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Taxation Reform

and Associated Pension Reforms

Bruce Barbour - February 2020

All figure in this page are for 2019/2020. They will change over subsequent years.

Taxation reform has always been problematic in Australia. The reason for this is quite straight forward: the word "tax" is poisonous to the general disinterested populous, except if it has the word "lower" or "abolish" associated with it. The general opinion seems to be - if it is a tax it must be bad. And it does not matter whether the person him or her self or most of the people they know will not be affected by the tax. In their mind - is tax = is bad.

Because of this it is so easy for either side of politics to "weaponise" any proposal to increase taxes or to introduce a new tax or to do significant tax reform that involves the introduction of new taxes. It seems that it does not matter to the politicians whether the proposal is good, in the nation's best interest or even whether they secretly agree with the tax proposal. They are most likely to take the political approach, and use it as a cheap shot weapon against their opponents.

From my observation the only way tax reform can be achieved is that any new tax introduced must be offset by other tax decreases or abolition probably worth two or three times as much as the new tax collects. Consequently opportunities only arise for tax reform after government tax receipts have increased substantially due to either a sustained period of "bracket creep", increased income from resources based taxes or from company tax in boom periods. These opportunities must not be wasted as they have been in the past, where governments have either decreased tax rates without reform or spent the windfall on services and projects, worthwhile or otherwise.

Why is tax reform necessary? If we stop giving tax subsidies and pensions to those that don't need them then the extra income derived will provide the opportunity to improve services and government social security payments (especially the unemployment benefit which is well below the poverty line) in Australia and to possibly lower income taxes and perhaps abolition of payroll tax by State governments.

It is with this knowledge of the difficulties of tax reform that I will suggest a number of tax and associated reforms for consideration. I provide just the kernel of the idea. While I could flesh them out, that would take many pages on each idea. This page is not the place for that.

Death Taxes and Gift Tax

Talk about poisonous words, death and taxes - no one wants either. So no wonder this is a difficult sell for politicians. However it seems to me that this is a reasonable time to tax an estate. Australia use to have death taxes. They were levied by the States. But then one State - Queensland - had a brainwave thinking they would attract retirees to the State - abolished their death taxes (or death duties as they were called). Once this happened all the other States were virtually obliged to abolish their death taxes or risk an exodus of retirees. There was no net benefit to Queensland - only a loss of revenue to all States.

I would propose a tax of say 20 percent on the value of the estate over, say, $2.5 million. And possibly say 25% on assets over $50 million. (All these figures - to be determined.) The value of the estate would include all houses, including primary residences. However the $2.5 million threshold means that the majority of estates, even those with normal residential houses, will not be impacted. There has to be an associated gift tax to limit avoidance. Various details have to be worked out associated with dealing with the estates where the deceased had a spouse and the assets split - as I said these are just kernels of ideas.

The only deduction I would allow to this tax is if the estate has left a bequest to registered charitable organisation(s) or to set up a charitable organisation which would be approved by the charities commission. To encourage charitable donation from the estate I would make it charitable donation deductible at twice the rate (or some other multiple) from the value of the estate for tax purposes. This is justifiable as it encourages donation of money which goes to community uses at many times the amount that would otherwise be collected by the government from the death tax.

To illustrate this an example: An estate is valued at $5 million and the will has made charitable bequests to registered charities totaling $500,000. The amount of death tax payable would be ($5million - $2.5 million - 2 x $500,000) x 20% = $300,000. This still leaves plenty of money for the beneficiaries. And the majority of people would not have to pay death taxes at all as most estates would be valued below $2.5 million.

Wealth Tax

When I heard Elizabeth Warren (US Democratic presidency candidate) propose a wealth tax I was amazed for two reasons. I could not imagine an Australian politician having the guts to propose this tax and still expect to be elected - never mind that it would only impact the very rich. The proposed rate of 6% on the super rich was also surprising considering that it would apply year after year - 60% after ten years! Even though I judge myself to be on the progressive side I consider this to be quite high, especially if it is applied in conjunction with normal income and other taxes.

However it is also apparent that some rich people will do whatever they can to minimise their income tax payments, and with the help of well paid accountants, setting up artificial schemes to minimise tax liability if not completely eliminate it. This is an issue. Every member of society that has the means must make a financial contribution to the running of a civilised society. For the rich, who enjoy their wealth largely because they live in a stable society that is governed according to the rule of law, the obligation to pay tax is high.

The proposal is that there be a wealth tax for the rich that runs in parallel with income tax. However the person does not pay both, they pay either the income tax or the wealth tax, which ever tax amount is greater. This should put a base under the amount that the rich pay so no matter what minimising arrangement they put in place for income tax they would still have to pay the wealth tax if this is higher than the income tax. (So long as all their assets aren't squirreled away in a Cayman's island tax shelter or in dubious trust arrangements - hence the need for reform of trusts.)

I will put some figures to the proposal, for illustrative purposes. The wealth tax would kick in for people with wealth over $2.5 million (I would increase that figure for people over the retirement age). The amount taxable for wealth tax purposes would include the value of the residential house assets. Super would be exempt. If the rich have a house and other assets valued at $10 million then $7.5 million of that value would be included in the wealth tax assessment. I would set the wealth tax at a modest rate, say 2.5% possibly increasing to 3.5% for wealth over $25 million.

Say someone has wealth of $25 million and they earn a taxable income of $1 million both from their job and their investments. Their income tax liability would be approx. $423,000. Their wealth tax liability would be ($25 million - $2.5 million) x 2.5% = $562,500. However they don't have to pay both, they pay the highest, that is, $562,500. If the person earned $2 million then their income tax liability would be $873,000, which is greater than the wealth tax liability and is therefore the tax debt. If they "arranged their affairs" so that they only earned a taxable income of $100,000 they would pay the wealth tax of $562,500.

The only deductions I would allow on the wealth tax would be donations to registered charities, at a deductible rate / formula to be determined.

Superannuation Tax and Pension reform

For retirement planning advice please seek the advice of a registered professional financial adviser rather than relying on anything I write here.

Superannuation is an area rife for reform. It needs to be done in a comprehensive manner rather than just piecemeal plugging of holes in a system. This was the issue I had with Labor's franking credit proposal at the last Federal election (2019). It was trying to plug a hole which if plugged would adversely effect one group of people while leaving the many other "holes" untouched. Unfortunately Labor lost the election, perhaps partially because of this policy.

The original idea of the Australian superannuation system was for people to save money so they could fund their own retirements, therefore taking pressure off the aged pension system. However it seems to have morphed more and more into a tax minimisation and an inter-generational wealth transfer vehicle. It provides more favourable tax treatment for the rich than the poor - the antithesis of a progressive tax system. It allows government payments and subsidies to the moderately well off. It does not force people to use their own savings, both inside and outside superannuation system, to support themselves until their resources reduce, allowing the payment of partial government pensions even though there is still significant money in the superannuation fund or as other assets, or they have other significant income.

Tax on payments into the superannuation fund and investment earnings of the fund are currently set at a flat rate of 15%. So consequently a person who earns over $180,000 pa gets a 30% discount on their tax payable compared to someone who earns $40,000 pa who only gets a 17.5% discount. I agree with the idea of a tax discount to encourage savings and also a recognition that the money is locked up until retirement age and (for at least some level) the contribution compulsory, the discount should be similar for everyone. So I suggest that the tax payable on investment and earnings in the superannuation fund should be, say, 22% less than the top marginal rate that the person pays. This means that super funds for people that earn less than $37,000 would pay no tax on monies contributed or earned. Between $37,000 and $90,000 the funds would pay 10.5% on monies contributed or earned. $90K to 180K - 15%. Over $180K - 23%. To be fair under for people earning under $18,000 dollars the superannuation account would be credited with an additional 19% on top of super guarantee payments made into the fund - from the government. These are based on 2020 marginal tax rate figures. Still a worthwhile discount to encourage saving. This would mean that tax can only be taken from the fund once the yearly income is known. The majority of taxpayers will be better off under this arrangement. And it will be fairer.

Determining the maximum that can be held in the tax advantaged superannuation fund depends on how much it is believed is necessary to fund a person's retirement. And whether this amount should be the bare minimum necessary for a "modest" lifestyle or a higher amount that will allow a more "comfortable" lifestyle.

A few figures first:
The Association of Superannuation Funds (ASF) provide two annual income figures:
(1) Modest Lifestyle (2019) - Single $27,913, Couple $40,194
(2) Comfortable Lifestyle (2019) - Single $43,789, Couple $61,786

Compare this to the current maximum aged pension (2019):
Single - $22,169, Couple - $33,370.

The aged pension is lower than what the ASF considers necessary for a modest lifestyle. This means that an aged pensioner that relies solely on the government pension may struggle to have a reasonable lifestyle. In other words they should endeavour to have additional resources to help pay for their retirement - if that is at all possible. The government allows aged pensioners to earn an additional $174 per week for a single and $308 for a couple before this impacts on their pension. These additional amounts would bring the total income up to a level comparable to the ASF modest lifestyle income.

There is a basic question: what level of income should a government superannuation fund scheme, in which contributions and earnings are subject to reduced taxation, aim to provide? Too much and it is providing subsidies to those that don't need them and losing tax revenue that could be funding better services, too little and it will not be achieving its purpose.

The current maximum amount that can be saved into a person's taxed advantaged superannuation fund portfolio is $1.6 million. There is also another rule that says once the person reaches a retirement age of 67 they must take a minimum of 5% of the funds value annually. This percentage increases with age. The stated reason for this is so that the fund will be drawn down over its life rather than just accumulating wealth to be transferred to beneficiaries. Of course it says nothing about having to spend this money - so it can just be accumulated outside of the fund instead of within it.

If a person has the maximum amount in the fund at 67 then they would have to draw out $80,000. This is tax free and way above the ASF modest lifestyle income and above the comfortable lifestyle figure as well. So why is the Government offering subsides to help people achieve a superior lifestyle in retirement? The money forgone could be used to improve social support - perhaps to increase the aged pension to the "ASF modest lifestyle" level.

If we used the ASF modest lifestyle income for a couple as the benchmark for what is desireable, that would suggest a fund size between $1 million and $1.2 million should be adequate. The $1.6 million maximum fund level should be decreased by at least $400K - possibly more. It might be prudent to allow a higher maximum for a couple that does not own their own home - so long as that does not introduce perverse outcomes. Note that very few people reach the $1.6 million - probably only the well off would achieve that level. Most people would not reach $1 million in their super fund, so the decrease in the maximum fund level would only effect a few.

The purpose of this is not to stop the well off from having a superior lifestyle in their retirement if they want it and can afford it. They just have to save for part of it outside the superannuation fund and therefore not have their superior retirement lifestyle subsidised by the taxpayer. If they choose to spend and not save then they have to cop the lifestyle that their super fund affords them. We do not need the state to protect the well off from their own extravagance.

A reduction in the government pension occurs when a persons assets or income is above a certain set point and will cut out if those values reach a certain cut off.

At present the pension cuts out at approx. $74,700 for a couple. I ask is it reasonable for a couple getting over $70K per annum to still receives a government pension, no matter how small? Especially considering the ASF figure for a comfortable lifestyle is $61,786. And the government must consider that a couple can live at least a modest lifestyle with an income of $33,700 as this is the amount they provide for a couple on the full aged pension. The formula used to decrease the pension for a person with increased income needs to be reviewed.

The pension cuts out when a couple has assets of $863,500 for a couple that own their own home. This figure excludes the value of the house they own and are living in. Again I ask the question whether a person with over $800K of assets (exc. their house) should be getting even a small pension. They could have the $800K in a super fund that has been built up in a subsidised tax reduced environment and still qualify for a part government pension as well. Even if they used $40K per year and the assets did not earn any interest (which is unlikely) they could still live on it for twenty years - and anyway the pension would not be abolished for them, it would just begin to cut in at a lower level of assets (suggest possibly half what it is now) as a safety net which is what the pension should be. It would also increase at a quicker rate as the value of assets diminished below that threshold.

A person's eligibility for a government pension does not take account the value of the residential home. I would question the total residential home exemption, and suggest that only the first $2 million of the home's value be exempted (though there is a perfectly valid argument against having even that level of exemption). If a person is living in a $10 million mansion then they don't really need a government pension, even if they don't have any other more liquid assets they can call upon. They can take out loans against the capital value of the house to fund their retirement. There is a government loans scheme for this, as well as many private reverse mortgage offerings. The people that benefit most from the residential house exemption are the will beneficiaries.

Trust reform

From what I can see the main use of trusts seems to be as a vehicle for tax minimisation, and asset protection in case of bankruptcy or legal action. While I am sure early on they had, and still have, other more worthy uses, such as for charitable purposes, I am also sure the vast majority of them are not used for that reason now. They are a vehicle for tax minimisation which is only available to the well off. Average and below average Pay As You Go (PAYG) taxpayers don't have this opportunity. The arrangement is inherently unfair and costs the tax system, and therefore other taxpayers, a fortune. The system must be reviewed to stop the use of trusts for tax minimisation while maintaining their use for the genuine charitable entities and other legitimate uses.

Company Tax

All I will say about this is that we should not chase the lower rates of other countries, on some idea that companies will move off shore. Some may but most won't.

We must stop companies using related overseas company payments to minimise their Australian tax liabilities.

We must stop giving away, or selling at very low prices, our natural (mineral and other) resources (our common wealth) to any company but especially oversea companies.

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