CHAPTER THREE - THE TAX SYSTEM AND LOW INCOME EARNERS

CHAPTER THREE - THE TAX SYSTEM AND LOW INCOME EARNERS

3.1 The terms of reference for this inquiry do not explicitly mention the impact of the tax system on low income earners. However, one focus of the inquiry is on the distributive effects of the taxation system, which inherently suggests attention to those with lower wealth and incomes. In effect, all of the Committee's terms of reference invite the Committee to consider the effect of the tax system on low income earners, and a substantial amount of the evidence received from witnesses and submissions related to this issue.

3.2 That evidence highlighted a number of specific issues, which will be considered in this chapter. Those are:

  • the link between this inquiry and the Senate Community Affairs Committee's Inquiry into Poverty and Financial Hardship;
  • the level of the tax free threshold for income tax;
  • income tax and 'bracket creep';
  • the impact of high effective marginal tax rates;
  • proposals for the use of income tax credits;
  • the impact of the GST and regressive taxes on low income earners;
  • the tax system and workforce participation;
  • income tax as a disincentive to delayed retirement; and
  • proposals for wealth taxes.

3.3 Like Chapter 2, a number of issues discussed in this chapter were affected by the 2004/05 budget. These changes will be noted as appropriate during the chapter.

The Senate Community Affairs Committee's Inquiry into Poverty and Financial Hardship

3.4 On 24 March 2004, the Senate Community Affairs References Committee tabled the report of its Inquiry into Poverty and Financial Hardship ('the Poverty Inquiry'), entitled A hand up not a hand out: Renewing the fight against poverty. As a result, for much of 2003, the Economics Committee and the Community Affairs Committee were both taking and considering evidence in relation to the impact of taxation on low income earners. A number of organisations made submissions or gave evidence to both inquiries.

3.5 Some stakeholders have asked the Committee to indicate the relationship between this report and A hand up not a hand out. The terms of reference for the Community Affairs committee and for this report were quite different, leading to some inevitable differences of focus between the two reports. In the case of this report, the broader ambit of the report is taxation, and the impact of taxation on low income earners is one component. For the Community Affairs Committee, the task was to consider the plight of those in poverty, and as a result tax was one component of their considerations. As a result, while the Committee will draw on A hand up not a hand out as appropriate during this chapter, the two reports should be seen as separate exercises.

3.6 Sections of A hand up not a hand out which are relevant to the current inquiry include:

  • the latter part of Chapter Three, which deals with the impacts of taxes (including the GST), transfers and other benefits on poverty, and examines the distribution of wealth in Australia;
  • Chapter Four, which examines unemployment and the labour market (and in particular the section on 'The working poor', from page 73 to page 84); and
  • Chapter Five, which examines the social security system (and in particular the section entitled 'poverty traps', from page 117 to page 120, which examines the interaction between the tax and transfer systems in Australia, with a particular focus on effective marginal tax rates).

Level of the Tax Free Threshold

3.7 The tax free threshold for Pay As You Go (PAYG) taxpayers is set at $6000 per annum. That is, no income tax is payable on the first $6000 earned. The tax free threshold itself should not be confused with notions of an 'effective tax free threshold' which are sometimes discussed in public debate on taxation. 'Effective tax free thresholds' are essentially the value of the tax free threshold, plus the value of any taxation benefits (such as, for instance, the family tax benefit) to which the taxpayer may be entitled. The tax free threshold is universal, while 'effective tax free thresholds' depend on personal circumstances.

3.8 Two common concerns expressed about the current operation of the tax free threshold are that it is not necessary to offer the tax free threshold to all earners, and that the threshold itself is set at too low a level.

3.9 On the first of these issues, the concern is that all PAYG taxpayers earn the tax free threshold. A taxpayer earning $10,000 per annum does not pay tax on the first $6000 earned, but neither does a taxpayer on substantially more money. If the tax free threshold was withdrawn for higher income earners, the additional tax received could fund further tax relief for low and middle income earners. ACOSS observed this issue, but considered that it is relatively unimportant:

the tax free threshold is the single most important element of progressivity in our income tax system. It offers the same flat exemption from tax for low-income earners as it does for high-income earners. Of course, it is proportionally of much more benefit to those at the bottom end. While some people would ask why that $6000 exemption is offered to millionaires, my answer would be that it is not worth that much to them but it is worth a hell of a lot to someone on $10,000.[42]

3.10 The Centre for Independent Studies has, for some time, consistently argued that the tax free threshold should be raised, to take account of both inflation and the taxpayer's requirement for a basic level of 'subsistence' income. In evidence to the Poverty Inquiry, Professor Peter Saunders, Director of Social Policy Research at the Centre for Independent Studies, put this argument as follows:

I think it is an outrage that we tax people as soon as they hit $6,000 of income when our welfare floor is $12,500 of income. Presumably, our notion of what the absolute basic subsistence level is must be $12,500 yet we start taking money away from people as soon as they earn $6,000. Then we say, Good heavens, they are in poverty. We need to give them welfare. So we are taking money out of one pocket and putting it into the other. I think the best solution to that is to raise the tax threshold back to where it was in 1980. If you had indexed the tax thresholds in 1980, we would now have a personal income tax threshold of $14,000 before you paid a cent of income tax, not $6,000.[43]

Income Tax and 'Bracket Creep'

3.11 The Committee received considerable evidence in relation to bracket creep, and in particular in relation to its impact on low and middle income earners. 'Bracket creep', as commonly used, in fact describes two different phenomena. The first arises from the impact of inflation upon constant income tax thresholds:

The cost of goods and services 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.[44]

3.12 The second arises from 'creeping' within tax brackets:

Consider the following brief example: A taxpayer earning income [of] $40,000 pays income tax of $8980, representing an average tax rate of 22.45% If the taxpayer earns $45,000 they pay income tax of $10,555. This represents an average tax rate 23.46%. This example demonstrates tax rate creep within brackets without the taxpayer moving from the 30% tax bracket, their average tax rate goes up by more than 1%.[45]

3.13 These two phenomena result in what one submission described as 'covert increases in income tax revenues'.[46] They result in wage earners maintaining their real gross wage, but facing higher levels of income tax.

3.14 The Committee received a range of evidence highlighting the impact of bracket creep on taxpayers and on government revenues. The Institute of Chartered Accountants stated that '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.'[47]

3.15 The Shop, Distributive and Allied Employees Association (SDA) stated in its submission that 'at least 250,000 workers moved into higher tax brackets during the period 1998-99 to 2000-01. The ranks of the over $50,000 jumped from 16% of tax payers in 1998-99 to 19% in 2000-01.'[48] In evidence, the SDA stated that 'since the GST came in, bracket creep has added approximately $3 billion annually to government revenue.'[49]

3.16 A recent report by the Melbourne Institute in conjunction with The Australian gave the following detailed assessment of the impact of bracket creep:

If the [A New Tax System (ANTS)] tax reform would have included a policy to annually index tax thresholds by the CPI (corrected in 2000/01 for increases due to the introduction of GST in the ANTS package,), then by 2005/6 the total personal income tax collected would be $3.8 billion lower than it would be if there were no further increases in the tax thresholds other than the ones that took place in the last 2003/04 budget. This amount is calculated from the difference in total income tax under the two systems (a cost of roughly 4.3 billion dollars for the government) and is then adjusted for the difference in total rebates (a saving of roughly half a billion for the government). This $3.8 billion is the dollar amount of bracket creep, expressed in first quarter 2004 dollars, and represents what it would cost to compensate the Australian tax payers for the extra amount of tax they would pay in 2005/06 as a result of inflation as measured by the CPI since 2000/2001.[50]

3.17 While most of the evidence before the Committee saw bracket creep as a problem, this view was not unanimous. ACOSS stated:

Some argue that even if middle income-earners do not face high tax rates now, they will do so in the near future, due to the effects of income tax "bracket creep". These commentators raise the spectre of average wage earners being taxed at marginal tax rates of 42% or 47%.

As we argued above, this does not mean they will pay 42% or 47% on all of their income, only a small proportion of it. Low inflation rates have taken much of the sting out of "tax bracket creep", and there is no pressing need to reduce income tax just three years out from a $12 billion a year tax cut.

In any event, average wage earners rarely face the top two marginal tax rates, or do so on just a small part of their income, because tax thresholds are raised from time to time to prevent this from happening.[51]

3.18 A number of those submissions which were concerned about bracket creep proposed solutions. The most common solution was to index the income tax thresholds to inflation. The Institute of Chartered Accountants, for instance, stated:

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. Australias 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.[52]

3.19 A related solution was suggested by CPA Australia, which would combine indexation with changes to the structure of the thresholds and the rate of taxation at each threshold:

CPA Australia submits that there are major efficiency gains to be achieved from lowering the income tax rates across the board in conjunction with a targeted rebate for low-income earners. Particular attention should be given to the marginal tax rates faced by middle and upper income earners. Consideration should be given to reducing the number of income tax brackets from the current five to three. Such a flattening of the personal tax rate scale would reduce bracket creep. Further, bracket creep could be completely fixed by indexation. All of these measures would provide taxpayers with greater incentive to work, save and invest.[53]

3.20 Finally, the Womens Action Alliance argued that the best solution was to index tax thresholds to average weekly earnings:

Womens Action Alliance believes that some form of tax indexation needs to be introduced, preferably based on a proportion of average weekly earnings, (eg: the tax free threshold applies to 15% of AWE, and so on up the scale).

This would provide a reasoned basis for the calculation of taxation, by recognising that, at a certain proportion of AWE citizens should not be required to pay tax, while at the other end, over a certain proportion (eg 175% ) the top tax rate should apply.[54]

3.21 The 2004/05 budget reduced the impact of bracket creep for some voters by lifting the thresholds at which the 42% and 47% income tax rates apply. However, the income tax rates remain fixed rather than being indexed.

Effective Marginal Tax Rates

3.22 A large number of submissions before the Committee discussed the impact of high effective marginal tax rates (EMTRs) on low income earners. The prominence of the EMTR issue in this inquiry reflected its prominence within wider contemporary tax debates where it is seen, in the Committee's observation, as one of the most important issues to be dealt with in any reform of the tax/welfare system.

3.23 The term 'Effective Marginal Tax Rate' measures 'the percentage of a one dollar increase in income that is lost to income tax and income tests on government payments and services.'[55] Intuitively, it is a somewhat misleading term, because the higher EMTRs result from the withdrawal of benefits rather than the application of additional taxation. Ultimately, the question is, if a taxpayer earns an additional dollar, how much better off are they, once the payment of tax and reduction of social security benefits are taken into account?

3.24 A recent report by the Melbourne Institute of Applied Economic and Social Research gave the following example:

Take the example of the jobless couple with two children. If one member of the couple secured a full-time job with a low wage rate of $11.80 per hour - $472 for a forty-hour week - the familys net after tax income would increase by only $144.31 per week. The effective marginal tax rate on the wage income earned would be 69 per cent.

Why is this? First, they would pay $65.10 in income tax. In addition they would have their income support payments reduced, losing $173.65 of NewStart Allowance and $127.05 of Parenting Payment. They would gain an additional $38.11 in Family Tax Benefit, but in total the net loss of assistance would be $262.59, a much larger effect than the $65.10 income tax.[56]

3.25 Evidence before the Committee suggested that in some cases the EMTRs faced by people moving from welfare to work in Australia can be prohibitive. ACOSS provided the following table highlighting some taxpayers who face prohibitively high EMTRs:

Characteristics of tax-payer

Effective marginal tax rate on the next dollar of earnings (%)

Main reasons for this high marginal tax rate

Unemployed adult on Newstart Allowance

75%

Income test for Newstart Allowance, income tax at 17%

Low income family with one child in day care

70%

Income tests for Family Tax Benefit (Part A) and Child Care Benefit, income tax at 30%

Low income family with children aged 15 and 17 years

78%

Income tests for Family Tax Benefit (Part A) and Youth Allowance, income tax at 30%

Notes: "Low-income family" in these examples refers to families with incomes of around $30,000 to $40,000 per year.[57]

3.26 The Government of Queensland noted that 'High EMTRs, by reducing the return from earning additional income, possibly discourage low income earners from working more hours or acquiring further skills to enhance their employability, productivity and thus their standard of living.'[58] UnitingCare stated that 'it is not commonly realised that many Australians on income support payments face effective marginal tax rates of more than 80%.'[59]

3.27 The St. Vincent de Paul Society stated:

For the lowest income Australians, those receiving Unemployment or Parenting Payments and totally dependent on government benefits, when seeking to move from welfare to work (a most desirable objective), suffer effective marginal taxation rates of between 60% and 110%, where even the richest person in the country who actually declares their income (and that is unlikely) would pay only 47%.[60]

3.28 Mr Tomas Nilson put the issue in these terms:

Ideally, we should have a progressive taxation system, but currently Australias taxation systems combine to create what is effectively a regressive tax system, where the effective marginal tax rate for people on very low incomes can be much higher than the top actual marginal tax rate of 48.5%. In some instances the loss of welfare payments and other payments such as Austudy mean that a person can face effective tax rates of more than 100%. In other word, a familys total income can actually decrease if a member of that family finds work. This situation is extremely undesirable.[61]

3.29 The SDA gave a summary of those most likely to be affected by high EMTRs, drawing on analysis from the National Centre for Social and Economic Modelling:

41% of couples with children and 36% of sole parents have EMTRs of 40% or above. In contrast only 18% of single people without children are in the same position. Clearly high EMTRs are more likely to impact on families with children.

If one looks at the situation of individuals with earnings it is even clearer that high EMTRs affect families. Of couples with children 54% have EMTRs above 40% and 79% of sole parents have EMTRs above 40%. 20% of couples with children and 51% of sole parents have EMTRs above 60%.

74% of all individuals with high EMTRs have at least one child aged under 16 years.[62]

3.30 The Department of the Treasury, while acknowledging the potential for high EMTRs to be an issue, considered that the issue has been largely dealt with by current policy:

One measure of the impact of taxation on income is the concept of the effective marginal tax rate (EMTR). EMTRs measure the percentage of a one dollar increase in income that is lost to income tax and income tests on government payments and services. While high EMTRs are thought to provide a disincentive to earn additional income, it is not generally possible to isolate fully the actual influence of EMTRs on workforce participation.

With the introduction of The New Tax System, the Government reduced effective marginal tax rates (EMTRs) for low income families. The lowest marginal tax rate was reduced to 17 per cent, and taxpayers that had previously experienced 34 per cent and 43 per cent marginal tax rates had their top tax rate reduced to 30 per cent. Changes in tax thresholds also meant that the vast majority of Australian taxpayers were in the very broad tax bracket from $20,001 through to $50,000. At the same time, the income test taper rate on family payments for low income families (Family Tax Benefit (Part A)) was reduced from 50 per cent to 30 per cent, and the income test taper rate on pensions was reduced from 50 per cent to 40 per cent.

Although high EMTRs can still occur as a result of interactions between the tax and social security system, studies have shown that only a small proportion of the population experience them. A recent NATSEM study found that in 2002, since the introduction of The New Tax System, only 8 per cent of people faced EMTRs in excess of 60 per cent, and only 1 per cent faced EMTRs in excess of 80 per cent. NATSEM estimated that in 1997, under the previous tax system 3 per cent of people faced EMTRs in excess of 80 per cent, including 1 per cent who had EMTRs in excess of 100 per cent.[63]

3.31 However another Commonwealth department, the Department of Family and Community Services, still sees high EMTRs as a problem:

Many people in paid employment now receive social security and pay income tax at the same time (a situation sometimes referred to as 'churning'). As a consequence, many households experience simultaneous income test and tax withdrawals from their overall income as their private income rises, producing discouragingly high effective marginal tax rates (EMTRs).[64]

Policies to address high EMTRs

3.32 Submissions and witnesses provided the Committee with a number of means of addressing the problem posed by high EMTRs. These included:

  • income tax credits;
  • eliminating the 'stacking' of income tests for social security benefits;
  • raising the tax free threshold and lowering the tax rate for low income earners; and
  • consolidating the means tests for all forms of assistance;

3.33 The proposal to raise the tax free threshold has been discussed above, and income tax credits will be discussed in the next section. The 'stacking' and consolidating of means testing can conveniently be considered together.

3.34 The Committee considers that use of income test thresholds for social security benefits is an appropriate way to direct these benefits to those in need. The concept behind income test thresholds is that, once a recipient is in receipt of a certain income, their entitlement to (and need for) the benefit is progressively withdrawn. The rate at which the benefit is withdrawn is intended to strike a balance between rewarding the recipient for working, and reducing the benefits payable, to allow that money to be directed to other, more needy recipients.

3.35 However the current system does not take account of the concurrent withdrawal of several forms of benefit. Stacking of income tests occurs when several different forms of benefit have income test thresholds which are very close to one another, or identical. The result may be that by crossing the threshold, the recipient begins to lose from all of those forms of benefit. This, in turn, upsets the balance between rewarding work and reducing payments.

3.36 ACOSS raised the issue of stacking of income tests in its submission to a recent Government consultation process:

The worst poverty traps occur when two or more income tests stack together (eg Family Tax Benefit, Youth Allowance, Child Care Benefit) subtracting 60-100 cents from every additional dollar earned.[65]

3.37 The Government of Queensland stated:

A shift toward social security targeting has resulted in income test stacking, where multiple income tests overlap each other and income tax bracket thresholds. This has led to an increased incidence of high EMTRs faced by families since the early 1980s.[66]

3.38 An obvious example is Family Tax Benefit A, and the Child Care Benefit. Both of these benefits begin to reduce once the recipient's family income reaches $31,755. Once a recipient's income crosses that threshold, for each additional dollar they earn, they lose 30 cents in income tax, 30 cents from FTB(A)[67], and a proportion of their child care benefit (this proportion is highly variable depending on their circumstances).[68]

3.39 It can be seen that as a result of this income stacking, the EMTR on dollar number 31,755 is 30% (i.e. income tax), while the EMTR on dollar number 31,756 is somewhere in excess of 60%[69]. It is suggested that if these tests were not 'stacked' but rather were graduated: if, for instance, the threshold for Child Care Benefit were set at $38,000, this would reduce the size of the increase in EMTR which occurs at $31,755.

3.40 A study by NATSEM[70] in 1998 suggested that another way to deal with this issue would be to control the overall EMTR at any particular income level by consolidating the income tests for all forms of benefit, and then structuring the 'free area' (i.e. the income range within which the full benefit is payable) and the taper rates (i.e. the rates at which the benefit reduces, once the income threshold has been passed). This would bring all of the thresholds and taper rates within one system, where their impact on the recipient could be managed, preventing income test stacking which may result from various benefits being considered in isolation. However, this proposal was presented in conjunction with an argument for income tax reform, and the introduction of a system of tax credits. It also included the following noteworthy caution:

Policy solutions to alleviate high effective marginal tax rates are inevitably about tradeoffs between, for example, the level of the effective marginal tax rate and the range of income affected, between horizontal and vertical equity, between targeting and the level of disincentives. There is no perfect solution to the interface of tax and social security just judgments about where to strike a balance between competing objectives.[71]

Income Tax Credits

3.41 One potential solution to the problem posed by high EMTRs is the introduction of a system of income tax credits, also referred to as a 'negative income tax'. This proposal has been the subject of widespread discussion since the mid 1990s.

3.42 Essentially, a system of income tax credits would provide a certain number of 'credits' to each taxpayer (or, possibly, each family). The number could then be varied according to their circumstances (for example the number and age of children in the home, the presence of people with disabilities, or veterans, or other circumstances targeted by policy). These credits would then be redeemed against the taxpayer's tax obligations, reducing the amount of tax paid. If the number of credits held by a taxpayer exceeded the amount of tax payable, they would receive 'negative tax', that is, they would receive a payment through the tax system.

3.43 A flat rate of tax is often discussed for such a system (though it is not inherently necessary). With a flat tax in place, the progressive nature of the tax system would be preserved because tax credits would represent a much lower proportion of a high income earner's tax obligation, and a much higher proportion of a low income earner's tax obligation.

3.44 This system could be applied in several ways. At its most radical, the system could replace the current social security system altogether, delivering all forms of welfare benefits through the tax system. Keating and Lambert described this proposal in the following terms:

The simplest but most radical reform of the tax-transfer system to ensure a single marginal rate of tax would be to replace the whole system with what is commonly called a negative income tax. This would involve a set of universal tax credits, which could be varied as now according to the number of children a recipient had and any other identified needs, and a flat rate of tax levied as a percentage of taxable income above a threshold, which could be set as low as zero.[72]

3.45 A less radical form of income tax credits could see the system targeted to low income earners, and used to 'smooth out' the high EMTRs associated with the transition from welfare to work. There are a number of variables which could be used to target this system: varying the recipients, the base tax rates, and the number of credits. Dawkins et al observed that such systems make more sense than the radical proposal, which they described as 'not likely to be feasible'[73]:

Alternative systems, which involve the tapering out of tax credits, variable tax rates, and some selectivity in who receives tax credits make the idea of a negative income tax look much more feasible.[74]

3.46 A further refinement of this targeted option is the use of earned income tax credits, where the issue of tax credits is not universal, but is earned in some way. This is the system in use in the UK, US, and Australian schemes outlined below. In the US and UK schemes, the tax credits are earned by being in work, and earning a low income. They therefore provide an incentive to enter the workforce, but limit that incentive to those on low incomes. Under the Australian scheme, credits are earned by having a low income, whether the recipient is in paid work or not. In all of these systems the credits, once earned, are used to reduce the recipient's remaining tax obligations.

Examples of earned income tax credit schemes
The UK Working Tax Credit and Child Tax Credit

3.47 The UK's Working Tax Credit and Child Tax Credit schemes are interrelated tax credit schemes which replaced a range of pre-existing social security benefits.[75] The working tax credit is available to people who are in work for at least 16 hours per week (at least 30 hours for single people 25 and over). The credit varies according to income. An annual credit of 3000 is available to eligible recipients with an annual gross joint (i.e. family) income of 5000 or less. The amount of the credit tapers off, and becomes zero at an annual gross joint income of 15000. Additional tax credits are available for working parents who require full time child care, up to 70p for every 1 spent.

3.48 The Child Tax Credit is a benefit designed to assist parents to support their children. It is payable in addition to the Working Tax Credit, and is very similar in design. A family with an annual income of 5000 is entitled to annual credits of 1990 if they have one child, 3435 if they have two children, and 4880 if they have three children. If the Working Tax Credit is added in, these three families receive 4990, 6465 and 7880 respectively in total tax credits. The Child Tax Credit is extended to higher income earners than the Working Tax Credit, and cuts out completely at 60,000. Higher rates of tax credit are received in the year following the birth of a baby.

The US Earned Income Credit

3.49 The US Earned Income Credit scheme provides income credits to taxpayers who have earned income of less than US$33,692 (for families with children) or $US11,230 for single taxpayers without children, and who meet a number of other criteria related to residence and investment income. The threshold is then adjusted for married couples filing their tax returns jointly, and for households including more than one child.[76]

3.50 The amount of credits available increases up to a peak as the taxpayer's income (and therefore their tax obligation) increases, up to a peak, then declines again until it reaches zero at the relevant income threshold. Thus, if a single taxpayer with one child, earns $10,000 per annum they receive the full tax credit of $2,547. However if they earn $5000, their tax credit is $1,709, and if they earn $20,000, it is $1541, in both cases less than the peak amount.[77]

The Australian 'Working Credit' Scheme

3.51 Since September 2003, a form of income tax credits have operated in Australia on a much smaller scale than the schemes in the USA and UK. The 'Working Credit' Scheme formed part of the Australians Working Together package, and commenced in September 2003. It is targeted to zero income earners and very low income earners. Under the scheme, taxpayers accumulate a balance of tax credits for each fortnight that their income (excluding income from Centrelink) is low. The following table shows the rate at which credits accumulate:[78]

Fortnightly Income

$0

$10

$20

$30

$40

$47

$48+

Fortnightly Credits

48

38

28

18

8

1

0

3.52 A maximum of 1000 credits can be accumulated. When a credit-holder moves from welfare to work, the credits can be used to increase the amount of income they can earn before their Centrelink payment begins to reduce. One credit is equal to one dollar of additional income which may be earned, over the relevant threshold.

Difficulties with tax credit schemes

3.53 The biggest difficulty for the implementation of tax credit schemes is their cost. The study by Dawkins et al cited above found that for the 'radical' tax credit scheme, with all social security payments replaced by tax credits, a universal tax credit allocation and a flat tax, the flat tax would have to be 57% in order to maintain revenue neutrality. The authors note that 'such generous systems tend to be expensive and produce a high marginal tax rate this suggests that such a system is not, at present, likely to be acceptable politically.'[79] However, the Committee noted that a number of the other scenarios modelled by Dawkins et al required less onerous tax rates in order to meet revenue neutrality.

3.54 As a general rule, the Committee observes that the cost associated with tax credit schemes depends upon the parameters of the scheme. Elements such as the following would all be important:

  • the manner in which credits are obtained;
  • the thresholds which apply to the accumulation of credits;
  • the way in which other factors (such as children and disabilities) affect credit entitlement;
  • the manner in which entitlement to credits tapers at higher income levels; and
  • the underlying income tax system

3.55 Wider policy settings may also have an impact on the cost and efficacy of a tax credit scheme. The Department of Family and Community Services, citing an OECD study, stated:

the choice of a particular approach to making work pay and its likely effectiveness depends upon the other institutional and social policy settings in place. These include the level of minimum wages, the distribution of incomes, the nature of the family assistance and income support systems, prevailing labour market conditions and so on.[80]

3.56 The Committee therefore considers that it is not a foregone conclusion that tax credit schemes will be prohibitively costly. Any judgment regarding the costs or public acceptability of a proposed scheme must be made once the details of the scheme are known.

3.57 Finally, the Committee agrees with CPA Australia's observation that 'tax credit systems are not a panacea or silver bullet to the problem of poverty traps.'[81] Under the current system, the challenge for policy makers is to find a solution which balances the provision of support to those in need with support for workplace participation, the costs of the welfare system, and the revenue needs which must be met by the tax system. If a comprehensive tax credit scheme were introduced, the need to successfully strike this balance would remain all that would change would be the policy 'levers' available to do so.

The Goods and Services Tax and other regressive taxes

3.58 A range of submissions argued against the use of regressive taxes, charges and levies. A tax is described as 'regressive' if it 'takes a smaller proportion of income as the taxpayer's income rises.'[82] As a result, any tax or charge which has a fixed price, regardless of the taxpayer's income, can be described as regressive, because the fixed price is a large proportion of a low income earner's income, and a small proportion of the high income earner's income.

3.59 The most common example discussed in submissions and evidence was the Goods and Services Tax (GST). The SDA described the regressive nature of the GST in the following terms:

The GST, excise, state and local taxes are by their very nature regressive. They do not take into account at all or sufficiently the capacity of a person or family to pay so they impact disproportionately on low-income families.[83]

3.60 In its submission, the Society of St. Vincent de Paul stated:

Clearly the GST was heavily skewed in favour of the wealthy. This package adds a net percentage increase in the value of goods and services, regardless of the income of the purchaser.[84]

3.61 In evidence, Mr John Wicks from St Vincent de Paul described the GST as follows:

The GST, above all, was a cruel ruse on low and middle income Australia, imposing a known regressive tax on them with ridiculously low levels of compensation whilst at the same time giving substantial gains in both direct compensation and lower prices for a wide range of luxury goods to the wealthy.[85]

3.62 The GST was regarded by submitters as regressive for two reasons. The first, described above, is that the GST on a particular item is the same whether the item is purchased by a person with a high, middle or low income. The second reason is that low income earners are more likely to use most of their income for consumption (as opposed to saving or investment). As a result, a larger proportion of their transactions are likely to attract GST, thus exacerbating the regressive nature of the tax. Professor Cameron Rider and Ms Miranda Stewart, in their submission, stated:

The Goods and Services Tax, even with the basic food exemption, is regressive because low-income people spend all of their income, while high-income people save some income (or buy investments) and are thus not taxed by the GST on their savings.[86]

3.63 The Southside Chamber of Commerce reported a similar finding from its own research:

The study also showed that the effects of the GST were regressive in that the less people earned the more they had to pay proportionally in tax. This was because all of their income was expended on living expenditure whereas the GST applied to the far lesser proportion of an affluent person's incomes spent on living expenses represented a lower percentage of total income.[87]

3.64 As indicated in a number of the quotations above, the New Tax Package (which introduced the GST) included a package of measures intended to compensate low income earners for the regressive effects of the GST. The Society of St Vincent de Paul described those measures as 'ridiculously low'[88], while the Womens Action Alliance said:

While recognising that the package of assistance implemented at the time [the GST was implemented], particularly the Family Tax package, has gone some way to alleviate these burden for many families, WAA is concerned that there has been no authoritative research to assess the actual impact on families in real terms.[89]

3.65 The society of St Vincent de Paul has proposed the following solution to the high incidence of the GST upon low income earners:

The St Vincent de Paul Society proposed the use of a smart card, that would have allowed poor households (on a graduated scale depending on income) a total exemption for all GST payments.[90]

3.66 The GST is not the only regressive tax within the Australian tax system. Mr Paul Kenny, Senior Lecturer in Taxation Law at Flinders University, stated:

in the 2001 income tax year, income tax accounted for 56.5% of total Commonwealth, State and Council taxes Indirect tax, though, constituted the other 43.5% of taxes. These indirect taxes include: the goods and services tax, taxes on financial and capital transactions, excises and levies, gambling taxes, insurance and motor vehicle taxes. These taxes are regressive since one's effective tax rate falls as one's ability to pay rises.[91]

3.67 The Society of St Vincent de Paul drew attention to regressive taxes in the form of levies:

There are over $100 billion of levies. These levies are widespread and they exist at both Commonwealth and State levels. Generally, these are not progressive. These include a wide array of agricultural levies (chickens, sheep, beef, sugar), as well as air fares, airports, insurance, emergency services, casinos, motor vehicle registration, stamp duty, driver's licenses, wine equalisation, etc. All of these fixed charges feed into the production costs of goods and services and thence trickle down to low and middle income earners in the prices they pay.[92]

3.68 It is important to note that tax expenditures can be regressive in the same way as taxes. This occurs when the size of the tax expenditure available is higher for high income earners than for low income earners. An example presented in evidence was the 30% rebate for private health insurance, which is regressive in that the rebate is 30% regardless of the means of the recipient, and is further regressive in that those on high incomes are more likely to be able to afford the remaining 70% of the private health insurance premium. Catholic Health Australia outlined this issue:

With private health insurance the poor pay the same amount as the rich but the relative impact on the poor is greater. And the argument that only the well off subscribe to private health insurance is false; many battlers, low income, elderly, disadvantaged, those on low incomes with children subscribe to it. The impact of queuing for needed health care, on low income workers in terms of their employment opportunities for example, is relatively greater than for those on high income who can afford to jump the queue. There may be scope to address equity objectives through a tiered system of premiums based on income and assets assessments.[93]

3.69 They present as one remedial option a graduated system of rebates to make this system more progressive:

Increase the rebate to say 40% for low income earners and the elderly, and reduce the rebate to say 0% for high income earners so that its impact is more progressive rather than regressive. This would be designed to capture high income earners who may be subscribing to low cost private health insurance products for the sole purpose of avoiding the Medicare levy surcharge contribution.[94]

3.70 The Committee noted, however, that while the private health insurance rebate may be regressive, it is one of a number of measures relating to the provision of health. High income earners pay a higher amount in terms of their medicare levy, if they do not take private health insurance they will be subject to a surcharge (which does not apply to low income earners) and, finally, by obtaining private medical treatment, patients reduce the pressure on the public health system, for the benefit of those patients who do not have private health insurance (including those who, as low income earners, may be unable to afford private health cover).

Impact of taxation on workforce participation

3.71 Concerns about workforce participation have underpinned almost every issue raised in Chapters 2 and 3 of this report. High effective marginal tax rates, the availability and cost of child care, difficulties associated with bracket creep, the operation of the Family Tax system, and the operation of the HECS scheme all have an impact upon the rewards received by a taxpayer who moves from welfare to work.

3.72 While workforce participation has therefore been a constant theme in this report, the Committee considers that this issue should not just be considered on a piecemeal basis. Submissions and evidence before the Committee suggested that one of the most important features of the Australian tax/transfer system should be that it promotes, facilitates and rewards workforce participation. UnitingCare, for instance, stated that 'providing practical pathways back into employment is one of the key planks of empowering individuals and addressing social exclusion, benefiting all Australians.'[95]

3.73 The Senate Community Affairs References Committee, in its poverty inquiry report, put this issue in the following terms:

Unemployment, particularly long-term unemployment, is the most significant cause of poverty and disadvantage in the Australian community. In the immediate post-war years through to the mid-1970s, Australia, like most advanced Western countries, maintained very low levels of unemployment. Since the mid-1970s the achievement of full employment has progressively lost ground as a policy priority, with the consequence that large numbers of Australians have been denied this basic right to work. As a consequence, unemployment and underemployment have remained at unacceptably high levels for over two decades and this has led to major social and economic costs for the community.

Unemployment has serious economic, social and emotional impacts. Unemployment puts severe financial and emotional stresses on families and leads to a loss of self esteem and social status. These can lead to family conflict and separations; to psychological and physical health problem; to homelessness and to a range of disadvantages for children growing up in these families. The effects of unemployment, however, reverberate beyond the jobless unemployment reduces economic output and national income and the wider community is adversely affected with further demands placed on governments via the social security system and on the charitable sector.[96]

3.74 The observations of the Community Affairs Committee highlights the view that the benefits from workforce participation are not restricted to the economic benefits associated with earning a wage. This view was also expressed in a number of submissions to the current inquiry. The Department of Family and Community Services, for instance, stated:

Individuals choose to work for many reasons because they wish to be self-reliant and contribute to their own support, for the social engagement work offers, and to ensure a more secure economic future for themselves and their children. The participation preferences of individuals are also influenced by individual capacity and opportunities.[97]

3.75 A number of submissions put the view that the tax system, as currently structured, hinders job seekers. The Australian Chamber of Commerce and Industry, for instance, stated that income tax dampens personal initiative:

At the most basic level high marginal income tax rates act to discourage personal initiative and effort. With impaired incentives to work harder, seek promotion or augment their human capital through vocational training, there is a corresponding reduction in the willingness on the part of employees to undertaken these activities.

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The effect on the broader economy is detrimental. Reduced workforce participation results in lower GDP per capita, while a less skilled workforce means decreased productivity. This adds up to a lower standard of living for all Australians.[98]

3.76 The Country Women's Association of NSW identified payroll tax as a significant impediment to employers creating new jobs (and, consequently, an impediment to potential employees moving into those jobs).[99] While payroll taxes are levied by states and territories, not by the Commonwealth, the CWA's submission is an important reminder that Commonwealth taxes form only one part of the overall tax burden upon those moving from welfare to work, and that the state and territory tax systems may also facilitate or inhibit workforce participation.

The tax system and retirement from the workforce

3.77 Just as the decision to move into the workforce is heavily influenced by the individual's economic circumstances, so too is the decision to retire from the workforce. In particular, a worker's decision on when to retire from the workforce is likely to be influenced by their eligibility for superannuation or a pension, and the difference in income associated with moving from the workforce to retirement.

3.78 The current direction of policy is to encourage older workers to remain in the workforce as long as possible. The recent Treasury discussion paper Australia's Demographic Challenges explains why this is so:

The Australian Governments Intergenerational Report (IGR) projects that over the next 40 years, the proportion of the population aged over 65 years will almost double to around 25 per cent. At the same time, growth in the population of traditional workforce age 15 to 64 is expected to slow to almost zero.

Over time, the ageing of our population will result in a greater demand for Age Pensions and health and aged care spending. And the need to keep up with changing technology and community expectations of accessing the most advanced diagnostic tests and medical treatments is putting ever increasing demands on health spending.

The Governments preferred solution to this challenge is to implement policies designed to grow the economy more quickly. A larger economy will provide us with higher incomes, improved living standards and better enable us to meet the costs associated with our ageing population.

The best way to achieve higher economic growth is via increases in labour force participation and productivity.[100]

3.79 The Committee considers that the taxation system has a role to play in this area. Tax policies which promote continued workforce participation, reward work, and reduce the rewards associated with earlier retirement, will assist the policy objective outlined above. In its submission to this inquiry, Treasury stated:

By international standards, the participation rate in Australia among women generally and mature aged is low. The structure of the tax and retirement income systems (as well as the income support system and other policies) should take account of their impacts on labour force participation.[101]

3.80 One tax policy which rewards retirement is the Senior Australians Tax Offset. In its submission, the Department of Family and Community Services outlined the scheme:

The value of the Senior Australians tax offset means that qualifying single self-funded retirees and age pensioners have an effective tax-free threshold of $20,000. These people pay no income tax until their taxable income exceeds $20,000. The effective tax-free threshold for a couple on equal incomes is $32,612.

In addition, the Medicare levy threshold for senior Australians was lifted from its 1999-2000 rate of $13,550 to $20,000 so that a senior Australian is exempt from the Medicare levy until he or she has taxable income above that amount.[102]

3.81 Witnesses before the Committee pointed to this issue as one which may be a target for reform:

The third pressure (on the tax system) is the future cost of the privileged tax treatment of retirees. For example, the senior Australians tax offset offers retired couples a tax free threshold of $30,000, five times that for other taxpayers, and it does not cut out completely until that couple earns almost $60,000 a year. The cost of tax concessions like this will escalate as the population ages, yet as far as we are aware, it has not even been modelled.[103]

3.82 In response to a question from the Committee about whether this form of preferential tax treatment for retirees was likely to result in 'generational rage', the same witness stated:

Most younger and middle aged people have not fully cottoned on to the effective tax free thresholds of many retirees. As they do, that problem will emerge and so they should be outraged. But I come back to an earlier point. If the retired population and the future retired populationthose currently over 50, for examplewant a guarantee of decent services, be it health or aged care, they are going to have to be prepared to forgo some of these excessively generous and costly tax concessions. As there are more of them in the population, governments will not be able to afford both. In that sense, it is in the interests of the retired population to reconsider some of these generous tax concessions that they receive. Unfortunately, it is largely a vocal, organised and well-off minority who command the floor in public debate around taxation and income support for retired people. Until that changes, those changes will be difficult to achieve.[104]

3.83 However, this view was not unanimous, and the above evidence was immediately countered by another witness, who stated:

two of the features which I think are part of that low tax scenario on the self-funded retiree that Senator Watson just referred to are neither concessions nor generous but simply fair and reasonable things to do. One of them is the taxation treatment of the undeducted purchase price. That is not a concession; it is simply a matter of preventing double taxation or taxing something which is a return of the persons own capital rather than true income. Another feature is the 15 per cent rebate arrangement, which again is neither an act of generosity nor a concession but simply a recognition that 15 percentage points of tax was paid at the time the money went into the superannuation fund either in the form of employer contributions or 15 per cent taxed earnings. So that 15 per cent rebate is not generous and not a concession. It is a recognition of tax that has already been paid.[105]

3.84 Indeed, much of the evidence presented to the Committee called for more, rather than less, generous tax treatment of superannuation. The Institute of Chartered Accountants took up the issue raised above by Professor Covick:

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.[106]

3.85 The Association of Superannuation Funds of Australia argued:

The relative tax advantage accruing to superannuation has decreased in recent years with both cuts in personal income tax rates and an increase in the number of individuals subject to the superannuation contributions surcharge.

This decrease in the tax attractiveness of superannuation has been particularly in regard to contributions, but less so in absolute and relative terms in regard to superannuation investment earnings.

ASFA suggests that a reform priority should be removing or reducing the tax on contributions. If the contributions tax were completely removed, it would reduce the retirement savings target by 2 or 3% of wages, making it considerably easier and more achievable for individuals. So instead of having to save 15% of wages to fund an adequate retirement income, individuals would only have to save 12 or 13%.[107]

Wealth taxes

3.86 There was an argument from some submitters that a 'wealth tax', either in the form of an additional tax bracket or as an independent tax, should be imposed on those with very high incomes. The SDA outlined the rational for this proposal:

Australia is now estimated to have more than 100,000 millionaires, and the number of people with estimated incomes of more than $1 million has more than doubled in just five years to about 600. The richest 10 percent of our families have 44 percent of the wealth.

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There is a strong argument for the imposition of a wealth tax on those with substantial wealth.

A wealth tax would reduce the wealth gap and help fund the establishment of greater vertical and horizontal equity in the system.

In some ways Australia has an unfair taxation system. There are still loopholes which can be exploited to allow some high earners and businesses to pay less than their fair share of tax.[108]

3.87 Another submitter, Mr Loris Hemlof, suggested a 5% tax on personal wealth in excess of $80,000.[109]

3.88 UnitingCare suggested the introduction of 'estate and gift duties at a level that at least captures major asset transfer by Australia's wealthiest 10 percent of taxpayers.'[110]

Conclusions

3.89 It is clear from the evidence before the Committee that the structure of the income tax system is seen as a significant challenge for low income earners in Australia. There are arguments that the tax free threshold (and, indeed, all of the income tax thresholds) is set too low, and that bracket creep (both within and between brackets) results in tax increases by stealth.

3.90 Evidence pointed to the major challenge posed by high effective marginal tax rates for people attempting to move from welfare to work. These effective marginal tax rates may be prohibitive, and are at least discouraging. A number of options exist to address high EMTRs, including the introduction of tax credits and the elimination of 'stacking' of income tests.

3.91 Further, evidence pointed to the impact of regressive taxes on low income earners. These taxes, charges and levies do not take account of ability to pay, and therefore constitute a much larger proportion of the income of a low income earner.

3.92 All of these issues, together with those discussed in Chapter 2, have an impact on workforce participation. Evidence supported changes to the tax system which will maximise workforce participation, particularly given the future costs which will be associated with Australia's ageing population.