Opinion & Commentary
Simpler tax is easy, but where's the political courage?
Reform is good. Sometimes, revolution is better.
Federal Treasurer Peter Costello has announced his intention to simplify the tax system by stripping out a couple of thousand redundant pages from the tax code. But if we really want a simpler tax system, we need to do a lot more than that.
Much has been said about the need for tax and welfare reform in Australia , but every serious attempt to rethink the system gets derailed by those who say there must be no losers or that government must not be asked to cut back its spending plans.
I propose a new system - 30/30. This involves a tax-free threshold of $30,000 and a flat income tax of 30 per cent for all types of income. The Medicare levy and all tax expenditures would be removed.
The tax debate cannot be separated from the welfare debate. Under 30/30, all current welfare payments would be replaced by a sliding scale of payments (called a negative income tax - NIT) that tapers out at a rate of 30 ¢ for every dollar earned and finishes at an income of $30,000. Under such a system, no individual would both pay tax and receive welfare. The NIT would allow the removal of the minimum wage, as NIT payments would top up incomes for low-wage earners. Based on Australian and international evidence, we could expect this to lead to 500,000 new jobs.
Under the current system, some workers are heavily punished for working, through high taxes and loss of welfare benefits. In some rare instances workers lose up to $1 to the government for every $1 earned.
Under 30/30, a worker will always lose 30 ¢ out of every $1 to the government. This drastically improves the reward for working.
But 30/30 does more than help the most disadvantaged - it helps all workers and also the economy in general. Workers on an average income will see their tax burden almost halve and workers on double-average incomes will see their tax burden reduced by 38 per cent.
The biggest winners in percentage terms are low-income earners who earn less than $30,000 and are now exempt from income tax and receive wage top-ups through the NIT.
Rough estimates suggest that the 30/30 reforms will lead to an economic benefit of about $90 billion in the medium term - or $4500 per person per year. In the long run these benefits may be even higher.
A low flat tax with a high tax-free threshold continues to be progressive (higher income earners pay a higher average tax rate), but it has the added advantages of lower administrative costs and fewer avenues for tax avoidance or evasion.
In addition, the dreaded tax pack would be unnecessary for the majority of taxpayers, and we would finally be rid of our absurdly high top marginal tax rates.
There are two likely complaints about this package, both coming from a conservative, static and short-term view point.
One possible complaint is that it would provide less welfare to the unemployed. I offer no apology. We distribute more of our welfare budget to the poorest 30 per cent of households than almost any other country, and support for groups like single parents is generous by international standards.
A slightly lower welfare payment is a small price to pay for better incentives, more job opportunities, fewer bureaucratic hassles, a stronger economy and higher long-run living standards. If cutting unemployment benefits seems inequitable, how much more inequitable is it to continue with the current policies that keep people unemployed?
Another complaint might be that the above reform agenda is not affordable. In the short-run it is true, as the tax cuts would return $40 billion a year to taxpayers. This is partially offset by the removal of tax expenditures, reduced administration and compliance costs, and reduced tax avoidance and evasion.
In addition, there will be an efficiency dividend, as a larger economy and more employment leads to more tax revenue.
Rough estimates indicate that in the medium term 30/30 will actually end up improving the budget position. However, even if this were not the case, the benefits of 30/30 are such that they justify eating into future budget surpluses and the removal of other failed government programs (corporate welfare comes to mind).
Australia is a great country. If tax and welfare reform are ignored, most people will continue to lead a full and happy life.
But there are problems that can and should be fixed and 30/30 offers a good template for serious change. It is efficient, equitable, simple and affordable. The only ingredient missing is political courage.
John Humphreys is an economist and adjunct scholar of the Centre for Independent Studies. This is based on his paper Reform 30/30: Rebuilding Australia's Tax and Welfare Systems, published today by the CIS
