is this steep ‘taper rate’ that is the main source of the participation disincentives that are faced by low-income earners. In some ways, high EMTRs are an inevitable by-product of

The EMTR is only one way of measuring work disincentives. The participation tax rate (PTR) is another, which more accurately summarises the disincentives facing a person at the extensive margin – the decision to work or not work. Effective average tax rates (EATRs) are also used, which measure EMTRs over a broader span of earned income. In practice, policy changes which reduce one tend to reduce the other, and this should be the case for an increase in the tax-free threshold.

Australia’s highly targeted system of social assistance, in which payments are tightly meanstested.26 The problem of high EMTRs has got worse, not better. Researchers from NATSEM estimate that the proportion of working-age Australians who face EMTRs of more than 50 per cent increased from 4.8% in 1996-97 to 7.1% in 2006-07. Low income people can face EMTRs well in excess of 50%, well in excess of the 46.5% marginal rate paid by high-income earners. These should be reduced. The question of how best to reduce low-income earners’ disincentives to work is an important and complex one. Progressive reform of the social security system is needed, but increases in the taxfree threshold can also assist to reduce disincentives. The carbon price package is therefore a step in the right direction: the ACTU’s estimates suggest that EMTRs for a single, adult Newstart recipient will be cut from a peak of 75% in the current system to a peak of around 68% once the package is in place. Figure 16: Estimates of EMTRs for single adult Newstart recipient: current system and post80%

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26 Peter Whiteford has found that our transfer system for working-age people is targeted more strongly to the poorest quintile than is the case in other OECD countries. See Whiteford, P. 2010 ‘The Australian Tax-Transfer System: Architecture and Outcomes’, Economic Record, vol. 86, no. 275, pp.538-544.

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Future reforms of the tax system should build on the carbon price package by moving towards a higher effective tax-free threshold, and lifting more social security recipients out of the personal income tax system. If policymakers wish to implement policies that will boost workforce participation, reforms should benefit low- and middle-income earners, not high-income earners.

8. Conclusion Tax cuts in the 2000s were poorly targeted and inequitable. They were ineffective in promoting workforce participation. Australian high-income earners, already lowly taxed by international standards, received much larger tax cuts than their counterparts in other developed countries, and larger cuts than middle-income earners. The tax system has been flattened, exacerbating the trend of rising inequality and shifting more of the tax bill onto ordinary working Australians. The AFTS Review proposed a personal tax structure that had some positive elements, but would exacerbate the trend of recent times by delivering large, unnecessary tax cuts to high-income earners and raising tax on average earners. The Clean Energy Future package was a step in the right direction. The statutory tax-free threshold is to rise by more than $12 000, with the effective threshold rising by over $4000. This will help to cut effective marginal rates for low-income workers and thereby promote workforce participation. The reform package leaves the progressivity of the tax system intact, without further flattening personal tax. Future reforms should build on the Clean Energy Future package by targeting lowand middle-income people. This is the best way to promote workforce participation, and it is the best way to keep some equity and progressivity in the tax system.

Paying Our Way Personal income tax in Australia ACTU Working Australia Tax Paper No. 4 level 6 365 queen street melbourne victoria 3000 t 03 9664 7333 f 03 9600 0050 w actu.org.au D60 - 2011 Working Australia Paper No:9

australian council of trade unions