Simpler taxation looks too costly

22 June 2016

I believe that this country’s taxation system needs simplifying.  There are all sorts of taxes around, applying to all sorts of things – more than I can remember, let alone go into.  But the trouble with simplifying taxes, if not getting rid of them, is in relation to how much tax revenue would be lost if they go.

Among the proposals for tax reform to have been floated over the years, there’s a proposal to simplify income tax, meaning how much tax we pay out of our wages when we work.  At present, the income tax system consists of several thresholds and brackets, and I suspect that these play some part in prompting people to try minimising their tax paid.

Depending on how much you earn from your job, you can also be entitled to various governmental rebates, or subject to various levies and charges.  I don’t pretend to know what these things all are, so I won’t complicate my argument by going into them.  But in illustrating how the income tax system alone works, you’ll get an idea of why people always advocate some sort of tax reform.

What follows is an illustration of the thresholds and brackets currently existing in the income tax system.

The first of these is a tax-free threshold.  In terms of a year’s pay, this threshold is currently set at $18,200 – the equivalent of about $350 per week, in a typical year of 52 weeks.  If your job earns you up to $18,200 per annum at most, you pay no tax.

In a hypothetical scenario, your income for this year might be below the tax-free threshold, but a pay rise might push you above it, meaning that you suddenly start paying tax.  You might be earning $18,000 in income this year, and getting a pay rise for the coming year of $5 per week – this raises your annual pay by $260 to a total of $18,260.  As a result, you’re suddenly over the tax-free threshold, by just $60.

But this is where it gets complicated.  Here you only pay tax for every dollar that you earn above the tax-free threshold.  Therefore, with the tax-free threshold at $18,200 and your new income exceeding that by $60, tax only applies to that amount of $60.  The lowest income tax rate sits at 19 cents for every dollar above the tax-free threshold, equating to less than $12 in tax for that amount of $60 mentioned here.

Making things more complicated, there are different rates of tax charged at different income levels.  Currently, you pay 19 cents for every dollar above the tax-free threshold, until you earn more than $37,000 – the next of the thresholds.  For the record, the gap between thresholds is termed as a “bracket”.

Sometimes, when you get a pay rise, your annual income goes above a certain threshold, and you start paying tax for every dollar that you earn above that threshold.  This is known as “bracket creep”.  I dare say that politicians actually like bracket creep, because when people find that their pay rises are pushing them into higher tax brackets, politicians get more tax out of them without actually changing taxes!

The bracket between the bottom thresholds amounts to $18,800.  If you earn exactly $37,000 in yearly income, you pay tax of $3,572 – meaning 19 per cent of $18,800.  Here the next pay rise would put your income above $37,000 – meaning a higher rate of tax for every dollar above that amount, on top of $3,572 already paid.

From this point, more thresholds and brackets and tax rates apply.  The next threshold up from $37,000 amounts to $80,000.  Above that threshold sits the highest threshold, amounting to $180,000.  Once your income exceeds either threshold, you pay higher rates of tax for every dollar above either threshold.

This gives you an idea of how complicated the tax system is, even if people consider it fair to charge people more in tax if they have higher incomes.  More significantly, if lowering your income enables you to get below a threshold, and therefore avoid paying a higher rate of tax, you can understand why wealthier people are always engaging in some sort of scheme to lower their incomes and minimise their tax!

In terms of tax reform, I’ve seen one proposal to set the tax-free threshold at $40,000 and charge a flat tax rate of 20 cents on every dollar above that amount.  This sounds much simpler than the series of thresholds and brackets present in the existing income tax system, and it would largely eliminate bracket creep.  But is it fairer, or affordable?

Currently, if you earn $40,000 per annum, you pay over $4,500 in tax.  This alternative proposal would reduce your tax to nothing.  And at higher income levels, your tax would drop significantly.

If you earn $80,000 per annum, you pay over $17,500 in tax.  The alternative proposal would more than halve your tax, to exactly $8,000.  If you earn $180,000 per annum, you pay over $54,500 in tax – the alternative would almost halve your tax to $28,000.

And if you’re on exactly $1 million, you currently pay over $423,000 in tax – the alternative would more than halve your tax to less than $200,000.

This whole situation seems to pit simplicity against fairness and affordability.  Some people might advocate simpler taxation, but from the perspective of public revenue, it looks too costly, as well as unfair.

I’m open to reforming the tax system.  Simplifying tax might reduce avoidance.  But the cost, at least in the short term, might be extremely high.