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 Each benefit has to be withdrawn as income rises and that inevitably leads to high effective marginal tax rates.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.

Strategy

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.

 

 

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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.

 

 

 

 

 

 

Case against Pell reminds me of the search for extra-terrestrials

Many years ago there was a TV program looking at the evidence that UFOs really exist. A man had a trove of films of various objects in the sky, each of them evidence of the reality of UFOs. However, he was confronted when one of the films was proven to be fake.

“Oh, yes. That one. That one was fake… but the others, they are real.”

Of course, someone will always believe.

Questions of ethics and sustainability

I’m always interested in the truth, but we do tend to construct our own truths to fit our preferred view of the world. It’s almost impossible to isolate from what we want to believe what is reasonable, ethical or sustainable. It does lead to some extreme contradictions in the strange way that society behaves and what society says is correct. Here are two observed lately:

The world is quite rightly appalled at men behaving badly (from Harvey Weinstein to Barnaby Joyce) but the hottest movie of this weekend is Fifty Shades of Something. From what I can glean, without enduring actually seeing it or reading the books, the series is about a classic narcissistic psychopath and his victim. In real life, he’s the type who throws his girlfriend off the balcony when she defies him. Still, I guess its entertainment. Maybe a Weinstein production?

The second one is more subtle. A young man recently has gained $1.75 million from the estate of the father he never met. The deceased father had denied his responsibility for him as a child after an affair. The judge obviously saw the biological connection as important.  Yet, just two months ago we all cheered when a law was passed that has such a situation as its basic tenet. We have created a new institution that demands that children not be raised by at least one of their natural parents. To me that is not reasonable, ethical or sustainable.

“We need more rope!”

Why does marriage exist in the first place? Marriage exists because men and women produce offspring. Without that simple fact, marriage would not exist. Marriage is unnecessary except for that fact. Society has depended on and nurtured the institution of marriage to provide certainty around the birth of children.

Story: A man visited a mountain kingdom where the people built rope bridges between the peaks so that they could trade with their neighbours. The man returned to his village on the plains and retold his stories. The people were puzzled and dismayed as they looked across the plains. “We need more rope!” they said.

Marriage between men and women has developed in every almost society on Earth for the entire history of man, and long before that, as a way to ensure the continuation of the tribe, the society, the culture. There are some minor exceptions, like the Naxi ethnic group in Yunnan province of China that refrains from marriage. In general though, marriage has been integral in the development of society and civilisation.

Story: The man who had visited the mountains had a better plan. The next morning the villagers were busy digging a deep trench around their village.

The concept of marriage has always been about a man and woman. Gay couples in the past have definitely established long-term relationships but until just recently, no one has expressed a need or desire to call this marriage.

Story: Having built bridges across the trench around their village, the people set off to trade with their neighbours. “Why didn’t we think of this before?” they asked.

Apart from man and woman, other combinations of the two sexes (man and man or woman and woman) do not produce offspring, so their pairing is irrelevant to to the original concept of marriage. Marriage is often celebrated as the act of two loving people coming together but we all know that it is the bit where a child is conceived that makes this pairing so essential to society. So essential that in the last two or three centuries, after thousands of years of custom, tradition and, indeed, thousands of years of religious observance, marriage between man and woman has now become part of the law of most nations.

Story: When the people of the village reached the neighbouring towns and villages they were astonished at what they saw. “Where are your bridges?” they asked. “How can you trade with your neighbours without bridges?”

Why were national laws required around marriage? After all, it is not the place of government to decide who can pair up with whom. When the marriage laws were first written (in British law specifically) there was a big difference between the relative status of the sexes. Marriage, at that time, ensured the legitimacy of a man’s children, protected the woman and her children from exploitation and placed obligations on both the man and the woman. There was already a stigma attached to pre-marital relationships and bearing children “out-of-wedlock”. A woman on her own with children was in the worst possible position.

Story: The people hurried back to their village puzzled to know why other villages did not have trenches and bridges but could still trade with their neighbours. The man who had come back from the mountains was ready. He replied, “Those people haven’t learnt the truth, yet. They are living in the past. Come with me and we can show them the right way.”

So the laws that we have today are based on two basic premises that had been true in most societies in most ages, that women are disadvantaged and require protection, and that their children must be provided for by their father, her husband. These may seem rather quaint concepts today.

Story: The people of the village went out across the land showing everyone how to dig trenches and build bridges so that they could trade with their neighbours. They attested to the stories of the mountain people and their special bridges between the peaks.

Are traditional marriage laws that exist in Australia today applicable to same-sex relationships?

Many of the conditions that existed when the laws were originally written are no longer relevant even for man-woman relationships. Nowadays, women often have children without marriage and the state helps looks after them. Men and women often forego the wedding ceremony and just live together with their children and there is no problem. Women are most often not dependent on a man as they can earn a similar income, although there is still room for improvement. There remains the automatic presumption of fatherhood for the husband.

Story: In the surrounding villages, the people encountered some resistance to their ideas, but they ridiculed and shamed whoever disagreed, and soon all the villages and towns had accepted the truth that they needed trenches and bridges in order to trade with their neighbours.

The preconditions of the marriage laws are not present for same-sex relationships. Obviously there are no issues concerning a mismatch of power between the sexes in the relationship, as both participants are the same sex. In same-sex relationships there are no natural offspring so the parentage of any children would need to be established by some other mechanism in any case. From a strictly logical point of view, same-sex relationships are irrelevant to the original tradition of marriage, and the laws that followed on from that tradition are irrelevant to any same-sex relationship. There is also no social pressure on gay people to marry before they cohabit, so it’s hard to see what is actually behind this push for change.

Story: Years later, a man who lived in the mountains went on a long journey. He came to the plains people’s villages. He asked them why they had trenches and bridges around their villages. They replied, “You should know better than us. After all, we learnt this from your people. It is so we can trade with our neighbours.”

The push for same-sex marriage has been pursued as if a society that doesn’t accept their demands is a society rejecting them altogether. That’s not an appropriate or logical extension. Same-sex couples are already free to have their relationships which are personal and can be just as valid as any relationship without the need for the marriage laws.

Story: The mountain man looked exasperated. “Don’t you realise how we much we resent having to cross those bridges to make the simplest journey and how we envied you people on the plains. You could go anywhere without any hindrance! Couldn’t you be satisfied with living in your own way in your own place?” 

Perhaps, some time in the future, same-sex couples will realise that the campaign for same-sex marriage was really about something else. Then they won’t really care about marriage anymore.

It’s official: Sun will rise in the West!

After countless years of being the last people to see the sunrise, and following a huge grass-roots movement to end the discrimination, a big change is coming for the people of the West (sometimes derogatorily referred to as Westies.)  The government is preparing legislation that will soon see the sun rise in the West.

“This is a small step toward redressing years of discrimination,” said a spokesman for the Westies.

“The consequences of this significant global shift have not been adequately considered,” said a spokesman for the Traditional Sunrise Lobby, to widespread jeers and derision.