Australia's Future Tax System

Consultation Paper Summary

4. Personal tax and transfers

Overview

The personal income tax and transfer systems have far‑reaching implications for the wellbeing of Australians and their choices to work, save and acquire skills.

Tax and transfer policies involve trade‑offs between the adequacy of payment rates, incentives to work, and the complexity individuals and families face. Higher payment rates can lessen individuals' incentives to work and to invest in skills. The application of means tests for transfers leads to a more targeted but more complex system. Most critically, incremental reforms generally involve a trade‑off between equity objectives on the one hand and efficiency and simplicity on the other.

With the ageing of the population and increasing global competitiveness, the structure and settings of the tax‑transfer system and resulting incentives are key components in meeting these challenges.

Reforms which reduce complexity and deliver adequate incentives will improve resource allocation, productivity and participation. However, there are significant tensions between such objectives, and with targeting, equity and fiscal sustainability.

Consultation questions

Q4.1 How might the personal tax system be changed to better achieve the goals of greater simplicity, transparency, equity and efficiency?

Q4.2 What is the appropriate distribution of income tax across income levels and how should it differ from the current distribution? Should governments seek to maintain a similar distribution over time, or should they fix the value of current tax thresholds through indexation?

Q4.3 Is the personal income tax base appropriately defined? Should reforms such as changes to the scope of deductions or other measures be considered?

Q4.4 Should the tax treatment of transfer payments be reconsidered? Should transfer payments be taxed at the same rate or a lower rate than earned income?

Q4.5 Should people in different circumstances be taxed differently (for example, by age, occupation, location), and what might be the implications of such arrangements? Are tax offsets the best way to achieve differential taxation?

Q4.6 How can fringe benefits tax be simplified while maintaining tax integrity? Would it be better to adopt the general OECD practice of taxing fringe benefits in the hands of employees, rather than employers?

Q4.7 Are the current categorical distinctions for income support, including rates of payment and income tests, still relevant? If not, would other categories be better? What goals or principles should guide categorical distinctions and associated payment rates?

Q4.8 What priority should be given to the different objectives associated with family assistance, such as poverty alleviation, recognising the social value of child rearing, facilitating workforce participation of parents, and early childhood education? Would it be better to provide less family assistance to higher income earners?

Q4.9 What are the key factors that should affect rates of transfer payments? What should be the relative importance of duration on income support, costs of work and job search, costs of children, value of home production and the level of the federal minimum wage?

Q4.10 Should transfer payments have a common benchmark? If so, should it be a proportion of a wage measure, and if so, which one? Or is there a better benchmark? Should there be a common indexation arrangement?

Q4.11 Should payments for retired people remain linked to payments for people of working age?

Q4.12 In a targeted system there is a trade‑off between the level of income support and workforce incentives. Given this, what priority should be given to reducing the disincentives to work?

Q4.13 What structure of income tests and taxes would best support the increasing diversity of work and the need to increase workforce participation, and where should improved incentives be targeted?

Q4.14 Does the tax‑transfer system create disincentives for individuals seeking to acquire new skills or upgrade existing skills? If so, what sort of tax or transfer changes would provide better incentives?

Q4.15 Given the competing demands of targeting assistance to people when they need it and minimising unnecessary transactions, what changes could be made to existing tax and transfer policies?

Q4.16 Should the different bases of assessment for tax and transfers be reconsidered (including the unit of assessment, income definitions, period of assessment and assets treatment)?

Key messages in submissions

A number of submissions call for greater progressivity in the personal tax system (through higher marginal rates for high income earners). Others argue that high personal marginal tax rates reduce incentives for skills acquisition and the ability for Australia to attract and retain high skilled workers. Submissions also suggest that the top personal tax rate should align with the company tax rate to reduce incentives for tax minimisation.

Several submissions raise concerns about tax offsets for complexity or equity reasons. Related to this, submissions raise concerns with the different tax treatment of transfer payments. In order to reduce complexity, some submissions suggest removing the Medicare levy and incorporating it into the personal income tax base. A number of the submissions call for indexation of the tax thresholds.

The current fringe benefits tax (FBT) arrangements are seen by business as complex and administratively burdensome. A number of submissions suggest fringe benefits should be taxed in the hands of employees, potentially at the employee's marginal rate. The majority of FBT‑related submissions by individuals, express concern about the environmental impact of the statutory formula for valuing car benefits.

A number of submissions identify problems with the categorical structure of income support, including its division into pensions and allowances. Concerns are raised with the resulting workforce disincentives and with the lower rates of payment to allowees.

A number of submissions express concern about the adequacy of income support and transfer payments more generally. Some organisations note that payment rates are below a number of indicators such as the Henderson poverty line.

Some submissions compare arrangements for retired people and those of working age, expressing a range of views as to whether existing links should be maintained or the retirement income system separated.

Working age allowance recipients are identified as a group for whom payment rates are particularly low, as were low‑income renters in the private housing market. Many submissions to the Harmer Review argue that payment rates and overall support packages are not adequate. The gap between pension and allowance rates, and its continuing growth, is a concern expressed in many submissions.

Several submissions propose a change to indexation or benchmarking arrangements, with several organisations supporting the development of a new single benchmark based on a range of research and data.

Submissions on family assistance primarily focus on its impact on work incentives for parents. Some submissions indicate a preference for a system that encourages families to move from one to two incomes.

Submissions raise concerns about the level of Rent Assistance relative to the costs of renting. A number of submissions comment on the generous treatment of a person's home for the purpose of the assets test. Several submissions propose changes such as including more valuable homes in the assets test.

Some submissions note that much of the assistance provided through supplementary payments and concessions advantages retired people, including relatively wealthy retirees, rather than low income people. Some submissions indicate that cash payments give people greater control over resources, while others indicate a high level of support for concession cards.

Several submissions argue an ageing population will create budgetary pressures which can be met by increasing workforce participation.

Some submissions argue that the tax and transfer systems can be a disincentive to part‑time work, such as high effective marginal tax rates discourage participation. Submissions also recognise the significant trade‑offs between incentives, adequacy and affordability.

A number of submissions suggest that reductions in effective marginal tax rates could increase participation. They propose several ways this could be achieved, including through: reductions in income test taper rates for Newstart; the introduction of an earned income tax credit; and a change to income testing for Family Tax Benefit to reduce effective tax rates.

Other submissions focus on the disincentives in the tax‑transfer system for women's workforce participation, such as the structure of the allowance income test, the income test on Family Tax Benefit, and interactions with child support.

The need to ensure there are incentives for people to invest in education and training in order to lift productivity is noted. Some submissions suggest that the current tax‑transfer system has adverse impacts on lower income students and on the types of degrees students undertake.

Some submissions argue in favour of tax‑favoured savings accounts for education and skills in order to assist people to continue to develop and update their skills. Submissions have differing views on the respective roles of tax and transfers in this regard.

Some submissions that raise churn as an issue view it negatively on the grounds that it is inefficient due to administrative duplication and compliance costs. Others view it more positively, valuing the ability of the tax and transfer systems to pursue separate goals.

Submissions express concern that the interaction of the tax and transfer systems is complex, as is each system in its own right. A number of submissions are supportive of increased harmonisation, or even integration, of the two systems. Some submissions advocate alternative models, such as a negative income tax, to achieve simplification.

Some submissions, particularly from individuals, argue that family unit taxation would be fairer than the individual basis of the existing system, premised on a view of couples or families as the primary economic unit. Other submissions argue that individual taxation is fairer and has more efficient outcomes in terms of incentives to work, particularly for mothers.