Date created: 14/4/07 Last modified:14/4/07 Maintained by: John Quiggin John Quiggin
27 April 2006
The task of designing a tax system has aptly been compared to trying to shape a balloon. If you squeeze the balloon in one place, it will bulge out somewhere else. The best you can do is to try and smooth out the worst of the bulges. Treasurer Peter Costello and his officials no doubt have some similar analogy in mind as they attempt to balance the competing demands that have been put forward in the leadup to the Budget. Even with a relatively healthy fiscal position, there are no easy answers.
That hasn’t stopped people looking for such answers. On the left, it’s been traditional to call for higher taxes on the wealthy, a category to which hardly any Australians will admit belonging, at least in this context. More generally, most people favour the idea that someone else is much better suited than they are to pay taxes.
There is some scope to increase the tax paid by the better off (say, the top 10 per cent of income earners), not so much by raising tax rates but by closing off tax concessions and reducing the scope for avoidance. The government has done a reasonable job with respect to blatant tax avoidance, but it has generally favoured ‘standard’ avoidance through family trusts and company structures, thereby exacerbating distortions in the choice between wage employment and self-employment. And it would certainly be desirable to reverse the ill-considered (and bipartisan) decision to halve the rate of capital gains tax back in 1998
Nevertheless the amount that can be raised through tightening the system is not enough to finance big reductions in rates across the board. And the option of raising rates enhances the scope for avoidance.
On the right, the standard call is for tax cuts, financed by lower public spending (Fortunately, we are not in the situation of the United States, where the Administration favours tax cuts financed by the printing press). Lots of people will support this in the abstract, but it becomes more problematic when the time comes to specify actual cuts.
There’s no indication that most people want less of services like health and education, or less spending on roads and public transport (even if they could get tax cuts as a result). John Howard recognised as much in the 2004 election campaign, when he outbid Labor with a range of new spending proposals.
Attempts to deliver these services, while spending less public money, have often ended up costing more in the long run. Neglect of capital and maintenance spending is one example, as is large-scale reliance on expedients like Public-Private Partnerships, which are only suited to relatively rare special cases.
We’re left then, with the problem of shifting the tax burden so that it causes least pain. The problem is complicated by the existence of substantial benefits for families, which have increased in importance under the present government. Such benefits are alternative castigated as ‘middle class welfare’ or praised as delivering ‘horizontal equity’, but neither of these labels is really useful. Rather the problem is to achieve the objectives of the tax-welfare system while minimising the cost in terms of distortions.
There is a good equity case for giving families with low or moderate incomes more favourable treatment than single people with the same income. And, at the top end of the scale, there’s fairly easy access to income-splitting, so some concessions for low-income spouses are probably inevitable. Once such concessions are taken into account, there is little value in looking at the income tax scale alone to determine either the average burden of taxation or the effective marginal tax rates.
For families, the tax-welfare system is considerably more progressive than the tax system as a whole, with lower average rates and higher marginal rates. The average burden of tax is partly or wholly offset by family benefits. On the other hand the progressive withdrawal of these benefits creates high effective marginal tax rates, particularly for second income earners, who are most commonly women.
Before this fact was taken into account, beginning in the 1990s, it was common to see ‘poverty traps’ where the effective marginal tax rate exceeded 100 per cent. Even after substantial reform, families on low and moderate incomes face marginal tax rates significantly higher than the top marginal tax rate of just under 50 per cent.
Everyone would like to pay less tax. But, from the perspective of improving both equity and efficiency, cutting the top marginal rate of tax is a low priority.John Quiggin is an ARC Federation Fellow in Economics and Political Science at the University of Queensland.
John Quiggin is an Australian Research Council Federation Fellow in Economics and Political Science at the University of Queensland.
Read more articles from John Quiggin's home page
Go to John Quiggin's Weblog