― 39 ―
6. Chapter 6 Inflation and Tax Reform
6.1. The Committee, which began its task of formulating advice in October 1972, has had to do so against the background of an economy in the throes of a continuing serious inflation—inflation at a rate which, at the time this report is presented, threatens to be far beyond anything contemplated during the initial stages of the Committee's deliberations. The rate has increased noticeably since the compilation of the Committee's preliminary report which was completed at the end of May 1974.
6.2. In the period from 1954–55 to 1968–69, the annual rate of increase in consumer prices—customarily treated as the main index of inflation—averaged 2.6 per cent; but over the last five years the annual rate of increase, taking the figures from one June quarter to the next, has sharply accelerated in the following manner:
| Percent | |
| 1969–70 | 3.7 |
| 1970–71 | 5.4 |
| 1971–72 | 6.2 |
| 1972–73 | 8.0 |
| 1973–74 | 14.4 |
| note |
6.3. Inflation on the present scale is gravely disturbing. It produces arbitrary changes in the distribution of income and wealth, favouring borrowers at the expense of lenders, the working population at the expense of the retired, and more powerful pressure groups at the expense of less powerful ones. It distorts the composition of production as people seek, not the commodities they most want for consumption and the level and pattern of savings most suited to their real needs, but rather what will give them the best hedge against inflation. It creates uncertainty and frustration over the whole range of the community, and leads to serious breakdown in commercial confidence and great industrial unrest. It may cause balance of payments difficulties. And once the rise in prices is at all rapid, the new threat emerges of further acceleration, leading if unchecked to hyper-inflation and to the undermining of the whole economic and social fabric.
6.4. There can be no denying, too, that tax arrangements are capable of intensifying or moderating the pace of inflation. In
its proposals on tax reform, compiled within its terms of reference of 1972 and spelled out in later chapters of this report,
the Committee has given only modest attention to the impact of taxes on inflation. For one thing, tax measures on their own
are hardly likely to remove inflation, and it is not within the Committee's competence to pass judgment on policies outside
the immediate field of taxation. Furthermore, effective action to deal with inflation may require at least temporary
adjustment to the overall level of taxation, and the Committee by its terms of reference is instructed to ‘ensure a flow of
revenue sufficient to meet the revenue requirements of the Commonwealth’. Also the role of taxes in the inflation process is a
matter of much controversy and uncertainty: any recommendations would thus have to be somewhat tentative. But with inflation
running at an
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exceptionally high rate and threatening to become a permanent feature of the Australian economy, the
Committee might justly be criticised for seeming to be out of touch with reality if it failed to make observations on tax
policy in relation to inflation, more especially in view of the variety of anti-inflation schemes now being canvassed that
assign a somewhat novel role to the tax system. Section I of this chapter is intended to forestall such criticism.
6.5. Just as taxation has a bearing on the rate of inflation, so inflation impinges on the tax system in important respects, furnishing both grounds for a measure of tax reform and, since it is reasonable to suppose that an undesirable rate of inflation is going to persist for some time, complicating the task of devising reforms that will still be relevant years from now. Some of the main ways in which inflation impinges on the tax system are outlined in Section II of this chapter; the manner in which the Committee has sought to allow for inflation will be explained in later chapters when particular taxes are being reviewed.
6.6. Before proceeding to Section I, brief reference should be made to a further way in which inflation has affected the drafting of this report. With prices rising at rapid but unpredictable speed, it becomes correspondingly more difficult to estimate tax yields a year or two ahead, let alone yields four of five years hence which may prove to be the earliest that at least some of the Committee's recommendations can be implemented. That the Government now has difficulty forecasting revenue accurately even 12 months in advance is fairly apparent when actual tax receipts in 1973–74 are compared with estimates published in August 1973: for instance, sales tax brought in 9.0 per cent more revenue than anticipated and the pay-as-you-earn component of personal income tax 7.6 per cent more. Understandably, therefore, the Committee has not sought to be precise about the revenue implications of its various tax recommendations. Nor, in most cases, has it attempted to attach particular money values to levels of proposed concessions, rebates and the like, except by the way of indicating rough orders of magnitude and then only on the basis of today's prices.
I. Taxes and Inflation Control
6.7. The causes of inflation are complex and incompletely understood. But broadly two schools of thought can be distinguished, commonly labelled demand-pull and cost-push.
6.8. The former school looks to the behaviour of individuals and groups in the face of excess demand for goods and services
over available supply, a rapid expansion in the volume of money, and expectations of changes in prices and earnings. It is
recognised too that inflation may stem in part from international factors, and a number of channels by which rising prices
may be transmitted from country to country have come to be identified: for example, by overseas demand raising exporters’
incomes or a balance of payments surplus causing the domestic money supply to expand. In general, the emergence of excess
demand is considered to be the prime initiating factor, though inflation may continue after excess demand has been
eliminated and perhaps even been replaced by a short-fall in demand accompanied by unemployment—what has come to be known
as stagflation. Inflation persists because the pursuit of income claims in response to price increases that have already
occurred establishes a wage-price spiral which is liable to continue as long as monetary conditions permit, reinforced in
some measure no doubt by wage-fixing practices inside and outside the arbitration system. The spiral tends to be
accompanied by greater strike activity as wage earners exploit their market power to press their income claims.
― 41 ―
To control inflation, according to the demand-pull school, the various sections of the community must be induced to
alter their behaviour, which can be done by manipulating such conventional economic variables as the money supply,
interest rates, the exchange rate, taxes and government spending.
6.9. The second school would acknowledge that the economic factors referred to in the last paragraph may at times be important, but argues that the underlying cause of inflation is more deep-seated and relates to a basic social struggle over the distribution of national income. Unions, firms and other groups use their economic and political power to try to protect or improve their share of national income, inflation of the cost-push variety being the means by which conflicting income claims find expression. The process is self-sustaining because governments have a strong political commitment to full employment and are therefore prepared to let the money supply expand to accommodate the income claims. This school also accepts that, to control inflation, behaviour must be changed, but the emphasis is less on manipulating conventional economic variables as on fundamental institutional and social reorganisation.
6.10. The explanations of both schools are undoubtedly important for an understanding of the inflationary process and it is misleading to polarise them. The first school points to the tendency for expenditure plans to exceed the capacity of the economy to satisfy them and sees rising prices as the inevitable consequence. The second school focuses on the conflict about income shares and sees rising money incomes as the manifestation of this struggle.
6.11. This latter view may help account for the long-term upward movement in the price level in the post-war period, but a more immediate explanation for the upsurge of inflation in Australia since 1970, and particularly after 1972, would seem to lie in the excessive growth in money supply, the pressure of demand on available resources and the build up of inflationary expectations. These tendencies can be traced to both international and domestic sources. The rapid growth of international reserves contributed in no small degree to the 26 per cent increase in money supply during 1972–73, while the steep rise in world commodity prices has obviously had a signficant influence on the growth of Australian prices and incomes. On the domestic front the easy monetary conditions of 1972–73 and early 1973–74 added to the growth of money supply and strengthened the demand for factors of production and final commodities. Budgetary policy was strongly expansionary throughout 1972–73 and only very slightly less so during 1973–74. Under these circumstances expectations of continuing and accelerating inflation led employers and employees to use their market power to maintain or increase their share of national income. The severest wage-price spiral since the wool-boom days of the early 1950s was thereby established.
6.12. It is fairly apparent that a reduction in the rate of inflation is only possible if individuals and groups in society can be induced to modify their behaviour. This is as much a political and social problem as an economic one, requiring common agreement about the extent to which the policy objectives of full employment, appropriate use of resources and a fair distribution of national income should be compromised for the sake of greater price stability. Conflicts inevitably arise in establishing satisfactory compromises, but until they are resolved an underlying inflationary trend seems unavoidable. Moreover, even if consensus about policy objectives can be achieved, there is still likely to be dispute over the means of ensuring that behaviour is consistent with the objectives chosen.
― 42 ―
6.13. Tax increases have traditionally been viewed as one of a number of policies for inclusion in a program to combat inflation. Increases in personal income tax reduced disposable incomes, thereby easing the pressure on resources caused by excessive spending in the private sector. Increases in indirect taxes tend to be shifted forward in varying degrees, producing once-and-for-all increases in the price level; but higher prices involve a cut in real spending power and in this sense such taxes are demand-reducing and therefore, in the absence of corresponding wage increases, anti-inflationary. It is conventionally assumed, when tax increases are to be used in a program to combat inflation, that any additional tax revenue is not in fact spent by the government.
6.14. Recent trends of events have called these views into question. It may be unduly optimistic to assume that government spending will be kept in check as taxes increase. Given the political commitment to full employment and pressures on governments to fulfil electoral promises, increases in tax revenue may have the effect, at least indirectly, of boosting government spending with the result that community spending is not in fact reduced. Such commitments and promises, morever, make it unlikely that tight monetary policies will be pursued for any length of time. In these circumstances the conventional assumptions may no longer be appropriate: there now seems to be a distinct possibility that personal income tax will in some degree be shifted too, and once-and-for-all price increases associated with tax shifting in general will become cumulative.
6.15. For a number of reasons personal income tax may be a somewhat weaker anti-inflationary device than used to be thought. To the extent that employees, in formulating their wage claims, anticipate the extra income tax that higher wages will attract, personal income tax may contribute in fairly direct fashion to the wage-price spiral. For if attempts to shift the tax through correspondingly higher wage claims prove successful and employers seek to recover their higher expenses by passing on additional labour costs (including those unavoidable costs accompanying a larger wages bill, such as payroll tax, workers’ compensation insurance premiums, and holiday and long-service leave costs), then commodity prices must rise as long as the money supply is allowed to expand. Workers, in deciding their wage demands, appear increasingly to be recognising the fact that personal income tax not only bites heavily into additional income but, because of the graduated rate schedule, does so with mounting severity the greater the additional income. It is understandable, in these circumstances, that employees should set their wage claims as high as possible, knowing as they do that the real value of their extra pay is going to be eroded not only by the rising prices but also by heavier taxation. Paradoxically, though, the more successful the work force as a whole in securing large wage increases, the more is the real value of extra pay liable to be eaten into by higher marginal tax rates.
6.16. The point is illustrated in Table 6.A. A 25 per cent increase in 1974–75 in the income of the average earner (row 1), if accompanied by similar increases throughout the work force and by a 2.5 per cent growth in national productivity, will mean a rise in consumer prices of the order of 22 per cent. The increase in pre-tax real income will thus be modest (row 2), being confined to growth in productivity. However, because of the considerable expansion in money income, tax payable will rise sharply in the context of an unadjusted rate schedule (rows 3 and 6). Were the 1973–74 schedule still functioning, the real value of the average earner's take-home pay would actually decline (row 5); indeed, had the 1974–75 schedule applied in both years, the decline would be somewhat greater (row 8).
― 43 ―
| 1973–74 | 1974–75 | Change 1973–74 to 1974–75 | ||
| $ | $ | Per cent | ||
| 1. | Average earnings per employed adult male unit | 6,136 | 7,670 | +25.0 |
| 2. | Value of average earnings at 1973–74 prices (a) | 6,136 | 6,289 | +2.5 |
| 1973–74 rate schedule and dependant allowance provisions | ||||
| 3. | Tax payable (b) | 761 | 1,202 | +58.0 |
| 4. | Take-home pay | 5,375 | 6,468 | +20.3 |
| 5. | Value of take-home pay at 1973–74 prices (a) | 5,375 | 5,302 | -1.4 |
| 1974–75 rate schedule and dependant allowance provisions | ||||
| 6. | Tax payable (b) | 455 | 922 | +102.6 |
| 7. | Take-home pay | 5,681 | 6,748 | +18.8 |
| 8. | Value of take-home pay at 1973–74 prices (a) | 5,681 | 5,531 | -2.6 |
| note | ||||
6.17. It is thus all too clear that tailoring wage demands to allow for the additional tax liability that higher incomes involve, if attempted by all employees, must be self-defeating in the absence of adjustments to the rate schedule or of the acceptance of lower profit margins by business. Nevertheless, particular sections of the work force, viewed in isolation, may be perfectly rational in seeking to maximise their wage demands; for if they are only modest in their demands, while other sections are not, they face the prospect of being made even worse off both absolutely and in relation to the rest of the work force. In the outcome, such inflationary pressures as already exist in the economy tend to be reinforced. Resistance to paying heavier taxation merges with the more basic struggle, adverted to in paragraph 6.9, between different groups in society each seeking a larger share of national income and reacting to the claims of others for a larger share.
6.18. This view of the contribution of personal income tax to the wage-price spiral has intuitive appeal and is beginning to gain many adherents. Empirical studies have yet to establish conclusively that there is a close relationship between changes in income tax, changes in wages, and changes in the general price level: investigations in the United Kingdom and Canada point to a relationship, but the research there is in its early stages and the findings are necessarily tentative. However, the wide publicity now being given to theories of inflation that attach importance to the passing on of personal income tax may in time serve to confirm such theories by bringing home more forcibly to income earners just how significant a bearing high and progressive rates of income tax have on the real value of take-home pay.
6.19. Doubts of other kinds have also been expressed about the efficacy of personal income tax as an anti-inflation device. Exactly how far work effort is inhibited by personal income tax is a matter of conjecture, but to the extent that it is it may tend to accentuate inflation by curbing the supply of goods at a time when demand is rising strongly. The issue is particularly important in relation to overtime work: it was concern on this account that led New Zealand, in 1974, to introduce a special rebate of tax on overtime earnings.
― 44 ―
6.20. There is the further point that if unions are now increasingly bargaining in net of tax terms, high and graduated rates of personal income tax may mean greater industrial unrest and strike action as workers attempt to achieve their wage demands, which again will be reflected in the supply of goods coming on the market as well as in the cost of producing them. Strong claims have been made, on the basis of United Kingdom data, for the existence of a relationship between strike activity and taxes.
6.21. Finally, the demand-reducing effects of personal income tax may be weaker than often thought. An increase in personal income tax expected to be only short-lived may do little to restrain personal consumption spending. To the extent that personal consumption depends upon ‘permanent’ rather than current income, the effect of a temporary increase in rates of personal income tax will be to reduce saving rather than consumption. A counter-cyclical increase in personal income tax may thus be ineffective in restricting demand precisely because it is seen to be a temporary stabilising measure. Moreover, in so far as personal income tax reduces the reward for saving and acts as an inducement to consume now rather than later, its efficacy in curbing demand may be further weakened.
6.22. In the conventional view, company tax reduces demand, and hence inflationary pressure, by diminishing company savings and the income of shareholders and thus reducing the rate of spending in both corporate and household sectors. To the extent that tax is shifted forward to consumers, the spending of companies and their shareholders will be less affected, but purchasers of the company's output will find their disposable incomes reduced in real terms. In the latter case, however, raising company tax is likely to exacerbate the wage-price spiral unless the offsetting demand-reducing effects are substantial.
6.23. It has been customary to argue that increases in rates of indirect tax are passed on as once-and-for-all increases in prices and constitute a deflationary measure because of the accompanying decline in the real spending power of consumers. However, the deflationary impact on the demand side may prove weaker than the initial effect on the general price level; furthermore, the price level effect may become embodied in expectations and hence in income claims. In these circumstances the tax increase will lead to cumulative shifting—forward to consumers through firms raising their prices and backward to firms through employees raising their income claims. Like other taxes, therefore, it is by no means certain that an increase in indirect taxation will be effective in reducing inflation; indeed, it could make things worse in some situations. Payroll tax is particularly open to criticism on this account, directly tied as the levy is to the size of an employer's wages bill.
6.24. Understandably, therefore, the view is now being widely canvassed that stabilisation policy in a period of severe inflation should feature tax cuts rather than tax increases, and the Committee can see some merit in this. Tax cuts, if accompanied by appropriate action in such other areas of policy as government spending, money supply, the exchange rate, tariffs and surveillance of prices and incomes, may have at least three attractions:
- (a) Once inflation becomes at all rapid, the appropriate setting of monetary and exchange rate policies and
levels of government spending is likely to be associated with long delays before the effects are seen in a
reduction of inflation. Tax cuts may fulfil the useful function of breaking into the wage-price
― 45 ―
spiral and thus of shortening the time-lag involved in applying other more conventional policies. - (b) Tax cuts in effect represent a reduction in the income claims of the government sector, which is one of the major groups involved in the struggle over income shares.
- (c) Tax cuts can be made to serve as a quid pro quo for trade union agreement to moderate wage claims. Employing taxes as part of a ‘social compact’ of this kind inevitably merges with the broader issue, now also attracting much attention, of using the tax system to implement some form of income and prices policy. This warrants closer examination.
6.25. Incomes and prices policies have found favour with many overseas countries, at one time or another, as a means of coping with inflation, though the results have been disappointing especially in the longer-term context. These policies usually involve the setting of guidelines for the growth of national and individual prices and incomes, and the adoption of devices to induce employers and employees to behave in a manner consistent with those guidelines. The inducement devices vary considerably, from moral suasion at the one extreme to legal compulsion at the other. In most countries the central government has had the power to pass legislation to regulate prices and incomes directly, but this is not the case in Australia and perhaps goes some way to explaining why, at least in peacetime, such policies have never been tried here. Lately, however, a number of proposals have been put forward for using the Australian tax system to induce employers and employees to formulate their income claims in conformity with certain national guidelines. This is not the place to debate the merits and shortcomings of incomes and prices policies generally; but it is not inappropriate to comment on particular tax arrangements designed to put pressure on management and labour to behave in certain ways.
6.26. Most of the suggestions in this area involve employing company tax to stiffen the back of the corporate sector in wage negotiations with employees. They include raising the basic company tax rate to, say, 60 per cent and then providing a rebate of perhaps 20 per cent for all companies holding wage increases within prescribed limits; leaving the basic rate unaltered but providing tax relief to firms that keep their wage increases down; and the denial of wage payments, in excess of some norm, as a tax deduction. More sophisticated proposals involve tapering the tax rebates or penalties. An excess profits tax has been canvassed too. Outside the company tax field there has been some support for a penalty rate of personal income tax on all increases in income in excess of a prescribed figure. One suggestion goes so far as setting the penalty rate at 100 per cent.
6.27. There may be constitutional obstacles to tax-penalty schemes of these kinds. Under section 51(ii) of the Constitution, the Commonwealth Parliament has power to make laws ‘with respect to taxation’. It is open to argument that a law purporting to impose differential rates of tax on employers according to their policy on wages or seeking to confiscate wage rises above a certain norm by imposing a marginal tax rate of 100 per cent would not be a law ‘with respect to taxation’ but one imposing wage control.
6.28. As well as constitutional problems, substantial tax shifting might occur, which would defeat the whole purpose of
such measures. Indeed, unless the tax penalties were carefully designed, and effective price controls to apply, price
might rise even faster than otherwise in circumstances where firms were readily able to shift taxes forward because of the
buoyant state of the market and were anxious to avoid becoming
― 46 ―
embroiled in protracted industrial disputes. The
ability to shift tax penalties is likely to vary markedly in different parts of the economy depending, for example, on the
degree of competition from overseas suppliers or from domestic producers not subject to the penalty provisions. Such
penalties might therefore prove highly inequitable, even as between firms exposed to penalties.
6.29. The use of the company tax system to restrain wage increases has further shortcomings. It might encourage some companies to assume partnership or trust status to avoid penalties. It might encourage others to change their method of operation, relying more heavily on sub-contractors instead of on their own employees. It could undermine many soundly-based production bonus schemes. It would make it extremely difficult for firms to estimate the effects of the coming into operation of major items of new equipment or the launching of additional products. There would be formidable administrative problems for employers and endless and unproductive argument on the exercise of the many discretions the Commissioner would need to be given to ensure that the scheme will function with some semblance of equity for all taxpayers.
6.30. It is extremely doubtful whether an excess profits tax aimed at inhibiting firms from pushing up their prices would achieve its purpose; it might simply weaken their resolve to hold down costs. Moreover, the problems to be faced in designing a scheme that would be both equitable and administratively feasible are daunting indeed. They were examined in some detail by the Spooner Committee which, in 1950, was asked to look at methods of giving effect to the government's decision, subsequently abandoned, to impose an excess profits tax as an anti-inflation measure.
6.31. There are also likely to be thorny problems in employing a penalty rate of personal income tax to curb wage claims. Persons working overtime or taking on second jobs or securing promotions would have to be accorded special treatment if the system was to be fair and work effort not to be unduly discouraged. Special consideration would also have to be given to persons with fluctuating incomes and to those entering the work force for the first time. There would be a strong inducement to understate income or attribute it to someone else, making the administration of the scheme even more burdensome for the Commissioner. Industrial unrest might intensify.
6.32. In the Committee's view tax penalties of the kinds outlined above are not a feasible proposition. Constitutional difficulties aside, effectively administering such penalties poses many awkward problems and there is no reasonable prospect that the rate of inflation would be held in check.
6.33. As already indicated, however, the Committee is not unsympathetic, in certain circumstances, to employing the opposite technique of tax cuts as part of a properly integrated program to halt inflation. It is particularly relevant in this regard to note the possible introduction soon of a scheme of wage indexation, intended to eliminate the insecurity and uncertainty employees feel about levels of real income and to establish an orderly basis for wage negotiations focusing on changes in productivity. A similar scheme, involving quarterly adjustments of wages by reference to changes in a price index, operated for many years in this country; it was abandoned in 1953 because it was thought to be inflationary.
6.34. The Committee is not in a position to judge the likely impact that the reintroduction of wage indexation would have
on the pace of inflation: much would obviously depend on whether incomes were indexed on a percentage basis or in flat
terms and on whatever other concurrent measures were taken. But if nothing were done to
― 47 ―
counteract price
increases already in the pipeline or to moderate wage claims currently under negotiation, wage indexation would almost
certainly make inflation worse. This is where tax cuts could perhaps play one useful role. They might serve to reduce the
impact on the consumer price index of wage and price increases already in the pipeline, especially if concentrated on
excise duties, sales tax and payroll tax which have a fairly immediate impact on the consumer price index. However, any
moderating effect that tax cuts might have on the consumer price index, and hence on those wage increases directly tied to
consumer prices, would count for little in the longer run if wage indexation failed to exert some downward pressure on
wage claims in excess of increases in the cost of living and improvements in productivity. Hence a second function of tax
cuts might be to foster a climate more conducive to wage restraint. Thus in so far as employees are increasingly seeking
to protect the real value of their take-home pay from the eroding effects of a progressive income tax by bargaining in
net-of-tax terms, one might hope that cuts in personal income tax rates would cause employees to moderate their wage
demands. But it would be asking too much of the tax system to shore up a wage indexation scheme that was poorly conceived
and badly timed.
6.35. In Section II of this chapter, and later in Chapter 14, attention is drawn to the need in times of inflation to adjust tax rates frequently when, in such cases as personal income tax and death duties, rate schedules are progressive. While the case for doing this, at least as far as personal income tax is concerned, may in some measure be to curb wage demands and thus assist in restraining inflation, the main object is to counteract the arbitrary and inequitable restructuring of tax schedules that inflation inevitably produces. In this main object the adjustment may be seen as an attempt not so much to control inflation as to make it more comfortable to live with. In Section II and later chapters attention is also drawn to the way inflation upsets the measurement of the base upon which a tax is levied, and suggestions are put forward for overcoming this problem. These suggestions, too, may be seen as measures to make inflation more comfortable to live with. They are partial expressions of a policy which, in its widest operation, would extend far beyond the tax system and include linking the number of dollars to be delivered on a contract—whether a wage contract, a sale or loan contract, or a pension entitlement—to changes in some specified price index. The Committee is not competent to determine the feasibility of comprehensive indexing along these lines. It would, however, reject the inference sometimes drawn that if a wide enough range of measures is taken to accommodate personal and business circumstances to rising prices, inflation no longer presents problems. Many problems would in fact remain—not least the prospect that inflation may be allowed to accelerate. The community's top priority, in the view of the Committee, must be to reduce inflation.
II. Effects of Inflation on Taxes
6.36. Whatever views are held about the impact of the tax system on inflation, there can be no question that inflation in its turn exerts a powerful influence on the character of the tax system which must be explicitly allowed for in any program of tax reform. This influence manifests itself in a variety of ways. They may conveniently be dealt with under the three headings of tax payment, tax drift and tax base.
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Tax Payment
6.37. With inflation, any appreciable delay between tax liability and actual tax payment may produce a not insignificant reduction in the real burden of tax: tax is, in effect, paid in depreciated currency. Unless such delays can be exploited by all taxpayers, inequities will occur. There is of course always an advantage in postponing tax payments as long as possible, but the advantage may be greater with inflation. Expressed another way, any delay in paying tax confers a benefit on the taxpayer unless a realistic rate of interest is charged on the postponed amount; and since nominal interest rates tend to be higher in times of inflation, the advantage of delaying payment is correspondingly greater. For example, present arrangements for paying company tax involve a noticeable time-lag, and the Committee has recommendations to make in this regard in Chapter 22.
6.38. The other side of the coin, where taxpayers find themselves disadvantaged through initially paying too much tax, is perhaps best illustrated by the system of instalment deductions under personal income tax. Most wage and salary earners are obliged to make interest-free loans to the government by way of excessive instalment deductions which are not paid back until after the end of the financial year. In a time of rapid inflation, as at present, both the size of these loans and the rates of interest taxpayers are forgoing by not having the money themselves, tend to rise sharply. This too is discussed in Chapter 22.
Tax Drift
6.39. Where a tax is levied at progressive rates or involves exemptions and deductions that remain unchanged in money terms over a period of years, substantial increases in prices and incomes have the effect of increasing tax receipts particularly rapidly. One important implication of this phenomenon, perhaps best described as ‘tax drift’, is the possible impetus it gives to inflation as wage earners find it necessary to pitch their income demands ever higher in a vain effort to compensate for the larger tax bite. Some of its other implications must also be considered.
Total Tax Receipts
6.40 In so far as tax drift applies to a major segment of the tax system, as in fact it does, it is inevitable that tax receipts will rise in relation to gross national product. As the statistics in Chapter 2 indicate, revenue from taxation has increased from 22.2 per cent of gross national product in 1959–60 to 27.7 per cent in 1973–74—in absolute terms an increase from $3,041 million to $13,768 million. While several factors have contributed to this upward trend, the tendency for inflation to push taxpayers into higher income tax brackets more quickly than otherwise has undoubtedly been responsible in no small measure. The windfall yield of tax drift is not without attractions for governments: extra revenue is obtained without the odium of lifting tax rates by legislation. But such illusions are unlikely to persist. People are already coming to realise that though their incomes before tax may be rising as fast or faster than prices, their incomes after tax are rising less than they had expected.
Tax Mix
6.41. Since tax drift mainly concerns personal income tax, a further effect of inflation is to increase the
proportion of tax revenue attributable to income tax. As recently as 1963–64 personal income tax raised only
$1,271 million, or some 32 per cent of all tax revenue; ten years later, in 1973–74, the figure had reached $5,490
million, which is nearly 40 per cent of tax revenue and puts Australia almost at the top among OECD
― 49 ―
countries in terms of reliance on personal income tax. It is the Committee's view, already expounded in Chapter
5, that less, not more, reliance should be placed on personal income tax.
Income Tax Rates
6.42 Even were the present trend towards greater reliance on personal income tax thought to be in the right direction, it is unlikely that inflation is achieving the restructuring at the right pace and in the right way. It especially has to be borne in mind that the drift associated with personal income tax does not operate uniformly over the whole income range. The Committee has received numerous submissions on this point and it deserves close examination.
6.43. The 1973–74 rate schedule, now superseded, was a modified version of the one introduced in 1954–55 which, apart from a special levy or rebate in certain years as part of counter-cyclical policy, remained unaltered until 1970–71. In that year, as Table 6.B reveals, reductions of approximately 10 per cent in tax payable on taxable incomes up to $10,000 were made, while reductions in tax payable above that level progressively declined to 4.4 per cent at $20,000 and zero at $32,000. The rate scale was again adjusted in 1972–73 to provide an overall reduction of about 10 per cent in total tax collections but the adjustment was so arranged that the percentage reduction in tax payable decreased as income rose.
| Taxable Income | 1954–55 | 1970–71(b) | 1973–74 | Taxable Income | 1974–75(c) |
| $ | per cent | per cent | per cent | $ | per cent |
| 0–200 | 0.4 | 0.3 | 0.2 | ||
| 201–300 | 1.3 | 1.2 | 0.8 | ||
| 301–400 | 2.9 | 2.7 | 2.4 | ||
| 401–500 | 4.6 | 4.1 | 3.8 | 0–1,000 | 1.0 |
| 501–600 | 6.3 | 5.5 | 4.9 | ||
| 601–800 | 8.3 | 7.4 | 6.5 | ||
| 801–1,000 | 10.8 | 9.7 | 8.2 | ||
| 1,001–1,200 | 12.5 | 11.3 | 9.8 | ||
| 1,201–1,400 | 14.2 | 12.8 | 11.3 | ||
| 1,401–1,600 | 15.8 | 14.3 | 12.7 | 1,001–2,000 | 7.0 |
| 1,601–1,800 | 17.5 | 15.8 | 14.1 | ||
| 1,801–2,000 | 19.2 | 17.3 | 15.4 | ||
| 2,001–2,400 | 21.7 | 19.5 | 17.2 | ||
| 2,401–2,800 | 24.6 | 22.1 | 19.6 | 2,001–3,000 | 14.0 |
| 2,801–3,200 | 27.1 | 24.4 | 22.0 | ||
| 3,201–3,600 | 29.6 | 26.7 | 24.4 | 3,001–4,000 | 20.0 |
| 3,601–4,000 | 32.1 | 28.8 | 26.8 | ||
| 4,001–4,800 | 35.4 | 31.9 | 30.3 | 4,001–5,000 | 26.0 |
| 4,801–5,600 | 38.3 | 34.5 | 33.3 | ||
| 5,601–6,400 | 41.3 | 37.0 | 35.7 | 5,001–6,000 | 32.0 |
| 6,401–7,200 | 43.8 | 39.4 | 37.9 | 6,001–7,000 | 38.0 |
| 7,201–8,000 | 46.3 | 41.7 | 39.9 | 7,001–8,000 | 44.0 |
| 8,001–8,800 | 48.8 | 43.9 | 41.8 | 8,001–10,000 | 48.0 |
| 8,801–10,000 | 51.7 | 46.5 | 44.1 | ||
| 10,001–12,000 | 55.0 | 50.6 | 48.2 | 10,001–12,000 | 52.0 |
| 12,001–16,000 | 57.9 | 56.4 | 54.6 | 12,001–16,000 | 55.0 |
| 16,001–20,000 | 60.4 | 62.4 | 60.3 | 16,001–20,000 | 60.0 |
| 20,001–32,000 | 63.3 | 66.7 | 64.0 | ||
| 32,001–40,000 | 66.7 | 66.7 | 64.0 | 20,001–40,000 | 64.0 |
| 40,001 and over | 66.7 | 66.7 | 66.7 | 40,001 and over | 67.0 |
| note |
― 50 ―
6.44. These changes were partly designed to meet the criticism that in periods of inflation when money incomes are rising rapidly the continued use of the same progressive scale, defined as such scales conventionally are on the basis of money income, produces substantial increases in the ‘burden’ of tax as reflected in average rates of tax.
6.45. The simplest way of depicting this increasing ‘burden’—a burden which, it ought to be stressed, derives ultimately not from inflation but from government spending increasing at a faster rate than gross national product—is to compare the average tax payable in different years on the same ‘real’ income, i.e. on an income which remains unchanged when the inflation component is removed. A set of such real incomes is assembled in Table 6.C. As a comparison of column 6 with column 2 indicates, average rates of tax in 1973–74 were somewhat higher than in 1954–55 at all levels of real income, notwithstanding the cuts made in 1970–71 and 1972–73. In terms of the percentage increase in average rates of tax (columns 4 and 7), the taxpayers whose position has changed most by comparison with their predecessors in 1954–55 are those at the bottom of the scale.
| 1954–55 | 1969–70(a) | 1973–74 | 1974–75(b) | |||||||
| Taxable income (constant real size 1973–74 prices) | Average tax rate | Average tax rate | Increase in average tax rate since 1954–55 | Reduction in after-tax income as a result of increase in average tax rate since 1954–55 | Average tax rate | Increase in average tax rate since 1954–55 | Reduction in after-tax income as a result of increase in average tax rate since 1954–55 | Average tax rate | Increase in average tax rate since 1954–55 | Reduction in after-tax income as a result of increase in average tax rate since 1954–55 |
| 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | 11 |
| $ | Per cent | Per cent | Per cent | Per cent | Per cent | Per cent | Per cent | Per cent | Per cent | Per cent |
| 1,500 | 3.7 | 6.1 | 64.9 | 2.4 | 6.4 | 73.0 | 2.8 | 3.7 | ..(c) | (0.1)(d) |
| 2,000 | 5.4 | 8.1 | 50.0 | 2.8 | 8.4 | 55.6 | 3.2 | 5.7 | 5.6 | 0.2 |
| 3,000 | 8.3 | 11.8 | 42.2 | 3.8 | 12.0 | 44.6 | 4.1 | 9.4 | 13.3 | 1.3 |
| 4,000 | 10.7 | 15.0 | 40.2 | 4.8 | 15.2 | 42.1 | 5.0 | 13.1 | 22.4 | 2.6 |
| 6,000 | 15.2 | 20.6 | 35.5 | 6.4 | 21.0 | 38.2 | 6.9 | 20.4 | 34.2 | 6.2 |
| 8,000 | 19.0 | 25.0 | 31.6 | 7.5 | 25.3 | 33.2 | 7.8 | 27.0 | 42.1 | 9.9 |
| 12,000 | 25.3 | 32.0 | 26.5 | 9.0 | 32.1 | 26.9 | 9.2 | 35.7 | 41.1 | 13.9 |
| 16,000 | 30.1 | 37.4 | 24.3 | 10.5 | 37.7 | 25.2 | 10.9 | 41.4 | 37.5 | 16.1 |
| 20,000 | 34.2 | 41.5 | 21.3 | 11.1 | 42.2 | 23.4 | 12.2 | 45.8 | 33.9 | 17.5 |
| 30,000 | 41.8 | 48.0 | 14.8 | 10.7 | 49.5 | 18.4 | 13.3 | 51.8 | 23.9 | 17.3 |
| 50,000 | 49.7 | 54.6 | 9.9 | 9.7 | 55.8 | 12.3 | 12.2 | 57.7 | 16.1 | 15.9 |
| 100,000 | 57.8 | 60.7 | 5.0 | 6.8 | 61.3 | 6.1 | 8.3 | 62.4 | 8.0 | 10.9 |
| note note | ||||||||||
6.46. A more satisfactory indicator of the change in tax liability resulting from inflation is the percentage
reduction in disposable income (i.e. income after tax) resulting from the change in average rates of tax. This
variable is shown in columns 5 and 8 of Table 6.C and, except at high levels, presents the contrary impression to
columns 4 and 7. Up to a certain income level the effect of inflation is to reduce disposable income by a greater
percentage as taxable income rises because under a progressive tax system disposable income increases at a smaller
percentage rate than does taxable
― 51 ―
income. As a result, even though average rates of tax may increase to
a greater extent in the lower income ranges, the net effect of inflation as one moves up the income scale is
intitially to reduce disposable income after tax by increasing percentage amounts. This reflects the fact that at
low incomes, where income tax is a small proportion of income, even a large percentage increase in tax takes only
a small part of income. Eventually this trend is reversed. At very high levels the percentage reduction in
disposable income, for a given rate change, is considerable.
6.47. It follows that criticisms based on percentage increases in the average rates of taxation claiming that the change in tax liability as a result of inflation is inversely related to taxable income are too simplistic. The changes in the distribution of tax liability as a result of inflation are much more complex than this: all taxpayers face increases in average rates of tax and the disposable incomes of taxpayers with higher taxable incomes are in many cases reduced proportionately more than the disposable incomes of those with lower taxable incomes. Much of the confusion about the distributional effects of changes in the effective rates of income tax as a result of inflation can be attributed to the application of an inappropriate summary measure to what is essentially a complex problem. If anything the pattern of changes in after-tax income as inflation proceeds lends support to a view that people well up the income scale, but not at the top, are relatively hardest hit.
6.48. The 1974–75 rate schedule, summarised in Table 6.B and described more fully at the beginning of Chapter 14, will moderate the effects referred to above only to a limited extent. Average rates of tax have been cut on taxable incomes up to $50,000, the reduction being fairly substantial on taxable incomes below $8,000 but no more than a gesture on taxable incomes above $12,000. Nevertheless, rapid inflation will soon offset these tax advantages, particularly for persons with taxable incomes between $5,500 and $11,000 who now face the prospect of paying noticeably higher marginal rates on any additional income they earn. It is impossible to tell how much tax real incomes of various sizes will attract in 1974–75: it depends on how quickly prices rise in 1974–75. However, Table 6.C has been extended to include figures for 1974–75 showing the tax implications for various levels of real income on the assumption that prices in 1974–75 are 20 per cent higher than in 1973–74. A comparison of the last three columns of the table with those for 1973–74 suggests that, as far as the tax schedule alone is concerned, all real incomes above about $7,000 (in 1973–74 prices) will face heavier income tax in 1974–75 than in 1973–74. Moreover, should a capital gains tax apply in 1974–75, requiring the inclusion in income of half of any realised capital gains, the taxable incomes of some individuals are going to rise rather faster than otherwise and thus accentuate the tax drift.
6.49. If inflation continues at anything like its present rate, it will be a matter of only two or three years before even the average wage earner finds himself paying taxes at marginal rates of 50 per cent or more. In 1954–55, as Table 6.D reveals, the average male wage earner claiming no deductions was subject to marginal tax at 17.5 per cent. In 1973–74 the marginal tax of his counterpart had risen to 35.7 per cent; and in 1974–75, if average earnings increase in the current year by the extremely conservative estimate of 20 per cent, the figure will be as high as 44.0 per cent. Admittedly, as the final column in the table makes clear, the increase in average earnings over the years is only partly due to inflation: growth in real incomes has also occurred. But as the final column indicates too, increases in average earnings in very recent years predominantly reflect inflation: thus, as much as 79 per cent of the $858 addition to average earnings in 1973–74 was matched by higher prices, the largest percentage for many years.
― 52 ―
| Year | Average earnings | Total tax | Average tax rate | Marginal tax rate | Inflation component of increase in average earnings(b) |
| $ per annum | $ | per cent | per cent | per cent | |
| 1954–55 | 1,799 | 173 | 9.7 | 17.5 | |
| 1955–56 | 1,924 | 197 | 10.3 | 19.2 | 59 |
| 1956–57 | 2,012 | 215 | 10.7 | 21.7 | (h) |
| 1957–58 | 2,070 | 227 | 11.0 | 21.7 | 34 |
| 1958–59 | 2,132 | 241 | 11.3 | 21.7 | 53 |
| 1959–60(c) | 2,304 | 264 | 11.5 | 20.6 | 31 |
| 1960–61 | 2,413 | 302 | 12.5 | 24.6 | 87 |
| 1961–62(c) | 2,475 | 301 | 12.2 | 23.4 | 19 |
| 1962–63(c) | 2,543 | 317 | 12.5 | 23.4 | 7 |
| 1963–64(c) | 2,678 | 349 | 13.0 | 23.4 | 17 |
| 1964–65 | 2,876 | 418 | 14.5 | 27.1 | 51 |
| 1965–66(d) | 3,011 | 466 | 15.5 | 27.8 | 77 |
| 1966–67(d) | 3,219 | 554 | 17.2 | 30.3 | 39 |
| 1967–68(d) | 3,406 | 580 | 17.0 | 30.3 | 57 |
| 1968–69(d) | 3,661 | 659 | 18.0 | 32.9 | 35 |
| 1969–70(d) | 3,968 | 760 | 19.2 | 32.9 | 38 |
| 1970–71(e) | 4,410 | 828 | 18.8 | 32.7 | 43 |
| 1971–72(f) | 4,836 | 986 | 20.4 | 36.0 | 70 |
| 1972–73(g) | 5,278 | 1,009 | 19.1 | 33.3 | 66 |
| 1973–74 | 6,136 | 1,308 | 21.3 | 35.7 | 79 |
| note |
6.50. Evidence of a different kind pointing to the same conclusion is presented in Table 6.E. In less than a decade the percentage of taxpayers with net incomes above $6,000 has risen from 4 per cent to nearly 16 per cent. Even within the space of a single year, according to the 1970–71 and 1971–72 figures, the change is striking—and will certainly prove yet more striking in 1972–73 and 1973–74 when statistics for those years become available.
| 1963–64 | 1970–71 | 1971–72 | ||||
| Net income (a) in excess of | Males | Total | Males | Total | Males | Total |
| $ per annum | per cent | per cent | per cent | per cent | per cent | per cent |
| 3,000 | 32.0 | 24.8 | 71.6 | 54.1 | 76.6 | 60.2 |
| 6,000 | 4.9 | 4.0 | 16.1 | 11.5 | 22.0 | 15.7 |
| 10,000 | 1.4 | 1.1 | 3.1 | 2.3 | 4.3 | 3.1 |
| note | ||||||
6.51. If the rate schedule is to be protected from the distorting and eroding effects of inflation, whether on grounds of fairness or to induce people to moderate their demand for higher incomes, it will need to be adjusted more comprehensively than was done in 1974–75. To ensure that the percentage of taxable income going in tax is properly cushioned against inflation at all income levels, the width of marginal tax brackets must be increased regularly in line with changes in the general price level. Frequent adjustment of the rate schedule and the manner in which it might be done are considered at greater length in Chapter 14.
― 53 ―
Concessional Allowances
6.52. Another aspect of tax drift relates to the complaint that adjustments to dependant allowances under personal income tax have not kept pace with inflation and that, in consequence, the real value of these allowances has been seriously eroded.
6.53. That this is a valid complaint may be illustrated in terms of a taxpayer with wholly dependent wife and two dependent children. In 1954–55 such a taxpayer would have qualified for a $520 deduction from net income for his dependants. Had the size of the deduction been fully adjusted for inflation, it would by 1973–74 have amounted to $1,030—almost exactly twice the earlier figure, the consumer price index having practically doubled in the meantime. In actual fact, the deduction in 1973–74 was $832, only 80.8 per cent of what it would have been if fully hedged against inflation. Table 6.F shows, for selected net incomes, how in 1973–74 a taxpayer with wife and two children was penalised by the deduction being $832 rather than $1,030.
| Tax as proportion of net income, assuming | |||
| Net income | $832 deduction(a) | $1,030 deduction(b) | Additional tax saving if deduction $1,030 rather than $832 |
| $ | per cent | per cent | $ |
| 2,500 | 4.8 | 3.7 | 26 |
| 3,000 | 6.6 | 5.4 | 32 |
| 4,000 | 9.9 | 8.8 | 43 |
| 6,000 | 16.2 | 15.1 | 66 |
| 8,000 | 21.2 | 20.2 | 75 |
| 12,000 | 28.8 | 28.0 | 96 |
| 16,000 | 34.9 | 34.2 | 108 |
| 20,000 | 39.7 | 39.1 | 119 |
| 30,000 | 47.7 | 47.3 | 126 |
| 50,000 | 54.7 | 54.5 | 132 |
| note | |||
6.54. The extent to which the dependant allowance for wife and two children, after adjusting for inflation, has fallen short of the 1954–55 allowance varies considerably from year to year depending on the size and timing of increases in allowances and the rate of inflation. This is apparent from the first column in Table 6.G. Since the late 1950s, however, there has invariably been a substantial short-fall, even in 1967–68 and 1972–73 when dependant allowances were adjusted. Moreover, because inflation has been so severe recently, the short-fall in 1973–74 was almost as great as it has ever been.
6.55. It is clear from the remaining columns of Table 6.G that the several categories of dependant allowances have been affected differently. In 1973–74 the spouse allowance was 70.7 per cent of the adjusted 1954–55 figure, the first-child allowance 84.3 per cent, while the allowance for other children was fully adjusted for inflation. In 1957–58, 1967–68 and 1972–73, all three categories were raised by identical amounts ($26 on the first two occasions and $52 on the last); but since the spouse allowance was the largest to start with and the other-children allowance the smallest, the percentage increases in allowances have inevitably been greatest for other children and least for spouse.
― 54 ―
| Percentage of inflation-hedged 1954–55 allowances | ||||
| Year | Spouse + 2 children | Spouse | First child | Other children |
| per cent | per cent | per cent | per cent | |
| 1955–56 | 96.1 | 96.1 | 96.1 | 96.1 |
| 1956–57 | 90.8 | 90.8 | 90.8 | 90.8 |
| 1957–58(a) | 103.4 | 98.9 | 104.9 | 112.4 |
| 1958–59 | 101.8 | 97.4 | 103.3 | 110.6 |
| 1959–60 | 99.3 | 95.0 | 100.7 | 108.0 |
| 1960–61 | 95.4 | 91.3 | 96.8 | 103.7 |
| 1961–62 | 95.0 | 90.9 | 96.3 | 103.3 |
| 1962–63 | 94.8 | 90.7 | 96.1 | 103.0 |
| 1963–64 | 93.9 | 89.9 | 95.3 | 102.1 |
| 1964–65 | 90.5 | 86.6 | 91.8 | 98.4 |
| 1965–66 | 87.4 | 83.6 | 88.7 | 95.0 |
| 1966–67 | 85.1 | 81.4 | 86.3 | 92.5 |
| 1967–68(a) | 93.1 | 86.0 | 95.5 | 107.4 |
| 1968–69 | 90.8 | 83.8 | 93.1 | 104.7 |
| 1969–70 | 87.9 | 81.2 | 90.2 | 101.4 |
| 1970–71 | 83.9 | 77.5 | 86.1 | 96.8 |
| 1971–72 | 78.6 | 72.5 | 80.6 | 90.7 |
| 1972–73(a) | 91.2 | 79.8 | 95.0 | 114.0 |
| 1973–74 | 80.8 | 70.7 | 84.3 | 101.0 |
| note | ||||
6.56. However, the erosion of the real value of the amount deductible from net income must not be confused with the erosion of the real value of tax saving resulting from deductions. As individuals are pushed into higher marginal tax brackets because of inflation, a dependent deduction of given size means larger tax saving in money terms—perhaps larger in real terms too. At the same time, the more fully are tax schedules adjusted for inflation, the lower still will be the real value of tax savings associated with dependant deductions of given size. It is thus important, if tax schedules are going to be regularly altered, to adjust dependant allowances regularly too—more important, indeed, than if tax rates are not so altered.
6.57. The link between the level of tax rates and the tax saving involved in concessions for dependants would vanish were such concessions to be given as tax rebates rather than as deductions from taxable income. It is thus significant that a special rebate of tax was in fact introduced in the 1974–75 Budget aimed at increasing the value of dependant allowances for persons at the lower end of the income scale. In future a taxpayer whose income is sufficiently low that the tax saving through claiming dependant deductions would be less than 40 per cent of the amount deductible will attract a rebate of tax to bring the tax saving up to 40 per cent. This means that a taxpayer on a marginal rate of, say, 32 per cent who, in the normal course of events, would save $266 in tax as a result of the present $832 concessional deduction for wife and two children, will now also receive a rebate of $66 to lift the tax saving to $332 (40 per cent of $832).
6.58. The rebate will compensate those families most in need for at least some of the recent inflation-induced
decline in the value of dependant allowances. It will also tend to cushion the value of dependant allowances, for
such families, from the effect of tax cuts—including the cuts introduced in 1974–75 when the rebate comes into
effect. But it means that as money incomes continue to expand with inflation, the element of tax saving from
moving into a higher tax bracket and thus being able to
― 55 ―
claim deductions against higher marginal tax
will disappear for persons on low incomes.
6.59. The eroding effect of inflation has been less conspicuous with other concessional deductions since the amount deductible is not restricted in the same way as dependant allowances. Some of these other deductions are open-ended; and in the case of one of the main ones that is not—life insurance and superannuation contributions—the maximum limit has gone up faster than inflation: in 1973–74 the real value of the maximum deduction of $1,200 was 50 per cent greater than in 1954–55, though it is true that the real value of this maximum deduction has fallen by nearly 30 per cent since being raised to $1,200 in 1967–68. What was said in paragraph 6.56 applies to these other deductions too: because the concessions are in the form of deductions from taxable income, the real value of the tax saving has in some measure been protected by taxpayers being pushed into higher tax brackets where the deductions are worth more, and would have been protected even further had tax rates not been cut in 1970–71, 1972–73 and 1974–75.
Estate and gift duties
6.60. Like personal income tax, Federal estate and gift duties are progressive levies. In the absence of offsetting adjustments to the rate scale and to the size of exemptions, duties will bite into estates and gifts with ever increasing severity as rising prices cause money values to become inflated.
6.61. The point is illustrated for estate duty in Table 6.H, though in very oversimplified fashion. No account is taken of death duties levied by the States, which are allowed as a deduction from the value of the estate in computing Federal duty; attention is confined to estates passing wholly to close relatives and unconnected with primary production; and the figures do not reflect the concessional treatment of the matrimonial home introduced in 1974.
| Average rate of duty | ||||
| 1954–55 | 1973–74 | |||
| Value of estate at 1973–74 prices (b) | If no change in rate scale or exemptions since 1954–55 | Actual | Change between 1954–55 and 1973–74 (actual) | |
| 1 | 2 | 3 | 4 | |
| $ | Per cent | Per cent | Per cent | Per cent |
| 20,000 | (c) | 2.0 | 0.0 | -100.0 |
| 50,000 | 2.4 | 7.0 | 0.8 | -66.7 |
| 75,000 | 5.4 | 9.5 | 3.7 | -31.5 |
| 100,000 | 7.0 | 12.0 | 7.1 | -1.4 |
| 150,000 | 9.6 | 17.0 | 14.4 | +50.0 |
| 200,000 | 12.1 | 22.0 | 22.0 | +81.8 |
| 300,000 | 17.1 | 26.2 | 26.2 | +53.2 |
| 500,000 | 26.0 | 26.7 | 26.7 | +2.7 |
| 1,000,000 | 26.7 | 27.9 | 27.9 | +4.5 |
| note | ||||
― 56 ―
6.62. As can be seen by comparing columns 1 and 2 of Table 6.H, had no adjustments of any kind been made to the rate scale or to exemptions since 1954–55, average rates of Federal duty on estates of the same real value would by 1973–74 have been higher right across the board; though in the case of very large fortunes already attracting maximum or near-maximum duties as far back as 1954–55, the increase would have been modest.
6.63. While the 1954–55 rate scale still applies—indeed it was introduced as long ago as 1940—the level of exemptions has been adjusted on two occasions: with estates passing wholly to close relatives, the maximum exemption was raised in 1963 from $10,000 to $20,000, and in 1972 from $20,000 to $40,000. These are sizeable increases that more than compensate for inflation; but the exemptions are vanishing ones conferring no benefit on estates above a certain value (currently $20,000 in the case of estates passing wholly to close relatives). It is thus possible, on the basis of columns 1, 3 and 4 of Table 6.H, to identify three categories of estates:
- (a) Smaller estates, up to a value approaching $100,000 at today's prices, are now in fact burdened with proportionately less duty than in 1954–55 because of more generous exemptions.
- (b) In the case of very large fortunes (in excess of say $500,000 at today's prices), the fraction going in duty has not been noticeably affected by inflation: in these upper reaches the rate of duty is virtually proportional.
- (c) The estates to be hit hardest by inflation are those in the $150,000–$300,000 range (at today's prices), being too large to benefit greatly, if at all, from more generous exemptions, yet low enough to attract higher rates of duty as money values rise.
6.64. If the burden of death duties on all estates, and not merely on smaller ones, is to be cushioned against inflation, it is clearly not enough to adjust vanishing exemptions as was done in 1963 and 1972: the rate brackets themselves must be adjusted for rising prices and, if inflation is rapid, must be adjusted quite frequently. Recommendations are made along these lines in Chapter 24 in the context of an integrated estate and gift duty.
Tax Base
6.65. Even in a regime of proportional tax rates or of regularly adjusted progressive schedules, there are still major problems in times of inflation in establishing just what is the proper tax base to which tax rates should apply.
6.66. One of the most important of these problems concerns business income. The effect of inflation on the measurement of business income, more especially for companies engaged in manufacture, has been the subject of intense discussion within the accounting profession and among business management generally for many years now; it has also featured prominently in submissions to the Committee. The fundamental problem is that in periods of inflation profits determined on the basis of conventional historical accounting methods do not reflect ‘true’ profits, which are materially lower. These same methods, when employed in arriving at net income for income tax purposes, can lead to business income being taxed more heavily than intended. When this occurs, the viability of business suffers, ‘true’ retained profits are reduced to below the level needed for continuing operations, and organisations are forced to seek new investment funds which are likely to prove difficult and costly to obtain in a period of tight liquidity.
― 57 ―
6.67. For many years certain larger businesses have sought to take some account of inflation in their financial accounts: in arriving at their profits they have deducted charges for the use of their fixed assets calculated by reference to their replacement values and not their historical cost. Also some countries permit methods of valuing trading stocks which allow for the effect of rising prices on profits and on net income for taxation purposes. It is generally agreed that there is urgent need to reconsider financial and tax accounting procedures in periods of high inflation. This is a crucial problem and one for which no generally acceptable solution is currently available. More will be said about it in Chapter 8.
6.68. A further effect of inflation is to highlight the concern felt by many that capital gains should be brought to tax, since such gains become extremely obvious to everyone in periods of rising prices. But inflation also makes the devising of a way of taxing capital gains that much more difficult. If capital gains are made taxable without adequate recognition of the fact that in a period of inflation a considerable proportion of such gains are not ‘real’ but simply an aspect of the change in the general price level, a large element of capital levy will be involved which may not be intended. Table 6.I illustrates just how heavily a 30 per cent capital gains tax that makes no allowance for changes in the value of money will bite into an asset whose money value has merely risen in step with inflation and whose real value has thus remained unaltered. Yet there are major problems, conceptual and practical, in devising a capital gains tax that takes proper account of the distinction between ‘real’ and ‘fictitious’ gains. In the eyes of some, these problems are sufficiently daunting to make it highly inadvisable to consider introducing such a tax during a period of serious inflation. The Committee generally agrees with this view.
| Tax as percentage of realised value of asset, (a) where annual rate of increase in general price level is | ||||
| Number of years before asset is realised | 5 per cent | 10 per cent | 15 per cent | 20 per cent |
| 1 | 1.4 | 2.7 | 3.9 | 5.0 |
| 2 | 2.8 | 5.2 | 7.3 | 9.2 |
| 5 | 6.5 | 11.4 | 15.1 | 17.9 |
| 10 | 11.6 | 18.4 | 22.6 | 25.2 |
| 20 | 18.7 | 25.6 | 28.2 | 29.1 |
| note | ||||
6.69. Inflation also has implications for the taxation of income from property, particularly fixed-interest income. When prices are rising but interest rates are held down, the real return on fixed-interest assets declines and the real capital value falls too. This raises problems in establishing an equitable tax base that are closely related to the appropriate treatment of business income and capital gains. These problems are briefly considered in Chapter 9.
6.70. What taxing of business income, capital gains and property income have in common that creates special problems in
a time of inflation is the necessity of having to compare values of items of property in different years when the unit
of measurement—money—has itself altered in value. Similar kinds of problems arise in relation to the integration of
money amounts established at different times and will
― 58 ―
need to be considered in appropriate context in later
chapters of this report. For example, a decline in the value of money means that business losses are worth less later
when applied as an offset to income: indeed, most tax provisions for income spreading, of which loss carry-forward is
but one, lose much of their conventional rationale in a period of rapid inflation. Again, a decline in the value of
money means that gifts made at different times by the one person cannot be regarded as equivalent. The Committee has
had to take special account of this in its proposals for an integrated estate and gift duty.
6.71. Where a tax is levied on a base significant components of which do not regularly enter the market and thus require special valuation, inflation poses added problems since values will quickly date. Thus one reason for the Committee's rejection of a wealth tax, as explained in Chapter 26, is the formidable administrative burden and cost to the taxpayer that would be involved in regularly revaluing such assets as freehold property and the inequities that would arise if regular revaluation were not in fact undertaken.
Need for Further Investigation
6.72. The variety of distorting and confusing ways in which inflation impinges on the tax system considerably complicates the task of tax reform. The setting up recently of an independent panel to inquire into the effects of rapid inflation on personal and company taxation payments is some indication of the concern felt by the Government in this regard. While the Committee has had inflation very much in mind in formulating its recommendations in later chapters, it acknowledges the need for intensive study of the implications of inflation for the tax system beyond what it has been possible to attempt in this report.