Gold-plated tax cuts

The first announcement of the federal election is out, and it’s a juicy big package of tax cuts from the Coalition. My guess is that much of the commentary will focus on the inflationary impact of the cuts when the RBA board meets 6 Nov, but to me that’s a second-order issue. More important is the distribution of these tax cuts across the income spectrum.

As I’ve pointed out before, the tax packages announced by the Coalition in the 2005 and 2006 budgets were highly regressive – largely because the government is unwilling to countenance negative income taxes (EITCs); the policy reform favoured by other developed countries to move people from welfare into work. Tax cuts don’t have to be regressive if they include EITCs. (For more of my EITC-spruiking, see the third part of this essay.)

To see how the new Howard-Costello tax cuts would bite, take two examples. If you’re a federal MP (base salary $127,060), then your total tax savings from 1 July 2007 to 2010-11 are around $3800. If you’re on the minimum wage ($27,150 for a full-time minimum wage worker), then your total tax savings over the same period are about $1280. A spending plan this regressive would be met with howls of outrage.

If the priority is moving low-skill workers into the labour force, does it really make sense to give three times as much to federal MPs as minimum wage workers?

PS. Looking again at the tax tables, I see that these tax cuts are certainly more regressive than the 2006 ones.

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21 Responses to Gold-plated tax cuts

  1. Dean says:

    It’s political gold though.

    It has got me worried. I’ve got to go and letterbox or something…

  2. Kevin Cox says:

    Andrew I agree with negative income taxes but the whole system could be made even more efficient if we did not distribute through the tax system with all its quirks but simply gave everyone a flat wage that was untaxed and taxed all income.

    We could set it at a rate that removed the cost of child rebates, baby bonuses etc. We may even be able to set it at a rate that removed the need for many pensions. The next step in the reform is to make all income (other than the social wage) taxable and to make the rate the same no matter what the income and remove all deductions including negative gearing etc.

    Those groups who are disadvantaged could have extra money that would gradually reduce over a period of time. My back of the envelop calculations show that the system would work with a social wage of about $10,000 a year for all adults over 18 and $4,000 for all under 18 and with a flat tax of about 33%. In the early years old aged pensioners might get a little more but this would gradually be eliminated.

    The cost savings to the community would be enormous as we would save all that time doing tax returns and going for our unemployment benefits etc.

    I also suspect that negative tax rates will as hard to get accepted as the simpler “social wage” which I think could be made easier to understand.

    However, the social wage approach could be an optin system. That is, we could allow people to optin to the new approach and so have an alternative tax regime for those that wanted it. We may even have several systems and people can “let the market decide”. That is why not take on the idea that private organisations could offer alternative tax schemes. People would be able to change schemes but perhaps only once every five years.

  3. Kina says:

    It is silly, way too early and will be forgotten in a few weeks. It is also the next 5 years tax cuts announced in advance – thus delayed benefit for most people and is in the never never tax cuts and, can have the label non-core attached.

    It gives Labor more chance to fine tune theirs now knowing the Govt’s hand.

    If they don’t get a poll rise out of it then they will all suicide as this is the big gun fire up front when the enemy is still over the hill.

  4. Big tax cuts promised in future sounds like US Republicans. Didn’t Labor propose an EITC in 1998 which nobody remembers. There is the Megalogenis argument that voters prefer regressive tax cuts because they anticipate becoming wealthy. How does labor appeal to, the suffering 100K aspirationals or Hanson’s children on the coast?

  5. Sinclair Davidson says:

    You don’t think there is a difference between spending money and not taxing money?

  6. Andrew Leigh says:

    Sinc, maybe I’ve been hanging out with folks who work on EITCs and HECS for too long (these are policies where the distinction is at its fuzziest), but I don’t see that the government should apply an entirely different social welfare function to its revenue-raising and expenditure (which is what the ‘they’re regressive because the rich pay the most tax’ folks seem to be implicitly arguing).

  7. Sinclair Davidson says:

    I’m inclined to agree with you – I see no reason why taxation should be progressive and expenditure regressive. But I suspect that’s not what you mean. 🙂

    As an aside, why isn’t HECS and Universty funding regressive?

  8. Kevin Cox says:

    I will come back to the point made above on choice in both taxation and government expenditure. Markets work because people can make choices.

    We do not have a market when it comes to paying taxes and with governments spending money. The first because there is only one tax system and the second because the government is the only “spender”.

    I would submit that a market based solution to both taxation and resource allocation of government spending is to give citizens a choice. The government could allow private organisations to submit alternative taxation systems and government spending could be done by giving the money to the citizens and requiring the citizens to make a choice.

    This way you could let “the market” decide where a market is defined as allowing choice in resource allocation.

    People will dismiss this as being impractical or impossible or cost too much. It is practical, it can be done and it would cost less than the current no choice solution. It will also be argued that elections are the time to make a choice – sorry the election market place is too constrained and too coarse a selection and there is not enough variability in the choices to make much progress.

  9. Labor Outsider says:

    I’m a little puzzled about the description of the tax cuts as being regressive. I take it you are basing that claim on the absolute magnitude of the cuts across the income distribution rather than the proportional change across the spectrum. I would have thought that it is the latter that is more important.

    Let me give you an example. Let’s assume that there are only 2 taxpayers in Australia – one earns $100k and pays a flat tax of 30 per cent. The other earns $20k and pays a flat tax of 20 per cent. Under that tax system the person with the higher income pays 88.2 per cent of the taxes. Now, let’s assume that the goverment cuts the tax rate on the higher income earner by 1 percentage point to 29 per cent and the rate on the lower income earner by 2 percentage points to 18 per cent. The higher income earner will receive a $1000 tax cut and the lower income earner will receive a tax cut of $400. Thus the higher income earner receives the greater cut in absolute terms.

    However, when we do the calculation proportionately it is the lower income earner that receives the greater tax cut and indeed their share of disposable income INCREASES with that tax policy and thus the system becomes MORE progressive not more regressive.

    So, let’s go back to the government’s tax cuts. If you calculate the total cuts between 2007 and 2010 and take them as a proportion of gross income at different points in the income distribution you find that the largest proportional gains go to those earning between $30k and $40k. There are some other dark spots of course (those on more than $100k receive more proportionately than those on $70k but on the whole the cuts are progressive.

    Now, you could argue that they should be more progressive than they are, but I can’t see how you can argue that they are regressive. In addition, if you look at the Treasury press release their is a graph that shows the proportionate change in tax from all the cuts from 2003 onwards. That graph shows clearly that the changes over time have been progressive, though a more complete picture would require taking family benefits and other welfare changes into account.

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  11. Patrick says:

    We do not have a market when it comes to paying taxes and with governments spending money. The first because there is only one tax system and the second because the government is the only “spender”.

    Kevin, I don’t think you are stupid, although you do come across as endearingly naive, especially in your comments about money.

    This comment, on the other hand, comes across as more just embarrassingly naive. Everyone earning more than $50k will just ‘choose’ the tax system under which they pay the least. Don’t argue that because you and your dog won’t that the above is not true.

  12. Kevin Cox says:

    Patrick, when I talk about the tax system it is more than the tax rates it is also how the taxes are spent. Thus you can choose a tax system where you do not get free hospitals but have to pay, where you do not get a baby bonus etc.

    Thus I choose to go into a tax system which gives me what I think will be to my best advantage in a total sense.

    Let me tell you the tax system that I would like to offer to the market.

    A flat tax of 30% on all income, a flat untaxable income to everyone, a given amount of money that I can spend on health and that if I don’t spend it I can keep for next year etc., a given amount that is paid on my behalf to the police and security – where I have no choice but I know how much is being paid on my behalf. That is, the tax system would be what I give and also list what I receive and how I receive it.

  13. Patrick says:

    ok, slightly more in ‘endearing’ territory than the first effort. Not much more in the real world, or I just don’t get it?

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  15. Kevin Cox says:

    Patrick,

    Here is how the idea arose. I was thinking about how we could ever introduce a more rational and efficient tax system because as soon as you start to think about ideas like negative income tax then it becomes apparent that you have to change the social welfare system at the same time because what you do on collecting tax affects what you do on spending it because most tax is spent as redistribution to people who pay tax.

    So then I thought about the tax system and what happens. Well it accumulates money through various payments and then it spends it. How does it get spent? It gets spent by governments allocating different amounts to different functions – this is called the budget and then deciding where the money is to be spent.

    So then I thought – do we have to have one system for doing this or could we envisage a system where there are two “tax systems”? Well yes of course it could be possible.

    We can imagine different systems for doing the same thing of collecting taxes and distributing them. In fact that is what happens at election time. We are asked to choose between different systems of collecting tax and distributing them.

    But there is no logical reason not to give us the choice so that we can optin to one system or the other and have them running at the same time. The problem would be keeping track of who was in what system.

    Five years ago that was impossible. Today it is possible. Believe me I can build two systems where I can keep track of who is in what system and both can work independently. We have at least 175 systems all operating different tax systems at the same time today and they are called countries.

    Accepting it is possible how can we implement it? Well again it turns out to be surprisingly simple. You keep the current system going and you allow organisations to construct different systems and offer them to the public. The only thing you have to do is to make sure both systems spend the same average amount per head on different budget items. That is, the systems have to achieve the same overall result.

    Doing the first system one is a bit tricky because we will not get the interaction between the two systems right the first time and so for practical reasons we need the government to take the risk and responsibility for the first one.

    But what do we have to lose? Well we have the cost of failure which will be how much it costs to build it and how much to dismantle if it doesn’t work. Both of these are relatively small and can be paid for from potential savings because the savings are immense.

    Why do I know the savings are immense? Consider the cost of collecting tax. The major cost of collecting tax is the cost to individuals and companies of collecting it not the cost of the government tax collectors. Consider the cost and the inefficiencies in spending money. Look at the distortions we get in the labour market because of the social welfare system. Look at how poor a job we do of organising the spending of money for hospitals.

    So how much would it cost to run a trial that could prove it. My back of the envelop calculations put the cost at about $20M. You do not have to do everything on the first go. You offer it to people and those that optin are volunteers. Some taxes are left alone – like the GST and we “just” do income tax and social welfare payments and we limit the number of people who can optin to the new system.

    That is, you run an experiment. The people who join in are all volunteers and can be allowed to withdraw from the experiment.

    The reason why it is cheap is because most the daily transactions stay the same. The changes are payments to and from government organisations.

    How do you know if the experiment is successful? Remember at the start I said that the systems had to achieve the goal of spending an average amount per head on different budget items. If the new system is more efficient then we will find that because the transaction costs are lower in collecting and then doing the distribution there is money left over or we have had to collect less tax and/or the people in the system will have more time to do other things and/or the people in the system will become employed or work less hours or …. and we can measure all these characteristics and compare against what happened before we ran the experiment. There is also no reason not to run a parallel reference group of people. That is, those that ask to optin to the system would be put into two groups. One where they stayed in the existing system and one where they moved into the new system.

    My guess is that we will see an effect almost immediately and so we will probably have enough information to see if it is a success within one year.

    What then happens? If it is a success then we simply allow more people to optin and we start up another trial with a different set of rules. If it fails we disband the system compensate the victims and go back to the old ways.

  16. harry clarke says:

    I think the expenditure and tax sides of the budget are determined separately on the basis of different criteria. The expenditure side provides public goods which often have a progressive impact (e.g. defence, primary education, health) whereas income taxes can target redistribution and reflect ability to pay.

    I also think it is wrong to claim that all tax changes should be in the direction of increasing progressivity – it depends on overall tax and expenditure incidence.

    A $1000 tax bill might optimally provide public good benefits worth $500 to a poor man and $500 to a rich man.

    How to pay for this $1000? A proportional tax system means the rich will pay more and a progressive tax system means the rich will pay more than that. So, for example, the poor guy pays $300 and the rich guy $700.

    The rich guy gets a $500 benefit for a $700 expense and the poor guy a $500 benefit for a $200 expense. Marginal changes in tax liabilities won’t change the overall redistributive impacts here much so generally you cannot reasonably argue that all tax changes should be in the direction of increasing progressivity.

    Some excise taxes are regressive so some of the progressivity in the income tax system is admittedly just offsetting that.

    Finally, how many households take home the minimum wage as their total income inclusive of implied social security and housing benefits?

  17. Patrick says:

    Kevin, I think Robert Nozick beat you to it, in Anarchy, State and Utopia.

    It is a great book. Personally, I can’t wait for an opportunity to explore ideas such as yours, which is largely why I am so keen on spaceflight and extraterrestial colonisation.

  18. Kevin Cox says:

    Patrick,

    We can help you go further than just exploring ideas. We are about trying them out for real and we do not really care what the ideas are.

    While I have put up the idea on taxes as a possibility our real business is to provide ways to implement any economic idea involving trading and transactions. We can build economic information systems (money systems) where if you have an idea and you can persuade others to join in we can build it for you. I am “throwing” ideas out as examples of what might be done and it looks as though we have a good chance of getting some of them off the ground. (not tax reform just yet:) We are also developing a methodology to help you find the solution. It works something like this.

    Recognise that there is a problem

    – e.g. inefficient allocation of resources in the health sector.

    Work out a way of measuring the problem

    – e.g. average medical procedure cost and cost of medical procedures not done. (e.g. person not having preventative dental health, person not taking cholesterol drugs)

    Make a guess as to the underlying cause of the problem

    – e.g. allocation of resources by governments rather than allocation by individuals through a market mechanism. No incentives for people to take responsibility for their own health.

    Invent a system that may fix the problem according to your guess as to the causes.

    – e.g. give money directly to people to spend on health and let them decide where to spend it. Give people money to go for a health checkup.

    Implement it (that is us) trial it on a small scale where you can experiment without too great a social impact

    – e.g. do it for the upper north shore residents

    Adjust the trial and the parameters and deploy widely

    So if you are a government policy maker or a company strategist and you find you have a problem – not enough sales, a water crisis, pollution of the environment with plastic bags, too many fat children

    then we may be able to help.

    In other words we are in the business of building information systems and economic information systems are so archaic that we think there are many untapped commercial opportunities – mainly because few have realised it can be done.

    Andrew – remove if you don’t permit ads:)

  19. Patrick says:

    I think the guaranteed annual minimum wage sucks all over because I am personally vehemently opposed to severing the ‘work-wages’ nexus. In fact I kinda think that it is one of the foundations of civilisation!

    But I would tentatively support something like an inflated EITC with, eg, 25% of it allocated to coupons, as you suggest, say 10% health expenditure, 10% education expenditure, 5% pension, plus say for kids an additional 15% solely for education.

    I don’t like it half as much as just a plain EITC, but I could support it.

  20. Kevin Cox says:

    Patrick,

    We don’t really know what will happen when we change the rules. It may well be that a guaranteed wage that everyone gets simply by being a citizen along with a flat tax on all “earned income” will be more efficient in terms of generating wealth. Or it may be that a system you suggest is better. We are offering an approach where governments can experiment and run trials and see what happens.

    If you think of our economic system as an evolving adaptive learning system then we need to give ways for it to change and to experiment.

    That is what we are suggesting – not which approach will be best. We can take the guess work out of policy changes and replace with “the scientific method” where we can run trials with subsets of the population who volunteer to participate and we observe and measure the outcomes. The “best” most efficient ways will tend to spread because the benefits arising from cost savings can be given to the participants.

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