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Is it time for Australia to tackle its Warren Buffett-style tax anomalies?

In his 2012 State of the Union address US President Barack Obama lamented the fact that billionaire Warren Buffett faces a lower tax rate on his income than his secretary. The situation arises because…

Billionaire US investor Warren Buffett pays less tax than his secretary - but Australia has its own anomalies. AAP

In his 2012 State of the Union address US President Barack Obama lamented the fact that billionaire Warren Buffett faces a lower tax rate on his income than his secretary.

The situation arises because the secretary’s salary income will be taxed at the normal US tax scales. On an income above US$34,500 but below US$83,600, Buffett’s secretary would face a 25% tax rate. But the dividends and capital gains the billionaire investor makes on his directly held investments are likely to be taxed at a maximum rate of 15%.

Political deliberations to tackle the fiscal cliff in the US are focusing heavily on the tax system that gives rise to these types of anomalies.

But Australia’s income tax system has its own Warren Buffett-type anomalies. Indeed, there is considerable momentum to add more of them, albeit that it is presently halted in light of the fiscal position. For example, consider the government’s announced policy of giving a 50% discount (tax break) on interest income up to a certain level, and the subsequent withdrawal of this proposal.

One of the most contentious anomalies was introduced in 1999 by the Howard government; discount capital gains for individuals. This essentially means a person only gets taxed on half of the capital gain they make (e.g. only $5,000 of a $10,000 gain would be taxed).

The effect is that a person on the top marginal rate of tax over $180,000 of income) would only pay a rate of 23.25% on a capital gain (50% of the top marginal rate of tax of 46.5%). A person on the tax rate one down from the top marginal rate (income above $80,000 but below $180,000) would only pay a rate of 19.25% on a capital gain (50% of the 38.5% marginal rate band).

Where is the anomaly caused by discount capital gains? A wage earner on income above $37,000 will face a tax rate of 34% on income above that amount. When the income reaches $80,000, every extra dollar is taxed at 38.5%. Yet, the most that is payable on a discount capital gain is 23.25%.

Why do we have such anomalies or differential treatment in the tax law? After all, isn’t a buck a buck, and therefore they should all be taxed in a similar way? Yes, a buck is a buck in terms of economic well being, and for accounting purposes, but for tax purposes, not every buck is quite the same.

Why? In short, governments seem to believe - with considerable help from official enquiries, the latest being the Henry Tax Review - that different taxes have different behaviour effects on taxpayers, and tax measures that have a damaging effect on investment and economic growth should be avoided.

Because of this, the general suggestion from the Henry Review is that higher taxes should be imposed on factors of production or activities that are not movable, or activities that are not susceptible to change or relocation.

Higher taxes on these factors or activities are regarded as efficient taxes as their imposition does not change taxpayer behaviour.

On the other hand, lower taxes should be imposed on those factors of production or activities that are mobile or for which there are substitutes. High taxation here is regarded as inefficient as it is likely to change the behaviour of the taxpayer to the overall economic detriment.

Applying these guiding principles, the state and territory land taxes should be increased and they should be extended to the main residence and land used for primary production. (Note, there are local government rates on the family home and primary production land already).

A well-designed death duty regime ought to be introduced because such a tax should not result in significant changes to taxpayer behaviour. There is little need to lower taxes on income from salary and wages as workers have no real alternative but to work.

There is some discussion though about lowering the tax rate faced by some workers to increase workforce participation (e.g. older Australians, second earners in a household) as these workers may have a viable alternative to working.

Money capital (and assets readily converted into money) is perceived to be the most mobile of all resources. The thinking is, if Australia overtaxes the return on money capital, the capital will simply move somewhere else where the tax rate is lower. This is the reasoning behind the push to lower taxes on money capital. Further, state and territory stamp duties ought to be abolished, or at least substantially reduced because they have large distortionary effects on behaviour.

It is inevitable the tax rate anomalies and differential treatment will arise in the income tax system. There are many present already (e.g. generous capital gains tax concessions for gains made by small business taxpayers, near zero tax on long-term savings through superannuation, zero tax on savings held through the family home).

And fiscal difficulties aside, we can expect more and more tailoring of tax rules, and finessing of the tax system, to cater for the efficiency of an impost.

Of course, it is hard to predict or measure the behavioural effect of certain taxes or tax rates with a high degree of certainty. There are so many factors at play around investment choices, work choices, and spending choices that to isolate the tax rules, and claim a certain response from those rules is not plausible.

Those pushing their self-interest (usually packaged as the public interest) know this, and their solution is to fill the information gap with logic. For example, we have all heard the claim that if we lower the tax rate on salary income, people will respond by working harder or more hours or they will pursue education to get the higher paying job.

Governments and politicians cannot fully implement the efficiency principle. For example, levying very high taxes on the “necessities” of life would not mean a significant reduction in consumption of necessities and therefore this would be an efficient tax measure.

But such a tax measure would rank very low in terms of fairness, and central to the notion of fairness is the idea that a buck is a buck. And fairness is at the top of many peoples’ list when it comes to the design of a tax.

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11 Comments sorted by

  1. Charles Driver

    logged in via email @gmail.com

    Looking at the issue only from the individual level ignores the fact that the various companies Wazza has invested in are paying tax, and any gains that get passed along to him occur after this tax. i.e. his gross income is reduced due to taxes on the various companies he has invested in. However the wages for Wazza's secretary are subtracted from the companies bottom line before tax, so the rate reflects the fact that this income hasn't already been taxed.
    I think inequality and tax loopholes are important to address, but I don't think the issue is presented fairly without noting the above point... unless I misunderstand something critical?

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  2. Gavin R. Putland

    logged in via Twitter

    FYI:
    __________

    The Treasurer,
    Cth, NSW, Vic, Qld, SA, WA, Tas, NT, ACT.

    Cc: The Australian, The Age, Australian Financial Review, The Drum (ABC), Business Spectator, Crikey.**

    December 13, 2012.

    Dear Sir/Madam,

    Abolish payroll tax or face the consequences
    An open letter to Australian Treasurers, by Gavin R. Putland

    Under s.90 of the Australian Constitution, only the Federal Parliament can impose duties of excise. State payroll tax, in so far as it applies to the value of labour…

    Read more
  3. Juan Vesa

    student

    it's funny, wasn't i reading the other day the oecd recommend increasing the gst to pay for a corporate tax cut?

    uh huh, big surprise.

    it'll happen, you watch.

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  4. Comment removed by moderator.

  5. Richard Charisma

    logged in via Twitter

    I tend to suspect that the Laffer curve for determining the optimum tax rate is a hell of a lot further towards the left of the graph than these big statists think or realise.

    We should have a flat rate tax of 25% on all income earned over a tax free threshold of $25k, a 25% capitial gains tax, and just keep it flat across the board.

    Don't target the wealthy to pay more because they have the capacity to pay more, that is a communist notion (i.e. "from each according to their means, to each according to their needs").

    History shows that communism doesn't work, so lets not try to implement even a little bit of it. Instead lets just create a fair, level playing field with the same rules for everyone and let the chips fall where they may.

    I'm willing to bet that, in the long run, total tax intake will be much higher, because economic growth will be much higher, because capitalism works and communism doesn't.

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    1. Charles Driver

      logged in via email @gmail.com

      In reply to Richard Charisma

      you're badly conflating communist central planning with socialist high and gradiated taxation. History shows that the latter can work exceptionally well (i.e. Nordic countries), particularly when the important objective measures (i.e. how well do people in the society live) are examined rather than the simplified and problematic proxy that is GDP.

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    2. John C Smith

      Auditor

      In reply to Richard Charisma

      We were a Socialist mob until Haw-Keat tax changes (1900-1990). If I am correct top marg rate was around 75%and was reduced to around 50%.

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    3. Richard Charisma

      logged in via Twitter

      In reply to Richard Charisma

      @Charles Driver~ well, Sweden IS the the biggest arms exporter in the world per capita... With that sort of booming industry bringing in the big bucks, I'm sure even wasteful socialist internal economic policies can work for a while. But producing and selling high quality military technologies and assets is a a far cry from just digging up massive truck loads of dirt and shipping them off overseas... If Australia wants to follow socialist economic policies, WE need to become huge military asset exporters…

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    4. Richard Dobson

      logged in via Facebook

      In reply to Richard Charisma

      the Scandinavian countries, are often held up as an example of why the welfare state system works, but actually its all just a massive myth! When you actually look at the statistics, Scandinavian countries have been out-performed terribly economically: http://www.brusselsjournal.com/node/510

      This and the fact that Norway is basically the Saudi Arabia of the Baltic, and Sweden is by far the the biggest arms-manufacturing country per capita in the world, and you can see that this leftist myth of the success of the welfare state (in the one place in the world where it hasn't been a complete disaster) is actually all just smoke and mirrors, based on the twin neo-con pillars of Fossil fuels and Military Arms exports.

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  6. John C Smith

    Auditor

    Waht Warren Buffet or Tanks got to do with our taxaes.

    Warren will say he is the one who makes the money beside who pays what taxes him or his sec.
    We have an entirely different econonomy to taht of Yanks, a primary prduction economy. Be it agricultural or mineral we just sell the rawest stuf not even pig iron. Before tax discussion we have to explore our economy and the fixes. and then the tax fixes. Tax fixes should be examined with tax expenditure issues.
    What is happening in overall economy is not good news in the current world economis and politics. Since the eighties Canberra house prices have skyrocketed. Our tertiary education sector has expanded exponentially while the industrial sector has collapsed. To make things worse what ever is left is owned by overseas interest. Take my vegemite which I pay royalties to overseas.

    Warren will argue that he is the one who made the money to pay his sec and so he is paying

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  7. Comment removed by moderator.