Tax things that can’t move. That’s all you need to know
Australians are generous at heart. You see it when disaster strikes – drought, flood, fire – we all chip in and help out a friend in need.
And the truth is, that sort of community spirit is not only reserved for crises. Every day, through the taxes we pay, we help out the community. Our taxes pay for all the services that a free market, consisting of only self-interested individuals, would fail to provide: roads, transport, education, health care, help for the elderly, the sick, the poor and other community services.
No one likes paying tax, but most of us grudgingly accept tax is a necessary evil. Necessary for all the reasons mentioned above. Evil because all taxes distort behaviour, preventing transactions from occurring that would have otherwise had mutually beneficial outcomes. For example, dollars diverted to pay income taxes are dollars that could otherwise have been spent, increasing enjoyment and creating income for business.
What really matters is that the taxes we pay are spent efficiently and raised in the least distorting way.
Of course, you’d know all this if you’d read the 1000 or so pages of the Ken Henry tax review, as I - for my sins - have.
But not to worry. I can summarise it for you in one sentence: we should tax things that can’t move. That’s it. That’s all you need to know. Tax things that can’t move.
Whenever you tax something, you create the incentive for that something to try to avoid the tax. All this tax avoidance is a drain on the economy. So we should, where possible, tax things that can’t avoid paying the tax.
If you started out with a blank sheet of paper, you’d soon find there are any number of things you could tax: paper clips, wages, interest earned on deposits, shoelaces, company profits.
Turns out these things can be grouped into roughly four main types: land, labour, consumption and capital.
It should be fairly obvious that land is the most immoveable of all these. For that reason, economists reckon land should be most heavily taxed. The ground under your feet is not about to up and leave. Land is an essential input to production and also a pretty good surface upon which to live. It is scarce, giving it value. It also tends to be owned by relatively wealthy people, making a tax on the value of land a pretty good in terms of “progressivity” – the degree to which taxes are paid by the rich, rather than the poor.
State governments do apply some land taxes, particularly on investment properties. But a major recommendation of the Henry review was for a broader land tax that could go a long way to providing state governments the revenue needed to replace inefficient taxes like stamp duty on property transfers. Stamp duty is inefficient because, as a tax on a moving house, it discourages people from moving house and downsizing to more suitable accommodation. It prevents a more efficient allocation of the housing stock that would otherwise happen.
So lesson number one: tax land.
Of course, a related source of taxation is the rare minerals located beneath the land. The investment needed to dig out these minerals is internationally mobile, in that businesses can decide to go dig up minerals in other countries instead. But the minerals themselves are immoveable, making them a good target for taxation, as, of course, the Ken Henry review also recommended through a tax on mineral resources.
What shouldn’t we tax?
The things we don’t want to tax too heavily are the very flighty things. Turns out the most flighty of things are people and business investment.
From the economic point of view, the sweat of your brow should be taxed the least. Lower income taxes encourage you to work harder, because you get to keep more of the reward. This is particularly true for women caught up in the maze of deciding whether to return to work after childbirth, facing, as they do, higher tax rates and the withdrawal of benefits. We should be seeking to remove these disincentives, and one of the ways to do that is by reducing the tax on labour income.
Capital is also mobile. Companies can invest overseas if the tax is too high.
So, in summary, tax land. Try not to tax labour and capital. Of course, it’s fairly clear we do exactly the opposite, and get most of our tax from companies and individuals and not from land and minerals.
The last of the four sources of tax is consumption. Australia’s main consumption tax is the goods and services tax. Economist think consumption taxes are pretty good because they don’t distort behaviour. Taxing consumption deters some purchases, but in the main, people continue to spend. After all, we still need to eat, wear clothes, entertain ourselves and purchase services like haircuts, vet services and so forth.
So consumption is a good target for taxation. In fact, most countries around the world tax consumption. The United Kingdom applies a 20 per cent “value added tax” on consumption. Japan recently increased its consumption tax from 5 to 10 per cent.
The Ken Henry report was prevented from discussing the GST, but most economists agree it is a relatively efficient tax that should be greater used.
The revenue raised could be used to cut taxes on company and or personal income which would boost the economy by increasing the incentive for companies to invest more and also giving workers more incentive to work harder.
Australia faces a looming problem that as our population ages, governments will have greater difficulty balancing the books. It’s already beginning to bite. An older population will require more spending on health and age care. Meanwhile, a dwindling proportion of working aged people will be under more pressure to pay for all the spending.
Unless we can have sensible debates about raising taxes like the GST or mining taxes or land taxes, it is workers who will end up carrying the can in higher taxes. That, or budgets will not be in balance.
These are the discussions we have to have. There will always winners and losers from tax reform. But everyone loses from an inefficient tax and transfer system.
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