HOW EQUITABLE IS AUSTRALIA S PROGRESSIVE TAX RATE A … · A progressive tax system is one where the tax burden, being the total amount of tax paid ... of a larger project assessing

JournaloftheAustralasianTaxTeachersAssociation2019Vol.14No.1

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HOWEQUITABLEISAUSTRALIA’SPROGRESSIVETAXRATE?AREVIEWATHIGHERINCOMELEVELS

SALLY-ANNJOSEPH*ANDMICHEALMALLON†

ABSTRACT

Verticalequityisconcernedwithdifferencesinabilitytopay,wherethoseabletoshouldpaymore—thatis,theprogressivityofthetaxsystem.Fundamentaltoanyassessmentofprogressivityofanincometaxsystemistheratestructure,consistingoftaxbracketsandtaxrates.ThisexploratorypaperassessestheprogressivityoftheAustralianincometaxsystem,foryearlyincomelevelsofAUD100,000toAUD250,000.Itfindsthat,whilethesystemisprogressive,itishighlyregressivelyprogressiveatincomelevelsassociatedwithchangesintaxbrackets,becominglessregressivelyprogressiveatthehigherendofeachtaxbracket.

*Correspondingauthor:sally@corporatereform.com.Sally-AnnJosephisapost-doctoralresearcherwithaparticularinterestintaxationpolicyandensuringthesustainabilityoftaxsystems.Sallyhasproducedanumberofinternationallyacknowledgedbodiesofworkandconductedresearchinconjunctionwithsomeofthehigher-profileinstitutionsintheAsia-Pacificregion,includingtheUniversityofNewSouthWalesandtheNationalUniversityofSingapore.†MichealMallonisanorganisationaltransformationspecialistwhoseprinciplefocusisaddingvaluetotheorganisationswithwhich heworks.Hiswork covers operating and businessmodel design through toimplementationthroughorganisationaldesign.Akeyaspectoforganisationaldesign isroledesignanddefinition,and thegradingof roles,whichdefines the incomeandseniority level.Tobeable todo thiseffectively,Michealbelievesitisnecessarytounderstandtheimpactofthetaxsystemontheincomeofindividuals.


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I INTRODUCTION

Aprogressivetaxsystemisonewherethetaxburden,beingthetotalamountoftaxpaidasapercentageofincome,increasesasthetaxableincomeincreases.Itisataxsystembasedontheprincipleof‘abilitytopay’.Thereisaninherentfeelingofequity,offairness,intheterm‘abilitytopay’.When‘equity’isconsideredinmattersoftaxation,itisusuallyconsideredintermsofhorizontalandverticalequity.Ataxissaidtobehorizontallyequitablewhenindividualswithsimilarincomeandassetspaythesameamountintaxes.Ifindividualswithmorewealth,incomeandaccesstomoreresourcespayproportionallyhigheramountsintaxesthenitissaidtobeverticallyequitable.Therearefourinstrumentsavailabletoinfluencetheprogressivityofataxsystem.Themostfundamentaloftheseistheratestructure,whichconsistsoftaxbracketsandtaxrates.Secondareallowancesanddeductions,bothofwhichinfluencethesizeofthetaxbase.Thirdaretaxcredits,whichreducenettaxliability.Lastistheexemptionofcertaintypesofincomefromtaxation,whichalsoaffectsthesizeofthetaxbase.Australia’s income tax system is said to be progressive.1 In addition to its relativelymatureincometaxsystem,Australiahasawell-developedtransfersystem,whichalsocontributestotheprogressivityoftheincometaxsystem.Thesetwosystems,theincometax and transfer systems, are generally considered together as a single tax-transfersysteminstudiesassessingtheequityofthetaxsystem.2Definingwhatconstitutesanequitablebenchmarkhasbeenelusive.AsnotedinthemostrecentreviewoftheAustraliantaxationsystem,Australia’sFutureTaxSystem,‘[w]hetherelementsofthecurrenttax-transfersystemimproveequityornotdependsonarangeofjudgements. People put different degrees of emphasis on different priorities of a tax-transfer system and these priorities can sometimes conflict.’3 Indeed, this report alsonotesthatthereare‘anumberofperspectivesonequitythatpeopleusetoinformtheirassessmentsofthetax-transfersystem’.4

1‘TaxWhitePaper:AtaGlance—TheProgressivityoftheTaxandTransferSystems’,Treasury,AustralianGovernment(WebPage)<https://treasury.gov.au/review/tax-white-paper/at-a-glance>;PeterWhiteford,‘Who Gets What? Who Pays for It? How Incomes, Taxes and Benefits Work Out for Australians’, TheConversation (Web Page, 22 June 2018) <https://theconversation.com/who-gets-what-who-pays-for-it-how-incomes-taxes-and-benefits-work-out-for-australians-98627>.2‘6537.0—GovernmentBenefits,TaxesandHouseholdIncome,Australia,2015–16’,AustralianBureauofStatistics, Australian Government (Web Page, 20 June 2018)<https://www.abs.gov.au/ausstats/[email protected]/mf/6537.0>; Treasury, Australian Government,Architecture of Australia’s Tax and Transfer System (6 August 2008)<http://taxreview.treasury.gov.au/content/Paper.aspx?doc=html/Publications/papers/report/index.htm>;Treasury,AustralianGovernment,Australia’sFutureTaxSystem,ReporttotheTreasurer—PartTwo:Detailed Analysis (December 2009)<http://taxreview.treasury.gov.au/content/FinalReport.aspx?doc=html/Publications/Papers/Final_Report_Part_2/index.htm>;PeterSaunders,Equityand the ImpactonFamiliesof theAustralianTax-TransferSystem(MonographNo2,InstituteofFamilyStudies,1982);AnnHarding,‘TheSufferingMiddle:TrendsinIncomeInequalityinAustralia,1982to1993–94’(1997)30(4)TheAustralianEconomicReview341.3Treasury,Australia’sFutureTaxSystem:PartTwo(n2)s3.2.4Ibid.


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Thisisanexploratorypaperthatexaminesanoldtopicfromanewperspective.Itispartof a larger project assessing the sustainability of the Australian income system. Thispapertakesastepbackandonlyconsidersprogressivityoftheincometaxsystembasedonratestructureandonlyformiddletohighsalaryandwageearners.Specifically, thispaper considers taxpayers earningannual salaryandwagesbetweenAUD100,000 andAUD250,000, and assesses the impact of any increase in salary andwages.Itisnotachoicebetween‘towork’or‘nottowork’,butratherexploreswhethertheincreaseinsalaryandwagesunderconsiderationisworththenecessaryadditionalworkcommitmentrequiredinacceptingapromotionand/orinchangingemployer.TheobjectiveandscopeoftheresearchassociatedwiththispaperaregiveninSectionII.Thisisfollowed,inSectionIII,withaliteraturereview.Thekeyterms‘progressivity’and‘equity’arediscussedinSectionIV,particularlywithregardtotheirinterpretationwithrespect to this research. Section V contains the data, its analysis and deliberation.ConcludingcommentsaremadeinSectionVI.

II OBJECTIVEANDSCOPE

Twofactorscanbehighlightedwithrespecttothetraditionalapproachtoconsideringtheequityoftheincometaxsystem.ThefirstisthattheprogressivityoftheAustraliantax system is not questioned. The second is that a socio-economic approach is taken,wherethetargetisthemosteconomicallydisadvantagedsectorofsociety.Thisapproachis not being questioned by this research. Indeed, it is appropriate given that benefitsunderboththeincometaxsystemandtransfersystemaretargetedmainlyatlowincomelevels(suchasthelowincometaxrebate)oratparticularcircumstances(suchasfamilytaxbenefits).Thispaperdiffersinrespectofitsfocus.Itlookstoexaminehowequitabletheincometaxsystem isat thehigher income levels.Underconsiderationareverticalequityand theprogressivityoftheincometaxsystemattheuppertaxbracketlevels.Itisacknowledgedthatthisisaverysimplisticapproach.However,itwillformthebasisofalargerresearchprojectwith later papers introducing other aspects of progressivity determination toassesstheequitableeffectivenessoftheirobjectivesandontheirtargets.BycommencingwithsalaryandwageearnerswithofAUD100,000toAUD250,000,onecandetermineabaselineunaffectedbyotheraspectsofprogressivity,namelyallowancesanddeductions,taxcredits,exemptionsandtheimpactofthetransfersystem.

Thescopeofthispaperisdelineatedasfollows.Only salary and wage income is considered. Excluded are untaxed income (such asexempt income and non-assessable non-exempt income), passive income (such asinterest,dividendandrentalincome)andcapitalgainsandlosses.Thisisverytaxpayerspecific,notpermittinggeneralisationstobedrawn.Only higher income levels are analysed. This is taxable income from AUD100,000 toAUD250,000.Inaddition,onlyannualincomesareconsidered.Itisacknowledgedthatalifetimeorlifecycleperspectiveisabettermeasureofpermanentincomeoverthecourseofalifetime,andthereforemoreaccurateincomparingdifferentmake-upsatanygiven


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levelofincome.5However,asthefocusofthisresearchisonadecisiontobemadeataparticularpointintime,anannualperspectiveisappropriate.Thetaxratesusedarethoseforthe2018–19incomeyear,foranindividualwhoisanAustralian resident for tax purposes. The Medicare levy is included as it affects alltaxpayers.TheMedicarelevysurchargeisdisregarded.Governmenttransfers,particularlywelfare-typeprogrammes,accruedisproportionallytothe lower levelsof incomedistributionandreduce inequality indisposable income.Conceptually,suchtransfersshouldbeincludedinanyassessmentofprogressivityofataxsystem.Giventhefocusofresearchisonthehigherlevelsofincomedistribution,andconsideringthattransfersrepresentasmall fractionofupper-middleandhighincomeearners’incomes,ignoringthesetransfersshouldhavelittleimpact.

Behaviouralresponses,suchastaxavoidanceandtaxminimisation,areignored.Thesevaryinsizeandimpact,requiringgeneralequilibriummodellingtodeterminetheireffecton total tax burdens.6 Considering the basic case with no behavioural response isthereforeausefulstartingpoint.Itisalsotobenotedthatsalaryandwageearnersdonothaveachoicebetween‘working’and‘notworking’.Anyreductioninhourswillgenerallyresult in a corresponding pro rata decreasing adjustment of their salary and wages.Further,salaryandwageearnersatthehigherincomelevelsareusuallycontractedtocompletetasksratherthancompleteapredeterminednumberofhours,asmaybethecaseunderenterpriseagreements.Thus,workingmorethanthestandard38hoursperweekwillalmostneverresultinanyadditional,orovertime,pay.7Finally,andtoavoidalldoubt,onlyincometaxisconsidered.Allotherfederalandallstatetaxesareignored.TheGSTisconsideredtoberegressive,aslower-incomeindividualsspendalargerfractionoftheirincomeontaxedconsumptiongoodsandservices.Asthestatetaxes impactingon individualsaregenerallyrelatedtoproperty(stampduty)orpersonal choices (gambling tax), ignoring these will have no consequence on theresearch.The research, therefore, considers what is normally referred to as middle and highincomelevels.Thesetermsare,however,notdefined.Studiesthatdorelatetoincomelevelstendtofocusonhouseholdincome,8whereastheincometaxsystemisconcernedwithindividualincome.IntheAustralianincometaxsystem,incomeisdividedintolevelsreferredtoas‘taxbrackets’,towhichaparticulartaxrateapplies.TheAustralianBureau

5ThomasPikettyandEmmanuelSaez, ‘HowProgressiveIstheUSFederalTaxSystem?AHistoricalandInternationalPerspective’(WorkingPaperNo12404,NationalBureauofEconomicResearch,July2006)8.See also Productivity Commission, Australian Government, ‘Tax and Transfer Incidence in Australia’(WorkingPaper,7October2015).6DonFullertonandDianeLimRogers,WhoBearstheLifetimeTaxBurden?(BrookingsInstitution,1993).7FairWorkOmbudsman,AustralianGovernment,MaximumWeeklyHoursandtheNationalEmploymentStandards (Fact Sheet, July 2017) <https://www.fairwork.gov.au/how-we-will-help/templates-and-guides/fact-sheets/minimum-workplace-entitlements/maximum-weekly-hours>.8See,forexample,AustralianCouncilofSocialServiceandUniversityofNewSouthWales,InequalityinAustralia2018(2018);TimEdwards, ‘Australia’sHouseholdIncomeandWealthDistribution’,Mccrindle(Blog Post, 2019) <https://mccrindle.com.au/insights/blog/australias-household-income-wealth-distribution>; ‘6523.0 — Household Income and Wealth, Australia, 2015–16’, Australian Bureau ofStatistics, Australian Government (Web Page, 13 September 2017)<https://www.abs.gov.au/AUSSTATS/[email protected]/DetailsPage/6523.02015-16?OpenDocument>.


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ofStatistics,ontheotherhand,dividesincomeandwealthintoquintiles,andoftenatthehouseholdratherthanindividuallevel.9Onewayofdeterminingwhatareconsideredlow,mediumandhighincomelevelsisbyconsideringtheoffsetsavailable.ThelowincometaxoffsetcutsoutatincomelevelsaboveAUD66,667.Eligibilityforthelowandmediumincometaxoffset,ontheotherhand,istaxableincomeuptoAUD125,333.Therefore,fortax purposes, amedium income level is onewhere the taxable income ismore thanAUD66,667anddoesnotexceedAUD125,333.BydefinitionataxableincomeexceedingAUD125,333isconsideredtobeahighincomelevel.

III LITERATUREREVIEW

Whentaxesincrease,therearebothpositiveandnegativeoutcomes.Thepositiveisanincreaseinrevenuethatcanbeusedtofundgovernmentalspendingortoredistributeundergovernmentalpolicies.Thenegativeisthattaxincreasesmaydiscouragetaxpayersfrom working. Thus, there is an inevitable trade-off between raising revenue anddistortingtaxpayerbehaviour.10

A OptimaltaxmodelsAsaresultofthistrade-off,optimaltaxmodelshavebeendevelopedtoprovideinsightsintowhatataxsystemshouldlooklike.11PikettyandSaezconsiderthe‘classicaltrade-off’ between promoting social welfare through taxation and preventing negativeinfluencesoneconomicproductivity.12ZelenakandMoreland’soptimaltaxmodelseekstoanswerthequestion:‘Whatistheidealtaxandtransfersystem?’13Othermodelsexplorehowindividuals’preferencesshapethetaxsystem.Theythereforecapturehowtaxpayersofdifferentincomeshavedisparatepreferenceswithrespecttothetaxsystem.Forexample,MeltzerandRichardconcludethat,whentheincomeofthe‘decisivevoter’ is less than themedian, theywouldchoose to increase taxesand fundmoreredistribution.14ForRoberts,‘[i]fthemedianincomeislessthanthemeanincome…thenmajorityvotingwill leadtothetaxschedulewiththehighestmarginaltaxratebeing adopted’.15 Taking a different perspective, Romer concludes that, ‘[f]or a givengovernmentrevenuerequirement,thepoorerindividualstendtofavourhighermarginaltaxrates’and,asaresult,‘[t]heconflictbetweenhighnationalincomeanddistributional

9 Groupings that result from ranking by the level of economic resources (income orwealth) and thendividingthepopulationintofiveequalgroups.10EdwardJMcCafferyandJamesRHinesJr, ‘TheLastBestHopeforProgressivityinTax’(2010)83(5)SouthernCaliforniaLawReview1031,1054;ThomasPikettyandEmmanuelSaez,‘OptimalLaborIncomeTaxation’inAlanJAuerbachetal(eds),HandbookofPublicEconomics(NorthHolland,2013)vol5,391.11See, forexample,PikettyandSaez, ‘OptimalLaborIncomeTaxation’(n10);JAMirrlees, ‘OptimalTaxTheory:ASynthesis’(1976)6(4)JournalofPublicEconomics327;JAMirrlees,‘AnExplorationintheTheoryofOptimumIncomeTaxation’(1971)38(2)ReviewofEconomicStudies175.12PikettyandSaez,‘OptimalLaborIncomeTaxation’(n10)392–3.13 See, for example, Lawrence Zelenak andKemperMoreland, ‘Can theGraduated IncomeTax SurviveOptimalTaxAnalysis?’(1999)53TaxLawReview51.14AllanHMeltzerandScottFRichard,‘ARationalTheoryoftheSizeofGovernment’(1981)89(5)JournalofPoliticalEconomy914,916–17.15KevinWSRoberts,‘VotingoverIncomeTaxSchedules’(1977)8(3)JournalofPublicEconomics329,331–2.


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equalityisparalleledbyaconflictofinterestbetweenrichandpoor’.16Whatthesetaxmodelsclearlyillustrateisthattaxpayers,ontheentirespectrumfrompoortorich,preferdifferenttaxsystemsbasedonhowmuchtheyarepersonallytaxed,howthebehaviourofothercitizensareaffectedbythetaxsystemandhowmuchredistributionoccurs.Anyoptimaltaxsystemmodelrequiresseveralinputs.First,elasticity,whichisameasureofhowsensitivetaxpayersaretotaxrates.Thehighertheelasticity,themoretaxpayersare likely to change their behaviour in response to higher taxes.17 There are severalfactorsthatcanaffectelasticity,includingindividualcircumstancesataparticularpointintime,ageandgender.Inastudyconductedin2002,GruberandSaezfoundthattheoverallelasticityoftaxableincomewas0.4,risingto0.57forthosetaxpayerswithalevelofincomeoverUSD100,000.18Thisseemstoindicatethatthehighertheincome,themoreelastic is the response to increased tax rates. French, on the other hand, calculatedelasticitybasedonage.Thisstudyfoundthatelasticityincreasesfromarangeof0.19–0.37beforeage60,to1.04–1.33afterage60.19Asageneralrule,thereisacorrelationbetweenolder taxpayersandhigher income levels.Therehavebeenelasticity studiesfocusedonthetoptaxbracket.20However,thefocushasbeenondetermininghowhightherevenue-maximisingtaxrateshouldbe.Thatis,thelocationofthetaxpayeralongtheincomescaleis‘criticallyimportantforrevenueresponsestotaxratechanges’.21Thesecondinputtobeconsideredisthedistributionoftaxpayerearningability.22Thisincludesnotonlynumbersoftaxpayersalongtheincome-earningspectrumbutalsothegap between the earning ability of the rich and the poor. However, earning ability isunobservableandcanthereforeonlybemodelledratherthanmeasured.Finally,thereisthesocialwelfarefactorthatrequirescombiningandvaluingtheutilitiesof the individuals in the population. That is, it is a measure of the ‘useful-ness’ orsatisfaction that an individual obtains from its consumption. Therefore, the choice ofsocialwelfarefunctionaffectsdifferentmembersofsocietydifferently.23Indesigninganoptimaltaxsystem,theseinputsmatter.McCafferyandHinesnotehow‘optimal tax models are extremely sensitive to changes in key assumptions andparameters’.24 If sensitivity to taxes is high/low (elasticity), if there is moreequality/inequality (earning ability distribution), and if more care is given to the

16ThomasRomer,‘IndividualWelfare,MajorityVoting,andthePropertiesofaLinearIncomeTax’(1975)4(2)JournalofPublicEconomics163,171.17PikettyandSaez,‘OptimalLaborIncomeTaxation’(n10).18JonGruberandEmmanuelSaez,‘TheElasticityofTaxableIncome:EvidenceandImplications’(2002)84JournalofPublicEconomics1,3.19EricFrench, ‘TheEffectsofHealth,Wealth, andWagesonLabourSupplyandRetirementBehaviour’(2005)72(2)ReviewofEconomicStudies395,411–12.20See,forexample,ESaez,JBSlemrodandSHGiertz, ‘TheElasticityofTaxableIncomewithRespecttoMarginalTaxRates:ACriticalReview’(2012)50JournalofEconomicLiterature3;SHGiertz,‘TheElasticityofTaxableIncome:InfluencesonEconomicEfficiencyandTaxRevenues,andImplicationsforTaxPolicy’inADViard(ed),TaxPolicyLessonsfromthe2000s(AEIPress,2009)101.21 John Creedy and Norman Gemmell, ‘Measuring Revenue-Maximising Elasticities of Taxable Income:EvidencefortheUSIncomeTax’(WorkingPapers inPublicFinanceNo02/2014,VictoriaUniversityofWellington,January2014)20.22Mirrlees,‘AnExplorationintheTheoryofOptimumIncomeTaxation’(n11)176–7.23ZelenakandMoreland(n13)53.24McCafferyandHines(n10)1057.


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poor/rich(socialwelfarefactor),thentheoptimaltaxsystemchanges.Thus,forexample,iftheelasticityoftaxpayerbehaviourishigh,theoptimaltaxsystemwillgenerallyfeaturelowerrates;theoptimaltoptaxratewillchangeifthedistributionofearningabilityatthetopendofthepopulationisdifferent.25

B ApplicationtoresearchWhileitisnecessarytoconsidertheliteratureonoptimaltaxsystems,theparametersofthis research are more limited. The focus is on taxpayers with salary and wages ofAUD100,000 to AUD250,000. The inputs for this research, as determined from theliteraturereview,are:

• elasticityishigh,meaningtaxpayersaresensitivetoincreasesintaxrates• earningabilityismeasuredasannualsalaryandwages• social welfare is not applicable, as only a portion of the total population is

considered.

IV TERMDEFINITIONS

Thisresearch isconcernedwith ‘progressivity’and ‘equity’.Thissectionexaminesthemeaningofthesetermsandhowtheyareinterpretedforthepurposesofthisresearch.

A MeasureofprogressivityAnincometaxsystemmayberegressive,proportionalorprogressive.Aregressivetaxsystemisonewheretheincreaseintaxliabilityislessthantheincreaseinincome,whiletheincreaseintaxliabilityandincreaseinincomeisuniforminaproportionaltaxsystem.Aprogressivetaxsystemmeansthattherateofincreaseintaxliabilityishigherthantherateofincreaseinincome.Anotherwayofphrasingthisisthat,inaproportionaltaxsystem,theaveragetaxrateequalsthemarginaltaxrate.Inaprogressivetaxsystem,theaveragetaxrateislowerthanthemarginaltaxrate,whereastheoppositeholdstrueforaregressivetaxsystem.A progressive tax system itself may be regressive, proportional or progressive. Ifregressive,therateofprogressiondecreaseswhenenteringintohighertaxbrackets.Aproportionalprogressionmeansthattherateoftaxincreasesuniformlywiththerateofincreaseinincome.Andtherefore,bydefinition,aprogressiveprogressivetaxsystemisonewheretherateofincreaseintaxexceedstherateofincreaseinincome.Whilethesedefinitionsofregressivity,proportionalityandprogressivityareuniversallyaccepted,measuringthedegreeofincometaxprogressivityisnotassettled.Therearetwoconventionalwaysofmeasuringprogressivity.Thefirstmeasureisaccordingtothedifferencebetweenthetaxratespaidbyhigh-incomeandlow-incomegroups.Forthis,thefocusisontaxbrackets(includingthetax-freethreshold)andmarginaltaxrates.Thesecondiswhereprogressivityismeasuredasthegreatertheshareofincomereceivedby

25PikettyandSaez,‘OptimalLaborIncomeTaxation’(n10)412.


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therich,thegreatertheirshareoftaxespaid.Herethefocusisontheproportionofthepopulationwhoarehighincomeearnersandontheshareoftaxpaid.Variousmethodsareproposedthatexpresstheratioofchangeinthevariablesusedinthecalculation.Pigoudevelopedtwomeasures,thefirstbeingaveragerateprogression,whichmeasures the change in the average tax rate, and the second ismarginal rateprogression, which is the ratio of change in the marginal tax rate to the change inincome.26Alternativemeasuresareliabilityprogression,whichmeasuresthepercentagechange in tax liability to the percentage change in income, and residual incomeprogression,whichmeasurestheratioofthepercentagechangeinincomeaftertaxtothepercentage change in income before tax.27 A variety of other measures have beenproposed,28includingusingtheshareoftaxespaid,29andcomparingtheimpactofataxwithmoregeneralmeasuresorindexesofincomeinequality.30For this research, progressivity is defined as the gap between pre-tax and post-taxincome.Itisnottheamountoftaxpaid.

B EquityEquityisoftenassociatedwithredistribution.Indeed,‘theequityorredistributivegoal’hasbeenstatedtobeoneofthe‘overallobjectives,orprinciples,oftaxation’.31The concept of equity, or fairness, refers to the fact that the tax system should beequitable in theway taxpayersare treated. It isusuallydefined in termsof ‘economicposition’.Thatis,

[h]orizontalequityrequiresindividualsinthesameeconomicpositiontobetreatedthesamebythetax-transfersystem.Verticalequity isgenerallyconsideredtomeanthatindividualsindifferenteconomicpositionsshouldbetreateddifferently,usuallywiththosehavinggreatereconomiccapacitypayingmore.32

Here‘economicposition’isdefinedbyreferencetocriteriasuchasfamilycircumstancesandgeographicalarea,notmerelytoindividualincome.Thus,twotaxpayerswithequalincomes,thefirstbeingsingleandthesecondmarriedwithtwochildren,arenotregardedasbeinginthe‘sameeconomicposition’.Thisimpactsonlyonhorizontalequity.Verticalequity,ontheotherhand,isconcernedwithdifferencesinabilitytopay,wherethoseabletopayshouldpaymore—thatis,theprogressivityofthetaxsystem.Vertical

26ASPigou,AStudyinPublicFinance(Macmillan,3rdreviseded,1960).27RAMusgraveandTunThin,‘IncomeTaxProgression’(1948)56(6)JournalofPoliticalEconomy498.28See,forexample,KSPeter,SButtrickandDDuncan,‘GlobalReformofPersonalIncomeTaxation,1981–2005:Evidencefrom189Countries’(2010)63(3)NationalTaxJournal447;IJoumard,MPisuandDBloch,‘TacklingIncomeInequality:TheRoleofTaxesandTransfers’(2012)1OECDJournal:EconomicStudies37;NCKakwani,‘MeasurementofTaxProgressivity:AnInternationalComparison’(1977)87(345)EconomicJournal71;DSuits,‘MeasurementofTaxProgressivity’(1977)67AmericanEconomicReview747.29Kakwani(n28);Suits(n28).30Anexample is theGinicoefficient,whichmeasureshowunequalthedistributionof incomeisamongindividualsandhouseholds.ByestimatingtheGinicoefficientbeforetaxesandtransfers,andcomparingitwiththeGinicoefficientaftertaxesandtransfers,theprogressivityofthetaxandtransfersystemcanbeascertained.31Saunders(n2)25.32Treasury,ArchitectureofAustralia’sTaxandTransferSystem(n2).


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equityalsoinvolvestheperceivedequityofthetaxpayer’sburdenrelativetothatofothertaxpayers.33 Indeed,ithasbeensuggestedthattheperceivedfairnessofthetaxrateismoreimportantthanitsabsolutelevel.34

Of relevance to this research is vertical equity and the perceived fairness of theprogressivityoftheincometaxsystemasdeterminedbytheobjectiveanalysisofpre-andpost-taxincome.

V DATAANDANALYSIS

A ThedataA progressive tax system is usually segmented into tax brackets that progress tosuccessively higher rates of tax. Each tax bracket represents amarginal tax rate thatincreasesineachtaxbracket.Thatis,incomeistaxedontheextraincomeearnedineachtaxbracketatsuccessivelyhigherrates.Atthehighestbracketitbecomesaflattaxrate.Australiacurrentlyhasfivetaxbrackets.The data used in this study is taxable income from AUD100,000 to AUD250,000, atAUD10,000intervals.Theseincomelevelscorrelatetothefourthandfifthtaxbrackets,withmarginaltaxratesof37percentand45percent,respectively.ThetaxpayableandMedicare levy is calculated using 2018–19 tax rates. With AUD100,000 being thebaseline, factorsof income, taxandnet incomearecalculatedandanaveragetaxplusMedicarelevyratedetermined.ThisdataisshowninTable1.Table1:Calculateddatabasedonselectedtaxableannualincomes

Taxableincome(AUD)

Taxpayable(AUD)

Medicarelevy

(AUD)

Netincome(AUD)

Factorfrombaseline Averagetax+

Medicare(%)

Income Tax Netincome

250,000 85,597 5,000 164,403 2.500 3.494 2.177 36.24240,000 81,097 4,800 158,903 2.400 3.310 2.105 35.79230,000 76,597 4,600 153,403 2.300 3.127 2.032 35.30220,000 72,097 4,400 147,903 2.200 2.943 1.959 34.77210,000 67,597 4,200 142,403 2.100 2.759 1.886 34.19200,000 63,097 4,000 136,903 2.000 2.576 1.813 33.55190,000 58,597 3,800 131,403 1.900 2.392 1.740 32.84180,000 54,097 3,600 125,903 1.800 2.208 1.668 32.05170,000 50,397 3,400 119,603 1.700 2.057 1.584 31.65160,000 46,697 3,200 113,303 1.600 1.906 1.501 31.19150,000 42,997 3,000 107,003 1.500 1.755 1.417 30.66140,000 39,297 2,800 100,703 1.400 1.604 1.334 30.07

33 BR Jackson andVCMilliron, ‘TaxComplianceResearch: Findings, Problems andProspects’ (1986) 5JournalofAccountingLiterature125.34DVMoser,JHEvansIIIandCKKim,‘TheEffectsofHorizontalandExchangeInequityonTaxReportingDecisions’(1995)70(4)AccountingReview619,citedinNicoletaBărbuţă-Mişu,‘AReviewofFactorsforTaxCompliance’(2011)1EconomicsandImpliedInformatics69,70.


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130,000 35,597 2,600 94,403 1,300 1.453 1.250 29.38120,000 31,897 2,400 88,103 1.200 1.302 1.167 28.58110,000 28,197 2,200 81,803 1.100 1.151 1.083 27.63100,000 24,497 2,000 75,503 1.000 1.000 1.00 26.50Figure 1 illustrates the relationship between taxable income and tax payable.Progressivityisdepictedbythewideninggapbetweenpre-taxincomeandtaxpayable.Itistheequitabilityofthisgap,thisprogressivity,withwhichthisresearchisconcerned.

Figure1:Relationshipbetweentaxableincomeandtaxpayable(AUD)

Abaselineisapointofreference.Usingabaselineallowscomparisonstobemadeandalsoenables the identificationof any correlationswithin thedataset.The factors, andthereforethecomparisonsandcorrelationsmadeinthisstudy,areincome,taxandnetincome.The relationshipbetween these factors is shown inFigure2,whichservesasanotherdepictionof theprogressivityof theAustralian incometaxsystem.As taxableincome(dashline) increases,sonet income(dottedline) increasesatadecliningrate,shownbytheincreasinggapbetweenthetaxableincomeandnetincomefactors.Whiletheincreaseintax(straightline)progressivelyincreases,itisatasubstantiallyfasterratethantaxableincome.

Figure2:Relationshipbetweenthetaxableincome,taxandnetincomefactors

Taxableincome

Taxpayable


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B GraphicalanalysisFigure3comparestheincreaseinincomeoverthedatarangewiththecorrespondingtaxpayable.Thereisclearlyadisproportionateincreaseintaxpaidcomparedwithincomebeforetax.Figure3:Comparisonofincomeandtaxfromthebaseline(AUD)

TheincomefactormeansthatasalaryofAUD250,000is2.5timesthatofAUD100,000.Thetaxfactor,ontheotherhand,showsthatanindividualonAUD250,000pays3.5timesthe amount of tax than an individualwho earnsAUD100,000. Thedisposable incomerelativetoAUD250,000,shownbythenetincomefactor,is2.2timesthatofdisposableincome from AUD100,000. The relationship between tax payable and net income isshowninFigure4.

Figure4:Comparisonofnetincomeandtaxfromthebaseline(AUD)


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Figure5illustratestherelationshipbetweentaxableincomeandthetaxfactor.Itshowsthat,uptoAUD180,000,thetaxpayeriskeepingincrementallymoreoftheirincreases.Abovethat(beingthetoptaxbracket),themoreincomeonegets,thelessofthatincomeonekeeps.

Figure5:Relationshipbetweentaxableincome(AUD)andthetaxfactor

ThisissupportedwhencomparingnetincomeandthetaxfactorasshowninFigure6.NotethatthenetincomeassociatedwithataxableincomeofAUD180,000isAUD122,303.

Figure6:Relationshipbetweennetincome(AUD)andthetaxfactor


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C DataanalysisForeachincreaseofAUD10,000intaxableincome,theincomeincreasesbyafactorof0.1fromthebaseline.Thisisirrespectiveofthetaxbrackets.ThechangeintaxbracketatanincomelevelofAUD180,000shiftsthetaxandnetincomefactorsfromthebaseline,giventhe increase inmarginal tax rate associatedwith the change in taxbracket.Thus, theincremental tax factor for eachAUD10,000 increase in taxable income is0.151 in thelowertaxbracketand0.184inthetopmarginaltaxbracket.Thisisagainof0.033.Fornetincometheincrementalfactordecreasesfrom0.083to0.073,adecreaseof0.01.Ahallmarkofaprogressivetaxsystemisthataveragetaxratesarelessthanmarginaltaxrates.That isclearlyevident inthedata.Thecurrentmarginal taxrate forthe incomebracketofAUD180,000andaboveis45percent,and37percentforthelowerincomebracketcontainingsalaryandwagesofAUD100,000toAUD179,999.ByexaminingtheincrementalchangeintheaveragetaxandMedicarerate,onecanascertainthedegreeofprogressivity.ThisinformationiscontainedinTable2.

Table2:Incrementalchangeinaveragetax(includingMedicare)rates

Taxableincome(AUD) Averagetax+Medicare(%)

Incrementalchangeinaverage(%)

250,000 36.24 0.45240,000 35.79 0.49230,000 35.30 0.53220,000 34.77 0.58210,000 34.19 0.64200,000 33.55 0.72190,000 32.84 0.79180,000 32.05 0.41170,000 31.65 0.46160,000 31.19 0.52150,000 30.66 0.60140,000 30.07 0.69130,000 29.38 0.80120,000 28.58 0.95110,000 27.63 1.14100,000 26.50


14

As taxable income increases, the average rate of tax and Medicare levy increases.However,itincreasesatadecliningrateineachtaxbracket.Thisshowsthatataxpayerisbetterofftowardsthetopendofeachtaxbracket.

It isalsoworthnotingthata taxable incomeofAUD140,000givesanaveragetaxrateclosetothecompanytaxrateof30percent,andthatataxableincomeofalittleunderAUD110,000equatestothe27.5percenttaxrateofabaserateentity.

D DiscussionObviouslyasalaryandwageearnerwillhavemorenetincome,ordisposableincome,themoretheirtaxableincomeincreases.Butitisthetaxliabilitythatwilldeterminewhattheincreaseinnetincomeisrelativetotheincreaseintaxableincome.A progressive tax system appears equitable and fair. Marginal tax rates increase asincomesgoup.Thismeansthat individualsonhigherincomespaymoreintaxesthanthoseonlowerincomes.However,thestructureofincometaxbracketsmeansthatanychangetothebottomoftheratescheduledirectlyaffectsthetaxliabilityofalltaxpayerswhomakemorethanthatamount.

Given that only themiddle to top end of the total salary andwage earning taxpayerpopulationisconsideredinthisaspectoftheresearch,itisnecessarytoconsidertheterm‘inframarginal’,meaningbelow themargin. For example, assumeTaxpayerBob earnsAUD170,000annually.AnopportunityarisesthatwillgiveTaxpayerBobanannualsalaryofAUD190,000.However,hewillneedtoworkharderatthisnewjobthanwhereheiscurrentlyemployed.InmakingthedecisionaboutwhethertoworkharderinordertogainanadditionalAUD20,000,TaxpayerBobisconcernedwiththemarginaltaxratethatappliestotheextraAUD20,000.IfthegovernmentweretoraisethetaxratethatappliestothefirstAUD90,000,thiswillhavenegligibleeffectonTaxpayerBob’sdecisionastowhether toearnadditional income.Becauseheearnsmore thanAUD90,000, this ratechangeis‘inframarginal’toTaxpayerBob.SincetherearemanytaxpayersearningoverAUD90,000,raisingthistaxratewouldresultinconsiderablerevenuebutrelativelylittledistortioninbehaviour.

However,raisingratesathigherlevelsofincomehaspotentiallytheoppositeeffect.Atleastintheory.Thereissupportforthecontentionthatifthegovernmentraisestaxratesathighlevelsofincome,itdistortsthebehaviouroftherich.35However,thisisnotsettled.Itisalsostatedthat‘thereisnoempiricalevidencethatmarginaltaxratesonmoderatelyhigh incomes, ofbetween35%and50%cause significant inefficienciesordiscouragework or investment’. At a practical level, one can say ‘of course not’. Only thoseindividualswithanalternativesourceofincometosalaryandwageshavetheluxuryofdecliningtoworkjustbecausethetaxratehasincreased.Workingforawageisthepricepeoplemustpay to live in society, put foodon the table, educate their children,haveaccesstomedicaltreatmentwhenrequired,andbeabletotaketheoccasionalholiday.Whatgivesthetaxsystemitsprogressivityarethetaxbrackets.Thehigherthenumberoftaxbrackets,thegreateristheprogressivity.Conversely,areductioninthenumberof

35McCafferyandHines(n10)1055;GruberandSaez(n18)3;Mirrlees,‘AnExplorationintheTheoryofOptimumIncomeTaxation’(n11).


15

taxbrackets causes the tax system tobecomemoreof aproportionalprogressive taxsystem.Thetaxrateshaveasmaller,ifany,impactonprogressivity.Theirimpactismoreonverticalequity.Reductionintaxratesflattentheratestructure,edgingtheprogressivetaxsystemtowardsbeingmoreofaprogressiveproportionaltaxsystem.Thisstudyconsidersverticalequityandtheprogressivityoftheincometaxsystemattheuppertaxbrackets.Itisconcernedwithsalaryandwageincome,ortaxableincome,ofAUD100,000 to AUD250,000. This covers two tax brackets with marginal tax rates(including Medicare levy) of 39 and 47 per cent, the change-over point being atAUD180,000,whichisapproximately2.1timestheaveragewageinAustralia.36AsdepictedinFigure6bythetaxfactorlineintersectingwithnetincome,anindividualkeeps incrementally more of their increase up to a taxable income of AUD180,000.Indeed,thedifferenceintheincomeandnetincomefactorsisaround0.1,whichincreasesto 0.2 and more from AUD200,000. The perception of fairness, or equity, from thetaxpayer’s perspective, therefore, diminishes as the taxpayer moves into the top taxbracket.There isadefiniteadvantagetobeingtowardsthetopofa taxbracket.Themoreoneprogressesthroughataxbracket,thelowertheincrementalincreaseintheaveragetaxrate is, as shown in Table 2. Due to the change inmarginal tax rateswhen changingincometaxbrackets, there isan increase inthe incrementalchangeintheaveragetaxrate.AtaxpayerwhomovesfromasalaryofAUD180,000toAUD185,000orAUD190,000isatmuchmoreofadisadvantagethanataxpayeron,say,AUD150,000orAUD230,000whoreceivesasimilardollarincrease.Thiscreatesspecificmotivationsforthetaxpayertochangeemployers.Itisusuallyonlybychangingjobsthatoneisabletosecureasubstantialincreaseintaxableincome.ThiscanbeillustratedusinganincreaseofAUD170,000toAUD200,000,wherethereisjustunderanaverageof2percentincreaseintax.Whennearingthetopendofataxbracketthereisanincentivetomovejobsandsecureasubstantialincreaseintaxableincome,otherwise the after-tax benefit of a normal or CPI-related increase (consumers priceindex)ismarginal.Thatis,theincreaseindisposableincomerelatingtoanincreaseintaxable incomeofAUD180,000 toAUD190,000 is less than thatderived froma lowertaxableincome.Thisalsoimpactsontheperceptionoffairness.As noted above, a progressive tax system can itself be regressive, proportional orprogressive.37Essentially, it isregressiveif therateofprogressionfallswhenenteringinto higher income brackets.38 This is shown diagrammatically when the line of taxprogressionliesabovetheincomeline,asinFigure7.Thecloserthelineswhenmovinguptheincomescale,theloweristheregressiveprogression.Conversely,ifthedistance

36 ‘6302.0—AverageWeeklyEarnings,Australia,May2019’,AustralianBureauofStatistics,AustralianGovernment (Web Page, 21 February 2019) Table 1<https://www.abs.gov.au/ausstats/[email protected]/mf/6302.0>.37SeeSectionIV.A.38 Florije Govori, ‘ADifferentApproach of Tax ProgressivityMeasurement’ (Working PaperNo 62846,MunichPersonalRePEcArchive,January2015).


16

between the tax progression and income lines increases, the higher is the degree ofregressiveprogression.39Figure7:Progressivityofthetaxsystem

Thisindicatesthat,atleastatincomelevelsbetweenAUD100,000andAUD250,000,theAustralianincometaxsystemishighlyregressiveprogressiveattheentrypointofeachtaxbracket.Asindividualsmovetowardsthetopendofataxbracket,theregressivityoftheprogressivetaxsystemdecreases.ItisalsointerestingtonotethatataxableincomeofaroundAUD140,000givesanaveragetax rate (includingMedicare levy)equivalent to thatof the statutorycompanyrate.AtaxableincomeofalittleunderAUD110,000equatestothesametaxrateapplicabletobaserateentities.Thelatteriswellwithinthe‘middleincome’level.40

VI CONCLUDINGREMARKS

Reducingthenumberoftaxbracketsdecreasestheprogressivityofthetaxsystem.Thisis what has been proposed in the 2019 Federal Budget by the Morrison CoalitionGovernment. The proposal is that, by 2024–25, there will be only four income taxbrackets. The third tax bracket will cover taxable income of over AUD45,000 toAUD200,000,atamarginaltaxrateof30percent.Thefourthtaxbracketremainsat45

39Ibid.40SeethediscussiononthelowandmediumincometaxoffsetinSectionII.

Progressiveness of Taxation System

$190,000

$100,000

$250,000

INCOME

Tax Progression $180,000

$190,000


17

percentforthoseindividualsearningoverAUD200,000.Thiswillbeamuchflattertaxsystemthaniscurrentlythecase.Nevertheless,itisstatedthattheprogressivetaxsystemwillbemaintained.Progressivityismeasuredasthe‘shareofpersonalincometaxpaid’.The example given is that an individual onAUD200,000 earnsmore than4.4 times apersononAUD45,000butwillpay10timesmoretax.41Thereforehowprogressivityisdefinedandmeasureddoeshaveanimpactonhowthemessageisperceived.Individualsarenotconcernedwithwheretheysitwithrespecttotheshareofpersonalincometaxtheypay.Indeed,mosttaxpayersconsiderthemselvestobe‘middleincomeearners’.42Individualsareconcernedwiththeamountofpersonalincometaxtheypay.Withrespecttoothertaxpayers,theconcernis largely limitedtoensuringcompliancewithtaxobligationsandthatthosewhoneedfinancialassistancereceiveanadequateredistribution.43Whilethetaxsystemisinherentlyequitable,itmustbeperceivedtobefair,too.Anditisfair,atthehigherendofeachtaxbracket.However,foranincreaseinincomeacrossthechangeintaxbracket,thisincreasemustbesignificantifitistoprovidematerialbenefittoanindividual.

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