Australia's flat tax that never was

Australia nearly adopted a flat tax this year - until common sense prevailed. David Uren of The Australian today reports on Costello's secret 30pc flat tax:

When Peter Costello left Canberra for his Christmas break last year, he had before him modelling for the most radical reform to income tax in 60 years. The ambitious plan, prepared for this year's budget, would have replaced all the existing tax scales with a single flat rate of tax of 30 per cent.

The current tax-free threshold of $6000 would have been abolished and replaced with a rebate to ensure low-income earners were no worse off. Treasury modelled a number of tax plans, including proposals from the Australian Chamber of Commerce and Industry, accounting body CPA Australia and the Government's backbench tax ginger group.

The most detailed work, however, was completed on the proposal for a flat tax. It included an analysis of winners and losers and an outline of legislation, covering other tax rebates and pensions, that would need to be amended.

The plan was clearly affordable without pushing the budget into deficit, with the cost rising from $7.7 billion in 2005-06 to $10.1 billion in 2008-09. ...Treasury projects that the budget will be in surplus by $8.5 billion in that year, so the pot from which tax cuts could be drawn totalled $15.2 billion.

The proposal was still live after the Christmas break. In January, Treasury considered an option for eliminating workplace deductions for high-income earners. That would reduce the cost by the fourth year to $9.6 billion. People earning more than $101,280 a year would be denied tax deductions for expenses such as motor vehicles, study and home offices. The plan was tailored so there would be no losers.

The key to this was the rebate for low-income earners that would replace the current tax-free threshold. The idea was that the rebate would be phased in for low-income earners up to incomes of $21,600, where it would be worth $3828 a year.

But instead Australian taxpayers got this in the 2005 Budget:

By contrast, the tax plan Mr Costello eventually announced on budget day in May - including a $6-a-week tax cut for low-income earners and the increases in the thresholds for the top two tax rates - was phased in, with the annual cost rising increasing from an initial $3.1 billion to $6.7 billion by 2008-09.

So why the backdown?

Only those privy to the Treasurer's thinking know why the plan was dropped, but it may have been because of an analysis Treasury prepared on who would be the winners. Although nobody would be worse off as a result of the changes, only 20 per cent of taxpayers would be better off. The gains were biggest for high-income earners.

In other words, to introduce a flat tax in with no losers, Australian Treasury ended up proposing a scheme which (1) was not revenue neutral - it would have costs billions in lost tax revenue - and (2) most of the winners would be the rich. This is hardly a politically savvy nor fiscally responsible strategy. Plus the proposed variable rebate hardly sounds like much of a simplification! (Stephen Kirchner has another explanation: "Costello is rationing tax cuts to fit with his leadership timetable").

I defy any of the vocal British flat tax advocates to come up with a system which is both broadly revenue neutral and does not give the rich substantial tax cuts at the expense of low and middle income earners. I have yet to see such a scheme - and until I do, I will continue to oppose a flat tax in the UK.

Comments

[gandalf]

Australia nearly adopted a flat tax this year - until common sense prevailed

I guess you mean the zero-sum "common sense" so beloved of socialists!

(1) was not revenue neutral - it would have costs billions in lost tax revenue - and (2) most of the winners would be the rich

This is your opinion, which may be correct, but it's possible that reducing taxes on "the rich" would have increased tax revenues, per Art Laffer.

With a more objective commentary, this would be a great blog.

[Lord]

This is hardly a politically savvy nor fiscally responsible strategy.

Really? Just who runs Australia anyway? Not the wealthy like everywhere else? And why is a surplus favorable unless you are expecting a recession?

[sauron]

Who said anything about socialism? Any tax that favours the rich won't get votes. That's the common-sense here. This whole flat-tax thing has already sunk Angela Merkel in Germany, and I think the British Conservatives would do well to drop it like a hot red brick. It looks great on paper, but doesn't seem to help anyone except the rich. I'd prefer a system that eliminated millions of working-class people from paying any income tax whatsoever by radically raising the personal allowance. The Flat Tax is Euclidean geometry for accountants--a thing of great beauty, but physically inappropriate.

[Andrew Leigh]

It's great to see commenters with such faith in Laffernomics. After all, given that his napkin-theory has only been shown to work in one instance (Sweden in the 1960s), you need a lot of faith to keep believing in it...

[New Economist]

One of the reasons for being a bit wary of the flat tax debate is that ideologues soon try to take over the debate, using rather dubious arguments. Let's go through some of the above comments:

1) Gandalf thinks that the Australian Treasurer's rejection of a flat tax was: "...the zero-sum "common sense" so beloved of socialists!"

I don't think Peter Costello is a socialist, and neither am I. Let's run through why the proposal was rejected again. In an Australian electoral system, where voting is compulsory, the median voter is typically a middle income earner living in the outer suburbs of the major cities. This is known in Australia as "the mortgage belt', and is where most of the marginal seats are. You are unlikely to win them if you propose a tax system that largely benefits the rich. I would have thought this point is obvious? Sauron (above) makes the same point, only more succinctly.

2) Gandalf: "it's possible that reducing taxes on "the rich" would have increased tax revenues, per Art Laffer."

Possible - yes. Likely - no, as Andrew Leigh explains. That is not to deny that there would be economic gains from simplification, including greater compliance. But I doubt it would fully offset the loss in revenue.

3) Lord: "Just who runs Australia anyway? Not the wealthy like everywhere else?"

Of course the wealthy have a lot of power and influence. But last time I checked the place was still a liberal democracy. Also see my answer to point 1 above.

4) Lord: "And why is a surplus favorable unless you are expecting a recession?"

A good point. Surpluses are not necessarily good things. However at times of strong economic growth it is prudent for governments to run a surplus, to provide them with the capacity to respond when the next economic downturn occurs. That said, such surpluses should not be excessive - if they are, then either tax rates should be lowered or the money should be used to boost national productivity and growth (such as by improving education or infrastructure). My objection is not to tax cuts per se, it is to tax cuts that advantage the rich over low and middle income earners.

[Sinclair Davidson]

What does "tax cuts at the expense of low and middle income earners" actually mean?

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