4 Ways to Boost Revenue

Richard Denniss is Chief Economist at the Australia Institute

If you only listened to the Coalition you would think that Australia’s budget deficit was caused entirely by out of control spending. But a closer look at the budget papers shows this is not the case. The most recent budget papers wiped out $90 billion in expected revenue over the next four years. It is not spending that is rapidly rising but revenue that is rapidly falling.

Revenue is falling because the economy is slowing. Tax revenue is falling and spending on social security is rising. The slowing economy has also revealed the structural hole in the budget created by Peter Costello’s huge income tax cuts during the boom years. This makes it very difficult for the budget to generate income.

The boom years temporarily brought in more revenue and this temporary boom time tax bonanza was spent on permanent tax cuts. About $170 billion was given away in tax cuts between 2005 and 2012. When the economy slowed the boom time revenue vanished and the budget was no longer able to generate as much revenue. This is why both sides of politics have so much trouble

reducing the budget deficit.

Since the structural deficit was created by cutting revenue it should be fixed by increasing revenue. Since over 60 percent of the boom time tax cuts went to high income households, the extra revenue required should also come from high income households.

Raising more revenue does not have to mean higher tax rates. The current progressive income tax system in Australia is leaking like a sieve. High income households are using tax loopholes to avoid paying their fair share. Plugging these loopholes would raise billions of dollars.

The Australia Institute recently put forward four changes that would close loopholes and raise almost $20 billion with 86 percent coming from high income households. These changes are:

  • focus super tax concessions to take pressure off the age pension
  • limit negative gearing to new housing
  • scrap the Capital Gains Tax (CGT) discount
  • introduce a Buffet Rule to stop massive tax deductions from high income households.

SUPER TAX CONCESSIONS

The superannuation system was designed to make people more reliant on themselves in retirement. Super tax concessions help people accumulate more in their super accounts by allowing them to pay less tax on money going in and less tax on investment earnings.

The problem is that 60 percent or almost $18 billion per year goes to high income earners who are unlikely to claim an age pension. So most money taxpayers give to help grow super balances does not reduce pressure on the pension.

The superannuation system was designed to help people have a comfortable retirement but

even the industry recognises that it is being used more and more for tax and estate planning.

The solution is to focus super tax concessions on taking pressure off the age pension. The Australia Institute released a paper before the Federal Budget that suggested that super tax rates should rise with income in the same way as income tax rates.

The paper proposed lower tax rates for the 60 percent of low and middle income households who are likely to be on the age pension in retirement. It also raised tax rates for those that are unlikely to be on the age pension in retirement. Very high income households would pay their full marginal rate.

While 60 percent of households would pay less super tax, the changes would still raise almost $10 billion per year because of the size of the super tax concession going to high income earners.

The changes also give taxpayers better value for money. Reducing people’s reliance on the age pension will save the budget even more. At the same time it closes a loophole being exploited by some high income individuals to avoid tax rather than to save for retirement

NEGATIVE GEARING AND THE CGT DISCOUNT

Negative gearing and the Capital Gains Tax discount add fuel to housing price increases by giving investors generous tax incentives and encouraging speculative behaviour. The result is that low and middle income households are increasingly locked out of the market.

Changes to negative gearing and scrapping the CGT discount are designed to slow house price increases, improve affordability, reduce speculation in the residential market and raise billions of dollars of revenue. The rate of investment in residential property has expanded dramatically. Loans for investment properties have increased from 16 percent of finance 23 years ago to 40 percent today. Armed with generous tax breaks, property investors are forcing up property prices.

Financial experts including the Murray financial inquiry are increasingly concerned that negative gearing and the CGT discount make property markets more speculative and less stable. Treasury Secretary John Fraser recently warned that Sydney and parts of Melbourne are in a housing bubble and the RBA Governor Glenn Stevens described house price rises in Sydney as ‘crazy’.

While negative gearing has been talked about a lot in recent months it is the way negative gearing interacts with the CGT discount that is causing the explosion in investors. Negative gearing means the taxpayer picks up some of the loss made on the property but it is only a good investment if the capital gain is greater than the rental loss when the property is sold.

In 1999 Peter Costello introduced the CGT discount which meant that only half of any capital gains were taxed. This made residential property investment much more profitable and as Figure 2 shows the size of the rental losses (and hence the amount of negative gearing deductions) grew rapidly.

The CGT discount means that if a property rises in value then the rental return is less important as the capital gain is more lucrative. A focus on capital gain at the expense of return is speculative investment.

In a normal investment market if the return on the asset falls because the price of the asset rises, this signals to investors that it could be overvalued. But an interest in capital gain makes rising prices a signal to enter the market because future capital gain is likely.

David Murray, the former head of the Commonwealth Bank, wrote in his report on the financial system that negative gearing and the Capital Gains Tax discount were encouraging speculative behaviour.

The solution is scrapping the CGT discount and limiting negative gearing to only new investment properties. This will raise $7.4 billion a year mainly from high income households. It will also make housing more affordable.

BUFFETT RULE

The Buffett Rule is named after billionaire American investor Warren Buffett. He noted that he paid a lower average rate of tax than his secretary and thought this was unfair. The idea of a Buffett Rule is that very high income earners should pay a minimum average tax rate.

Very high income earners have an ability to structure their income and tax affairs to maximise their deductions. In 2012-13 55 people who earned more than $1 million claimed so many deductions that they paid no tax. While the 55 did not pay tax they did on average pay $770,000 for tax advice. Five of the 55 also claimed an Australian Government allowance and five claimed a pension. The Buffett rule makes deductions after a certain point worthless.

The Buffett Rule sets a minimum average tax rate for very high income earners based on their total income not their taxable income. A minimum average tax rate of 35 per cent applied to the top 1 percent, those earning more than $300,000, would raise $2.5 billion per year.

OVERALL IMPACT

Combining these four policies would raise $19.5 billion dollars a year, fix distortions in the system and raise revenue in a progressive way. Unlike the current Government’s strategy of making low income households pay to decrease the deficit, 86 percent of the income raised would come from the top 20 percent of households. By comparison only 4 percent would come from the bottom half of households.

While the roots of the deficit can be found in the profligate spending and tax cuts of Peter Costello, the solution does not have to see cuts to health, education and the social safety net. The revenue can come from the beneficiaries of all that mining boom largesse.


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