Opinion & Commentary
Ditch deductions to lower the tax rates
Get out your shoe box of receipts; the end of the financial year is near. Australian workers rely on tax deductions to save as much of their income from Canberra’s clutches as they can. We make about $32 billion of personal tax deductions each year, more than half of which are “work-related expenses”. Who doesn’t have a “home office” with a computer that is used “for work”?
But tax deductions are the fool’s gold of the tax system.
For every tax deduction, income tax rates are higher for all, with all the illiberal expropriation and incentive-sapping inefficiency that entails.
Advertisement: Story continues below Moreover, the complexity of tax deductions makes them a tax on the busy - who can’t be bothered spending hours at night with a Tax Pack - and the low-paid, who generally can’t afford to hire an accountant.
About three quarters of Australian taxpayers offload their tax affairs to an accountant, more than in any other country bar Italy. In Spain and New Zealand, where very limited or no work-related expenses are allowed, only about a quarter of taxpayers use accountants.
Yet Australian accountants should not fear a world without tax deductions. With an Australian tax code that has blown out from about 500 pages in 1975 to about 6000 today, they won’t struggle to find work.
Many of the tax office’s 22,000 staff could be better employed in the private sector too, if they weren’t otherwise occupied administering tax-breaks. Interminable tax office guides or costly court judgments accompany every available deduction: look out for the 3000-word ruling that distinguishes a “home office” from a “private study”.
Tax deductions stem from the idea that expenses necessarily incurred to keep your job should be deducted from your income before income tax is calculated. As the Henry review into Australia’s tax system notes, “people with the same level of income may incur different costs in earning that income”.
That sounds fair but the rules we have do not live up to the principle. Ordinarily you can’t claim the cost of getting to work. But you can if you are carrying a cello or a ladder, or if you write a few substantive work emails at home before setting out.
You can claim union fees but not social club dues. Nurses and chefs can deduct the costs and cleaning of their coats, but professionals can’t even claim a capped amount to buy their suits and ties, which for many, are compulsory attire.
Rather than maintain our Byzantine system, Australia should abolish all work-related tax deductions.
We could abolish the deductibility of managing one’s tax affairs too, which lops $2 billion off Australians’ taxable income. A simple system would not need a subsidy to alleviate complexity. All the extra revenue should be used to cut income tax rates.
Let’s assume that taxpayers making work-related tax deductions pay the second-highest marginal tax rate on average: 38.5 per cent. The government could raise an extra $7 billion or so in revenue by canning them.
Provided all the money was used to cut income tax rates, and I can’t stress that proviso enough, all taxpayers could get a tax cut of about $800 a year. For instance, the government could cut the 15 per cent income tax rate to 12 per cent - a permanent and politically irreversible tax cut that enhances incentives to work for the lowest-paid.
All this without the government having to cut a dollar of spending.
Tax deduction addicts might be worse off financially but they might also value freedom from shoe boxes of receipts, accountants’ fees or copious hours of reading the Tax Pack. In the long run, wages and salaries would adjust to reflect the costs of employment that had been foisted onto staff. Or employers would simply come to pay them directly.
Based on advice in the Henry review, the government is proposing to give taxpayers a “standard” $500 tax deduction beginning in July 2012 and ramping it up to $1000 a year later. Even if you have nothing that actually warrants deduction, you can still mindlessly claim one.
None of the old mess will be cleaned up. Taxpayers can still elect to make deductions as before if their work-related expenses and tax affairs exceed these thresholds.
This is a marginal improvement at best. Government revenue will fall about $800 million a year, as the volume of “deductions” increase dramatically. And Treasury reckons welfare costs will jump $300 million a year, as family tax benefit and baby bonus recipients get an automatic fall in their taxable income - and hence an increase in their payments. So much for tax cuts and incentives to work.
Surely having lower tax rates is better than ticking a box marked “deduction”? The government’s plan assumes taxpayers are too stupid to see that a “standard” deduction of $1000 is exactly the same as having no deductions and paying less income tax, but with more opacity, bureaucracy and inequity.
Complexity is the enemy of freedom and fairness, but the friend of big government. Taxpayers who can easily see how much tax they pay and how they pay it, will scrutinise government spending more carefully.
Adam Creighton is a Research Fellow at The Centre for Independent Studies.
