Submission to the Senate Economics References Committee
On
“The Structure and Distributive Effects of the
Australian Taxation System”
By
The Institute of Chartered Accountants in Australia
April 2003
The Structure and Distributive Effects of the Australian Taxation System
Page 1
Table of Contents
Introduction....................................................................................................................................................................... 3
What is the “Australian Taxation System”? ........................................................................................................... 3
Effects of the Australian Taxation System ............................................................................................................. 5
Contacts .................................................................................................................................................................. 5
Social And Economic Initiatives ....................................................................................................................................... 6
An example ............................................................................................................................................................ 6
Another example .................................................................................................................................................... 6
Effect on the Australian Taxation System .............................................................................................................. 6
Potential solution .................................................................................................................................................... 7
Hypothecated Taxes .......................................................................................................................................................... 9
The problem with hypothecated taxes .................................................................................................................... 9
Potential solution .................................................................................................................................................... 9
Taxing And Collection At Multiple Points ..................................................................................................................... 10
Inefficiencies ........................................................................................................................................................ 10
Half the solution ................................................................................................................................................... 10
An example .......................................................................................................................................................... 11
Effect on the Australian Taxation System ............................................................................................................ 11
Potential solution .................................................................................................................................................. 12
Effectiveness Of Social And Economic Deductions ....................................................................................................... 13
An example .......................................................................................................................................................... 13
Use of rebates ....................................................................................................................................................... 13
Another example .................................................................................................................................................. 13
Carry forward or refundable rebates ..................................................................................................................... 13
Potential solution .................................................................................................................................................. 14
Corporate And Personal Tax Rates ................................................................................................................................. 15
The inequity ......................................................................................................................................................... 15
Potential solution .................................................................................................................................................. 15
PAYG Earners With Straightforward Tax Affairs .......................................................................................................... 17
Effect on the Australian Taxation System ............................................................................................................ 17
Potential solution .................................................................................................................................................. 17
Concern regarding loss of revenue ....................................................................................................................... 18
Indexing Marginal Tax Brackets ..................................................................................................................................... 19
Definition ............................................................................................................................................................. 19
Example – Introduction of the GST ..................................................................................................................... 19
Costs and difficulties of implementing ................................................................................................................. 20
Effect on the Australian Taxation System ............................................................................................................ 20
Potential solution .................................................................................................................................................. 20
Indexing Other Thresholds.............................................................................................................................................. 21
An example .......................................................................................................................................................... 21
Another example .................................................................................................................................................. 21
Effect on the Australian Taxation System ............................................................................................................ 22
Potential solution .................................................................................................................................................. 22
Fringe Benefits Tax ........................................................................................................................................................ 23
An example .......................................................................................................................................................... 23
Why the highest marginal tax rate ........................................................................................................................ 23
Salary packaging inequalities ............................................................................................................................... 23
Another example .................................................................................................................................................. 23
Potential solution .................................................................................................................................................. 25
Car Fringe Benefits ......................................................................................................................................................... 26
Potential solution .................................................................................................................................................. 26
Goods and Services Tax.................................................................................................................................................. 27
An example .......................................................................................................................................................... 27
The purpose of the exemptions............................................................................................................................. 27
Potential solution .................................................................................................................................................. 27
Superannuation ............................................................................................................................................................... 29
Effect on the Australian Taxation System ............................................................................................................ 29
Potential solution .................................................................................................................................................. 29
The Structure and Distributive Effects of the Australian Taxation System
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Introduction
The Institute of Chartered Accountants in Australia (“ICAA”) welcomes the
opportunity to make the following submission to the Senate Economics
References Committee regarding the structure and distributive effects of the
Australian Taxation System.
The ICAA is the leading professional accounting organisation in Australia,
representing 38,000 members in public practice, commerce, academia,
government and the investment community. The ICAA’s members are advisers
to businesses at all levels, from small and medium sized businesses to the
largest global corporations operating in Australia and overseas.
Due to the broad nature of the terms of reference for the inquiry, the submission
canvasses issues relating to a range of core elements of the Australian Taxation
System and we acknowledge that some of the issues we raise may be politically
difficult to remedy. However, the Senate Economics Committee is seen as the
opportunity to air all such options. The issues addressed in this submission
include:
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The delivery of social and economic initiatives through the tax system;
The use of hypothecated taxes;
Taxing and collection at multiple points and on multiple bases;
Social and economic deductions;
Corporate and personal tax rates;
PAYG earners with straight forward tax affairs;
Marginal tax rate thresholds;
General thresholds;
The Fringe Benefits Tax rate;
Car fringe benefits;
Exemptions in the Goods and Services Tax; and
Superannuation.
What is the “Australian Taxation System”?
The concept of the “Australian Taxation System” is often debated but very rarely
defined. The ICAA believes that the Australian Taxation System is made up of
the following:
1. Various Acts at both the State and Federal level that serve the purpose of
revenue collection. Responsibility for the drafting of these Acts resides
with the Department of the Treasury in each jurisdiction.
2. Statutory bodies to implement the policies in the above mentioned Acts.
This is the responsibility of the Australian Taxation Office at the Federal
level and the Office of State Revenue (or similar entity) in each of the
States.
The Structure and Distributive Effects of the Australian Taxation System
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3. Taxpayers from whom the revenue is collected.
And what the ICAA believe is often the overlooked component of the Australian
Taxation System:
4. Tax practitioners whose responsibility is to ensure that the great majority
of the “tax illiterate” community complies with both the policy evidenced in
the Acts and the administrative provisions implemented by the statutory
bodies.
We use the term “tax illiterate” because the ATO have indicated that registered
tax agents lodged 79.37% of all income tax returns in the 2001/02 year. Further,
some 85% of all activity statements are also lodged by tax practitioners, or with
tax practitioner involvement. Therefore, in all but the simplest tax situations, the
tax practitioner is the only conduit between the legislation, policy and
administration of the Australian Taxation System and the point of revenue
collection, namely the taxpayer.
The Australian Taxation System can be seen as follows:
TAXATION
&
TAXATION
LEGISLATION
ADMINISTRATION
TAXATION
PRACTITIONER
TAXPAYER
Government and Statutory Bodies
Therefore, while it is the Government and Statutory Bodies that have established
the structure of the Australian Taxation System, it is the tax practitioner that is
largely left to manage the practical application of the system and compliance
obligations. As such, inefficiencies in, or adverse effects of, the Australian
Taxation System are experienced primarily by ICAA tax practitioner members.
The ICAA is therefore in a unique position to comment on the tax system as it
represents a large proportion of the tax practitioner population. We are therefore
concerned to see issues relating to current administrative inefficiencies rectified
to assist our members to more effectively provide the professional services they
are trained to do. The majority of the issues raised in this submission are
presented as a result of our knowledge of the difficulties that practitioners are
facing. The ICAA also feels it is well placed to comment on solutions to broader
structural issues that might offer the promise of a better system in the longer
term.
The evidence is mounting to support the ICAA view that the ability of the
community to meet tax administration arrangements will worsen over the next
decade unless there are major improvements in efficiency. The ICAA has raised
with the ATO our concern about the decline in the numbers of accountants
entering the tax profession, and in particular the less glamorous world of the
small practice that traditionally services the SME sector. Unless we see
The Structure and Distributive Effects of the Australian Taxation System
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wondrous simplifications of the tax system in the next few years, which we
consider unlikely, we will see a scenario of a shrinking pool of practitioners
attempting to service a growing SME sector, who will continue to want to avoid
the complexities of the tax system. In that light, we see the need to streamline
the data collection aspects of tax administration so that practitioners are offered a
career with a better balance between form filling, and the more productive valueadding advisory work. We urge the Senate to recommend to the Government
that they direct the ATO to fast track its evaluations of the various options that
would allow more automated collection of core tax compliance data, at "point of
first contact " in the business transaction that has a tax consequence. Those
developments will be completely consistent with the way business transactions
are heading, and the ATO needs to go hand in hand with business, rather than
playing catch up.
Effects of the Australian Taxation System
Due to the fact that ICAA members, as tax practitioners, are the major conduit
between the parties in the Australian Taxation System, the ICAA requests that
the Senate Economics Committee consider the following recommendations.
We have not been in the position to fully explore each of the potential solutions
offered to the inefficiencies or suggestions on options potentially offering a better
long -term system. However, we have consulted with senior members of our
consulting committees and believe the concepts we put forward are
fundamentally sound. Hopefully the Senate Economics Committee will agree
and take out of our submission a range of issues that are worthy of further
consideration. .
Contacts
Should you wish to discuss any of these matters further, or would like the ICAA
to provide further information on any of the suggestions in this paper, do not
hesitate to contact:
Brian Sheppard
Tax Counsel
Institute of Chartered Accountants in Australia
GPO Box 3921 Sydney NSW 2001
02 9290 5623
[email protected]
The Structure and Distributive Effects of the Australian Taxation System
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Social And Economic Initiatives
The Australian Taxation System has a long history as a platform to deliver social
and economic initiatives. Unfortunately this has created “disconnects” between
the systems implementing the initiatives and the purpose of the social and
economic initiative. This disconnect often hampers both the delivery of the
initiative and the operation of the Australian Taxation System.
An example
For example, ICAA members are extremely concerned about the potential loss of
the Family Tax Benefit (FTB) claimed in the tax return, if the tax return is lodged
later than the statutory FTB claim deadline, namely 30 June of the following year,
even if an extension is granted by the Australian Taxation Office to lodge the tax
return after this date. In the midst of the current compliance pressures, taxation
practitioners focus on the detail of the tax return only to find that they have
missed a deadline set by a government department they do not have any dealing
with and that they have no experience or expertise in relating to. Further the
government department has no experience in dealing with tax practitioners.
Rectifying this “disconnect” through an administrative arrangement is not
possible due to the legislation implementing the policy not applying discretions to
the organisation that practically administers the policy. Therefore the ICAA has
been left to advocate that the FTB legislation must be amended to provide
discretions to the ATO, an organisation the legislation does not generally apply
to, to extend the claim deadline where there is an extension for the tax return.
Other examples
The same potential for “disconnect” occurs with the administration of the complex
research & development incentives shared between the ATO and the
Department of Industry, Tourism and Resources (DITR). Again the ICAA has had
to lobby for a change in legislation that relates to the R&D Tax Offset that is
required, due to the body creating the policy (DITR) not being the one who
implements it (ATO).
The administration of employee superannuation payment obligations and the
funds themselves are another minefield for many practitioners.
Effect on the Australian Taxation System
As a result of these “disconnects” it is logical to ask whether the tax system is the
best platform to deliver initiatives that at their core are not about revenue
collection? The regular experiences we hear about from our members suggest
that there is a strong case emerging to support the view that the answer is no.
The Structure and Distributive Effects of the Australian Taxation System
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Alternatively there is at least a case to argue that the tax system should not be so
readily regarded as the automatic choice as the delivery platform.
It has been recognised that we have a tax system already struggling to meet its
core role of revenue collection. Further, almost all of the additional responsibility
for social and economic initiatives implemented through the Australian Taxation
System falls on the tax practitioner. This is the case with the examples evidenced
above. ICAA members constantly indicate that they are unable to keep up with all
the detailed changes to the legislation relating to the “core role” of the taxation
system, being revenue collection”, let alone the other roles built around social
and economic initiatives. Adding the implementation of social policy to the
administration of the Australian Taxation System only adds to the already
overwhelming burden on tax practitioners.
Potential solution
Provide social and economic initiatives through other systems, allowing the
Australian Taxation System to effectively and efficiently perform its “core role” of
revenue collection.
This potential solution requires more detailed evaluation but we see inherent
attraction in the broad system outlined:
Exclusive "Tax System" and "Benefit System"
As discussed above, the fact that in the current Australian Taxation System, the
government has attempted to deliver initiatives that are not associated with the
core function of a taxation system, being revenue collection, has led to
unfortunate consequences in the Australian Taxation System. However, it is
imperative that the government undertakes both its revenue collection role, and
provides initiatives targeted to those in some form of need.
Therefore we suggest the Government needs to rethink the merits in creating two
exclusive systems, being a "tax system" and the "benefit system". The role of the
tax system is purely revenue collection. The role of the benefit system is to
provide support to those in some form of need. However, unlike the current
systems used to achieve these two purposes we see merit in systems that would
be mutually exclusive; every taxpayer is either in the tax system or the benefit
system, but not both the tax system and the benefits system, at any point in time.
If a taxpayer is in the tax system, the taxpayer pays tax and receives no benefits.
Such a system is managed by the ATO. If a benefit recipient is in the benefit
system, the benefit recipient does not pay tax but receives benefits. Such a
system could be managed by an appropriate organisation (like Centrelink for
welfare benefits and AusIndustry for payments encouraging research and
development).
The Structure and Distributive Effects of the Australian Taxation System
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In the Australian Taxation System, there are a series of liabilities that are related
to revenue collection policies that are offset against a series of benefits provided
for welfare policies. It would be preferable that there was only one net
transaction. This could be achieved by having for each individual, one system
(being either the tax system or the benefits system), administered by the one
entity, either requesting a payment (or payments) or making a payment (or
payment) each year.
The major difficulty in the implementation of such a system would be defining the
threshold between the tax system and the benefit system. This threshold could
be drawn from combining the current benefit rules and the lowest marginal tax
rate. However, while the threshold may be difficult to assess, the administration
would be simplified. Every taxpayer or benefit recipient is assessed each year
based on their lodged documentation and if they have “changed status” (gone
from being a benefit recipient to a taxpayer or vice versa) the file is merely
handed to the other authority managing these individuals.
The Structure and Distributive Effects of the Australian Taxation System
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Hypothecated Taxes
The ICAA is concerned at the culture that has developed within Government to
use these taxes. Hypothecated taxes are taxes that are earmarked for a specific
purpose. Such taxes in Australia include the Medicare levy, Ansett ticket levy,
milk and sugar levies and the former Gun buy-back levy. However, such taxes
are sometimes seem to be driven by political imperatives rather than sound
policy principles, but certainly contribute to the perception of the complexity in the
tax system, as a patchwork of many taxes.
The problem with hypothecated taxes
Hypothecated taxes bind the use of the revenue collected, even in cases where
arguably the revenue could be spent to better effect elsewhere. Conversely,
while it is argued that hypothecated taxes will be directed to a specific purpose,
often the fact that there is such a guaranteed revenue outlay in a specific areas
means that any discretionary spending from the general revenue base in the
area is reduced by the same amount.
While hypothecated taxes may be an effective way around public hostility to
paying tax and may be seen as the best way for the public to understand the
trade off between taxes and services, the ICAA is concerned that they also
create an inefficient binding of revenue and are not delivering the promised
targeting of funds. If the revenue need is real, it would seem that the need could
be more simply met by an increase in existing taxes.
The existence of these taxes is seen as little more than window dressing to
disguise inadequate revenue collection to meet spending needs. Therefore,
rather than solving these problems through the use of hypothecated taxes, it
would be preferable to fix the cause of these problems in the current taxation
system.
Potential solution
A phase out of all hypothecated taxes should be undertaken by ensuring no
further such taxes are introduced and the current hypothecated taxes should be
given a legislative end date or rolled into the general taxing system.
The Structure and Distributive Effects of the Australian Taxation System
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Taxing And Collection At Multiple Points
Currently the administration of the Australian Taxation System is spread between
the Federal and State governments (and to a much lesser extent the local
government level). This causes a series of inefficiencies that will be difficult to
eliminate but they must not be relegated to the too-hard basket either.
Inefficiencies

As it is not politically possible to tax the identical economic effect at both
State and Federal level, the two governments are required to tax unique
economic effects. Often these are based on differing bases, for example,
land tax is on the unrealised gain on property while the capital gains
system predominantly taxes a realised gain. As such there is no
consistent underlying philosophy of the basis for taxation in the Australian
Taxation System.
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Tax practitioners find it near impossible to provide comprehensive advice
when various taxes apply differently throughout the country. Further
additional work is required as different jurisdictions implement different
policies and administer these policies with different systems. For example
a tax practitioner advising an entity that is present in multiple jurisdictions
will need to consider the legislation in each different jurisdiction as it may
apply differently to the same economic effect.
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Differing jurisdictional taxes will favour undertaking various economic
effects in one jurisdiction rather than others. For example the location of
incorporation of a company can affect stamp duty payable on the future
sale of the shares in the company. The inconsistencies of the Australian
Taxation System are driving corporate decisions that may not be the best
decisions, outside the tax considerations, for the company.
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Different statutory bodies have been set-up to undertake the same roles,
but relating to a different set of economic events that are to be taxed, or
merely the economic effect occurs in a different location. The inefficiencies
are obvious.
Half the solution
The introduction of the GST, and the revenues associated with this tax being
paid to the States and Territories, has started to remove many of these
inefficiencies while providing "growth funding" to the States. The introduction of
the GST has seen the removal of certain other taxes implemented on ineffective
economic effects (e.g. financial institution duties). Further it has seen the
reduction of taxation rates or increased exemptions in other State taxes (payroll
tax and stamp duty).
The Structure and Distributive Effects of the Australian Taxation System
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However, while these taxes are levied on different economic effects in different
jurisdictions, the inefficiencies remain. Additional exemptions (as has occurred
with stamp duty) or decreased thresholds (as has occurred with payroll tax) do
not solve the problem with taxing and collection at multiple points in the
Australian Taxation System.
An example
This relates to basic salary and wages payments. There are withholding
requirements on the payment of salary and wages. Further, on the same
payment of the same salary and wages, payroll tax is required. The same
economic effect, being the payment of salary and wages, leads to two revenue
collection events. However, each is managed by a different statutory authority,
under a different Act, paid using a different system and audited separately (note
that it is standard practice on a payroll tax audit to look at the difference between
the amount withheld from and the amounts payroll tax is paid on, to look for
under/over payment).
The resources that a tax practitioner has to put into managing these inefficiencies
add no value to the revenue collection.
Effect on the Australian Taxation System
While most academic discussion on the basis for, and jurisdictional issues, in
having eight taxing organisations in the Australian Taxation System has related
to the costs of running these bodies, and the obvious administrative inefficiencies
having all these bodies creates, very little discussion has occurred on the effect
these inefficiencies have on tax practitioners.
Having multiple organisations to report to, regulated by multiple Acts, clarified by
multiple statements, with taxes applying on multiple economic effects, at multiple
rates makes the role of the tax practitioner in the Australian Taxation System
difficult, to the point of being impossible. The inefficiencies of the system are
driving the tax practitioner community to either specialise in a single area of
taxation or only work in the “simple” areas, where it is possible to have the
requisite generalist skills.
Some time ago the ATO started a project to provide an overlapping template
reminder of all Federal and State tax obligations. This was an attempt to
understand the compliance pressure points on practitioners so that ATO projects
could be tailored to these. We recently heard that they abandoned the project. It
was just too complicated, in that the compliance demands were constant and
often overlapping and impossible to put into a useable checklist tool . . .
The Structure and Distributive Effects of the Australian Taxation System
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Potential solution
While we understand the difficulties in removing these inefficiencies, we believe
the Senate Economics Committee should use its considerable influence to
emphasise the state, complexity and inefficiencies of the Federal/State tax
demands on a population base of only 20 million. The Senate will hopefully
endorse projects that have as their long-term goal the possibility of the bodies
administering revenue collection in Australia being merged, or at least their
common functions being merged so that we start to redress these inefficiencies.
Further, where possible the basis of taxation should be merged and collected on
one set of economic effects. This would involve the repeal of the various State
Acts and replacing these with Federal legislation.
The Structure and Distributive Effects of the Australian Taxation System
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Effectiveness Of Social And Economic Deductions
The Australian Taxation System uses both marginal tax rates for certain entities
(e.g. individuals) and flat rates of tax for other entities (e.g. companies).
However it applies deductions for certain expenditure that the government
believes should be encouraged, across both types of taxpayers. The use of
deductions to encourage spending in relation to taxpayers who are subject to
marginal tax rates is regressive.
An example
The government want to encourage “self employed” taxpayers to save for their
retirement by putting money into superannuation and so offers a tax deduction
(see Section 82AAT of the Income Tax Assessment Act 1936). If Taxpayer A,
whose taxable income is $100,000 (48.5% tax bracket), were to make a payment
of $1,000 to a superannuation fund, the net cost would be $515 (the reduction in
the tax paid on the taxable income would be $485). If Taxpayer B, whose taxable
income is $19,000 (18.5% tax bracket), were to make a payment of $1,000 to a
superannuation fund, the net cost would be $815 (the reduction in the tax paid on
the taxable income would be $185).
The use of tax deductions to encourage certain expenditures will always benefit
those with higher taxable incomes where there are a marginal tax rates. In the
example above, the “encouragement” provided by the deduction is much greater
for the individual on the higher marginal tax rate.
Use of rebates
However, replacing these deductions with rebates will overcome this problem.
Another example
The government wants to encourage employees to add to their employer
provided superannuation and so offers a tax rebate of 30% (for a similar
provision see Section 159SZ of the Income Tax Assessment Act 1936). If
Taxpayer A, whose taxable income is $100,000, were to make a payment of
$1,000 to a superannuation fund, the net cost would be $700 (the reduction in
the tax paid on the taxable income would be $300). If Taxpayer B, whose taxable
income is $19,000, were to make a payment of $1,000 to a superannuation fund,
the net cost would be $700 (the reduction in the tax paid on the taxable income
would be $300).
Therefore the “encouragement” is identical for both taxpayers.
Carry forward or refundable rebates
The Structure and Distributive Effects of the Australian Taxation System
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Further, if rebates are to be used to equally encourage taxpayer expenditure then
they must be either:
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Able to be carried forward in to future years; or
Be refundable;
so that if the taxpayer makes a tax loss in a year they will still be “encouraged” to
make the commercial expenditure (see Div 65 and 67 of the Income Tax
Assessment Act 1997) as they can apply the rebate against future income or be
provided with the benefit.
Potential solution
These “encouragement” deductions (for example, environmental protection
expenses) that can apply to individuals who are taxed at marginal rates should
be replaced with rebates that can be carried forward or are refundable.
A project should be undertaken to identify these “deductions” and they should be
replaced with rebates set at appropriate level.
The Structure and Distributive Effects of the Australian Taxation System
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Corporate And Personal Tax Rates
Currently the corporate tax rate is 30% and the top marginal tax rate is 47%
(48.5% including the Medicare levy). This difference caused major distributive
inefficiencies that the taxation legislation has constantly attempted to rectify.
However, none have completely rectified this inefficiency.
The inequity
The problem the difference between these rates creates is that it gives certain
investors the ability to "warehouse" their income in a corporate vehicle and have
it taxed at 30%, while a taxpayer earning income that falls within the PAYG
withholding regime (salary and wages) must pay the marginal rate that is
applicable. The income in the corporate vehicle can be held until a tax year that
the taxpayer is in a lower tax rate or distributed to a related entity at a lower tax
rate.
With the applicable top marginal rate being 30% up to $50,000 (31.5% if you take
the Medicare levy into account), this means that the benefit of this warehousing
of income only applies to those earning greater than $50,000.
There have been many specific legislative provisions that have attempted to limit
this warehousing opportunity, including provisions targeted at specific uses of
this inequity (the recent personal services income legislation), but while these
have limited the scope of the inequity, they have not rectified it.
Potential solution
As many commentators have stated, the purist’s solution to this inequity is to
align the corporate tax rate with the highest marginal tax rate.
We appreciate that to increase the corporate tax rate would be economically
unsound as Australian companies would be non-competitive internationally and it
would also be to the detriment of overseas investment in Australia. Further, we
understand that the cost of reducing the highest marginal tax rate to the
corporate tax rate would, without any further measures, be prohibitively
expensive.
We consider that the options to address this problem is completely interwoven
with other areas of review of the tax system and in particular the evaluation of the
appropriateness of Australia’s personal tax rates, and perhaps an evaluation of
more targeted solutions to the problem of “warehousing” of company income.
The solution is probably a mix of these measures.
The Structure and Distributive Effects of the Australian Taxation System
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The ICAA is not in the position in this submission to take the matter much further,
however we recommend that the Committee undertake further consideration on
the ways to mitigate the loss in revenue.
The Structure and Distributive Effects of the Australian Taxation System
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PAYG Earners With Straightforward Tax Affairs
In the Australian Taxation System, every taxpayer is expected to lodge a yearly
tax return. However, a large proportion of the taxpayers fall into the following
broad grouping:
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They have only two forms of income. These are income in the form of
salary and wages, from which PAYG withholding has occurred, and
interest on bank deposits;
The majority of their income 95-100% comes from salary and wages from
which PAYG withholding has occurred;
They have only minimal deductions, and these are primarily small
unreimbursed business expenses and minor education expenses.
The effort that is undertaken to complete these tax returns is not in proportion to
the revenue collection and has the following effects.
Effect on the Australian Taxation System
While these returns are simple to prepare and in most cases could be completed
by the taxpayer, tax agents prepare many of these returns. This puts a large
burden on the tax practitioner element of the Australian Taxation System for
limited gain in revenue collection.
The 2002 individual tax return is 12 pages long and to complete this form for
simplistic cases is not an effective use of the limited tax practitioner resources or
ATO processing resources.
Potential solution
While we are aware that ATO research suggests taxpayers want the tax return
process as some sort of “settling up” of their tax affairs, perhaps we can no
longer afford that luxury in we are to achieve a more efficient tax system. We see
merit in the Committee recommending that the ATO investigate the possibility
that for taxpayers who:


Only have income in the form of salary and wages, from which PAYG
withholding has occurred on the entire amount, and interest on bank
deposits; and
The interest income falls below a certain threshold (possibly <$500
indexed by CPI) ;
are not required to lodge an Income Tax Return. All they would be required to do
would be to attach to a declaration indicating that their interest is below the
threshold, copies of the payment summaries they have received for the tax
period and documentation from their health fund.
The Structure and Distributive Effects of the Australian Taxation System
Page 17
The declaration may also have to have a few other simple questions. These
should be kept to a minimum and the information they request should not be in a
numerical form.
When assessing these taxpayers, the ATO should give the taxpayer a deemed
deduction, being an estimate of what the average deduction would have been to
a taxpayer of this category.
This would be an optional system at the election of the taxpayer in that the
taxpayer may continue to decide to complete a return reflecting the taxpayer’s
specific situation. This is the US/UK system.
Concern regarding loss of revenue
Obviously there is a concern regarding loss of revenue with the implementation
of such a change in the Australian taxation System. However, it is likely that this
may also increase revenue, as deductions may not be fully calculated. Further,
any revenue leakage would be minor due to the nature of the taxpayers in
question, and if standard deductions are tailored appropriately.
There should be no concern that the correct withholding has not occurred
because action to recover these amounts can be brought against the employer.
The current resources dedicated to assisting and verifying the returns of these
taxpayers can be released to review compliance with the withholding regime.
Finally, should there be a concern regarding non declaration of interest, an
interest withholding tax could be introduced, such that financial institutions must
withhold certain amounts from interest they pay, and this amount becomes a tax
credit.
The Structure and Distributive Effects of the Australian Taxation System
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Indexing Marginal Tax Brackets
There has been a great deal of political and academic debate on the marginal tax
system and what has become known as “bracket creep”. Bracket creep can be
defined as follows:
Definition
The cost of goods and services acquired to consumers increases over time due
to inflationary pressures. Such pressures drive increases in salary and wages so
that consumers have the same buying power. However, as salary and wages
increase, many consumers “creep” into a higher tax bracket under the current
marginal tax rates. As a result, the effective tax rate of taxpayers increases,
thereby reducing the effectiveness of their wage increase. Bracket creep leads to
the situation that a consumer whose wage increases is linked to inflation will
have a decreased buying power.
Example – Introduction of the GST
A practical example of this is as follows:
On 1 July 2000, with the introduction of the Goods and Services Tax (“GST”), the
taxable income required for the top marginal rate of 47% to apply, increased from
$50,000 to $60,000. This was a part of the measures to assist taxpayers with the
additional costs that will eventuate due to the introduction of the GST.
A person earning $50,000 on 1 July 2000, who has received only Consumer
Price Index (“CPI”) increases in salary, would currently earn $55,270. By
February 2005, based on the CPI growth since the introduction of the GST, they
will be earning $60,000. Therefore, by February 2005, any benefit taxpayers
received by the increase in the taxable income required before the top marginal
rate is applicable is gone. Identical calculations can be undertaken for the other
changes in the thresholds that occurred on the introduction of the GST.
As a result, by February 2005, the taxpayer has to pay the GST on almost all
acquisitions but has no additional cash due to the increase in the tax brackets of
1 July 2000 to pay for the GST. Taxpayers Australia have estimated that one
million taxpayers in Australia have moved into a higher tax bracket since the
reduction in the marginal tax rates on 1 July 2000.
However, if the government had decided that it was equitable that, as a part of
introducing the GST, the new marginal rates be indexed to the CPI, the highest
marginal rate today would be around $66,324 and by February 2005, $72,000.
As a result anyone earning more than $66,324 today is paying $317 more tax
than they would have paid had CPI indexing of the marginal tax rates been
introduced, rising to $600 by February 2005. Their buying power has been
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effectively reduced by these amounts. The change in the marginal tax rate has
offered a short term benefit for an indefinite cost.
Costs and difficulties of implementing
While there would be a major cost in indexing marginal tax rates, it should be
noted that from 1 January 2000 Canada indexed its marginal tax rates without
major detrimental effects to their revenue. Additionally, the cost of indexing
marginal rates will be greater, the higher the inflation rate. Australia’s inflation
rate is currently at one of its lowest ever rates and so there is no better time than
now to make this change.
Further, commentators argue that indexing marginal rates makes revenue
planning difficult, as it is dependent on movements in inflation. However capping
the increase if inflation goes beyond a certain percentage could avoid such a
concern. For example, the marginal tax rates are indexed to CPI capped at 5% if
CPI increases above this figure.
Effect on the Australian Taxation System
Effectively the buying power of consumers is decreased as the effective tax rate
is increased. Further, it is generally low income earners who have their salary
increases linked to inflation. Therefore they are the ones who, when they pass
through a threshold, find that their effective buying power decreases for that year.
Access economics has indicated that the increase in revenue is about $1.2 billion
dollars a year due to bracket creep which is the effective reduction in buying
power each year.
Potential solution
Index the marginal tax thresholds by the minimum of CPI or 5% each year.
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Indexing Other Thresholds
There are numerous other thresholds in the tax legislation. Further there are
administrative thresholds that are used by the Statutory Bodies to classify
taxpayers and when their obligations are due. While many are now indexed,
there are still a series of amounts that are not. Examples of these include:







Various substantiation thresholds;
Classification thresholds (large, medium or small taxpayer which effects
lodgment and payment obligations)
Payroll tax thresholds;
Stamp duty thresholds;
Non profit company thresholds;
CGT collectables; and
Income tax thresholds for minors.
The fact that these thresholds are not indexed erodes the original parliamentary
intention of providing the threshold. Every year, inflationary pressures decrease
the benefit to the taxpayer that many of these thresholds were designed to
achieve, eventually making the parliamentary intention obsolete. For example:
An example
In 1980 Division 6AA was introduced into the Income Tax Assessment Act 1936
adding special rules in calculating the tax payable on the income of a minor.
These were introduced to stop income splitting techniques by applying the
highest marginal tax rate to “unearned income”. However this was only to apply
after $416 was earned. The $416 figure was used as it was a figure that was also
used in applying marginal rates at the time (where the Commissioner exercised
his power not to apply the highest marginal rate to trust income not presently
entitled). The amount was intended to represent a reasonable amount that could
be provided to a minor for their expenses that was not too great to allow for
income splitting.
However since that time, the rate table from which the $416 was drawn has been
replaced and inflationary pressures have increased by just over 300%. $416 may
have been a reasonable amount to cover certain expenses in 1980 but some 23
years later the equivalent costs would be over $1,200. The effect of the
concessional treatment is now one third of what its original legislative intention
was.
Another example
The lowest rate for stamp duty in NSW was if the price was less than £7,000 in
1962. The only change in this threshold since this date has been a conversion to
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decimal currency and an increase in the rate (from 1% to 1.25%). Since this time
inflation has been just under 1,000%.
Therefore the intention of a stamp duty rate greater than a nominal amount (1%)
only applying on a transfer that is large (i.e. £7,000 in 1962) has become an
application that stamp duty rate greater than a nominal amount will apply to all
transactions other than minor transactions ($14,000).
Effect on the Australian Taxation System
Commonly these thresholds are designed to assist in complying with many of the
provisions in the taxation legislation. They are administrative concessions
recognising that the compliance burden, if the threshold were not granted, would
not justify the revenue collected.
Therefore the effect of these thresholds not being indexed is that the Australian
Taxation System becomes more difficult to comply with each year as the effect of
these administrative concessions is eroded.
Further, many of these concessions are designed to assist small business.
However, as the effect of the thresholds is eroded, more and more small
businesses fall outside the concessionary arrangements.
Potential solution
Undertake a project to identify the various non-indexed thresholds in the taxation
system and replace them with appropriate figures, based on their original
intention, that are indexed to CPI.
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Fringe Benefits Tax
Many of the inequitable effects of the current fringe benefits tax (“FBT”)
legislation were identified in the Ralph Review of Business Taxation. The primary
inequity is that FBT levied at a rate of 48.5% on all benefits, even where the
benefit is provided to a taxpayer on a marginal rate less that the highest marginal
tax rate. This creates the following inequity:
An example
An employer decides to purchase a $550 (GST inclusive) health club
membership for all its employees. Bill is an employee who has a taxable income
of $30,000. If the employer purchases the health club membership for the
employee, the cost will be $1,067.96 (made up of +$550 cost, -$50 GST &
+$567.96 FBT). However, if the employer was to give enough money to the
employee so that after tax they could buy the health fund membership
themselves, they would only need to provide $802.92 to the employee.
This difference occurs as a result of the fact that FBT is levied at 48.5% while in
this situation the marginal rate applying to Bill is 31.5%.
Why the highest marginal tax rate
The highest marginal rate was used for the FBT rate as, when FBT was first
introduced in 1986, there was no need to report benefits by employee and so it
was not possible for employers to assess what the marginal rate was applicable
to each benefit. However, since 1 April 2001, employers have had to report
almost all benefits on an employee basis and provide this information on
payment summaries to each employee.
As such the argument for using the highest marginal tax rate is no longer valid.
Salary packaging inequalities
Further, a consequence of FBT being charged at the highest marginal tax rate is
the established practice of salary packaging. Salary packaging is where an
employee forgoes salary for the provision of benefits. Therefore it is much more
tax effective for employees taxed at the highest marginal rate than those at lower
marginal rates. Where there are concessional taxing treatments in the Fringe
Benefits Tax Assessment Act 1986 there will be benefits in salary packaging. For
example:
Another example
Two employees (earning $100,000 and $40,000) are provided cars by their
employer under a novated lease arrangement. The cars’ purchase price was
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$40,000. During the year the running costs of the cars were $12,000 (GST
exclusive) each and each was driven 20,000 kilometers (20% statutory fraction).
Calculation of Package #1 - $100,000 Employee
Packaged
Car Running Costs
$12,000
FBT
$8,261.25
Amount to package
$20,261.25
Consequence for the Employee
Salary
$100,000
Amount Packaged (-)
$20,261.25
Salary after Package
$79,738.75
Tax and Medicare (-)
$26,053.29
Benefit Costs
Cash in Hand
$53,685.46
Saving due to packaging
$0
$100,000
$0
$100,000
$35,880
$12,000
$52,120
$1,565.46
Calculation of Package #2 - $40,000 Employee
Packaged
Car Running Costs
$12,000
FBT
$8,261.25
Amount to package
$20,261.25
Consequence for the Employee
Salary
$40,000
Amount Packaged (-)
$20,261.25
Salary after Package
$19,738.75
Tax and Medicare (-)
$2,631.67
Benefit Costs
$0
Cash in Hand
$17,107.08
Loss due to packaging
Not Packaged
Not Packaged
$0
$40,000
$0
$40,000
$8,980
$12,000
$19,020
$1,912.92
The fact that FBT is charged at the highest marginal tax rate creates a situation
where there is an inequity towards taxpayers at the highest marginal tax rate. In
the case above, the inequity is that by packaging the car, the employee on the
highest marginal tax rate increases cash in hand by $1,565 compared to not
packaging, whereas if the taxpayer not on the highest marginal tax rate packages
the car, they are $1,912 worse off than if they had not have packaged the car.
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Potential solution
The solution is to replace the FBT rate with the marginal tax rate applicable for
the employee where the benefit is reported on the employee’s payment
summary. This could be easily administered to an additional step to the current
FBT procedures.
FBT returns would be completed and lodged by 21 May each year and payments
would be made at the current FBT rate. When a taxpayer lodges a tax return that
includes a payment summary with a reportable fringe benefit amount, the
difference between the taxpayer’s marginal rate on the reportable fringe benefit
amount and the highest marginal tax rate is an FBT credit available to the entity
that issued the payment summary. Each March, every employer who has an FBT
credit is informed of the credit so they can reduce the amount they pay in the
subsequent year. This will add no additional work on tax practitioners and could
be fully automated.
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Car Fringe Benefits
There are two methods for calculating the FBT on a car fringe benefit, being the
Statutory method and the Operating cost method. For the majority of car fringe
benefits the Statutory method is used. This method uses four “step” percentages
based on kilometers to calculate the FBT payable. However, where a driver is
approaching the end of the year and is also approaching the number of
kilometers that is required to fall into a lower percentage, the driver may drive
additional kilometers to make the packaged car more tax effective. Currently by
adding as little as one kilometer an employee can reduce the FBT payable by as
much as 45% (going from the 20% statutory fraction to the 11% statutory
fraction).
Therefore the structural effect of the Australian Taxation System is such that it
encourages drivers to travel additional kilometers in cars for no other purpose
than reducing FBT.
Potential solution
If there were a straight line drop in the percentage applicable in the Statutory
method based on kilometers traveled, then the “benefit” of just falling within the
lower fraction would be removed. As such there would be limited encouragement
to drive additional kilometers.
Rather than the four “step” percentages based on kilometers for calculating the
FBT payable on car fringe benefits, we propose having a single formula that
decreases the statutory fraction with every kilometer traveled. The formula we
propose is the following:
Less then 15,000 Kilometers
Greater then 40,000 Kilometers
Otherwise
26%
7%
(37.4 - (76*Kilometers/100,000) )%
This percentage is the same two steps for less than 15,000 kilometers and
greater than 40,000 kilometers as in the current “steps” and is a straight line
between these two steps.
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Goods and Services Tax
The simplicity of a consumption tax is always defined by the extent of supplies
that the consumption tax applies to. The simplest model is either the
consumption tax applying to no supplies or all supplies. Unfortunately, during the
introduction of the GST, the submissions of many of the professional bodies,
including the ICAA, were not heeded and a series of exemptions were
introduced.
These have added a level of complexity and uncertainty to the GST.
An example
Due to the complexity cause by certain supplies of food being treated as GSTfree the ATO has been forced to decide in thousands of situations what is the
applicable GST treatment of certain foods. The following are some of the
Interpretive Decisions that the ATO released in 2002 so that taxpayers could
determine whether any of the following were GST-free food:
GST and bird's nest with sugar, GST and essence of chicken, GST and the
supply of food grade fish as bait, GST and supply of sachets of soy sauce and
wasabi, GST and semi-dried soft biltong, GST and permeate, GST and rugelach,
GST and psyllium husks, GST and mushroom borekas, GST and Chinese
pancakes, GST and concentrated lactofermented whey
These considerations would never have arisen had the GST been implemented
without the exemption for certain foods.
The purpose of the exemptions
The reasoning behind many of the exemptions to the GST was to assist low
income individuals with the increase in prices that the GST would create in
various acquisitions. However, is this the most effective way to provide such
assistance? Based on the complexity and inefficiency it has created we suggest
it is not.
If the government wants to provide support to those in some form of need, the
indirect tax system is not the appropriate or the most efficient system of delivery.
Potential solution
Whilst we acknowledge that the debate on the GST exemptions was an issue of
extreme political sensitivity three years ago, in the context of this inquiry, we feel
obliged to restate the purist view that offers a less complex GST system.
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Exemptions to the GST should be removed in relation to food, education and
health if issues of complexity and unfairness with the Australian Taxation System
are to be resolved. We suggest that the complexity with introduction of the GST
is more a result of exemptions than issues with Business Activity Statements.
Rather than the current exemptions, the alternative of a refundable tax credit, like
the Canadian system to offset the effects of the GST on low income individuals
could be used. However, it would be preferable to put the additional revenue
gained from the removal of the exemptions into the benefits system directly and
allow that system to provided the social initiatives the government has identified.
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Superannuation
The policy behind Australia’s superannuation system is to encourage individuals
to be “self providers” in their retirement. Much of this policy has been delivered
through the Australian Taxation System. Subject to our earlier comments on the
removal of various social and economic initiatives from the Australian Taxation
System, we briefly identify below a series of effects that the Australian Taxation
System has in relation to the policy driving retirement savings in Australia.
Effect on the Australian Taxation System
There are certain elements of the Australian Taxation System, relating to
retirement savings that have adverse effects on the intended policy. Many of
these actually fundamentally contradict the policy of encouraging retirement
saving. Examples of these include:

The superannuation surcharge creates an inequity between taxpayers and
discourages high wealth individuals to make additional payments into
complying superannuation funds. As such we advocate the removal of this
artificial “equity tax”.

Currently there are a series of age based limits on the deductibility of
payments made to complying superannuation funds. This discourages
younger taxpayers to increase or undertake a retirement saving plan.
However, a simple understanding of savings shows that an individual who
is encourages to start saving earlier is much more likely to be a self
provider in retirement.

Income taxes were reduced on 1 July 2000 through the increase of the
thresholds, while superannuation contributions taxes remain the same.
This has resulted in an erosion of tax concessions for superannuation for
many lower and middle-income earners. In addition to this an increased
number of people will find themselves in the situation where they are
paying a higher rate of tax on superannuation contributions than they
would have paid if they received the contributions in their own hands.

Superannuation is taxed twice on entry (the additional being the
surcharge) while in the fund and on exit. Four separate taxing points
cannot be efficient.
Potential solution
Australia’s superannuation system is not the subject of this inquiry, however, the
way the policy is delivered through the Australian Taxation System is inefficient.
We recommend the Committee commission a report on the interaction of
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Australia’s superannuation and taxation systems to ensure that the policy
objectives are effectively provided.
Specifically we recommend the government address the equity issues raised
above by giving consideration to the removal of front end taxes including
surcharge and the move to end benefit taxation.
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