MODULE 1: TAX THEORY, POLICY, REFORM AND ANTI-
AVOIDANCE
PART A: TAX THEORY 3
Purpose of taxes
• Reallocate resources from taxpayers to government
• Fund government expenditures
o Redistribution/transfers (e.g. social welfare)
o Public goods/services (e.g.F correcting market failures)
1.1 The principles of taxation and tax theory relevant to a tax regime 3
Tax law is public law defining the terms of the government’s collection of revenue from taxpayers. Collecting tax is a
sovereign activity that distinguishes the government from a private creditor. Public law values, underpinned
primarily by administrative law, include:
• openness
• fairness
• participation
• impartiality
• accountability
• honesty
• rationality.
Fiscal adequacy 4
Two key reviews of the Australian taxation system highlighted fiscal adequacy. In 1974, the Treasury defined fiscal
adequacy as ‘the government’s ability to meet revenue needs’.
This principle was considered to be the ‘primary requirement’ of the Treasury in 1974. More recently, it was
considered to be one of the ‘primary objectives’ of the tax system in the Henry Review report.
Equity 4
Divided into the 3 dimensions:
- Horizontal equity: is achieved when people who are equally placed have equal tax burdens
- Vertical equity: is achieved when the wealthy have greater tax burdens than those less fortunately placed.
- Intergenerational equity: Taxpayers benefitting should pay related taxes.
Defining Income 4
Degree of Progression of the Tax System 5
- Progressive: the rate of tax increases as income increases. E.g. direct taxes on individuals are progressive in
Australia.
- Proportional: the rate of tax is constant as income increases. For example, a 20% proportional tax would
result in a taxpayer who has taxable income of $100 paying $20 in tax, while another taxpayer who has
taxable income of $100 000 pays $20 000 in tax.
- Regressive: the rate of tax decreases as income increases. E.g. GST, excise, customs duties and property
taxes
Incidence of Tax 6
- Statutory v Economic
e.g: the statutory incidence of tax falls on the supplier, but the economic incidence of tax falls on the end
consumers of goods and services sold within Australia
- Direct v Indirect
,Economic efficiency 7
Two key elements (Henry Review):
• Putting productive resources (labour, land, capital) to their highest value use
• Distributing goods/services to consumers to best meet needs and wants
Taxes Cause Distortions to Behaviour
Taxes should seek to maximise social welfare while raising the necessary tax revenue.
Economists argue that the extent to which tax distorts individual choices in the market should be minimised.
Economists take into account the ‘income effects’ and ‘substitution effects’ of the imposition of a tax.
Income effects (efficient):
- An increase in marginal tax rates will reduce a taxpayer’s disposable income, and so it may be desirable for
that taxpayer to work harder to put themselves back in the same position occupied before the increase in
tax.
- the most efficient way to meet the cost of the additional tax burden.
Substitution effects (inefficient):
- the higher tax rate will reduce the disposable income the taxpayer can get from an additional hour’s work,
which may result in the taxpayer preferring leisure to work.
- create economic inefficiencies as productive resources (like labour, land or capital) are not put to their
highest value use, even if all they do is offset the influence of the income effects (e.g. a taxpayer may
substitute untaxed home duties for taxed work).
Aim to achieve a neutral tax system: Should not alter:
• Relative investment returns
• Relative entity attractiveness
• Relative productive resource prices
Introduce taxes to overcome market failures:
• Positive externalities (e.g. SME benefits to society => SME concessions)
• Negative externalities (e.g. pollution => carbon tax)
Simplicity 8
The tax and transfer system should be easy to understand and simple to comply with. A simple and transparent
system makes it easier for people to understand their obligations and entitlements. People and businesses will be
more likely to make the most beneficial choices for themselves and respond to intended policy signals. A simple and
transparent system may also involve lower compliance costs for taxpayers and transfer recipients.
1.2 Weighting the tax policy criteria 9
Trade-offs required between the key tax principles
• Conflict between equity, efficiency and simplicity
, • More equitable = More complex
• Depends on the focus of the tax system and its performance
1.3 Political considerations 9
Politicisation of tax reform process can compromise good tax policy
• Powerful interest groups can sway policy
• Tax expenditures can lead to inefficiencies
PART B: TAX POLICY 11
1.4 Australian tax reviews 11
Asprey report 11
The recommendations: broadening the tax base and cutting statutory rates of tax.
The major reforms following the Asprey report were implemented in the 1980s and included capital gains tax (CGT),
dividend imputation and large cuts to personal and business income tax rates.
Draft white paper 12
Key outcomes from the draft white paper included the introduction of a CGT and a comprehensive FBT.
Tax reform: not a new tax, a new tax system (ANTS Report) 12
The ANTS report also called for a wide-ranging review of Australia’s business tax system.
The key recommendation:
- replace the wholesale sales tax (WST) and some state taxes with a broad-based consumption tax, known as
GST.
- introduce an Australian Business Number (ABN) for enterprises, a simplified tax system (STS) for small
businesses and Pay-As-You-Go (PAYG) tax collections for businesses and individuals.
Henry Review 12
Future tax reform 2015 13
1.5 Australia’s tax system 13
,Commonwealth and state taxes: the tax mix 13
The majority of Commonwealth Government taxation revenue, which represented 81.1% of the total taxation
revenue received for all levels of government in the 2020–21 financial year, is derived from taxes on income.
Most state government revenue arises from taxes on goods and services and payroll tax, whereas local government
taxation revenue arises from taxes on property.
International comparisons with Australia 15
Relative to the OECD average, Australia’s tax mix can be characterised as generating:
• a substantially higher proportion of revenues from taxes on personal income, profits and gains; taxes on
corporate income and gains; payroll taxes; taxes on property; and taxes on goods and services (excluding
GST)
• a substantially lower proportion of revenues from GST
• no revenues from taxes on social security contributions.
, 1.6 Income and capital taxes 15
Income taxes 15
Australia relies heavily on income taxes, particularly company tax, compared to other OECD countries.
Personal Income Taxes
- Personal income taxes are very visible and, therefore, attract considerable economic and political debate.
- They are able to be imposed on a broad base, which results in significant revenue gain at tax rates that are
relatively modest.
- They are usually progressive in nature.
- They create minimal substitution effects, or other efficiency effects among most working people,
particularly those taxpayers engaged in full-time work.
- On a macroeconomic level, they can act as a stabiliser to control the economy
- They are also seen as being more harmful to growth than consumption taxes.
- Personal income taxes are also seen to discourage savings as, generally, returns from savings (e.g. interest,
dividends and rent) are taxed
- Progressivity in the personal income tax system is affected by ‘bracket creep’ (also referred to as ‘fiscal
drag’). This refers to the situation where taxpayers face higher average, and sometimes marginal, tax rates
over time even if their income has only increased as a result of inflation. Governments respond to bracket
creep by adjusting the thresholds periodically and providing tax cuts.
- more harmful to growth than consumption taxes
- discourage savings as, generally, returns from savings (e.g. interest, dividends and rent) are taxed.
- The trend to reduce personal income tax rates has been caused by globalisation, but also by governments
wanting to create a fiscal environment that promotes saving, investment and entrepreneurship, and
creates work incentives.
Taxing Capital Gains
- The main rationale for taxation of capital gains is to protect the income tax base. If these gains were not
taxed, it would be relatively easy for taxpayers to convert traditional income gains into capital gains to
avoid the imposition of tax, leading to inefficiencies.
Tax concessions and business decisions 17
Capital Gains Tax
• CGT 15-year asset exemption: Income Tax Assessment Act 1997 (Cwlth) (ITAA97), Subdivision 152-B.
• CGT 50 per cent active asset reduction: ITAA97, Subdivision 152-C.
• CGT retirement exemption: ITAA97, Subdivision 152-D.
AVOIDANCE
PART A: TAX THEORY 3
Purpose of taxes
• Reallocate resources from taxpayers to government
• Fund government expenditures
o Redistribution/transfers (e.g. social welfare)
o Public goods/services (e.g.F correcting market failures)
1.1 The principles of taxation and tax theory relevant to a tax regime 3
Tax law is public law defining the terms of the government’s collection of revenue from taxpayers. Collecting tax is a
sovereign activity that distinguishes the government from a private creditor. Public law values, underpinned
primarily by administrative law, include:
• openness
• fairness
• participation
• impartiality
• accountability
• honesty
• rationality.
Fiscal adequacy 4
Two key reviews of the Australian taxation system highlighted fiscal adequacy. In 1974, the Treasury defined fiscal
adequacy as ‘the government’s ability to meet revenue needs’.
This principle was considered to be the ‘primary requirement’ of the Treasury in 1974. More recently, it was
considered to be one of the ‘primary objectives’ of the tax system in the Henry Review report.
Equity 4
Divided into the 3 dimensions:
- Horizontal equity: is achieved when people who are equally placed have equal tax burdens
- Vertical equity: is achieved when the wealthy have greater tax burdens than those less fortunately placed.
- Intergenerational equity: Taxpayers benefitting should pay related taxes.
Defining Income 4
Degree of Progression of the Tax System 5
- Progressive: the rate of tax increases as income increases. E.g. direct taxes on individuals are progressive in
Australia.
- Proportional: the rate of tax is constant as income increases. For example, a 20% proportional tax would
result in a taxpayer who has taxable income of $100 paying $20 in tax, while another taxpayer who has
taxable income of $100 000 pays $20 000 in tax.
- Regressive: the rate of tax decreases as income increases. E.g. GST, excise, customs duties and property
taxes
Incidence of Tax 6
- Statutory v Economic
e.g: the statutory incidence of tax falls on the supplier, but the economic incidence of tax falls on the end
consumers of goods and services sold within Australia
- Direct v Indirect
,Economic efficiency 7
Two key elements (Henry Review):
• Putting productive resources (labour, land, capital) to their highest value use
• Distributing goods/services to consumers to best meet needs and wants
Taxes Cause Distortions to Behaviour
Taxes should seek to maximise social welfare while raising the necessary tax revenue.
Economists argue that the extent to which tax distorts individual choices in the market should be minimised.
Economists take into account the ‘income effects’ and ‘substitution effects’ of the imposition of a tax.
Income effects (efficient):
- An increase in marginal tax rates will reduce a taxpayer’s disposable income, and so it may be desirable for
that taxpayer to work harder to put themselves back in the same position occupied before the increase in
tax.
- the most efficient way to meet the cost of the additional tax burden.
Substitution effects (inefficient):
- the higher tax rate will reduce the disposable income the taxpayer can get from an additional hour’s work,
which may result in the taxpayer preferring leisure to work.
- create economic inefficiencies as productive resources (like labour, land or capital) are not put to their
highest value use, even if all they do is offset the influence of the income effects (e.g. a taxpayer may
substitute untaxed home duties for taxed work).
Aim to achieve a neutral tax system: Should not alter:
• Relative investment returns
• Relative entity attractiveness
• Relative productive resource prices
Introduce taxes to overcome market failures:
• Positive externalities (e.g. SME benefits to society => SME concessions)
• Negative externalities (e.g. pollution => carbon tax)
Simplicity 8
The tax and transfer system should be easy to understand and simple to comply with. A simple and transparent
system makes it easier for people to understand their obligations and entitlements. People and businesses will be
more likely to make the most beneficial choices for themselves and respond to intended policy signals. A simple and
transparent system may also involve lower compliance costs for taxpayers and transfer recipients.
1.2 Weighting the tax policy criteria 9
Trade-offs required between the key tax principles
• Conflict between equity, efficiency and simplicity
, • More equitable = More complex
• Depends on the focus of the tax system and its performance
1.3 Political considerations 9
Politicisation of tax reform process can compromise good tax policy
• Powerful interest groups can sway policy
• Tax expenditures can lead to inefficiencies
PART B: TAX POLICY 11
1.4 Australian tax reviews 11
Asprey report 11
The recommendations: broadening the tax base and cutting statutory rates of tax.
The major reforms following the Asprey report were implemented in the 1980s and included capital gains tax (CGT),
dividend imputation and large cuts to personal and business income tax rates.
Draft white paper 12
Key outcomes from the draft white paper included the introduction of a CGT and a comprehensive FBT.
Tax reform: not a new tax, a new tax system (ANTS Report) 12
The ANTS report also called for a wide-ranging review of Australia’s business tax system.
The key recommendation:
- replace the wholesale sales tax (WST) and some state taxes with a broad-based consumption tax, known as
GST.
- introduce an Australian Business Number (ABN) for enterprises, a simplified tax system (STS) for small
businesses and Pay-As-You-Go (PAYG) tax collections for businesses and individuals.
Henry Review 12
Future tax reform 2015 13
1.5 Australia’s tax system 13
,Commonwealth and state taxes: the tax mix 13
The majority of Commonwealth Government taxation revenue, which represented 81.1% of the total taxation
revenue received for all levels of government in the 2020–21 financial year, is derived from taxes on income.
Most state government revenue arises from taxes on goods and services and payroll tax, whereas local government
taxation revenue arises from taxes on property.
International comparisons with Australia 15
Relative to the OECD average, Australia’s tax mix can be characterised as generating:
• a substantially higher proportion of revenues from taxes on personal income, profits and gains; taxes on
corporate income and gains; payroll taxes; taxes on property; and taxes on goods and services (excluding
GST)
• a substantially lower proportion of revenues from GST
• no revenues from taxes on social security contributions.
, 1.6 Income and capital taxes 15
Income taxes 15
Australia relies heavily on income taxes, particularly company tax, compared to other OECD countries.
Personal Income Taxes
- Personal income taxes are very visible and, therefore, attract considerable economic and political debate.
- They are able to be imposed on a broad base, which results in significant revenue gain at tax rates that are
relatively modest.
- They are usually progressive in nature.
- They create minimal substitution effects, or other efficiency effects among most working people,
particularly those taxpayers engaged in full-time work.
- On a macroeconomic level, they can act as a stabiliser to control the economy
- They are also seen as being more harmful to growth than consumption taxes.
- Personal income taxes are also seen to discourage savings as, generally, returns from savings (e.g. interest,
dividends and rent) are taxed
- Progressivity in the personal income tax system is affected by ‘bracket creep’ (also referred to as ‘fiscal
drag’). This refers to the situation where taxpayers face higher average, and sometimes marginal, tax rates
over time even if their income has only increased as a result of inflation. Governments respond to bracket
creep by adjusting the thresholds periodically and providing tax cuts.
- more harmful to growth than consumption taxes
- discourage savings as, generally, returns from savings (e.g. interest, dividends and rent) are taxed.
- The trend to reduce personal income tax rates has been caused by globalisation, but also by governments
wanting to create a fiscal environment that promotes saving, investment and entrepreneurship, and
creates work incentives.
Taxing Capital Gains
- The main rationale for taxation of capital gains is to protect the income tax base. If these gains were not
taxed, it would be relatively easy for taxpayers to convert traditional income gains into capital gains to
avoid the imposition of tax, leading to inefficiencies.
Tax concessions and business decisions 17
Capital Gains Tax
• CGT 15-year asset exemption: Income Tax Assessment Act 1997 (Cwlth) (ITAA97), Subdivision 152-B.
• CGT 50 per cent active asset reduction: ITAA97, Subdivision 152-C.
• CGT retirement exemption: ITAA97, Subdivision 152-D.
