Big tax cuts will lead to more prosperity

From: Louise McBride
To: Treasurer
Date: Effective immediately
Subject: Big tax cuts will lead to more prosperity

JOHN Howard and Malcolm Turnbull recognise something needs to be done to fix the broken tax system. But is Peter Costello listening?

Not going by recent correspondence with Assistant Treasurer and Minister for Revenue Mal Brough, who thanks me for suggesting the top marginal tax rate be drastically cut, at a minimum initially to 30 per cent, to bring it in line with the corporate tax rate.

High income earners pay proportionately a greater percentage of their income in tax.

Rather than being encouraged, the people responsible for the bulk of individual savings and investments are hit by punitive tax rates.

Under vertical equity, Kim Beazley can label a package of tax cuts as "blatantly unfair" simply because the cuts go mainly to those who are paying the great bulk of revenue. Tax cuts, it seems, are only fair if they are limited to those on low incomes, who don't pay much tax.

"Any major changes to the Australian personal income tax system," says Brough, "could potentially lead to a substantial loss of revenue, making it difficult for the Government to meet its commitment to priority programs ... such as assistance to families, health, education and social welfare."

Wrong. There is no empirical evidence of loss in revenue in any jurisdiction when the top tax rate has been drastically cut. Escalating rates of tax lower everyone's standard of living and discourage taxpayer compliance.

Tax shelters are not worth the trouble at a top rate of 25 per cent but become very attractive once the top rate rises to above 40 per cent.

There have been three significant income tax cuts in US economic history. Federal revenue, gross domestic product and employment grew faster after each reduction in top marginal rates. In the popular mind, cutting taxes leads to budget deficits. But this is only true if government spending grows faster than the growth in tax receipts and GDP.

In any case, the mantra of the Howard Government is supposed to be "self-reliance". So why take excessive amounts in tax only to recycle it as family assistance and welfare payments, unless the Government's intention is to create long-term dependency on the state or, worse, to buy votes?

According to Brough: "It's a long-standing principle of Australia's tax system that tax deductibility is allowed for expenses incurred in earning assessable income.

"The principle applies to many forms of assessable income, for instance, work-related expenses may be deducted against wages and salaries, business expenses deducted against business income and rental expenses deducted against rental income."

It's time to think outside the square. The plethora of available deductions only makes the tax system even more complex, distorts investment decisions and undermines economic efficiency. Deductions also prompt investors to be more concerned with the tax advantages of investing than with the economic benefit of the project.

Allowing a few concessions only invites a few more and leaves politicians prone to browbeating by every lobby group pushing every truly deserving case. This leads to hundreds of loopholes, thousands of skilled professionals and millions of dollars wasted in exploiting every available tax deduction. As Turnbull argues, getting rid of deductions would help in the task of bringing down rates.

Brough says: "Many of the countries mentioned as having a flat tax impose other taxes on employment income ... compulsory employee social security contributions ... and health contributions."

Wait a minute. Australia has a superannuation guarantee surcharge, which is like compulsory social security. It is just not called a tax.

Ditto the Medicare levy. It is a compulsory flat impost of 1.5 per cent of your tax bill.

It is just not called a tax.

Although there is always argument over Australia's ranking among Organisation for Economic Co-operation and Development countries, the superannuation surcharge and Medicare levy don't fall within the OECD's definition of tax. And Australia taxes higher earners much more harshly than almost any other OECD country.

"Australia is unlikely to have significant problems with outright failure to declare personal income, compared to some other countries," says Brough. "Many eastern European countries have adopted a flat tax system in part to increase compliance."

The Commissioner of Tax probably has a different view of compliance. Ask him about the miners in Kalgoorlie, who were easy targets for the promoters of tax schemes. While rates remain high, scheme promoters will continue to flourish.

Many small businesses endeavour to keep their legitimate business under $50,000 to avoid the horrendous compliance costs associated with administering the GST. The black economy is alive and well.

There wouldn't be a tax practitioner or a judge in Australia who would agree that our existing system makes compliance easy.

A drastic reduction in marginal tax rates would be the greatest legacy John Howard's Government could leave. Getting the top personal tax rate down to the 30 per cent company rate would fix much of the system's complexity and be an investment in a more prosperous Australia.

Louise McBride, an adviser to the Board of Taxation, is a director of Grant Samuel in Sydney. This is the second in a series of opinion-page articles on income tax cuts.