Tax simplicity threatens fairness

The tax system can be made simpler, but only at a cost to fairness. The trick is to make it simpler where the cost to fairness is minimal. And that is at the lower end of the scale.

Treasury secretary Ken Henry was bemoaning last week that the system is too complicated. He said it had 128 different taxes and that nearly three-quarters of taxpayers used a tax agent compared under a third in New Zealand.

First to a proposal for the lower end and then to a warning about making simplicity an end in itself.

At the wage-slave end, the trade-off between fairness and simplicity is not difficult.

At present we have 11.5 million individuals filing returns claiming deductions averaging about $2400. But if you took out the individuals who had significant business or investment income, my guess is you would have about eight million people filing returns for deductions averaging maybe less than $500. And the average $500 deduction would result in a rebate of, say, on average $150.

It is a lot of work by a lot of people for some very small beer.

But will anyone have the political courage to say to eight million wage slaves: “Here’s a few hundred dollars off your tax. Now go away and never do another tax return again.”

My guess is there would be an outcry for “no-disadvantage” tests and the like. But the new system would be a lot less wasteful and overall we would be better off

However, it would require a fairly radical change in tax thought. Instead of the present tax event being the accumulation of income at the end of the financial year, the tax event would become the actual weekly, fortnightly or monthly payment of wage or salary. Upon the transfer of the money to the wage slave, the tax would be levied and that would be the end of it, unless you were a registered business taxpayer to whom complex annual-tax rules would apply. For the wage slave, the tax would be gone, just like GST upon purchase of a good or service.

The trick is for someone to have the political courage to wipe out a raft of fairly minor deductions: work-related; self-education; medical; charities and so on. They could be replaced with the equivalent of a single universal deduction by lowering the tax rate. Much of this has already been done but overflow rebates are still allowed for heavy medical expenses which would be better met solely through Medicare, the PBS and the welfare system. Charities could get a two for three dollar grant (or whatever) for all money given.

If you did that, the vast majority of wage and salary earners would not have annual tax returns.

Yes, it is not as fair as the present system, but only slightly less fair. And the benefits would be huge.

That is different, though, from the proposition of simplifying business taxation.

Henry told the story of Jim who he had met in a small town on the way back from Epping Forest National Park. Jim had grilled him as to why a simple thing like fencing wire was dealt with in three different ways by the tax system. Why couldn’t the tax system be simpler, Jim asked. Why couldn’t it just add up the cash in and the cash out and tax the difference.

In his speech to the National Press Club, Henry expressed some sympathy for Jim’s view. He thought that policymakers should take more notice of the views of ordinary Australians.

“Yet it’s been my experience that the bar room conversations of practical people can sometimes contain more wisdom than high-brow policy seminars,” he said.

To this end his Tax Review Panel will enter into a six-month consultation period next year.

Let’s hope the panel does a better job of sifting out the chaff then Henry did with his bar companion Jim. A simple cash-in, cash-out system would be calamitous for individuals and partnerships who could not, like a company, spread dividends over several years. To deduct all capital in the first year would result in a roller coaster of tax liability — nothing one year, far too much the next.

Of course fencing wire has to be treated differently according to how it is being used. If Jim fences in his private vegetable garden it is not deductible. If he uses it to repair an existing fence it is deductible immediately. If he constructs fences where there were no fences before it is deductible over the lifetime of the fence, say, fifteen years. Sure, that is more complex, but it is fairer and more economically sensible.

The primary task of Ken Henry, as the senior public servant in Treasury, is to try to save us from the idiocies of the Jims of the world, or more particularly to save us from politicians who have been persuaded by the Jims of the world.

Perhaps the fact that Henry made Jim’s fencing wire public at the National Press Club is significant – it has as often been a forum for populist politics than a place for sound policy formulation.

We need a public service that can thoroughly test proposals and put forward its own tested proposals that promote the national interest. It is then up to the politicians as to whether they adopt those proposals or go off on policy frolics of their own that might have some short-term benefit for the incumbent government. But at least the starting point would be sound.

Two examples of unfair simplicity replacing fairer complexity arose in the term of the previous Treasurer, Peter Costello. The first was the change to capital gains tax. The second was the change to superannuation. My guess is that Treasury would have opposed to both — as they should.

The superannuation changes replaced a tangle of rules and tax incidents on superannuation with a simple rule that if you take your money out after the age of 60 it is tax-free. A simple, whoppingly unfair bonus to richly undeserving baby boomers.

The new capital gains tax got rid of the complicated rules and calculations on allowing for inflation by simply halving of the tax and having no allowance for inflation. But in this new economic environment that will be unfair. It is easy to imagine someone buying an investment house in 2003 for $500,000 and selling for $600,000 in 2008, just keeping up with inflation and therefore making no gain whatever. But under Costello’s simple rule the investor would be taxed on $50,000 – half the notional $100,000 gain, which after allowing for inflation would be no gain at all. It would be a big, unfair tax on no gain.

There is no harm in having complexity in the tax system on the business side. Indeed, it is necessary. Without it business will find ways of dodging their way through simple tax system. People in business and investment usually have the resources or knowledge to deal with complexity.

Do not get rid of it because someone in a pub suggests otherwise.