Ideas@TheCentre
Taxing illusions
One of the milestones of the tax year is upon us – the necessity of filling in a tax return and receiving back an assessment, together with a refund or a demand for more tax. It is a good time to reflect on the visibility of modern taxation and the features of the tax system that create the illusion of a smaller tax burden than the reality.
The Goods and Services Tax (GST) is largely invisible to the consumer. Prices advertised and charged to the consumer must, by law, include the GST. Contrast this with the United States, where the state-based sales tax is more noticeable to the purchaser because it is an add-on to marked prices.
In the realm of income tax, the device that does more than anything else to delude taxpayers is the Pay As You Earn (PAYE) deduction from wage and salary income. PAYE started during World War II. It is difficult to exaggerate its importance in facilitating the post-War enlargement of government.
PAYE ensures that by 30 June, each year, most wage and salary earners have fully discharged their income tax liability – or even overpaid it – without ever needing to have transacted directly with the tax office. Their employer has done it all for them before the money even landed in their bank account. Getting a refund may even make people feel good about the income tax system, regardless of how much has been spirited away from them during the year.
The state-based land tax is one of the most despised taxes in Australia. There are a number of reasons for this, but surely one of them is that the taxpayer has to make a payment directly to the tax office at least once a year.
In Hong Kong, wage and salary earners are in the same boat as Australian land tax payers. There is no PAYE system. Wage and salary earners actually have to pay their tax directly to the tax office. That is one reason why income tax in Hong Kong is very light compared to other countries, and confined to around 35% of wage and salary earners. Imagine the resistance to current income tax rates in Australia if we did not have a PAYE system.
PAYE does of course minimise the administrative and compliance costs of income tax, but one can’t help thinking that even if it wasn’t designed to make the tax burden less painful and visible, governments are happy that it does.
A world without PAYE is wonderful to contemplate but never likely to return. There are, however, small steps that the government could take to make income tax more transparent. Most taxpayers would not know what percentage of their income they have paid in income tax each year (their average rate), or how much they paid on their last dollar of income (their marginal rate). The government could improve transparency by prominently displaying on every taxpayer’s annual assessment both the average and marginal rates in the year just ended.
Robert Carling is a Senior Fellow at The Centre for Independent Studies.
