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Is Scott Morrison dreaming when it comes to tax reform?

By Professor Miranda Stewart | February 19th, 2016

“This Government isn’t dreaming,” the Treasurer told us in his speech yesterday. He is right that “the scope for tax reform is limited in this economy.” As he bluntly says, “we don’t have a surplus to fund reductions in taxes.” In fact, we have a $35 billion deficit.

The Treasurer might be dreaming when he says he wants a “friendly” tax system: “Growth friendly, earner friendly and profit friendly.”

Much as I admire our Australian Tax Office, you are not supposed to be friends with your tax collector. Just pay what’s required like everyone else does so we can raise sufficient revenue to fund the public goods and services that people want.

Dreaming about spending?

Based mostly on bracket creep in the income tax, without any change, the budget is projected to reach a small surplus by 2021. The Treasurer aims instead to return to surplus with expenditure restraint, which is going to be tough. Even if expenditure is successfully “controlled” over the next five years, over the medium term that surplus is projected to decline again into the red. In the long term, the Intergenerational Report projected a growing deficit, on more heroic economic growth assumptions.

The times are not right for a GST

The Government has already said it’s not the right time for a GST increase, or a major “tax mix switch” between GST and personal income tax, finding that there would only be a modest growth effect. That seems sensible now – but we should not be looking to the GST to deliver significant growth. That does not mean the GST is irrelevant: the main thing it is good for is revenue.

In the medium term (see above on budget) – or even in the next term of either a Liberal or a Labor government – we are going to have to look again at increasing the GST rate or broadening the base. We will need to support an ageing population; fund education, retraining and early childhood human capital investment needed for a transitioning economy; let alone the true cost of the National Disability Insurance Scheme.

Will there be tax cuts aimed at “bracket creep”?

Bracket creep affects everyone because tax brackets are not indexed so your total tax payable as a percentage of income (the average tax rate ) increases with nominal and real wage growth. Is bracket creep a “killer” of economic growth? It’s far from clear. The Treasurer conspicuously did not express concern for people at the top rate of 45 per cent plus the 2 per cent temporary budget repair levy plus the 2 per cent Medicare levy (that is 49 per cent if you are counting). That temporary levy comes to an end on June 30, 2017 unless it is extended.

Instead, the Treasurer focused on the average wage earner moving into the “second top” tax bracket of 37 per cent (plus the Medicare Levy) at a threshold of $80,000. An increase in that threshold would, in fact, benefit higher bracket taxpayers too. Average full time male earnings are above the 37 per cent threshold now, but average full time female earnings are a lot lower, and most workers sit below about $60,000 in wages.

It’s been suggested that bracket creep is a disincentive to work. The Treasurer did not say this, but Treasury modelling assumes that bracket creep does affect work behaviour to some degree (it assumes work elasticity of 0.2). Yet empirical studies consistently show that most men are very unlikely to change their work behaviour because of tax rates(e.g. see a recent analysis of 30 studies around the world).

More importantly, women have much higher work responsiveness (estimated at more than four times that of men). That suggests that if the Treasurer really wants to help workers and growth by cutting taxes, he should focus on women with children working part-time and on the interaction between the tax and transfer systems.

A tried and tested approach

Tax reform does not have to be big bang. The Treasurer indicated that “modest” personal tax cuts would have to be funded from other tax changes. The biggest benefit would come from broadening the income tax base. This would help prevent the increased tax planning that we know is a behavioural response to bracket creep (as demonstrated in a US study).

The Treasurer criticised the Labor Party’s proposals to limit negative gearing to new housing construction and reduce the capital gains tax concession. But he seemed to leave open the option of capping deductions for higher income earners, possibly both interest and work expenses. He also did not rule out increased tax on superannuation contributions and earnings.

Unlimited negative gearing of rental losses against other income, in a context of easy finance and rising property markets, has become one of our most widely used tax shelters for wage earners. It is indeed true that some nurses, teachers and police negatively gear to reduce their taxes, although high earners get about 10 times the tax benefit from negative gearing and get much higher capital gains at a reduced tax rate. The Treasury chart below shows that a much smaller fraction of 10-15 per cent of taxpayers in income bands under $80,000 are negatively geared, compared to 24 per cent of high income taxpayers.

It’s time to apply a sensible limit, just as we did on introducing Fringe Benefits Tax in 1986 to crack down on tax-free fringe benefits. The Henry Review recommended reducing the capital gains tax discount to 40 per cent and quarantining investment expenses – both still worthwhile reforms. Deduction of property losses against wages was halted in the US by Ronald Reagan in 1986. In the UK, such losses are limited to rental income and the government announced in 2015 it would cap this deduction at a 20 per cent tax rate.

What about the federation?

It was disappointing to hear the Treasurer speak of the states as sovereign governments responsible for their own affairs (and hospital funding), when the Commonwealth continues to pick up the lion’s share of tax revenues. John Freebairn and I have previously argued that state tax reform could make the biggest contribution to economic growth through land, payroll and transport tax changes, but this needs national coordination.

And one last word… er… climate change?

The Treasurer spent quite a while talking about the global context for Australia’s tax system, but he failed to mention one aspect: climate change. Specifically, the legally binding Paris Agreement of December 2015 to keep global warming to 2 degrees.

The unpleasant reality in which the Government finds itself is partly because the Abbott-Hockey government abolished the carbon pricing mechanism, or carbon tax. It raised more than $6 billion and growing in the single year of 2012-13, with less pain per household than a GST increase, while having a positive impact on transitioning – to use the Treasurer’s word – Australia to a new economy for the 21st century. I wonder if it’s time to revisit that idea?

Professor Miranda Stewart is director of the Tax and Transfer Policy Institute at ANU.

This article was originally published at ABC’s The Drum.

Sectors: Government

Around the world, regulators are realising Bitcoin is money

By Professor Miranda Stewart | August 13th, 2015

The tax treatment of digital currencies is a challenge for governments around the world, as it is for other aspects of the “disruptive” digital economy.

In October 2014, the Commonwealth Senate Economics Committee launched an inquiry into digital currencies. The Committee released its report last week, with a particular focus on tax.

Last year, the ATO published several rulings outlining how bitcoin and similar cryptocurrencies should be treated under the Australian income tax and GST regimes.

The rulings provided useful clarity on bitcoin’s tax treatment, but the ATO’s approach received widespread criticism.

Bitcoin purportedly functions as money, but the ATO rulings treat bitcoin as a commodity for tax purposes. This disparity creates a number of tax inconsistencies.

The impact is particularly acute under the GST regime, where bitcoin transactions are taxed as barter transactions. Australia’s GST regime applies somewhat clumsily to barter transactions, which may cause double taxation, or at least double tax administration, as we emphasised in our submission.

Why should the law be changed?

Imposing 10% GST on bitcoin transactions increases the price of purchasing bitcoin from Australian vendors, affecting the commercial viability of operating a digital currency business in Australia, as we have highlighted before. Submissions to the inquiry outlined the potential benefits the industry could offer Australia, but many argued the GST treatment stood in the way of success.

From a regulatory perspective, supporting Australian digital currency intermediaries to establish an industry here is likely to make financial supervision and taxation easier for government.

The ATO’s characterisation of digital currencies as a commodity is probably the best interpretation of the current law, which emphasises wide use and sovereign backing for currencies. But it’s not clear cut. There is a legal basis to treat digital currencies as money based on their function as a medium of exchange, especially as this becomes more widespread.

Digital currency and GST

The Senate report identified the GST anomalies arising from the ATO’s characterisation of digital currencies and recommends the government amend the GST regime to treat digital currencies as money. This would promote fairness and neutrality in the taxation of both modern and traditional forms of money.

Implementing the necessary changes to the GST Act and Regulations will ultimately require approval from the Commonwealth and all State governments, as it affects the GST base.

Adopting the report’s GST recommendation would bring Australia’s GST treatment in line with the UK, and some other EU nations. Last year, the UK changed its VAT laws (the UK’s GST) to exclude digital currenciesfrom taxation as a commodity.

When the UK first introduced this approach, it was praised for supporting the local digital currency industry, although there is little empirical evidence at this early stage.

Digital currencies are also treated by the ATO as commodities for income tax. The evidence before the Committee, although limited, suggests most bitcoin holders are investors not traders.

The report did not recommend any alterations to the income tax treatment at this stage – and we agree that caution is needed before altering income tax treatment. The report recommended further research to determine whether change is needed.

The regulatory future of digital currencies

The Committee concluded that digital currencies fall outside the scope of many of Australia’s financial, banking, and consumer protection regulations. It recommended that Australia’s anti-terror and anti-money laundering regimes should be extended to ensure they encompass digital currency activity.

However, the report does relatively little to address the longer-term regulatory concerns surrounding digital currencies. At this early stage, the report proposes to allow the industry to self-regulate, with oversight from a proposed “Digital Economy Taskforce”, rather than introducing a specific regulatory framework.

The Committee accepted that extensive regulations might stifle the growth of the digital currency industry. Although digital currencies’ utility has been emphasised recently, their future remains uncertain. Bitcoin, the largest digital currency, has seen a steady, significant price decline over the past two years. Further, much of the industry’s innovation comes from small start-ups, which have relatively few resources to comply with regulations. Regulatory simplicity seems proportionate at this stage.

It will be interesting to see how effective the self-regulation approach is, particularly given digital currencies’ historic involvement in illicit activities and the regulatory concerns voiced by other governments and the OECD.

The combination of introducing a more favourable GST treatment, and a relatively simple regulatory framework will hopefully foster this nascent industry’s development. If the industry experiences any major growth in Australia, the greater number of users (and more tax dollars at stake) may heighten regulatory attention surrounding the technology.

Ultimately, the self regulatory approach and Digital Economy Taskforce is the beginning, not the end, of the government’s involvement in regulating and taxing this new technology.

This article was originally published at The Conversation. Co-author is Joel Emery.

Sectors: Government