24 August 2015

'The economic case for personal income tax cuts', Address to the Tax Institute and Chartered Accountants Australia and New Zealand


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Thanks Stephen for that kind introduction, to Lee and Noel for your leadership of your respective organisations and thank you, everyone. I really appreciate the invitation to come here to further progress the essential national debate about tax reform.

As Treasurer, my view is that our tax system is holding us back from reaching our end goal of a stronger economy.

The price we pay for failing to strengthen and improve our tax system is less income than Australians should receive and fewer jobs than Australians could hold.

Our existing taxation system is increasingly reducing the incentive for many Australians to work harder, earn more, invest and, in the end, give our families greater financial security.

So the Government’s main motivation for seeking to improve the tax system is to start building an economy that is ready for the twenty first century.

In fact at a meeting with State and Territory Treasurers last Thursday and Friday it became increasingly apparent to me that the common cause of reform, to improve the growth trajectory of the Australian economy, cuts across the political divide –well at least at a governmental level.

Yes some jurisdictions want more income and see an increase in Commonwealth taxes as a way to get more revenue. I confess that I find it unappealing to dress up increased tax and spending as tax reform. Especially, if it’s the Commonwealth raising taxes to help states increase their spending.

The best way for a government to improve its revenues is to have a faster growing economy. Prosperity is the best friend of fiscal order.

So when our tax system represents a structural handbrake on growth – it is clearly time for change.

We need a system built on the belief it is people — those with ideas, energy and determination — who create wealth.

A system that does not hinder but encourages their enthusiasm and with it, embraces new technologies.

A system that sends the simple message: we believe in you — have a go!

It must have reward for effort at its core. And we should encourage this, because this is how we can create jobs, promote stronger economic growth, and pay for the services we want and need.

Prosperity is not assured

The Coalition Government believes that lower, simpler and fairer taxes will deliver a stronger economy; more jobs; increased living standards for Australians and support for those who need it most.

That is why we abolished the carbon tax. It’s why we abolished the mining tax. And it’s why we have cut the small business company tax rate to 28.5 per cent – the lowest tax rate in almost fifty years.

Despite these positive changes, Australia’s future prosperity is not assured. A better standard of living is not guaranteed.

To achieve these, we must make the necessary decisions and choices now.

We need to ensure our economy continues to transition successfully from the mining boom, and that we lay the foundations for our future.

To do this, we will need modern industries and new businesses to lead the way; all of us will need to seize the opportunities of our technology and our geography.

It will take planning, and it will take effort. And every one of us will need to play a role: to seek out new opportunities; to run with our ideas; to do our bit to drive growth so we can continue to live comfortable lives.

The stealth tax

And tax reform will be important in promoting this new, vibrant Australia.

And that is what I want to talk about today — to outline the case for change in our tax system, particularly personal income tax rates.

And the starting point must be bracket creep.

Bracket creep occurs when people are pushed up into higher tax brackets as a result of inflation and rising wages.

If people are left in those higher tax brackets, this can lead to negative financial and economic outcomes, for individuals and the nation.

The incentive for hard work is blunted – and inflation means that without a real wage rise, people pay a higher and higher average tax rate each year.

Now, some argue bracket creep is a natural consequence of a growing economy. Others argue the Australian community is prepared to pay more in taxes to address the demographic challenges we face.

But I do not accept the view that we can sit by and allow bracket creep to cover rising government spending.

Bracket creep means governments can raise extra money without drawing the attention of the public. Many Australians are not fully aware that they will be paying higher taxes as a result of the stealthy rise of bracket creep.

For the worker out there on an average income, they might not notice it the first year. They might not even notice in the second or third year.

But, eventually, it bites. We are now at that point.

Apart from the increase in the tax free threshold in 2012, the personal income tax brackets have not been significantly adjusted since the changes announced by the Howard Government in 2007 — and not since 2000 has the average full-time wage been in the second top marginal tax bracket.  

In the next two years, without action, about 300,000 Australians will move into the second highest tax bracket.

And in 10 years, if tax cuts don’t happen, almost half of all taxpayers will be in the top two tax brackets, a jump from 27 per cent to 43 per cent.

For the average income earner on around $77,000 each year they are just below the second highest tax bracket of 37 cents in the dollar, which kicks in above $80,000. 

At their current wage, they are taxed a marginal rate of 32.5 cents plus the Medicare levy.

But say they pick up an extra shift, or are tapped on the shoulder for a promotion. For every extra dollar they earn, they will be taxed at 39 cents including the Medicare levy. So the reward for effort is to move into a higher tax bracket to pay more tax.

Where, we have to ask, is the incentive to work harder and to reach higher?

Why should the reward for hard work and endeavour be swallowed up by higher taxes?

And what is remarkable is that this is happening in the shadow of successive Intergenerational Reports, which have all highlighted how increasing workforce participation is essential for our future growth prospects given our ageing population. 

If people are discouraged from work and we cannot address our workforce participation challenges, then Australia will face greater economic pressures.

Clearly, governments must act and give periodic tax cuts to maintain the incentives that reward effort.

And the worst part of all of this is that the burden of bracket creep falls disproportionately on low and middle income earners.

Take a concreter, for instance. Five years ago, your average concreter earned just over $50,000 per year and paid an average tax rate of about 18 per cent.

Today, that same worker earns around $65,000 and pays almost 22 per cent in tax.

Or what if you’re a nurse? In 2010 you would have been earning just over $50,000 and also paying less than 18 per cent.

Five years on, and with a salary of about $60,000, you’re paying more than 20 per cent.

These people are deserving of income tax relief especially if they are earning significantly more as a result of increasing skills and seniority.

And this is exactly what the Abbott Government wants to do. We want to short-circuit the negative impact of bracket creep on the incentive to earn more and be more successful.

Personal income tax

The problem is that, right now, Australia relies heavily on personal income tax.

It is our largest source of tax revenue. It raises around $170 billion per year.

And when you combine it with corporate taxes, this makes up around 60 per cent of our tax revenue — compared with an average of 34 per cent across the world’s top economies in the OECD.

Or, to put it another way, we rely on revenue from income tax more than any other country apart from our friends in Denmark.

And this reliance is reflected in the high rates of tax, particularly at the top level.

In Australia, the highest marginal tax rate is 47 cents for each extra dollar earned. To contrast this, New Zealand’s is only 33 cents; Singapore’s is 20 cents; and Hong Kong’s is only 15 cents.

And, in addition, our top rate kicks in relatively quickly, at $180,000. That is only 2.3 times the average full-time wage. This is extremely low when compared with other OECD nations.

In the United Kingdom, their top rate kicks in at 4.2 times their average wage. This matters because our existing personal income tax rates make us uncompetitive.

Research tells us that high personal income taxes — along with company taxes — are particularly harmful for economic growth.

A study1 of 21 OECD countries found that the proportion of tax revenues raised from taxing personal incomes is negatively correlated with growth.

That is, it has an economic cost because it diminishes the capacity of individuals to use their take home pay for consumption, investment, innovation or job creation.

The more the Government collects in income tax the greater the economic cost.

Even though Governments have vital social spending responsibilities in areas such as social security, health, education, law and order, we should not pretend that everything Government spends taxpayer money on has an economic benefit. The Australian Bureau of Statistics doesn’t even report on productivity in the public sector because not only is it difficult to economically measure the output of public servants but Government spending is hardly an economic value add.

So the heavier the tax burden on productive earnings the greater the economic dead hand weighs on job creation and productivity.

There is also a social cost associated with high income tax rates.

Gradually but increasingly high personal income tax rates will become a major incentive for Australians to live and work overseas.

Currently most of the world economy is lagging the performance of Australia’s economy. New Zealand is one country however, that has been performing well in recent years. It is one of the fastest growing economies in the OECD.

The New Zealand population is benefiting from a stronger economy, more jobs, and a Government that lives within its means. It is also making itself a more attractive investment destination with a top personal tax rate of just 33 per cent and no payroll tax.

Sounds like a pretty workable model, doesn’t it?

Partly as a result of this there has been a significant turnaround in trans-Tasman migration flows over the last couple of years. There are now instances where each month there are more New Zealanders returning from Australia than are departing to Australia. Kiwis are going home – and staying home – because times are good.

Other competition for our economy in the region – places like Hong Kong and Singapore - will become more and more attractive for service delivery exporters to relocate to with their very low income tax rates.

We live in a new and increasingly mobile age. People are more comfortable moving overseas for work than ever before. They will work wherever the reward is greatest.

Ambitious and driven people tend to be the innovators and the global disruptors; the new age job creators. They are the people who can give our economy an edge in a digital age where distance is no impediment to wealth creation.

These are the people we should be keeping in Australia. And right now we rely on them too heavily.

But it is not just the income tax that they pay that we rely too heavily upon. It is also their capital that poses a high ‘flight risk’ — that is to say, the funds they choose to save and invest.

And as we increasingly integrate into our region, more and more Australians will have the opportunity to participate in the wider Asian economy.

This could not only result in Australians physically moving offshore, but making investments in assets and capital moving from Australia to our Asian competitors, while they remain in Australia.

This scenario poses a high risk not just for tax revenue, but for Australian business profits and Australian jobs.

At the moment, 2.7 per cent of Australian taxpayers fall into the top income tax bracket. And they are paying more than 28 per cent of all personal income tax.

And the top 10 per cent pay almost half of all personal income tax.

Back in 1996–97, under the Howard Government, the tax burden was less concentrated, with the top 25 per cent paying a majority of income tax.

And when the Howard Government introduced the GST, 80 per cent of taxpayers had a headline marginal tax rate of 30 cents in the dollar or less.

By 2012–13, because of Labor’s tax rate increases at the time of the carbon tax, this had dropped to around a quarter of taxpayers.

That’s just not good enough. The system must be fixed to give reward for effort.

What this shows is that our redistributive tax system has created a situation in which we as a nation are over-reliant on a very narrow base.

To borrow an old analogy from Louis XIV’s finance minister, collecting tax can be like plucking a goose — and you don’t want to run out of feathers.

Worse still, you don’t want to kill the goose.

Our personal income tax system should be one that encourages growth and development, and creates settings that are right for all Australians.

Reducing taxes will put money back where it belongs — in people’s pockets — and send that simple message I spoke of earlier: have a go!

Lower personal income tax will also encourage our budding entrepreneurs to make something of their ideas; it will give people the jolt they need to get better qualifications; it will provide incentive to go for that promotion — to climb the ladder of opportunity.

I should also say, importantly, I do not accept that to advocate lower taxes is to turn your back on society.

Australians are fair-minded people. We all want excellent services, particularly for the most vulnerable and disadvantaged in our community. In a modern liberal society no one should be left behind. Australians accept that they have to pay their fair share of tax.

But not only is our personal income tax system uncompetitive — it is increasingly penalising lower income or secondary earners in our society.

This is particularly the case when our tax rates are mixed in with the transfer system for social security. The combination that determines household net income weighs heavily on the minds of many Australians.

We know that the current interaction of the tax and transfer system with a highly regulated labour market can create some strong disincentives for working extra hours and, in some cases, working at all.

Let me give you an example: a young couple with a baby. They’re juggling the demands of modern life and, like all Australians, want the best for their family.

They are the people governments should encourage.

Assume the most likely scenario that Dad earns a full-time wage of about $85,000, while mum stays home and looks after the baby. They receive Family Tax Benefits A and B.

After a year, mum wants to go back to work to boost the family budget. They might want it for the mortgage or to have another baby. Perhaps they need capital to start a small business.

But if mum works three days a week, earning about $20,000 a year, the cost of income tax, day care and the loss of Family Tax Benefit A — and a reduction in B — would only see her receive an extra $7,500. $6,000 of this would be from the childcare rebate once the Government’s changes to the rebate are legislated.

So even with our positive changes to the childcare system, it’s clear we need to address these disincentives at the lower income end of the tax system. As our population ages, we simply can’t afford to have one parent discouraged from working if they want to be working.

Budget impact

So with all of this in mind, you can no doubt understand why the Government is committed to reducing income taxes.

All the evidence points to the need for this. If we want stronger growth, this is the path we must be prepared to take.

But we still have a Budget to balance. We still have a Budget to repair. There’s no denying this.

And it will be managed through continued discipline on spending decisions. We are undeterred in our mission to pinpoint government waste; to stop spending money where it doesn’t need to be spent.

In short, we need to live within our means.

What is clear is that only a government that is serious about Budget repair can deliver lower taxes over time. A government that cannot contain expenditure inevitably falls into the trap of searching for new sources of revenue – as our political opponents are now with new taxes on superannuation, electricity and jobs.

This in turn hurts growth, which reduces tax revenue – creating a vicious cycle.

Principles of tax reform

Now, all of the ideas I have put forward today originate in the Government’s six principles of tax reform.

They are our reference points — the basis upon which any reform will be judged and, ultimately, made. Let me briefly revisit them for you now:

First, tax changes must promote a strong economy, building jobs, growth and opportunity.

We know that a stronger economy can provide each of these things, in particular the conditions for entrepreneurship.

By encouraging people to invest, innovate and create growth, we’ll be provided with the additional wealth we need to fund services, and protect the disadvantaged.

Second, any reform must be fit for purpose in a modern economy.

As I’ve said many times before, we have a tax system that was built with 1950s rules. It cannot keep up with a modern, globalised economy — one in which technology is king and global disruption is the new black.

We need to make sure it is fighting-fit for this new age.

Third, changes must encourage workforce participation and ensure families control their own money.

As I said earlier, higher taxes and bracket creep mean people have less incentive to earn more; to go for that promotion.

To our best and brightest, to our investors, to hard-working families, this sends the wrong message. And this Government knows that Australians are best placed to decide where their money goes.

Fourth, in general you should not be taxed until you have earned the income.

Australians need to be given the opportunity to get their foot in the door, to become a player in the game of business. And the best way to do this is for Government to get out of the way.

Fifth, reform must encourage innovation and opportunity, and reward for effort.

To create an economy of ideas where start-ups thrive in Australia the way they do in places like Silicon Valley, we need to make it easier for entrepreneurs. To reward them for their efforts, not hinder them.

And sixth, as best as possible, the revenue-raising capacity of each tier of government should be aligned to responsibilities of funding and service delivery.

States and territories

This last principle brings me to an important point.

The authors of tax reform must come from all quarters. Macquarie Street, Harvest Terrace, Salamanca Place — every one of our state and territory governments.

The Abbott Government can advocate what it believes, as I clearly have today. But reform must come from across the political divide.

And I think what we can all say is that we want a simpler, fairer tax system; one that provides incentives and puts us in the best position for the future.

And I am pleased to see us making some progress.

Just last Friday I met with state and territory treasurers to discuss the future of our tax system. Together, we are making good progress.

We agreed to completely abolish the GST low-value threshold on goods imported into Australia, which ensures our GST system is fit for purpose in the modern economy.

It is an administrative and integrity change that will put local retailers on a level playing field with their offshore competitors, supporting jobs and growth here in Australia.

We also made good progress in discussions on the tax mix between direct and indirect taxes. We discussed at length the sustainability of our revenue base and we discussed the economic merit of particular taxes.

Importantly we have all agreed to work together to develop potential models for a future tax system that delivers the revenue we need without harming the economy we want.

Closing remarks

Let me end by coming back to what I said at the beginning: a good tax system that delivers lower, simpler and fairer taxes is not an end in itself.

A good tax system is one that gives people an incentive to get ahead.

For the hard-working families in western Sydney, the enterprising teenager in Adelaide, the small business owners in Brisbane — wherever you are in Australia, whoever you are, you should be able to be your best.

Australians should have a tax system that does not hinder that goal. It should reflect the hopes and aspirations of a modern, vibrant nation.

It is not the job of government to take more than is needed. It is the job of government to live within our means and achieve expenditure restraint.

A fair dinkum government should encourage work, ideas, having a go.

A fair dinkum government must do all it can to support stronger growth so, when the new day dawns, society is stronger.

That’s why our forthcoming Options Paper on tax reform will include options for cutting personal income tax.

We don’t have any other choice.

I know Australians are eager for change. And it’s time we started.

Thank you.

1 Arnold, J. (2008) Do tax structures affect aggregate economic growth? Economics Department working paper no. 643, OECD.