Dispatches From the Moderate Left

Wednesday, September 14, 2005

Unprincipled Tax Reform

I wrote a while ago about principled tax reform. I'm glad to see that The Age seems to be pushing a similar barrow, with no less than two pieces (one news, one opinion) advocating pretty much what I was arguing for. From the business section:
AUSTRALIA'S tax system is riddled with $31 billion worth of exemptions, concession and deductions that distort the economy, favour high earners.
He said negative gearing — allowing taxpayers to offset the cost of borrowing for assets against total income — had massively distorted the housing market.

The problem had been magnified by the Howard Government's decision in 2000 to halve the rate at which assets held for at least 12 months are taxed.

[A prominent economist said] "It is absolutely no coincidence that established house prices in Australia's capital cities rose by an average of over 70 per cent during the following four years... in 2004 the share of GDP allocated to residential investment exceeded that devoted to productive plant and equipment for the first time in Australia's history."

And Tim Colebatch:
There are two good reasons to cut tax rates. The first is that high effective marginal tax rates deter people on welfare from seeking work. The National Centre for Social and Economic Modelling has estimated that almost a million people face rates so high that 60 cents or more of every extra dollar they earn goes to the government. The vast majority of them are low and middle income earners.

The second is that high tax rates coupled with a honeycomb of legal ways to avoid them encourages people to engage in unproductive investments and artificial arrangements for no other reason than to avoid tax. It leads people to waste resources setting up hundreds of thousands of shelf companies and trusts, and put their money where it does no good.

The classic example is negative gearing. In 2002-03, the Howard Government spent about $2 billion through the tax system to subsidise unprofitable housing investments. Because the tax break is there, more and more Australians have made unprofitable housing investments in order to collect it. On their own reckoning, by 2002-03, 60 per cent of housing investments were losing money. And the more they lose, the more the Government subsidises them.

It's a stupid tax break that drives people to make bad investments. But it is supported by both parties because, with almost a million taxpayers now using it, they don't have the guts to take it away - even phased out over 10 years, as Melbourne University tax lawyer Cameron Rider suggests - and give us the money back through lower tax rates.
The good arguments for tax reform are that we need to give more incentive for low-income people to work (or work more), and to clean up the tax system with a revenue-neutral reform that gets rid of unproductive tax loopholes, and uses the revenue instead to cut tax rates.

Those sorts of arguments make sense to both the hard nosed economist and the equality-concerned liberal inside of me. Unfortunately they're not the ones being made from most parts of the Liberal party.

Sophie Panopolous, who is fast becoming my least favourite Liberal backbencher (she was awfully quick to join the jihad against the hajib a couple of weeks ago and always seems to be quick to supply an extreme conservative quote to the papers), has recently called for her own brand of distinctly non-principled tax reform:
Victorian Liberal Sophie Panopoulos [is] calling for a review of capital gains tax to give relief to people with longer-term investments.
"We need to examine differing capital gains tax rates for speculative investments and for longer-term investments," she told The Sunday Age."Most people's nest egg or investment is in real estate other than their own home, so we do need to look at the issue of capital gains tax."

Under changes made in 1999, people can receive a 50 per cent discount on their capital gains bill if they sell an asset they have owned for more than 12 months.

A person on the top tax rate of 47 per cent pays 23.5 per cent tax and someone on the 30 per cent marginal rate pays 15 per cent.

That sort of thing is exactly what we don't need. The distortionary effects of this on its own would be extraordinary. It would exacerbate the problem of negative gearing by increasing the returns of these unprofitable investments – provided you wait five years and one day to sell. So that's what people would do. You'd get this silly and woefully inefficient churn in unprofitable investment properties which get extremely good returns for people paying the top marginal tax rate simply because of the tax regime. That sort of thing shouldn't be a primary motivation for investment decisions.

This proposal is also horribly inequitable. Capital gains taxes are progressive in two ways. Firstly the people who can actually buy capital are the reasonably well off anyway (see Sophie's assumption that everyone owns not only their own home but investment properties too). Secondly as noted in this article, the rate paid is equal to your income tax rate, and (for the moment) those rates are progressive. So cutting the CGT on these sorts of investments is a seriously regressive move. And the 'benefits' from this move would be more money for rich people and an even more distortionary tax system. Lovely.


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