An ideal combination of fairness and efficiency

Let’s consider a couple of propositions.

  1. What if… we taxed all income, from the first dollar, at the same marginal rate?


  1. What if… we gave welfare to everyone, regardless of their income?

You can imagine the reaction to each proposition – “You must me mad, that would never work!”

  1. But, what if we do 1 & 2 at the same time?

Now, that becomes interesting because it turns out we get some very desirable results.

  • We remove the ‘welfare’ component currently built into tax rates (like tax-free thresholds, low marginal tax rates, Medicare exemptions and low-income rebates) and that’s a good thing because…
  • We can target the actual welfare payments better than we can with tax-free thresholds or low marginal tax rates or the low-income rebate.
  • We can eliminate poverty traps because now everyone has the same incentive to earn money and enjoy spending it. We eliminate high effective marginal tax rates (EMTR) and we encourage participation in the workforce for everyone.
  • We can remove the phrase, ‘class warfare’ from any discussion of taxation or welfare. How? Everyone will have the same basic entitlements and obligations. No one can complain that any group is not doing its fair share of lifting.

What else does it do?

  • Surprisingly, for the vast majority of taxpayers and welfare recipients, the final disposable incomes of people under the new system are very similar to the current complex arrangements. How can that be? I did the arithmetic and can assure you that its true. You can do the arithmetic and find it is indeed the case.
  • We also get the opportunity to factor in wealth, via an asset test on the welfare payment, to determine a person’s final disposable income.
  • We can remove all the fuss about low Newstart and all the anguish of recovering over-payments from the welfare system when mistakes are made. We can actually reduce Social Security complexity to a minimum and thereby reduce the staff required to manage it. No one has to apply for anything – ‘welfare’ as a concept becomes obsolete.

Anything else?

  • We would factor in the family home as part of the asset test, so that we can distinguish a mansion in Vaucluse from a flat in Cabramatta.
  • We can give everyone an age-related threshold of wealth, below which it doesn’t affect the welfare payment, as everyone accumulates their own wealth (total net assets) over their lifetimes.
  • We need to factor in previous tax paid, so that people have an incentive to declare income and pay tax.
  • We can effectively eliminate the need for complex tax and financial planning advice because all assets count and all assets are treated equally.

What would the marginal tax rate need to be?

I estimate that the marginal tax rate would be in the high 30s, say 37% or 38%. This would need to be modelled to determine the best result. There would be another higher rate, say 45% for very high incomes. Why? Didn’t I say they’d all be the same? We would have a higher rate for very high incomes because these people are probably no longer getting the welfare payment and we want to reintroduce progressiveness at that point.

What would the factors affecting the welfare payment be?

  1. Just existing qualifies a person for a payment, after which it is adjusted for…
  2. Household type and one’s position within the household: single without dependents, single with dependents, couple with dependents, couple without dependents, in foster care etc.
  3. Age – child, adult and aged.
  4. Disability – a variety of disabilities with a variety of payments.
  5. Carer – related to the disability.
  6. Tax paid in prior period – a formula based on previous tax paid up to a limit.
  7. Being in education would raise the rate.
  8. Total net wealth – above an age-based threshold – would lower the rate.
  9. Number of children qualifying – the welfare payment for additional children diminishes as the number of qualifying children grows.

What would the age-based threshold be?

The threshold would be zero for 0 – 15 years but then grow by $6,000 per annum until the age of 65. A person aged 65 would have a $300,000 threshold. A single over 65 would have their threshold doubled.

Here are some examples, to show how the factors relate.

Consider three similar working families with two adults and two children. The only difference between them is their incomes. Assume that the flat income tax rate is 37%.

Family one has two adults and two children with a combined income of $100,000. They pay $37,000 tax. Each adult gets a welfare payment of $10,000 and the children get welfare payments of $5,000 and $3,000 respectively. Because each adult paid tax in the preceding period they get an additional payment of up to $3,000 each. Ultimately, their net disposable income is $97,000 (i.e. 97% disposable income from gross income.)

Family two with a combined income of $200,000 will pay $74,000 in tax and receive the same welfare payments of $34,000. Their net disposable income is $160,000 (80%.) Family three with $400,000 income has a net disposable income of $286,000 (71.5%) (Refer to column one in the table below.)

As you can see, the proportion of disposable income declines as income rises, which is a progressive system. In each case, high or low income, the families have equal incentive to earn money.

Add wealth into the equation

Now add wealth into the equation. The welfare payment reduces by 0.6% of each family’s wealth over an aged-related threshold. (Let’s assume the combined threshold is $500,000 for each family.)

Family one is under the threshold. Family two has assets of $1.5 million so they lose $6,000 from their welfare payment and their net income is reduced to $154,000 (77%.) Family three has $6.2 million in assets, so they will lose all of their welfare payment. Their net disposable income drops to $252,000 (63%.) (Refer to the diagonal in the table below.)

The changes in peoples’ circumstances, including net wealth, produce an intuitively fair and reasonable change in their overall tax burden and welfare benefits.

Disposable income as a percent of gross income
Income\wealth over threshold $0 $1.0 million $5.7 million
$100,000 97% 91% 63%
$200,000 80% 77% 63%
$400,000 71.5% 70% 63%


A flat tax is fair because it affects everyone in the same proportion and gives everyone the same incentive to earn income. Current low marginal tax rates for low income earners are a lie, as it can be shown that low-income earners actually face the highest effective marginal tax rates and so have the strongest incentives to limit participation in the workforce.

A ‘welfare’ payment can be targetted far more effectively than any distributional features built into the tax system. The current tax-free threshold benefits both wealthy and poor in a blunt and non-specific way. A welfare payment can take account of a multitude of verifiable circumstances, including net assets.

When a flat income tax applies to almost all income earners and a welfare payment is paid to all under the same set of qualifying conditions then we approach an almost ideal combination of fairness and efficiency.



Morrison’s big mistake

Treasurer Scott Morrison made a big mistake in the budget, judging by some of the commentary. He thought that people understood marginal tax rates and progressive tax.

We have a commitment to progressive income tax in Australia, so when the Treasurer suggested that the 32% marginal tax band be expanded he had all forms of experts lamenting that he was removing the progressiveness of the system. But that’s not necessarily true.

A progressive tax system means that higher incomes pay higher proportions of their total income as tax, which is the case with Morrison’s plan.

Simplicity leads to fairness and efficiency

Income tax and welfare payments are very complex in Australia. As testament to this, the government is adding 1000 call centre staff to handle Social Security questions from the public but I fear that the number is not enough. Last year, we had Centrelink’s bungled robodebt recovery system which made tens of thousands of mistakes. Why are these systems so complex?

Income tax

Income tax is very complex because it is trying to be both a revenue system and an income redistribution system, via:

  1. Progressive tax scales
  2. The tax-free threshold
  3. Medicare levy exemptions
  4. A variety of rebates and concessions for people in different circumstances.
  5. Low-income tax offset

Social Security

Social Security is very complex because:

  1. Qualification criteria concerning income, assets, age, personal circumstances, spouse’s circumstance, rent paid, dependents etc. interact to produce results that are unpredictable, may shift rapidly, require constant reviews and often lead to over-payments.
  2. Each benefit has to be withdrawn as income rises and that inevitably leads to high effective marginal tax rates. To avoid situations where rising income actually leads to some people getting less disposable income, additional rules and exemptions are created in the structure of each payment. Again, there is the possibility of over-payments, requiring special measures for recovery.

Effective Marginal Tax Rate (EMTR)

EMTR is the combination of marginal tax rates and the rate of withdrawal of benefits.

The most glaring failure of the existing system is that, unbeknownst to most taxpayers, it is the lower paid workers who often face the highest marginal tax rates. (EMTR can approach 100% of additional income in some income ranges for certain family types.)

There ought to be a way to administer both income tax and welfare in a simpler manner that is still fair, so what principles would underlie this?

Basic principles

  • Let the tax department take care of revenue collection
  • Let Centrelink take care of redistribution
  • The system should be fair, predictable, understandable and its operation transparent.
  • The system should not discourage participation in the economy.

Desirable features

Let’s consider some desirable features of such a system.

  1. Remove the so-called class war that many in Canberra attribute to the other side of politics whenever personal income tax or welfare payments are debated.
  2. Ensure that effective marginal tax rates are never higher for low-paid workers than those on higher incomes.
  3. Treat everyone equally when deciding tax rates.
  4. Remove poverty traps whereby poor people have a disincentive to improve themselves.
  5. Take account of a person’s assets when deciding how much assistance they receive.
  6. Consider as many circumstances as possible to determine that assistance.
  7. Treat everybody equally when deciding assistance.
  8. Provide people with an incentive to declare their income accurately.
  9. Ensure no one has an incentive to change their circumstances or rearrange their affairs in order to avoid tax or gain welfare.
  10. No one gets penalised for failing to rearrange their affairs.


Let’s consider a strategy that can capture the desired results.

  • Tax almost everyone at the same marginal rate – a flat proportional tax. That must be fair.
  • Pay everyone the same welfare payments based on their circumstances – universal payments. Same rules for everyone.
  • Pay the same welfare to all, regardless of income. Changes in one’s income do not affect the amount of welfare.
  • Add wealth to the list of circumstances that determine one’s welfare payment. Importantly, we must include the family home in the calculation of wealth. Have an age-based threshold of wealth and only wealth above the threshold affects the payment.
  • Include income tax previously paid as a circumstance in order to boost the welfare payment of those that have contributed.

The result would be a very simple income tax system, with just two rates – one for ordinary people and one slightly higher for the very well-remunerated. The vast majority of ordinary people would pay the same basic marginal tax rate on all income and there would no longer be a tax-free threshold.

Factors affecting welfare payment

Social welfare would be simpler too. It would never have to take account of someone’s income, but would take account of some basic demographic information. Here are the major ones:

  1. Household type: single without dependents, single with dependents, couple with dependents, couple without dependents, in foster care etc.
  2. Age – child, adult and aged.
  3. Disability – a variety of disabilities with a variety of payments.
  4. Carer – related to the disability.
  5. Tax paid in prior period – a formula based on previous tax paid up to a limit.
  6. Under twenty-five living at home.
  7. In education.
  8. Total net wealth – above an age-based threshold.
  9. Number of children qualifying.

This seems like a long and complex list, but these items are already in many social security calculations. Moreover, it is far simpler not having to account for changes in income. Note that rent payments will not need to be included as a circumstance as this will be implicitly captured by a person’s wealth and employment status has disappeared from the list as it becomes irrelevant.

What would it be like in operation?

The amazing thing, when you apply this method of flat tax and universal asset-tested payments, is that the result is quite similar to the existing complex arrangements in terms of disposable income, but without the complexity, the loopholes and the confusion. Above all it is fair.

Some examples:

Compare three working families

Suppose the flat income tax rate was set at 37%.

Family one has two adults and two children with a combined income of $100,000. They pay $37,000 tax. Each adult gets a welfare payment of $10,000 and the children get welfare payments of $5,000 and $3,000 respectively. Because each adult paid tax in the preceding period they get an additional payment of up to $3,000 each. Ultimately, their net disposable income is $97,000 (97% of gross.)

Family two with a combined income of $200,000 will pay $74,000 in tax and receive the same welfare payments of $34,000. Their net disposable income is $160,000 (80%)

Family three with $400,000 income has a net disposable income of $286,000 (71.5%)

As you can see, the proportion of disposable income declines as income rises, which is a progressive system. In each case, high or low income, the families have equal incentive to earn money.

Add wealth into the equation

Now add wealth into the equation. The welfare payment reduces by 0.6% of each family’s wealth over an aged-related threshold. If the combined threshold is $500,000 and family two has assets of $1.5 million they will lose $6,000 from their welfare payment so their net income is $154,000 (77%.)

Family three has $5.0 million in assets above their threshold, so they will lose all of their welfare payment. Their net disposable income drops to $252,000 (63%.)

The changes in peoples’ circumstances, including net wealth, produces an intuitively fair and reasonable change in their overall tax burden and welfare benefits.




Outrage is such a good feeling. Pity it doesn’t actually achieve much.

With the very popular reception to the Royal Commission into banks and people enjoying their daily shot of outrage, I thought of a great idea. There are many other juicy topics that can be put before a Royal Commission, such as the ATO, Centrelink, climate change, electricity prices, live animal exports, immigration, Islam, Sydney’s light rail, renewable energy, Sydney property prices and what about the legal system itself and lawyers fees? With all of these opportunities for outrage the whole population would be abuzz, like flies on the carcass of a dead sheep heading for the Middle East.

But it still might not be enough, so I propose the ultimate “Royal Commission into Everything!” In many years, after it draws to a close and presents its 325 million page report with 17,325 recommendations we could all breathe a sigh of relief that Everything was now OK. There would be silence in all the pubs, nightly news would be a sports report, and the newspapers would all close their doors. Barry Cassidy would retire.

Peace would reign. Good night.

Remember the ‘Talkfest’?

Kelly O’Dwyer once said that the proposed Royal Commission would become a “talk-fest” that would kick the can down the road for a number of years. Proponents of the commission now are crowing that the recent revelations prove they were right, but I think they actually prove that Ms O’Dwyer’s original take was correct. All that the commission is achieving is airing matters that have already been dealt with by existing regulators.

The existing regulators do a good job and very little gets past them. The bank I work for is extremely diligent about meeting the requirements of the regulators and has been enhancing its compliance capability year on year, long before the Royal Commission. So why do these incidents keep happening? Given staff turnover in, say, a five year period, a large bank may have 60,000 individual employees and thousands of associated agents and brokers engaging with millions of customers in millions and millions of transactions, some of them extremely complex. Some employees may make mistakes and others may be bad eggs. The bad eggs are gotten rid of and the mistakes a compensated. Among those millions of customers there will always be some dissatisfied customers and if each of them gets a day before the commission then this is going to be a very tedious process.

It is laughable that the Royal Commission is ‘revealing’ issues that were satisfactorily dealt with long ago. Is it just an excuse for some popinjay to strut about making sarcastic comments?

It also seems that one particular bank is coming up over and over again, but no one in the press is brave enough to point fingers at which bank.

One person giving very emotional evidence that her bank’s financial advisor had destroyed her retirement plans attracted a lot of attention. But when you read the details of her case you found that she was merely lamenting the unfortunate fact, that after a lifetime of work, she and her husband were ‘poor.’ They had received compensation. The advisor who gave them bad advice made the mistake of not telling them, at the outset, that their retirement dream was not affordable. Besides, the real culprit turned out to be one of the rules surrounding how SMSFs can invest.

Anyway, the simple-minded and voyeuristic will again have another chance to feel outraged, and that’s important.

If it’s a good policy it doesn’t need exemptions.

My instincts already lead me to distrust anything that Bill Shorten says. Recently he found a way, in the name of fairness, to save $65 billion dollars in the budget by not paying franking credits to people with low ‘taxable’ income. His policy was targetted at the Liberal heartland of older self-funded retirees. Then someone pointed out that this policy would hurt poorer people as well so he back-tracked and said, of course,  genuine pensioners would be exempt. But then an ordinary working person with a low income and some shares might also be affected. What then? Another exemption?

The lesson to learn is that making policies on the basis of political considerations is always going to lead to inconsistencies, and then making exemptions creates more inconsistencies.

Good policies don’t require exemptions. Exemptions create opportunities for people to adjust their behaviour to take advantage of the new loophole. Costello created the problem back 11 to 13 years ago. He first exempted drawing from a retirement fund from income tax. That was reasonable, as such drawings are like taking money from your bank account. But he also made earnings within a retirement fund free from tax. Contributions to super funds were already concessional. At first, the cost to the budget was minimal, but now it is huge and growing. While superannuation rules were originally created to encourage ordinary Australians to contribute to their own retirement, Costello created a virtual tax haven on-shore that mainly advantaged the already wealthy.

Super concessions were initially there to compensate those who were not drawing a pension, but we now had the case where the tax concessions far exceeded the value of universal pensions. The current government has already put in train some changes which will, over time, dilute the worst excesses of Costello’s policies. These same policies will also negate the effect of Shorten’s thought bubble.

There should be some simple rules that can be applied to see if a budget measure is a good one.

  • Does the measure encourage an undesirable change in people’s behaviour?
  • Does the measure apply to citizens in an equitable manner or in a regressive manner?
  • Does the measure discourage self-reliance and invite people to become welfare dependent?
  • Is the measure so complex that an ordinary person requires a planner to assist them, even though they probably don’t realise it?

Here are some examples of what I mean.

I saw a chart of incomes reported to the Tax department and many of them were clustered just below the marginal tax thresholds, like $87,000. This was very sad because it meant these people didn’t understand marginal tax rates. They had forgone income they could have earned and enjoyed because they thought that by earning over $87,000 they would pay a lot more tax.

The baby bonus was a bad policy because some naive poor women had children just to get a small bit of cash.

People will delay or sabotage their recovery from illness or injury in order to gain a disability allowance. The reason for this is that unemployment benefits are so miserly and difficult to qualify for.

Asset tests on pensions are bad policy (in their current form) because the exemption for the family home and the rules about gifts make it impractical for some pensioners to sell their large home for a smaller one.  Likewise, farmers who want to stay on their farm (their home) after they retire will be penalised because of a rule about property size.

Let’s ask a few questions that might point us to good tax or pension policy.

  • Who should get a bigger pension? A person with a $3million home or a person with just $100,000 in the bank? (I think they get about the same.)
  • Who pays more tax? A 25 year-old person with a $1million home, $0.5million in super and income of $80,000 or a 55 year-old with the same income but no assets? (It’s the same, except that the super fund will pay a little tax.)
  • Who should get more income assistance? An unemployed couple with two teenage children or a single teenage girl with one child under five living with her mum? (I’m pretty sure that the single parent gets a lot more.)
  • If a man put his home into a trust many years ago but then died and the proceeds of the trust passed to his spouse, what would be the tax consequences? I think his wife will have a huge CGT bill to pay.

I often read Noel Whittaker’s column in the Herald. Apart from constantly reminding me how poor I am, it amazes me what a minefield awaits unwary people when they make decisions about their wealth, getting pensions, saving on CGT etc. In most cases Noel can only tell people the rough chances of their plans blowing up in their faces and suggest that they get professional advice. It’s as if the gnomes who populate the bureaucracy are constantly manipulating the rules to trap the poor fools who haven’t done their homework.

So I conclude that the current system is both complex and unfair, littered with inconsistencies and loopholes that punish the naive and reward the cunning.

My view is that simplicity is key to fairness and that exemptions may seem to be justified in some cases but we should always think whether there is another way to achieve the same end. I’ll give my plan in a future blog.







“The Martians are foreclosing” – IMF report

“Lies, damn lies and statistics.” … a quote from some dead guy.

I’m not interested in people who lie with statistics, more interested in people who use statistics that just don’t make sense or actually show just the opposite of what they purport to show.

Here is an example. “Men are more promiscuous than women because men have more sexual partners.” Does it make sense? No. On average the number must be the same! Unless men are including rubber dolls, or something. The true conclusion would be, “Men exaggerate.”

At times we hear that the opposition bemoaning the high current account deficit, while the government is boasting about the high level of overseas investment. However, a current account deficit (trade in goods and services plus interest payments) always equals a capital account surplus (net foreign investment.) They must be the same.

I saw recently that 70 percent of Muslim women have been abused on public transport. That is a shocking and sad statistic, but on the other hand, 30 percent of Muslim women have never been abused on public transport, which is quite an achievement. To put it in perspective, only 0.5% of Australians are Muslim women, while the number of disgusting people who abuse them is unknown. But the number of offenders is small enough that 30% of Muslim women have so far escaped this kind of abuse by this person or persons unknown. That seems like a good thing. Since offenders get many chances to offend, that might imply that the number of abusers is actually quite tiny.

A few years back the ABC had an expose on inner harbour pollution on Sydney Harbour caused by heavy metal contamination. They found a man of Greek heritage who had caught and ate seafood from the inner harbour every day for forty years and he had some heavy metal levels twice (yes, twice!) the WHO standard. The implication was that this was shocking. But for me it was reassuring as I could definitely eat as much inner harbour seafood as I liked as I would never come near the WHO standard!

The ABC had an interesting take on the statistics related to the Catholic Church and the Child Sexual Abuse Royal Commission. Under the heading, “The worrying figures from the 2000s”, the ABC said, “In the full report there are datasets that appear to show there is very little abuse happening in the last decade of survey — the 2000s.” For the ABC, what was cause for worry? That they wouldn’t be able to keep up their anti-Catholic crusade?

Two days ago the IMF reported, “Global debt hit a new record high of $164 trillion in 2016, the equivalent of 225 percent of global GDP. Both private and public debt have surged over the past decade.” Sounds shocking, but when you realise that one man’s debt is someone else’s asset, then there really should be no reason for concern – unless we borrowed from Martians and they are planning to foreclose. I think the IMF should try finding out who the hell keeps lending all this money! If something terrible like the climate suddenly changing and rising sea-levels swamping all our valuable assets – now that would be something to worry about.

12 May 2018 – I was watching the PBS Newshour and they were looking at ordinary people’s assessment of Mr Trump. One of those ordinary people said that Trump had reduced unemployment from 20% to 2%. Even from over here in Australia I knew that wasn’t right but the PBS panellist only said, “that is an impressive statistic!” Would be if true. Unemployment reached 10% when Obama became Pres after the GFC but had reduced to 4.5% by the time Trump was elected. Now it’s 3.9%. Congratulations Mr Trump, you reduced unemployment by 0.6%!