Flat-out making some proportional changes

OF the many assumptions behind Australia’s taxation system, two stand out.

One is that personal income is one of the fairest tax targets.

The other is that this tax should be progressive.

That is to say, not only should you pay more tax on your income the higher it is, but you should pay proportionately more.

In a liberal democracy a taxation system can only work with widespread voluntary compliance.

Voluntary compliance depends on the tax system being accepted as, by and large, just.

Unless it appears fair and reasonable in what it targets, the rates it strikes, and in how it is administered, far more coercive methods are required.

In an open democracy, large-scale dependence on such methods would obviously be politically untenable.

One reason income tax is so widely accepted is that so many taxpayers never actually have in their hands what they lose in income tax.

They simply do not see it for what it is the compulsory sacrifice of something originally rightfully theirs.

How different it would be if no tax instalments were deducted, but after June 30 every taxpayer had to write out a cheque for the full amount of the tax assessed as due.

From a government point of view, instalments paid at source are a very smart psychological move.

There are new moves to reduce income tax at both the top and bottom ends.

Such moves would also reduce its progressive character, making it closer to a flat tax a uniform proportionate rate on all taxable personal incomes.

Apart from the far Left, and what Lenin called its “useful idiots” among the clergy, there is an emerging consensus that Australia’s highest rate of personal income tax is far too high.

At 48.5 per cent counting the Medicare level, it is now higher than that which applies in the UK and US.

Their highest rates once exceeded ours.

Moreover Australia’s highest rate cuts in at a level which no longer marks a high income.

At the bottom end, the tax-free threshold was once meant to reflect the principle that nobody should be taxed on earnings that are absolutely essential for minimal subsistence.

Today nobody could subsist at that level, which means many low earners are both taxpayers and welfare recipients.

Raising the tax-free threshold means a tax cut for everybody since it reduces every taxpayer’s total taxable income.

There are only three ways of securing these changes.

The most important is to reduce total government spending.

The second is to simplify the income tax system by stripping away the maze of deductions, credits, offsets and so on, other than those for expenses reasonably incurred in earning the income taxed.

Income tax should not be an instrument for providing incentives to support all sorts of other government initiatives.

The third is by increasing the GST, with the Commonwealth retaining the net increase, leaving the rest as at present for the states and territories.

Some will oppose these changes as bringing us closer to a flat tax.

The only things they believe should be flattened are the gross income disparities between high and low earners.

They want the tax system to correct this alleged injustice (which it isn’t) by penalising higher earners to subsidise those on much lower incomes.

Yet they overlook a fundamental point made nearly 250 years ago by Scottish economist Adam Smith that income tax is in the end not a tax paid by earners but a flat tax paid by consumers.

This is because gross salaries and wages paid by employers are business costs which, together with their profit margins, are reflected in the prices charged consumers.

If a business employs a high proportion of highly skilled, highly paid workers then their proportionately higher taxes are reflected in higher production costs and therefore higher consumer prices.

In the name of equalising net incomes, you actually increase prices for all consumers, poor as well as rich.

This is hardly progress.

Professor Lauchlan Chipman is the author of ‘The Very Idea of a Flat Tax’, the latest in The Centre for Independent Studies’ series on taxation reform.