Australia's Future Tax System

Architecture of Australia's tax and transfer system

11.4 An optimal level of complexity and operating costs

Complexity and operating costs

A certain level of complexity and operating costs is required to implement the tax‑transfer system in a manner that is both efficient and equitable. For example, it is recognised that means testing is required to ensure that transfers are targeted to those in need of assistance. However, at some point, equity or efficiency is likely to be compromised by increasing levels of complexity. There is also a limit to how much complexity individuals can bear without needing to engage professional assistance, particularly in a self‑assessment system such as income tax. See Box 11.2 for a discussion of the theoretically optimal level of complexity.

Changes in technology and the information marketplace can be an important determinant of society's capacity to deal with complexity and the accepted balance between complexity and other policy objectives. The evolution of more advanced low‑cost computer hardware and software, and the advent of the internet and electronic filing, have increased the capacity of taxpayers/recipients and administrators to deal with more sophisticated procedures and to deal with existing procedures at lower cost. For example, advances in information technology have increased the ATO's ability to put some information into taxpayers' tax returns for them.

Box 11.2: A socially optimal level of complexity

The socially optimal level of complexity is where the benefit of an additional unit of complexity just equals the cost of that additional unit of complexity. Beyond this point the incremental cost exceeds the incremental benefit and overall wellbeing is reduced, other things being equal. The difficulties in determining the optimal level of complexity are substantial. Careful subjective judgments are required when assessing policy choices and these judgments are typically made with limited information. However, it is clear that for a given set of policy objectives, society will be better off if those objectives are achieved with less complexity and lower operating costs.

From the perspective of an individual taxpayer or transfer recipient, the optimal level of complexity is also influenced by any benefit they might receive from engaging in tax‑minimising/transfer‑maximising behaviour or seeking a targeted tax concession or enhanced transfer. This behaviour results in a higher level of complexity than is socially optimal. The additional costs arise from the complexity of multiple tax concessions or transfers and revenue or expenditure protection provisions intended to circumvent that behaviour. The extent to which complexity, administration costs and compliance costs exceed the socially optimal level will be influenced by a range of factors, including: the expected size of the benefit to the individual from such behaviour; community attitudes towards such behaviour; the extent of awareness of the broader costs of such behaviour; and the policy response. See Oliver and Bartley (2005) for further discussion of this issue.

The allocation between administration costs and compliance costs

To an extent, administration costs and compliance costs may be substitutes for one another. For instance, the move to self‑assessment in the income tax system in the 1980s reduced administration costs while increasing compliance costs. In deciding the appropriate balance between administration and compliance costs there are several important considerations. First, it may be more or less cost effective for particular activities to be handled by the administration than by individual taxpayers and transfer recipients. Second, the allocation of costs between the administration and taxpayers may influence behaviour by altering the direct cost to the taxpayer/recipient of exploring tax‑minimising or transfer‑maximising strategies. Third, the balance between administration and compliance costs has equity implications, since the ultimate burden of administering the tax‑transfer system falls on taxpayers in general, rather than on specific groups of taxpayers.