Wednesday, March 15, 2006

Annual Tax Pack ritual is just poor form

Spending money in advance to get money back later - maybe - doesn't make sense, says Peter Martin.

So the Treasurer wants to know what's wrong with the Australian tax system. Here's an idea the two business figures conducting his tax inquiry are unlikely to mention in their enthusiasm to make the case for a cut in Australia's "punitive" top rate of tax. That rate (47 per cent) will be paid only by the top 4 per cent of income earners after the changes announced in the last budget come into effect in a few months' time.

The imposition I am talking about is endured by nearly every one of us, year in and year out. It's the requirement to wade through the 120-question Tax Pack to send to the Tax Office information it most probably already has.

As Australian as the compulsory vote, it is a ritual not imposed on the citizens of Britain or New Zealand. In those countries, submitting a tax return is voluntary. Two out of every three citizens don't do it.

Going through the Tax Pack actually takes a lot more time than the compulsory vote. Two decades ago it typically took 4½ hours. (1) A decade later it took 8½ hours. (2) I don't know of any surveys since then but I do know that the Tax Pack has exploded in complexity in that time. Dr Andrew Leigh, an economist at the Australian National University, has costed the time lost nationwide as a result of attempting to fill in the form. He says it approaches $3 billion a year.

And it's not just time... Filling in unnecessary forms creates anxiety, often among those Australians with the simplest of tax affairs. And it can encourage dishonesty. An astonishing 75 per cent of us now use a tax agent - the highest proportion in the world. (3)

In New Zealand it is no longer possible to make claims for deductions. In Britain it has always been very difficult. The only things that matter for the tax affairs of a typical New Zealander are his or her salary (from which tax has already been deducted) and any income from interest or share market dividends (from which tax has already been deducted). The tax authority already has that information and it adjusts deductions throughout the year to make sure that, by the end, there is very little extra money owing. If it is, it sends a statement.

Entitled Simplifying Taxpayer Requirements, the change was introduced in 1999 partly to "reduce the extent to which the tax system intrudes on the lives of most individual taxpayers".

Reports from across the Tasman suggest it has been a success. I believe it would be here, too. Remember all the anguish leading up to the introduction of the GST? After the event, there seems no concern whatsoever among ordinary Australians. (Among businesses, there is concern, but that's the point: the more that the paperwork associated with a tax intrudes on someone's life, the worse they feel about it.)

So why won't authorities here make the income tax system as painless as New Zealand's or as the GST?

Peter Costello actually floated the idea in the lead-up the GST. He told a business lunch that if Australia "had a strong pay-as-you-earn tax system with a strong interest-withholding tax system, we could kick most Australians out of the necessity to file income tax returns". (4)

Then he moved the idea to the backburner. The Tax Office had tested it with focus groups and found people worried about losing their refunds: "For most taxpayers, refunds are what the personal tax system is all about." The obsession with the annual refund is indeed bizarre. Seventy-five to 80 per cent of us get a refund and we seem prepared to endure anything - even routinely having more tax than necessary taken out - to get it.

Professor Chris Evans, formerly of the British tax office, runs the Atax program at the University of NSW. He says: "Frankly, it is inexplicable, and unique to Australia. What rational person overpays in order to get something back at a later stage? It defies logical explanation - I would certainly not contemplate overpaying for my electricity in advance just so that I could have some 'forced savings' coming back to me at some point in the future." (3)

The lever most of us use to get a refund is to claim for so-called work-related expenses: things such as tools, conference fees and uniforms. But the rules governing what is in and what is out are so arbitrary as to make it look like a rort.

Professor Jonathan Baldry, of the University of New England, notes that a shearer can claim a deduction for the cost of jeans used as working clothes but plain-clothes police officers cannot claim for their clothes. (5)

The biggest claims are made by those with the biggest incomes. Baldry says the typical claim climbs by $49 for every $1000 increase in salary. Politicians and judges claim more than $10,000 each. We should abolish the right to claim deductions and let the chips fall where they may.

Then most of us wouldn't need to fill in the Tax Pack - although people such as landlords still would. Much of the information could be collected in another way. (For instance, the Tax Office could ask health funds directly about who is a member.)

An Australian twist might be to hand each of us a $300 deduction. That way we could still get our beloved refunds.

(1) Pope, J., and Fayle, R. "The Compliance Costs of Personal Income Taxation in Australia, 1986/87: Emperical Results"., Australian Tax Forum 8, (4) 485-538.

(2) Tran-Nam, B., Evans, C., Ritchie, K. and Walpole, M., 2000, “Tax Compliance Costs: Research Methodology and Empirical Evidence from Australia”, National Tax Journal 53(2): 229–252.

(3) Chris Evans, 2004, “Diminishing returns: The case for reduced annual filing for personal income taxpayers in Australia” Australian Tax Review 33: 168-181

(4) Committee for the Economic Development of Australia Conference, January 28, 1998

(5) Jonathan Baldry, "Income Tax Deductions for Work-Related Expenses: The Rationale Examined" Australian Economic Papers, 1998, vol. 37, issue 1, pages 45-57, Jonathan Baldry 1998, "Abolishing income tax deductibility for work-related expenses", Agenda, Vol. 5(1), 49-60.