Every time the budget comes out, we get little spreadsheets showing how much different kinds of households get in tax cuts. Something that struck me about last night’s budget was the fact that people on $30 000 got a smaller cut than people on $25 000. As far as I can see, no one has commented on this (feel free to point out exceptions) but on the face of it, there’s a puzzle here. As Costello said last night, if you cut the marginal rate on low incomes, (or raise the threshold), everybody gets the cut. So unless a rate is raised somewhere, people on higher incomes always get at least as big a cut as those on lower incomes.
The answer turns out to be something called the low income tax offset, which has been around for a while, as this factsheet from 2003 shows. As the name implies, low income earners* get an offset against their tax, but this is phased out as incomes rise from $20 000 a year to $30 000 (with this budget the phaseout starts at $25000 and runs to $40000).
Effectively, this is much the same as raising the threshold at which tax is paid (to around $9000, compared to the officially published $6000) and increasing the marginal rate on incomes between $25 000 and $40 000. I haven’t checked out how much, but I estimate it’s equivalent to around 2.5 percentage points, raising the effective marginal tax rate from 30 per cent to 32.5 per cent.
So, where the official tax scale suggest that low and middle income earners face the same threshold and lower marginal rates, the truth appears to be pretty much the opposite. It’s an open question as to which is better, but it would certainly be good for the tax scales to reflect reality instead of obscuring it.
*Another group of beneficiaries, far from low-income, are the children of those (probably including quite a few Cabinet ministers) who dodge tax through family trusts. The offset raises the threshold at which the income nominally assigned to them becomes taxable.
John Quiggin 
I’ve argued the same point before. The low income tax rebate could be abolished if middle income tax rates were increased as JQ suggests. However whilst this would simplify the system it would not smell as nice in the newspaper headlines. The system is riddled with such complexity. The medicare levy is another. It should be rolled into the normal tax tables since it only pays a tiny fraction of medicare anyway and it just clogs up the system with complexity.
EMTRs. The ALP needs to stand on a large chair and yell E-M-T-R until the next election. Beazley should learn to sing E-M-T-R. Somebody should start a website devoted to EMTRs. It should combine:-
1. Progressive income taxes.
2. Means testing of state public housing assistance.
3. Family tax benefit tapper rates.
4. Pension taper rates.
etc, etc.
Latham had it right. Several rungs are missing from the ladder. We have build a huge big income merry go round. A giant churn machine. The system is full of EMTR trade barriers discouraging interhousehold trade, suppressing productivity and putting the next step on the lifestyle ladder beyond the imagination of many.
Keeping interest rates low?…
Ross Gittins in the SMH:
The notion that we need a tax cut to compensate for the increase in interest rates is actually a strange one, akin to the idea that the solution to a hangover is to go back on the turps.
In other words, it’s by spending our ta…
Who argued that the tax cut was to “compensate” for interest rate increases. Sounds like a straw man.
The following is possibly a little out of date but it makes the point:-
http://www.theage.com.au/articles/2004/04/02/1080544690931.html
If these only applied to a select few then it might not matter so much. However with middle class welfare everywhere high EMTRs are widespread.
Given the large budget surplus shouldn’t some attempt at reform of means-tested welare/progressive tax scales be made? Progressive taxation is important when welfare is not means tested, but why have both? How about a flat tax and progressive welfare?
So long as we are going to continue to operate a welfare state, then I think that we should abolish the means testing of welfare. We should instead make all welfare payments taxable and use the progressive tax scales to shape income outcomes.
The word “dodge” seems to imply “dodgy” as in something being of questionable ethics. Minimising your tax bill is not unethical. It’s a basic act of self defence.
Could not agree more about EMTR’s and the Labour party. If they cannot put this issue on the map then there really is no point in putting them in office.
Its a winner for Labour too. To counter it Costello would have to explain why he doesn’t think the traditional conservative idea of lowering tax rates to increase incentives doesn’t apply to low income earners, while using that same argument to justify tax cuts for high incomes. Or he will have explain not doing anything about it for ten years.
No doubt the labour polling experts have already declared the issue a loser because they think its too complicated to fit in a 20 second ad.
High EMTRs are not limited to low income earners. The family tax benefit taper off extends to middle income earners (well above average income levels) and exposes them to EMTRs of over 60%.
The political problem with talking about EMTRs is that you’ll get asked what you propose to do about them. And doing serious things about them is both politically and economically hard for a variety of reasons mostly to do with the old saw about there being no such thing as a free lunch (hint: those who talk about lowering EMTRS while reducing middle class welfare/churning are schizoid – they’re directly contradictory things).
The LITO is withdrawn at 4 c/$, so the new one cuts out at $40K. IOTW the tax rate on those earning between 25 and 40K is 34 c/$, while it’s 30c/$ between 40 and 75K.
Options to reduce EMTRs include:-
1. Abolish welfare.
2. Abolish taper rates (ie increase middle class welfare).
Personally I am all for the first one but it is not politically feasable (but at least it is not schizoid).
The way to make the second one acceptable is to make all welfare payments taxable (many already are). And then use the tax scales to shape income levels.
Try saying “dynamic tax analysis”. And besides the budget is in surplus.
Why have brackets and margins at all? Why not curves?
Sorry, I’m no economist, just feel like a progressive tax scale should be smooth, not bumpy. Is it just that people would find it confusing?
‘Cos I’m FAR more confused by the logic of a staircase than a slope. It’s arbitrary and I’ve never heard a good argument for it other than simplicity. And in practice, it fails that test anyway.
The increase in the EMTR is 4%, the same as the exit rate on the Low Income Offset. So our tax scales are actually:
0% – $10,000
15% – $25,000
34% – $40,000
30% – $75,000
40% – $150,000
45% >$150,000
Of course there are exceptions, in this case one that I am aware of, which is children with income cannot claim the Low Income Offset.
Presumably you are only looking at EMTRs by adding income tax and the low income tax rebate. Clearly you have not factored in the taper rates for:-
Family Tax benefits
Pensions
State public housing assistance
etc
JQ is correct to make his point about the low income tax rebate. However it is small fry compared to the other complexities and EMTR issues in the system.
The problem of high EMTRs is surely the result of a low threashold and staggered withdrawal. Why not just lif tthe threshold to a sensible position and then have a set tax rate after that? Have most of the benefits (except, perhaps the family ones, which could be set at a flat rate) set to phase out at or below that level and the problem is simply gone.
For example, and to create a straw man, a flat rate of 35% (or some other number) starting at $60K with no deductions with all benefits means tested and ceasing at $60K would mean that a large number of people can move outside the tax system, reducing administration costs and the pointless paying of tax by people earning low wages, only to see it returned as benefits, could be eliminated or reduced.
Company tax could be given a similar treatment (set at 35%, but with the standard deductions for expenses) and the incentive for high income earners to play games is similarly eliminated.
Andrew,
Your example is not that clear.
I assume you mean that we should have a tax free threshold of $60k plus all welfare benefits tapered out by $60k.
It would probably be simpler to have a completely flat tax, no means testing of benefits and make welfare benefits taxable income.
Terje,
It probably would be – but putting in a high threshold would take out of the taxation system the people that would not be net payers into the system, reducing costs. The system in the UK is a good one for this – each pay period the tax liability on standard scales is re-calculated so that, unless you have unusal (untaxed) income, there is normally no net tax owing or owed at the end of the year.
Yeah, of course you can add up all the benefits a family is entitled to and take it away in a single low taper – this was once looked at very hard indeed in the bureaucracy. Mike Keating also made this proposal publicly in his later academic incarnation. But:
a) This massively increases churning and middle class welfare (not necessarily inefficient IMO, but it is in a lot of others’)
b) its massively expensive (that goes for the high threshold idea too)
c) it runs a risk of people accidentally acquiring big end-of-year tax debts (a problem which IMO is solvable, but not that easily)
d) it leaves no room for “horizontal equity” payments such as FTB B (again not a big problem IMO but it is in some others’).
e) it still leaves all those problematic interactions from having a family-based welfare system and an individually-based tax system.
For a given payment level (you’re right about that stipulation Terje) you can have good incentives or you can have less middle class welfare. You can’t have both. There have been an awful lot of schemes in which this tradeoff – a product of the laws of arithmetic – is hidden from casual inspection (usually hidden from the proponents too), but not evaded.
Terje, the only major welfare payment that’s not taxable is DSP (which is tax exempt due to a quirk of history which JWH was heavily involved in as Treasurer- he’ll never make it taxable while he’s PM). FTB is not taxable because it is intended as a tax credit (it’s historic origin, BTW), not welfare. Making FTB taxable would result in quite massive and totally unnecessary churning.
In general, if you want to reduce churn you make payments tax exempt. If you want to reduce EMTRs you make them taxable (because the reduction in benefit feeds through as taxable income & helps reduce tax liability), at the cost of churning (and unanticipated end-of-year tax debts by low-income workers too, BTW). Of course in both cases you can then adjust the income test to compensate – which brings the EMTRs back to where they were.
“the children of those (probably including quite a few Cabinet ministers) who dodge tax through family trusts.”
Distributions from family trusts to children under 18 get taxed the top rate.
Can you check this, Uncle M? The references I’ve seen suggest that trust distributions to children under 18 attract the low income rebate, but none of them are authoritative.
JQ, I can’t give you a reference to the ITAA, but I have been told this by by someone who has a family trust. This surprised me, so I checked with my accountant who confirmed it. I should add that it is possible to distribute small amounts (a few hundred dollars) to children without attarcting tax.
I’ve found my source again now. The Age says
John Q wrote:
Effectively, this is much the same as raising the threshold at which tax is paid (to around $9000, compared to the officially published $6000) and increasing the marginal rate on incomes between $25 000 and $40 000.
[snip]
It’s an open question as to which is better,
You’ve answered your own question, John.
We’ve had a tax-free threshold of $6,000 for yonks. In a word of tax indexation it would have been steadily rising. But we live in a world of visible tax cuts, instead. A rise in the tax-free threshold benefits all taxpayers by the same dollar amount, but would be perceived as mainly helping the poor. And while an increase in the tax free threshold and a corresponding rise in middle-income marginal rates would leave middle-income earners no worse off it would be perceived as a tax slug.
Better far to compensate low-income earners with a low income offset, keep the tax-free threshold the same and concentrate rate cuts and threshold increases at the upper levels. It looks much better, even if it isn’t. Not all voters are economists, you understand.
TAY-A:
Yeah, “dynamic tax analysis” is something I can say. But its a case of taking an obvious truth – that lower tax rates encourage people to report, and also actually earn, more income, and that this can offset some of the revenue effects of a tax cut – and exaggerating the hell out of it. The “Laffer curve” proponents are talking complete bullshit, as even a casual inspection of the tax and labour supply literatures will reveal.
Even on the very high deadweight and reporting effect estimates of people like Martin Feldstein (a true supply-sider) the behavioural effect can come nowhere near fully offsetting the direct effect on revenue of a cut in the rates.
BTW I believe Treasury’s revenue projection models do include these effects, albeit in a pretty ad hoc way. MITTS at the Melbourne Institute also does it if you want to explore the questions with a published model.
$1400 going to children tax free via the family trust saves $651 in tax, per child. It’s pretty small beer in the scheme of things.
The big beer comes when the kids turn 18. Then thousands can be sent their way, tax free, up to the tax free threshold (effectively about$10K), or even more, and they would pay tax at the lower rates. This works particularly well in the years between school and post university full time work.
Of course, if you send say $30K as a distribution to your 18 year old daughter via the family trust, you’ve got to hope that said daughter doesn’t turn around and say “Where’s my $30K?”, as she would be perfectly legally entitled to do. Good insurance against this is to pay for her uni fees up front. Not only do you (hopefully) stop her claiming her trust distribution, you get a big discount on the HECS fees as well.
She’s happy (her uni fees are paid, no HECS debt) and you’re happy (big tax saving). It’s win-win.
I agree its small beer compared to the larger rort, but $600 per kid for the rich is still a rort worth noting I think.
derrida derrida,
Even John Quiggin has previously stated that there is obviously a Laffer curve effect. He just believes that the maxima is at a rate of tax much, much higher than that encountered in Australia or the USA today.
Lets flesh this out a bit more. The Laffer curve is based on the notion that as taxes increase they create a disincentive for private effort. Next to nobody wants to work if 100% of the income is taxed away. So it rides on the assumption that for every increment in taxation there is an incremental decline in private output.
In other words tax revenue is the result of the arithmetic effect of the tax rate and the incentive effect of the tax rate.
Now of course as tax revenues rise there is scope for an increase in the quantity of public goods. The laffer curve is intended to illustrate the point at which public goods are maximised. Beyond that point the tax revenue declines and so to does the amount of public goods.
What the laffer curve story tends to neglect is that the quantity of private goods is declining the whole time that tax rates are increased. So if we were to add private goods and public goods the point at which the combined total peak would be before the peak of the Laffer curve. In other words if we care about human wellbeing we should tax at a rate lower than that suggested by the laffer curve.
Even in an era when taxation was lower than today Keynes thought that a tax cut would be a good way to raise more revenue:-
John Maynard Keynes:-
So do you include Keynes when you say:-
In relation to trust distributions to children and children’s income tax, Pr Q stated: “I agree its small beer compared to the larger rort, but $600 per kid for the rich is still a rort worth noting I think.”
I should point out that because of the rules related to children’s taxation, it’s not that worthwhile to obtain the full $616 tax saving every year that a child is under 18 because of the restrictions on what is allowed to be done with the money the child legally owns. Refer to Children’s savings accounts and TAXATION RULING NO. IT 2486. Basically the money either has to be saved or can only be spent entirely on the child’s own initiative and for his or her benefit. This pretty much rules out spending any of the money until the child reaches a reasonable level of maturity so it has to accumulate until that age. This means it has to stay invested for a long period of time and that means that it either has to stay in a cash investment to avoid earning too much interest or the distribution has to be reduced below the $1325 tax free limit if the money is put into a growth investment. Keeping the money in cash for many years is not a really great way to invest it and putting it into a growth investment wouldn’t allow you to distribute to the full $1325 every year without the child’s own income going over $1325 after several years. Also, I don’t know how you’d go about investing a child’s money in a growth investment. I think managed funds etc. usually only accept applications from people over 18 but I haven’t scoured them.
I agree with Uncle Milton’s suggestion that this is pretty insignificant compared with what happens with a non-working child over 18, i.e. they will be able to receive $10,000 per annum tax free (currently $7566 p.a.). Considering that the government expects well-off families (greater than about $110,000) to support their children without any help from the government, the tax saving on this $10,000 p.a. is a large difference between families that can arrange it and those who cannot. Interesting to keep in mind that in Victoria, for example, most schoolchildren would be entitled to this rate of tax-free income for the last 6 months or 18 months of school depending on whether their 18th birthday is after or before midnight on the 30th of June in their last year of school.
Regarding Uncle Milton’s suggestion that your 18 year old daughter would be happy with the Uni fees paid and you siphoning-off the rest of her $30,000 distribution, that would depend on how much she knew about tax law :-).
Regarding Uncle Milton’s suggestion: “Of course, if you send say $30K as a distribution to your 18 year old daughter via the family trust,”
Umm, Terje, its quite possible to argue your line – that there is an optimal point of tax (and hence spending) for human welfare, that there is a revenue-maximising point, and that the welfare-maximising point is likely to be lower than the revenue-maximizing point – without believing either that we are already above the welfare-maximizing point or that we are above the revenue-maximizing point.
Unlike the welfare-maximizing point measurement, it is actually easy to empirically settle whether we are above the revenue-maximising point. And we are nowhere near it.
My beef with the Laffer types is NOT with their theory, but their empirics – they are talking complete bullshit because they refuse to face empiric facts which render their position theoretically interesting but practically irrelevant. Facts are stubborn things, mate.
DD,
Its a relief that you can appreciate the theory and that your concern is with the empirical side of things. What piece of empirical evidence do you have to disprove the “Laffer types”?
To be fair in evaluating the effect of a tax cut you need to look at total revenue not just revenue from that specific class of tax. So for instance if the GST was reduced to 0% we would expect GST revenue to decline to zero but might (if we are a “Laffer type”) expect to see total public sector revenue (across the three layers of government) rise.
Lets say we were to cut the GST to 0% and then as Keynes would suggest “given sufficient time to gather the fruits” and observing total tax revenue across the three layers of government. Your assertion is that the total tax revenue would be lower due to the change than would otherwise have been the case.
I wonder why Keynes in his era thought differently.
Regards,
Terje.
P.S. I could claim that the 1999 reduction in the capital gains tax rate has been great for government coffers. You could counter by claiming that it was all due to China and the minerals boom. How do we sort the evidence without prejudice?
“I could claim that the 1999 reduction in the capital gains tax rate has been great for government coffers.”
I’d just like to point out that the “reduction” in capital gains tax rate was a reduction only if your nominal capital gain was more than double the growth in the consumer price index for an indiviual and more than triple for a superannuation fund. e.g. if the inflation rate is 3% p.a. then an individual needs more than 6% p.a. to do better with the new capital gains tax and a super fund needs more than 9% p.a.
Chris,
Yes I agree.
Regards,
Terje.
JQ said:
$600 per kid for the rich is still a rort worth noting I think.
If a $600 tax saving per child per annum is a rort, what is a $7,296.35 family tax benefit handout?
It costs between $1,000 and $2,000 to set up a family trust. If you have any income producing assets (as does half the country) you’re wise to put them into some kind of trust both for asset protection and distributional purposes. At that price it hardly seems like the preserve of the rich.
And with all the handouts for breeding in this country, the people at the bottom end are doing very nicely indeed. It’s incomprehensible social policy at best: what’s the probability that the children of someone who is a net negative drain on the economy will themselves be a net negative drain on the economy? Quite a lot higher than average, no doubt. Yet the lower down the economic totem-pole you are in Australia, the more financial incentive you have to breed.
>And with all the handouts for breeding in this country, the people at the bottom end are doing very nicely indeed. It’s incomprehensible social policy at best: what’s the probability that the children of someone who is a net negative drain on the economy will themselves be a net negative drain on the economy? Quite a lot higher than average, no doubt.
Yes, it really is terrible that the lower orders are allowed to breed, bad enough that they’re allowed to vote.
I’m sure if you had your way all such nonsense would be done away with.
The “lower orders” as you put it are free to do what they like. But Governments are answerable to the electorate. We’re told the enormous sums of taxpayer money handed out in Family Tax Benefits are to assist in raising the next generation who will then drive the economy as the population ages. However, increasing the incentive to breed as one’s economic contribution decreases will have precisely the opposite effect.
I prefer honesty in Government. As far as I can tell, Family Tax Benefits are vote-buying handouts – nothing more and nothing less. The Government should stop pretending otherwise.
A coupel of random follow-up thoughts:
– “Negative economic contributors” sounds so much nicer than “untermeschen”.
– DogZ better be careful here, he’s perilously close to suggesting that poverty might be the result of environmental factors and not one’s own innate sinfulness and moral turpitude.
– I’m sure if DogZ were rendered paraplegic in a car accident tomorrow he’d spit on the government’s offer of sit-down money and after a quick trip to his local GP would be back at work the same afternoon.
– My father was probably one of those “negative eocnomic contributors” seeing as he spent much of his life on an invalid pension due to the malaria he contracted while on active service in WWII.
I’m pretty sure I’m not a “negative economic contributor” – not given the size of the cheque for GST; group tax and PAYG I just sent to the ATO.
So I’m wondering which of my siblings DogZ thinks should never have been born: the psych orderly; the bricklayer; the shopkeeper; the farmer or the school teacher?
Probably the bricklayer, the bastard was on the dole for a whole month once and he has THREE kids.
Dogz, I’ve never quite understood the whole payment to breed idea. My sister and brother-in-law in Germany have received kindergeld for each of their 3 children since they were born. They are solidly middle class and certainly didn’t need the money, nor did they have the kids just for the money, they would have had them even if they’d never gotten a mark (at the time) or a euro now. And with the amount they get for each child it doesn’t make much of a difference to them each month but if you add up with everyone is getting in kindergeld, it has to be a huge amount of money the government is putting out every month. Wouldn’t it be better to lower taxes for everyone and forego the kindergeld?
Ok Ian, why don’t you tell us how you think welfare should be targeted?
Be careful: any suggestion that we not divert every possible spare tax dollar towards encouraging the poorest members of society to breed will be subject to your own objections.
Wow great read this – I have 4 kids (4 to 12) and I dont have a family trust I earn a combined wage (wife and myself)of Gross $248,144.00 Tax $87,746.24 Net Wage $160,397.76 looking at this budget ill now get Gross $248,144.00 Tax $69,257.60 Net Wage $178,886.40 Saving $18,488.64 Thats great. Ive been paying bloody huge tax for years and if I can save some great, As regards the family trust with 4 kids I might just start one up. Private school fees and the like are going to hit soon. Thanks mister taxman.
ops got that wrong saving is $ $10,748.64 missed a scale or two.
For most legal tender coins the value of the metal in the coin is less than the legal tender face value. So for example if you take a 50 cent coin and melt it down and then sell the metal at the current spot price it will be worth less than 50 cents.
Yet the opposite is true with our legal tender gold bullion coins. The A$100 legal tender coin for instance contains 1 troy oz. of 24 carat gold. Currently in the gold markets 1 troy oz. fetches about A$900. So if you take a A$100 gold coin and melt it down and then sell the metal at the current spot price it will be worth more than A$100.
Lets say they decided to issue a 1 troy oz. gold coin and gave it a legal tender face value of $1000. Then like the 50 cent piece the coin would be worth more than the metal. And such a coin might actually circulate.
Of course over time inflation would catch up and such coins would get yanked from circulation. Imagine a system where inflation causes part of the base money supply to be taken out of circulation. What would be the monetary implications?
Regards,
Terje.
P.S. 10 points go to the first person who figures out how a A$100 coin can be fabricated using A$900 worth of gold and still be brought to market at a profit.
http://www.perthmint.com.au/imagelist/Normal/1ozNuggetobverse .jpg
Oops!! wrong thread. It was meant for the Monday message board. Please delete and I will repost.
“It costs between $1,000 and $2,000 to set up a family trust.”
Or less. Just ask a solicitor to sell you a trust deed and then pay the stamp duty at the State government revenue office. Get someone to be the (supposed) creator of the trust and put in the application for a tax file number yourself and there’s no need to bother with an accountant middleman.
“If you have any income producing assets (as does half the country) you’re wise to put them into some kind of trust both for asset protection and distributional purposes. At that price it hardly seems like the preserve of the rich.”
Indeed. The real rich use private companies which are a far more powerful tax-minimizing system.
Indeed. The real rich use private companies which are a far more powerful tax-minimizing system.
Private companies are cheap to set up too., Costs around $1,000 in Oz and you can do it over the internet. But they are more expensive and complex to maintain than trusts.
The main reason you want a private company in the loop is to park money at 30% tax rate. Trusts are taxed at the top marginal rate on retained income, whereas companies are taxed at 30%.
One way to organise your affairs is to put your assets in a discretionary trust, with family members and “related entities” as beneficiaries and ensure that one of those related entities is a company. Don’t own the shares in the beneficiary company yourself, because they will become an asset that you caan be sued for – make sure the beneficiary company shares are owned by another trust.
Make the trustee a company, and make yourself a director of the trustee company. That way you’ll control the distribution from the trust (via the trustee company) but will not own the trust assets yourself (again – noone can sue you for those assets), and will avoid stamp duty because you’ll never have to change the trustee (eg when you die) – you just appoint a new director (in your will).
The trust can distribute as it wants, so it can distribute the lion’s share of profits to the beneficiary company which will pay 30% but then the money is parked and insulated – provided the beneficiary company’s shares are owned by another trust and not an individual (who can be sued).
None of this is particularly expensive to setup (a few thousand dollars), but the problem is most people don’t think about it until they have significant assets (I didn’t), and then it gets tricky because you have to pay capital gains tax when transferring assets from your own name into the trust. There are ways around that but they don’t work for all assets.