There was a time when Australia had a far simpler taxation system, one with lower rates and greater incentives for work and productivity. Taxes were introduced on income from personal exertion by the Australian colonies between 1884 and 1902. South Australia was the first to introduce a tax on income in 1884 at a rate of 1.25%. After an initial attempt in 1886, New South Wales introduced an income tax of 2.5% in 1895. In 1902, Queensland levied a tax at rates up to a maximum of 5% on income from personal exertion. Finally, Western Australia introduced an income tax of 1.66% in 1907. Of course, simplicity and incentives for work were even greater before these taxes were introduced.
Facing the cost of war, in 1915 the Federal government decided to introduce a tax on income from personal exertion at rates from 1.25% to around 13% for amounts below £7,600 ($743,540), and 25% after that. The income of companies was taxed at a flat rate of 7.5%. Upon the introduction of the Act, the Attorney-General said, “This Bill, of course, is frankly a War measure designed to meet the present circumstances … No doubt this Bill reaches the high-water mark of income taxation, but it does not do so without ample warrant”. The war is now over but the tide of taxation has not receded.
From 1915 until 1942, both State and Federal governments levied income tax. Amid the expenses of another world war, in 1942 the Commonwealth passed four Acts as part of the ‘Uniform Tax Scheme’. These Acts raised the Commonwealth income tax and, through section 96 of the Constitution, granted an amount of money to the States (approximately equal to what they would have received from their own income tax) on the condition that they would not levy an income tax. Commonwealth exclusivity in the field of income tax was to be temporary. No word yet on the end date.
Centralisation, Higher Taxation and Greater Complexity
Through the demands of war and the centralisation of power, governments have increased spending and taxation. This increase in tax has led to greater complexity. In making representations to their elected representatives, rather than argue for a lower tax rate for everyone, interest groups are far more likely to argue for special deductions, exemptions or subsides, adding to complexity and requiring more taxation from the rest of the public. As the tax rate becomes higher, special concessions become far more profitable for the interest group. Since each concession represents only a small portion of the budget, an interested politician is likely to lend a listening ear. Economist Milton Friedman explained how special interests prevail in a democratic system as the concentrated interests of the few overwhelm the diffuse interests of the many.
“The benefit an individual gets from any one program that he has a special interest in may be more than canceled by the costs to him of many programs that affect him lightly. Yet it pays him to favor the one program, and not oppose the others. He can readily recognize that he and the small group with the same special interest can afford to spend enough money and time to make a difference in respect of the one program. Not promoting that program will not prevent the others, which do him harm, from being adopted. To achieve that, he would have to be willing and able to devote as much effort to opposing each of them as he does to favoring his own. That is clearly a losing proposition.”
Any government inquiry will also be affected by these incentives. A member of the public will not likely make a contribution unless there is a highly concentrated interest to serve. It is likely that the contributions received will argue for special deductions or exemptions, adding yet more complexity to the existing taxation system.
A brief survey will show how complexity has arisen in our present taxation system. To prevent leakage from high rates of income tax, the federal government introduced fringe benefits tax as well as high rates of tax on undistributed trust income and the unearned income of minors. Before capital gains tax, a taxpayer could avoid income tax by investing in an asset that appreciated in value rather than delivered a flow of income. Even after introducing capital gains tax, the government has introduced new methods of calculating gain plus rollover relief, concessions and exemptions. With high personal and company tax rates, dividend imputation was introduced to eliminate double taxation of dividends. In recent federal budgets, the federal government has introduced more complexity with differential rates of company tax for companies with turnover of less than $10 million as well as an 8% discount on tax payable for unincorporated enterprises up to a cap of $1,000. Meanwhile, the federal government expands the Tax Avoidance Taskforce to enforce tax rates that are uncompetitive on the world market.
An Aim for Lower Tax
How can the burden of taxation on Australians be lowered and simplified, with greater rewards for productive effort? Greater simplicity will most likely be achieved when taxation is lower. This in turn requires lower spending. But how can the government cut spending when the public has such high expectations of government and when the aggregation of special interest groups are arguing for subsidies. Is anyone really going to volunteer that subsides or special consideration be withdrawn from their own situation or line of business? No! Clearly, lower taxation and government spending will be very difficult to achieve.
Recommendations for Lower Spending and Taxation
In order to achieve this, the balance of incentives must be tilted towards lower spending and lower taxation. This can be achieved using two approaches: the indexation of personal income tax brackets, and the decentralisation of taxation and spending power from the federal to state governments.
Indexation of Income Tax Brackets
With a progressive income tax, a government can increase tax revenue over time through ‘bracket creep’. As income rises with the general price level, it is taxed at a higher rate. This process lowers the incentive to work over time, as income earners are able to keep less of their income. Bracket creep is also an automatic tax increase without the requirement of legislation. It enables politicians to avoid the political cost of announcing tax increases, and lowers scrutiny on government spending. In order to avoid the problems of bracket creep, income tax brackets could be indexed to the higher of consumer price index or earnings.
Decentralisation of Taxation and Spending Power
At the moment, state governments compete with each other in the areas of payroll tax, stamp duty, land tax and workers’ compensation premiums. States aim to keep spending tight and ensure they are getting value for money so that they can offer lower tax environments to encourage business to create jobs and be productive in their state. Where a business sees opportunities in another state, and the tax environment is more favourable to productive activity, it is relatively easy for the business to move.
While the tax system of the Commonwealth competes in an international market, it is more difficult for an Australian citizen to move overseas than to move to a different state. If Australians think that Commonwealth taxes are too high, they must leave for another country and perhaps obtain a whole new citizenship. This could take years and may be an uncertain prospect. Compared to a state, the Commonwealth government has less incentive to temper their taxation and spending because it is more difficult for citizens to leave for a different country than to move to a different state. Economist Hans-Hermann Hoppe explains how the geographic size of a government’s territory relates to taxation and regulation.
“Smallness contributes to moderation, however. A small government has many close competitors, and if it taxes and regulates its own subjects visibly more than its competitors, it is bound to suffer from the emigration of labor and capital and a corresponding loss of future tax revenue. … the larger the territories, the fewer and more distant the remaining competitors, and thus the more costly international migration—the lower a government’s incentive to continue in its domestic liberalism will be. … Thus relieved of the problem of emigration, a fundamental rein on the expansion of government power is gone.”
This is part of the reason why state governments might be reluctant to have taxation and spending power returned to them. States can use the Commonwealth as a form of tax cartel without having to compete with each other on rates, or take responsibility for increasing taxes. This tax cartel concept applies to the income tax as well as the Goods and Services Tax (GST). The concept also points to the potential consequences of the Commonwealth entering into international agreements to ensure tax compliance. It may result in higher taxation for all countries involved.
In order to tilt the balance of incentives towards lower spending and lower taxation, the Commonwealth could return entire policy areas to state governments. This might involve the lowering of the Commonwealth income tax to allow room for state governments to levy their own income tax so that they can fund services out of their own revenue, rather than requiring grants from the federal government with strings attached. It could also include replacing the Goods and Services Tax with taxes levied by the States. Where to start?
In 2016-17, the Commonwealth will provide the states with $55.3 billion in specific purpose payments (tied grants) and $61.3 billion in general revenue assistance (GST entitlements), a total of $116.5 billion. Total Commonwealth expenses are $450.6 billion.
|Commonwealth Grants to States (2016-17)|
|Amount ($b)||Proportion (%)|
|Specific Purpose Payments||55.280||12.27|
|General Revenue Assistance||61.265||13.60|
|Total Payments to the States||116.545||25.87|
|Total Commonwealth Expenses||450.553||100.00|
According to the budget documents, “The Commonwealth provides payments to the States for specific purposes in policy areas for which the States have primary responsibility. These payments cover most functional areas of State and local government activity, including health, education, skills and workforce development, community services, housing, Indigenous affairs, infrastructure and the environment.” As state and even local governments administer these policy areas, there is no reason why the states should not raise revenue for them.
For 2016-17, the Commonwealth Budget estimates $188.4 billion of income tax on individuals, $64.7 billion in company tax and $57.8 billion in Goods and Services Tax.
|Selected Tax Receipts (2016-17)|
|Amount ($b)||Proportion (%)|
|Goods and Services Tax||57.808||15.86|
|Total Tax Receipts||364.507||100.00|
- Index income tax brackets to the higher of the consumer price index or earnings, in order to avoid bracket creep.
- Cut income taxes by $55.3 billion (around 29.4%) in order to leave room for the states to levy their own income tax (or other mix of taxes). States could use this revenue to fund policy areas covered by Specific Purpose Payments. The Commonwealth might also take the opportunity to lower company tax as part of the tax reduction. This would reduce compliance costs and may see multinational companies shift their profits to Australia.
- Abolish the Goods and Services Tax and allow the States to further increase their income or other taxes to fund policy areas paid for by General Revenue Assistance payments. The Commonwealth would then go without $57.8 billion in GST receipts and cut spending by $61.3 billion.
These policy recommendations would cut the size of the federal government by about one quarter ($116.5 billion in spending) and represent an historic development in federal financial relations. They may also lead to decentralisation of other policy responsibilities. As State governments find value for money in these policy areas, change policy preferences to suit the desires of their own people, and lower taxes, Australians may also find greater opportunity with a lower, simpler and fairer tax system with greater reward for work.
 In 2015 dollars according to the Reserve Bank of Australia’s Pre-Decimal Inflation Calculator
 Woellner, Barkoczy & Murphy (1999) Australian Taxation Law 2000, 10th edition, CCH Australia, p. 8-11
 Bizioli, Gianluigi & Sacchetto, Claudio (2011) Tax Aspects of Fiscal Federalism, IBFD, p. 158
 Friedman, Milton & Rose (1980) Free to Choose, Harcourt Brace, p. 294.
 Hoppe, Hans-Hermann (2001) Democracy—the god that failed, Transaction Publishers, pp. 110-2
 Commonwealth of Australia, Budget Paper No. 3, Federal Financial Relations 2016-17, p. 1.
 Commonwealth of Australia, Budget Paper No. 1, Budget Strategy and Outlook 2016-17, pp. 5-7
 Commonwealth of Australia, Budget Paper No. 3, Federal Financial Relations 2016-17, p. 9.
 Commonwealth of Australia, Budget Paper No. 1, Budget Strategy and Outlook 2016-17, pp. 4-14
 $55.3b in specific purpose payments as a proportion of income tax receipts of $188.4b.