Personal income tax
Australia has a progressive personal income tax system; that is, the average tax rate people face increases as they earn more income. This complements our transfer system, which uses means tests to target payments to those with the greatest need. An important aspect of the personal tax system is how it rewards workforce participation, particularly when interactions with the transfer system are taken into account. Improving participation is a key challenge for Australia’s economy.
Participation in work brings social and economic benefits to Australians. Improving participation is also important to meet the labour demands created by a growing economy in the near term, and the changing labour needs as our population ages. Personal taxes mean that people don’t get to see all of the returns to their work. Research has shown that participation by secondary earners can be particularly responsive to the financial returns to working.
Lower personal tax, and in particular tax cuts aimed at low- and middle-income earners, can increase the returns to work and increase participation, especially for secondary earners. In the personal income tax system, in addition to the progressive statutory rate structure, there are also a range of ‘tax offsets’ which reduce the amount of tax payable by particular groups. For example, the Low Income Tax Offset (LITO) provides targeted tax relief to low income earners, and the Senior Australians Tax Offset (SATO) further reduces the amount of tax payable by older Australians.
One problem with these tax offsets, however, is that they add to the statutory tax rates in the income ranges where they are withdrawn. By way of illustration, the LITO is currently withdrawn at 4 cents for each additional dollar of income over the income range $30,000 to $67,500.
This means that over this income range, the actual marginal tax rate is 4 percentage points higher than is apparent from the statutory rate scale. Similarly, the exemption from the Medicare levy for low-income earners is withdrawn at 10 cents in the dollar from $18,839 for individuals.
The personal tax reforms announced in the Clean Energy Future package address some of these issues by raising the tax free threshold, adjusting some statutory rates, and cutting the withdrawal rate of LITO by 2.5 cents in the dollar.
These reforms make the tax scales more transparent and reduce reliance on the LITO to deliver tax relief. Chart 2 shows the effective tax rates for an individual as a result of the introduction and withdrawal of the Medicare levy and the LITO in 2012-13, when the Government’s reforms are due to commence.
As well as creating complexity, offsets and other special concessions can erode personal tax revenues and create adverse incentives. Concessions that let one form of labour remuneration be taxed less heavily than other forms of remuneration can encourage people to take their pay in forms that are less flexible, just to minimise tax. Sometimes not everybody can access these concessions, which can also be unfair.
Fringe Benefits Tax
Fringe Benefits Tax is paid by employers who provide non-cash benefits to their employees. The existing law includes a large number of valuation rules for different types of benefits. Some of these are complicated and in some cases there are a number of alternative rules for the same type of benefit. This imposes high compliance costs on employers.
Some types of benefit are concessionally taxed, as some valuation rules produce a taxable value that is well below the market value of the benefit, and some types of benefits are exempt altogether. This creates incentives for employees and employers to engineer remuneration packages heavy in concessionally-taxed or exempt benefits, even if that does not match the employee’s preferences.
There are special Fringe Benefits Tax concessions for some categories of employees, especially those in the not-for-profit sector. These are an important part of overall remuneration arrangements for the sector, but the AFTS review also found they can add complexity and suggested there may be different ways to support the sector more effectively. The Government remains committed to continuing to support the not-for-profit sector.
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