Treasurer Jim Chalmers should consider dual income tax

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Now, here is a big, bold idea.

A significant tax reform that could achieve more productive and fairer taxation is a “dual income tax system” used in Nordic countries that splits income and deductions into two components: labour and capital/savings.

It would be a very Labor reform that could assist hard-working wage earners, while delivering fairness and efficiency.

After delivering his first budget on October 25, Chalmers should seriously consider a dual income tax system in the second half of this government term to take to the next election.

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It would be a very Labor reform that could assist hard-working wage earners, while delivering fairness and efficiency.

A flat tax rate of, say, 25 per cent on personal capital income and deductions would be a simpler and more equitable system than the current hotchpotch of concessions and distortions. It would help eradicate the “tax planning” Kennedy lamented.

Currently, a property investor has their capital gains taxed at half their marginal tax rate. For a high-income earner, that equals a top tax rate of 23.5 per cent. But they can fully deduct at a rate of 47 per cent their interest and other property expenses, including against wages and salary. It is an asymmetric arbitrage that makes little sense.

Meanwhile, a simple saver pays a punishing rate of up to 47 per cent on bank interest, with no deductions.

Uniform rate across personal capital income

While there are legitimate asset protection reasons for trusts, they allow streaming of income to beneficiaries to minimise tax for the families of well-heeled people who can afford clever tax accountants and lawyers.

The dual income tax system would ring-fence investment income and deductions at a flat tax rate of perhaps 25 per cent.

Investment losses would be carried forward to offset against future capital income, not immediately or fully deductible against wages.

It may be possible to deduct a portion against wages and salaries, but only the dollar amount determined by a flat 25 per cent capital income rate.

A uniform rate across all personal capital income would slash tax-driven distortions.

Otherwise, selectively picking off individual tax breaks without a comprehensive approach just leads to tax planners shifting to remaining loopholes.

Over time, a dual income tax system would give the government more fiscal capacity to cut income taxes for wage and salary earners and stop bracket creep hitting a record high of more than 26 per cent by 2030, as Kennedy’s analysis shows.

The Australian Taxation Office’s world-class single touch payroll system would also make it easier to distinguish between labour and capital income.

Income tax cuts would be limited to wage and salary earners, and not flow through to tax breaks on capital income. It would be more affordable for the budget.

For years, the Coalition government leaked billions of dollars of tax refunds for “unearned” or passive investment income through the $8 billion annual low and middle income tax offset.

Moreover, at a time of worker shortages, alleviating the tax burden on wage earners would increase the incentive to work more hours and aid workforce participation.

Chance to recalibrate stage three tax cuts

There may also be an opportunity to recalibrate – not cancel – the $15 billion-a-year stage three personal income tax cuts due from July 2024, to get maximum bang for buck.

Perhaps the tax cuts for high-income earners could be partly traded off for clamping down on other concessions on superannuation and capital income.

Longer-term, a dual income tax system may present an opportunity to lower the top personal income tax rate for labour income closer to the capital income rates and the 30 per cent corporate rate.

This would further slash tax arbitrage through companies and trusts.

Former Labor prime minister and treasurer Paul Keating has consistently advocated cutting marginal tax rates, including the maximum 47 per cent rate (counting the Medicare levy) that kicks in at a $180,000 a year.

By international standards, the top threshold applies to relatively modest incomes for wage earners living in high-cost Sydney and Melbourne who are trying to pay a mortgage or rent and raise children.

A simpler tax system and more uniform rates would reduce Australia’s high dependence on tax agents. More than 70 per cent of taxpayers use a tax agent to file tax returns, even though 86 per cent either claim no deductions or claim only work-related expenses, gifts and the costs of managing tax affairs.

In Nordic countries, less than 5 per cent of taxpayers use tax agents.

Australia’s human capital pool would be enhanced by having fewer well-educated tax lawyers and accountants, and diverting these smart people into more innovative and productive engineering, technology and science professions.

Australia National University economists Robert Breunig and Kristen Sobeck have advocated the dual income tax system to apply a uniform tax rate to most savings. They argue the rate on savings should be low – between 5 and 20 per cent – because savings have usually already been taxed as wages. They also suggest taxing the principal place of residence, although this would be politically very difficult.

The 2010 tax review by former Treasury secretary Ken Henry recommended taxing remuneration for work, including wages, salaries, fringe benefits and employer superannuation contributions, “in a more consistent manner and with few exemptions”.

“Income from savings would be taxed on a more consistent basis with other income.”

Chalmers is the government’s best public communicator. He might have the ability to connect with the community and sell economic reforms like Keating.

Chalmers is taking a medium-term view and not rushing to offer counterproductive Band-Aid solutions to cost of living pressures and the energy crisis.

He has learnt the follies of trying to win the daily media battles from his time working as a senior adviser in the Rudd-Gillard governments.

Let’s hope genuine tax reform comes on to his agenda.



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