Architecture of Australia's tax and transfer system
There is a range of factors influencing the complexity of the tax‑transfer system and the levels of administration and compliance costs.
Increasingly complex policy objectives
Tax‑transfer policy and its implementation is an obvious determinant of the level of system complexity and operating costs. More complex policy objectives tend to result in increased system complexity and higher operating costs. To a considerable extent, the complexity of tax‑transfer policy is a reflection of the complexity in markets for factors of production, goods and services. For example, a growing number of Australian taxpayers now own equity investments, are involved in complicated business structures, or invest or work overseas. Increasing globalisation, e‑commerce and financial innovation have also prompted more sophisticated tax rules.
The review of Australia's tax history in Section 4 outlined the progression over time in the objectives sought from tax reform, from the feasibility of administration, to revenue raising capacity, to improving the performance of the tax system. As one set of policy objectives is achieved the focus shifts to more complex policy outcomes. The Taskforce on Reducing the Regulatory Burdens on Business (Australian Government 2006) noted the changing needs and expectations of society, driven in part by increasing affluence, knowledge and an aversion to risk, as a key driver of increased regulation.
Tax policy considerations may extend beyond the trade‑offs between complexity, equity and efficiency to include other considerations. For example, the tax system is sometimes used to deliver non‑tax policy objectives such as delivery of social security, industry assistance or environmental initiatives. These objectives often require targeted implementation of tax provisions using information that is not otherwise relevant to revenue collection.2
Changes in social circumstances have also led to a more sophisticated transfer system. The increasingly complex financial and working arrangements of Australians have resulted in significant changes to transfer design, as have other changes to family structures and relationships. Policy considerations have broadened over the past two decades from a primary focus on poverty alleviation, to a system that also encourages self‑provision (through work and saving) and is better integrated with other social services and economic policies. The complexity within the transfer system is seen in the different eligibility criteria, payment structures (including rates of payment and available supplementary payments) and the income and assets testing arrangements that apply to different entitlements.
Incremental policy based on partial assessments
Many seemingly worthwhile small changes to policy may result in the evolution of a tax‑transfer structure that is inherently complex and potentially inconsistent (see example in Box 11.3). A new tax or transfer measure does not have to be complex itself to increase the level of system complexity and associated compliance costs. Often government is asked to make a 'simple' change to the tax law, but the compounding effect of many separate relatively simple tax measures can result in a complex set of interrelated provisions.
The current system reflects the outcome of many independent choices about the trade‑offs between simplicity, equity and efficiency. These choices are often made in a constrained policy environment with limited information about potential impacts, interactions with other parts of the law and real world practices. Incremental change has often been preferred because it is less disruptive than more fundamental change. A key issue is the extent to which these incremental policy choices, when viewed as a whole, reflect a preferred outcome.
Box 11.3: An example of complexity arising from incremental policy change
Since its inception in 1915, many separate regimes have been added progressively to the income tax system to achieve an appropriate treatment of assets (Chart 11.2). These regimes have been added in response to concerns about the equity and efficiency of the tax system. As the various regimes have been added, gaps and overlaps have considerably increased the complexity of the income tax system and associated operating costs. They have also created fertile ground for tax planning and the need for revenue protection provisions.
Chart 11.2: Asset regimes within the income tax law
Source: Board of Taxation, Tax Value Method, An Overview, March 2002.
The rate of change in policy and the law
The complexity and compliance costs that taxpayers/transfer recipients experience may be further compounded by the rate of change in the law, whether due to the addition of new provisions or changes to existing provisions. The higher the rate of change, the more difficult and time consuming it can be for taxpayers/recipients to understand their obligations or entitlements. In 2004, Australian tax practitioners were surveyed on their attitudes to compliance costs relating to capital gains tax (CGT). The outcomes of the survey ranked the rate of change in the law as the third most important determinant of CGT compliance costs (Evans 2004) (Box 11.4).
Box 11.4: Sources of CGT compliance costs
Table 11.2: Key sources of CGT compliance costs identified by tax practitioners
Source: Evans (2004).
Instability in tax settings may also reduce economic efficiency by increasing the level of uncertainty about the expected payoffs to long term investment decisions, such as investment in education, retirement products, long‑lived productive assets or choice of business structure.
Implementation of policy
The implementation of policy has a direct bearing on the level of certainty, transparency and compliance costs. The experience of the taxpayer/transfer recipient is heavily determined by their interactions with those who administer the policy and legislation. The approach taken by administrators can have a significant bearing on the complexity experienced by taxpayers and recipients
Complexity will be lower where: the law and/or the administration enable people to readily understand the implications of their actions; policy is internally consistent and is consistent with broader economic objectives; and policy is well articulated and understood, so that people have confidence that its broad direction will be maintained. In addition to reducing complexity and uncertainty, transparency in the tax‑transfer system imposes a degree of discipline on the decisions of policy makers and administrators.
The desire for certainty about the obligations or entitlements of taxpayers/transfer recipients can also be an important source of complexity in the legislation. A high level of precision within the law potentially provides the certainty to make optimal decisions at lower cost and with lower risk. However, such detail can obscure what the law is trying to achieve at a broader level and the linkages between different parts of the law may be lost in the technical detail. Striking the right balance can be difficult to achieve. The drafting approach used for recent tax legislation reflects a preference for more principle‑based rules.
Income‑maximising behaviour through the tax‑transfer system
Private incentives to maximise after tax income (in the case of businesses) or disposable income (in the case of individuals) are also a significant driver of complexity and operating costs. Individuals and other taxpayers have an incentive to voluntarily incur compliance costs if they expect the beneficial change in their income to outweigh the costs of achieving that outcome. Such behaviour might include testing alternative income calculation methods, searching for effective ways to structure transactions, or engaging in other activities. The existence of choice in the tax‑transfer system, deliberate or otherwise, can lead to increased operating costs, as individuals and other taxpayers seek to navigate there way through the available (see examples in Box 11.5).
Box 11.5: Choosing between alternative transfers …
There are many situations where the complexities of the transfer system present people with significant problems. For example, when a child turns 16 the maximum rate of Family Tax Benefit (FTB) Part A falls substantially and Youth Allowance becomes available for some families. Almost all low to middle‑income families experience a reduction in assistance and many are faced with a choice which payment to receive. Making this choice is complicated:
Feedback suggests many parents struggle to determine which payment choice will provide the greatest benefit. Compliance costs result from the time taken to understand their entitlements and evaluate their options.
… and tax concessions
The small business CGT concessions have been identified as a key source of complexity with the CGT provisions (Box 11.4) Chart 11.3 shows the benefits available from the small business CGT concessions. Limitations on some of the small business CGT concessions, particularly the retirement exemption, mean that different tax outcomes arise depending on how the concessions are applied.
Chart 11.3: Complexity in the small business CGT concessions
Individuals may also seek to reduce their tax liability, or increase their access to transfers, by lobbying government for preferential treatment. Lobbying may be successful because those seeking preferential treatment are more informed and better represented than the broader community. However, the community bears the direct cost, the operating costs and any loss of equity and efficiency. The benefit of a preferential treatment to the target group is also typically more easily measured, more tangible and of greater value to each taxpayer/recipient than the cost imposed on each member of the broader population.
Box 11.6: The capital allowance system
The Review of Business Taxation (1999) identified over 37 different regimes in the income tax law that provided annual write-off for depreciating assets. The rules were complex, inconsistent and involved significant duplication. A new system based on the effective life of assets was proposed in A Platform for Consultation (RBT 1999) to rationalise and simplify these provisions.
During consultation on the proposal, the review recognised that some variations to the consistent approach were necessary to preserve the current treatment for particular taxpayers, as well as to protect the revenue. In particular, the review reflected the then Government's commitment not to disturb specific primary producer concessions by retaining accelerated depreciation for them.
Since the inception of the effective life regime there have been further changes, on national interest grounds, with the introduction of statutory caps on the effective life of certain aircraft and some assets used in oil and gas production (2002), buses and trucks (2005) and tractors and harvesters (2007).
The new regime has been criticised as falling well short of simplification as it merely repackaged, as exceptions to the new general rules, the many separate systems that existed previously (Dirkis and Bondfield 2004).
'Grandfathering' (that is, preserving the treatment of pre‑existing arrangements when rules are changed) often occurs in response to concerns about the equity and efficiency implications of a change in policy settings. However, it can add to the complexity of the tax‑transfer system, particularly where its effects are long lived. For example, before the 2007 Better Super reforms, end benefit taxation had become very complex due to successive grandfathering of the taxation treatment of existing contributions and earnings, as illustrated in Table 11.3 and discussed in Section 4.1. This grandfathering was designed to ensure that an individual's accrued entitlements were not adversely affected by successive changes to the superannuation taxation arrangements.
Table 11.3: Grandfathering of superannuation benefit taxation
Post‑1983 component introduced.
New pension deduction arrangements.
|Tax rate applying to lump sum payments accrued pre‑July 1983.|
|1984||New non-qualifying component (integrity measure) introduced.|
New reasonable benefit limits (RBL) system applied — formula based.
15 per cent tax on contributions and earnings introduced.
New RBL system applied — flat rate.
New post‑June 1994 invalidity component introduced.
New undeducted purchase price introduced.
Previous RBL system for amounts above flat rate.
Concessional benefit component for payments made before 1 July 1994.
Previous undeducted purchase price for existing balances.
|2007||Better Super reforms implemented. For 90 per cent of people, benefits are not subject to tax after age 60.|
Twenty‑three years after the introduction of CGT, the exemption for pre‑1985 assets continues to add considerable complexity to the provisions. With respect to the transfer system, the regular practice of 'saving' transfer recipients from changes to income support arrangements that would otherwise reduce their entitlements adds to system complexity.
For a given budgetary position, the behaviour outlined above reflects a 'negative sum game'. Such behaviour shifts the tax burden from one individual to another. It results in a higher rate of tax applied on the remaining narrower base, typically increasing the efficiency costs imposed on the broader community. The added complexity increases total operating costs. Equity may also be compromised, though this will depend on the overall distribution of the preferential treatment. The net result is usually a reduction in the wellbeing of society as a whole.
Income‑maximising behaviour also tends to result in higher compliance monitoring and enforcement as well as a wider use of integrity rules in the tax‑transfer system. These responses benefit society by preserving equity and efficiency in the tax‑transfer system but they increase system complexity and operating costs. For instance, the existence of the cash economy threatens the equity of the system, but there are considerable administration and compliance costs involved in more active enforcement of the law. These benefits and costs need to be appropriately balanced. The optimal point is where the benefits of additional compliance activity just equal the costs it imposes. Determining this point in practice is often a matter of judgment. Some in the community argue that there has been too much emphasis on equity and efficiency through the use of integrity provisions, given the consequential impacts on operating costs.
Coordination between governments
In Australia's federal system of government, the many taxes referred to in Section 2 are administered by several layers of government. For an individual, their interaction with the tax system is typically in terms of the Australian tax system and that of the State and local area in which they reside. In contrast, businesses which operate in several jurisdictions or nationally have to comply with a much wider range of tax systems. These businesses face a cumulative burden of complexity and compliance costs due to differences in the way essentially similar taxes are imposed in different jurisdictions. The differences between jurisdictions also extend to the administrative systems and procedures applied by governments, as well as the taxes themselves.
For individuals, the multiplicity of transfers provided at different levels of government can make it difficult and time consuming to understand one's entitlements and obligations.
2 While moving these functions outside the tax system would decrease tax system complexity and operating costs, it may not decrease the overall level of complexity and operating costs imposed by government. This will be the case where the tax system is a more efficient means than an expenditure program or regulatory mechanism to achieve the same policy outcome.
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