II Other Concessional Deductions: Issues of Principle

12.17 Besides the deductions for dependants, existing legislation contains no fewer than twenty-three other deductions from net income. A list will be a reminder of additional complexity they introduce into a tax that must inevitably be complex even without them: net medical (including chemists’) expenses, dental expenses, optical expenses, therapeutic treatment expenses, expenses for artifical limbs and eyes, expenses for hearing aids, expenses for medical and surgical appliances, attendant's remuneration paid on account of blindness or permanent confinement to a bed or invalid chair, maintenance expenses of a guide dog for a blind person, payments to a medical or hospital benefits fund, funeral or burial or cremation expenses, subscriptions to professional associations or unions, payments of insurance premiums, payments to a superannuation or similar fund, rates and land taxes paid on principal

  ― 167 ―
residence, mortgage interest on home purchases, gifts to approved institutions, zone allowances, overseas service allowance, living-away-from-home allowance, education expenses for dependants, self-education expenses, legal and other expenses incurred in the adoption of children. Most of these deductions apply to expenditure made by the taxpayer on behalf of dependants as well as on the taxpayer's own behalf; in some cases, the amount of the deduction is limited.

12.18. Collectively, the deductions for dependants and these deductions are of very great quantitative significance. They reduce the tax base by almost 20 per cent, involving a loss of revenue under the current progressive rate structure equivalent to more than one-third of the sums actually raised. In other words, removal of all concessional deductions would permit a reduction in tax rates over all income levels by a proportion, on average, of more than 25 per cent of the rate currently applying. Figures for the most significant of the concessions available are set out in Table 12.A. for the year 1971–72. As indicated in the footnote to that table, 28 per cent of total deductions claimed in that year was for dependants; a further 24 per cent for life insurance and superannuation payments; 19 per cent for medical expenditure, broadly defined, and medical insurance; 8 per cent for education expenses; and 7 per cent for rates and land taxes. Some general discussion of the issues of principle to which they give rise is essential.

12.19. There are two main reasons in principle why in one form or another such concessions may be considered necessary. As already mentioned, some are introduced for purposes of equity. But they can also be given for efficiency reasons: to encourage individuals to adjust their expenditure in various ways, because increases in expenditure on particular items are held to be socially or economically desirable. Gifts to charity and contributions to superannuation funds and life insurance policies probably come under this head, and so perhaps do the deductions for education and zone allowances, in so far as these are specifically designed to increase sums spent on education or to attract population to remote areas.

12.20. Concessions granted for any one purpose will generally have consequences for others, whether this is desired or not. A deduction of medical, dental and chemists’ expenses designed to achieve horizontal equity will also serve to raise taxpayers’ expenditure in this area. Allowing mortgage interest as a deduction from assessable income, so as to encourage home-ownership among lower income groups, will incidentally influence the progressivity of the income tax structure; it will also have equity repercussions between home-buyers and others, and between different home-buyers according to the proportion of income spent on housing.

12.21. It cannot be presumed that the benefits of any concession will fully accrue to the taxpayer. When the supply of the commodity or service to which it is directed is unresponsive to price changes, the higher demand stemming from the concession will cause a noticeable rise in price, to the ultimate benefit of suppliers rather than consumers. For example, the aids to home-ownership may evaporate in capital gains to landowners and home-owners, and may reduce the supply and raise the cost of rented accommodation.

12.22. It is important to bear in mind that the particular objectives served by concessional deductions are also served by other kinds of government activity. The dual assistance given on account of children has already been noted. In other cases the range of instruments employed is as great or greater. Provision is made for old age by age pensions, subsidised medical and transport services, and by the tax assistance given to saving through superannuation and life assurance policies; for unemployment not

  ― 168 ―
only by social service benefits but also by their exemption from tax; for sickness by tax deductions for medical, dental and pharmaceutical expenses, by the exemption of medical supplies from sales tax, by the provision of public hospitals, by the subsidisation of medical insurance funds, and by sickness benefits and their exemption from income tax. The ends of education are served by various income tax deductions, by the exemption of educational supplies from sales tax, by the public provision of much education at all levels, by the partial subsidisation of private educational institutions, by scholarships and student living allowances and their exemption from income tax. Home-ownership is encouraged by the income tax deduction for local rates and land taxes, and by a new scheme, devised on a family basis, for the deductibility of mortgage interest, as well as by the subsidisation of housing loans, and by home savings grants. Furthermore, the exclusion of imputed rents from the income tax base may not improperly be regarded as an income tax deduction. Doubtless this summary list could be extended.

12.23. It is plain enough that this welter of simultaneously operating aids to areas of need that are partly met through income tax deductions has grown up over the years in a piecemeal way. Some of their cumulative consequences, could they be estimated, might be found to be very far from what was intended.

12.24. Rationalisation and simplification in the pattern of government intervention in these areas of expenditure are obviously called for. It is not the Committee's function to examine the expenditure side in depth; but the future of the concessional deduction system is nevertheless very much bound up with it. Two directions of change can be distinguished. One is to use the tax system in yet more complicated ways while excising some of the activities on the expenditure side. The other is to adjust the expenditure measures and gradually reduce or eliminate the corresponding tax concessions. A good case can be made for the latter course.

12.25. To take the principal areas involved, government expenditures in the fields of health and education are already substantial and may well increase. Government thereby exerts a powerful influence over the quantity of these services and the price at which they are offered to the public. Any extension of assistance given in these ways need not necessarily entail much expansion of bureaucracy: it might largely be a matter of adjusting the scales of existing subsidies and grants. When tax deductions are the technique adopted, assessors have a task that is essentially retrospective: to check claims made in the light of past expenditures by persons who may well have been uncertain whether or not deductions would be allowed. They have also to establish general rules to cover difficult matters: Is this book educational? Are wigs medically necessary? Concessional deductions are recognised by those who administer income tax as one of the more difficult, uncertain and costly parts of their task. On grounds of efficiency and simplicity alike, greater reliance on carefully administered public expenditure and less on concessional deductions might bring gains.

12.26. The equity problems raised by reform in this direction may not be so serious as at first sight appears. As the figures in Table 12.A bring out, the deductions allowed under the present system tend to favour those with higher incomes. The shift away from tax concessions towards expenditure measures may well reduce the extent to which this is so. If the attendant change in effective progressivity was felt to be undesirable, appropriate adjustments could be made to the rate scale.

12.27. Horizontal equity would not necessarily be diminished. The case on this ground for deductions essentially involves the proposition that when one of two persons with equal incomes spends more on the item in question than does the other, his

  ― 169 ―
‘true’ income is thereby reduced in relation to the other's. Most people, in the case of medicine for example, might agree with this, but putting a number on the difference in ‘true’ incomes is quite another matter. No two people are exactly alike, and we will all rank differently the expenses we consider ‘necessary’ rather than ‘enjoyable’ or ‘satisfying’. Once it is accepted that certain ‘necessary’ but not ‘satisfying’ expenses should be tax deductible, the flood-gates are open for endless pleading; and when a concession is made in one area, there are instant pleas for its extension into neighbouring areas. In the realities of political life, concessions for this are almost irresistibly followed by concessions for that, and then for the other thing. The income tax base, already hard enough to define at the net income level because of the problems of deciding what are expenses of earning income, becomes liable to continual erosion at the taxable income level; and with every erosion rates have to be increased if the revenue is to be maintained.

12.28. Further, it must be remembered that as the income tax is reduced, as it would be if the Committee's recommended strategy were accepted, concessional deductions become less and less capable of giving substantial help.

12.29. Hence on grounds of efficiency, simplicity and equity alike, the Committee considers that the long-term aim should be to replace concessional deductions, wherever possible, with assistance given in other ways to meet the principal needs the deductions now serve. It recognises, however, that at least three qualifications are necessary:

  • (a) Some concessions, of which those relating to superannuation and life insurance payments are the most conspicuous, are of a kind that have necessarily influenced the lifetime expenditure plans of many who have benefited from them. Considerable transitional problems would have to be attended to in any change in these areas.
  • (b) In other cases where political issues concerning the freedom of the individual are involved—possible examples of which are the cases of educational and medical expenses—a tax concession has the merit of leaving the citizen with a free choice and of saving the authorities some of the burden of administrative control.
  • (c) In certain cases, measures on the expenditure side may not be a wholly adequate replacement for tax concessions: there is likely, for example, whatever the form of government expenditure on medical services, to be continuing private expenditure in this area.