Mike Steketee: A way to spark real incentive
April 28, 2005
It's a 30per cent flat tax levied from the first dollar of earned income.
It would be offset at lower to middle incomes by a so-called negative income tax in the form of a flat-rate government payment, while at higher incomes an assets test would apply and many of the vast array of tax concessions would be removed. Company tax would remain at 30per cent and capital gains tax would be raised to the same level.
On his basic proposition of a flat-rate tax, Garnaut, professor of economics at the Australian National University and an influential economic adviser to Bob Hawke as prime minister, keeps some interesting company. The recently departed Joh Bjelke-Petersen was an advocate of flat tax. It has become all the rage in eastern Europe, with single-rate income taxes ranging from 12per cent in Georgia and 13per cent in Russia up to 33per cent inLithuania.
So what is Garnaut on about? In short, setting Australia up for another burst of economic growth, integrating and greatly simplifying the tax and social security systems and making the tax system more progressive.
Garnaut was a participant in the last wave of bold economic reform, including the floating of the dollar in 1983, financial deregulation and tariff cuts. He thinks we are overdue for another bout to stave off a future of mediocre economic performance. And part of that is rethinking the tax system.
"My main objective is to get people thinking about first-best solutions, rather than just tinkering at the edges," he says.
"There is recognition that you need to do something pretty radical like this if you are really going to deal with the problem of [work] disincentive, which has become so horrific as the social security system has expanded."
This expansion has occurred as more people on lower incomes qualify for benefits to supplement income from part-time and low-paid work and as family benefits have grown. Taxes combined with the withdrawal of multiple benefits as incomes rise creates the problem of effective marginal rates of tax of 70per cent or more and the resulting disincentive to take up work.
Garnaut points out that the proportion of the population employed was higher in Australia than the US and New Zealand up until the 1980s but now it is lower than both. One reason he identifies is Australia's higher EMTRs.
His reform would lower these rates for most people to 30per cent. Combined with a freeze in minimum wages, which also are higher than in the US and New Zealand, he suggests that this could raise total employment by 5per cent or more over four to five years.
The tax system would become fairer because most of the opportunities high-income earners have to reduce their tax would be removed. There no longer would be an advantage in diverting income into companies or capital gains because they would all be taxed at the same rate.
As you would expect with such a big-bang reform, there are plenty of potential problems and objections. Garnaut is really proposing a move away from means tests and back towards a universal system as a means of increasing incentives. That makes it expensive.
He suggests phasing it in and paying for future stages from future economic growth, including that unleashed by reform. But that involves an act of faith.
Rather than replacing all benefits, the negative income tax could be paid at the same level as unemployment benefits to those in the labour force -- that is, both employed and unemployed.
Those taking jobs would continue to receive the payment and lose only 30per cent of their earned income, as opposed to 70per cent or more now (although during the phase-in period, the flat tax rate would have to be set higher).
Garnaut says the payment could be removed at high incomes -- perhaps $80,000 to $100,000. This would mean that, having first taken away the EMTR problem, it would return, though less severely and higher up the income scale.
To those few higher-income earners paying tax at somewhere close to the top marginal rate of 48.5per cent, a 30per cent tax would be a boon. Garnaut would accept a higher tax rate for high- income earners but says that it would not add much to revenue because it would apply to only a small proportion of taxpayers.
The Government has been mulling for more than six years over the barriers to work created by high EMTRs but made progress in only a few areas. The problem will only get worse on current trends. Forcing more people into work by changing the eligibility requirements for benefits, as it plans to do in the budget, is a limited response.
The undeniable logic of Garnaut's reform has to be balanced against implementing it in practice and the political risks involved in any bold reform, particularly one advocated from Opposition.
But shadow treasurer Wayne Swan is interested in Garnaut's ideas, particularly in the longer term. "We have relied too much on the social security system to redistribute income rather than on our primary redistributive mechanism, the tax system," he said recently.
There also has been "a bit" of interest from the government side, says Garnaut, "although it doesn't mean the Treasurer is about to run with it".
Still, Garnaut has spiced up the debate.
