Four steps back, one step forward

A backward step

While we had low expectations for tax reform coming out of the recent 2012/13 Federal Budget, we were surprised to see tax reform actually go backwards with the deferral or cancellation of previously-announced tax reform measures. If previously-announced tax reform measures get dumped even before they get introduced, what hope do we have for major reforms? Will this year’s proposed measures get the chop next year, one might ask? Anything that uses the word “proposed” must now be questioned on whether it will see its way into reality. It seems remnants of tax reform have been sacrificed in order to fund more benefits to families instead.

Off the agenda

Cancelled or postponed measures announced on Budget night include the following:

• no company tax rate reduction (the Henry recommendation was to reduce this to 25 per cent). This would have made the headline corporate tax rate more competitive

• cancellation of tax discount for interest income (a Henry recommendation). This is a disappointing decision. Interest income receives no preferential tax treatment as compared to other asset classes such as property and shares. This measure was seen as a small step in the right direction to address the inequitable tax treatment of interest income

• simplification of the deduction for work-related expenses (a Henry recommendation). While the IPA had some design concerns on how this measure was to be implemented, it represented another positive step towards simplifying the annual tax compliance burden relating to work related expenses

• deferral of higher super contribution caps for people aged over 50. For the next two years there will only be one concessional cap that applies regardless of age. Restricting over 50-year-olds to $25,000 will play havoc with retirement plans for those nearing retirement and is an extremely disappointing announcement for those trying to provide for their own retirement

The one step forward

One positive tax reform measure announced was the loss carry back initiative. Had we known that we needed to trade off other reform measures to achieve this outcome, we could be excused for feeling less excited than what we would otherwise be when it was announced. Nonetheless, the IPA has been a strong advocate of this measure and its introduction is long overdue. It should have always been a feature of our tax system acting as an automatic stabiliser during an economic downturn.

Most are labelling this initiative a small business measure, but only one-third of small businesses operate through companies and this initiative applies to all incorporated entities regardless of size. It is, however, potentially more beneficial to smaller entities as the amount of loss carry back is capped at $1,000,000.

Operation of loss carry back

The loss carry back regime applies from 1 July 2012 and a one-year carry back applies in its first year of operation. Thereafter a two-year carry back period applies enabling taxpayers to claim losses against tax paid up to two years earlier. Thus to benefit, you will need to have made a profit in 2012 and a loss in 2013 or 2014. If the company has already distributed profits and has run down its franking account, it will not benefit from loss carry back regime as the carry back will be limited to the company’s franking account balance.

While this change is a welcome announcement, unfortunately it will not provide any immediate relief for losses incurred in the 2012 year. So any corporate small businesses doing it tough in the current or previous years will not benefit. However, it will improve the tax treatment of losses going forward for these small businesses.

Change to thresholds

The tripling of the tax-free threshold from $6000 to $18,200 was touted as significant tax reform measure on Budget night. In reality, the tax-free threshold has only moved from $16,000 to $20,542 due to a simultaneous reduction in the low income tax offset (LITO). The low income tax offset reduces from $1500 to $445. Also the first marginal tax rate of 15 per cent rises to 19 per cent and the second marginal tax rate rises from 30 per cent to 32.5 per cent (shown in Table 1). Only those earning less than $80,000 will receive a tax cut. If our tax rates were indexed for inflation, there would be no need to adjust the tax-free threshold and personal income tax rates along the way.

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Wait and see

Whether the changes to the tax-free threshold will take a significant number of taxpayers out of having to lodge returns remains to be seen. The Government is indicating that one million taxpayers will not have to lodge tax returns as a result of the tripling of the tax-free threshold. However, if the taxpayer has had a withholding tax event or is entitled to a refundable tax offset then they will still need to lodge a tax return to receive a refund. The Government’s estimate relies on taxpayers not bothering to fully claim their entitlements, which would indicate that the estimate is grossly overstated. Time will tell.

Tax practitioners often complain when the tax system is used to hand out income tax offsets linked to Centrelink entitlements such family tax benefit (FTB) Part A that are out of their control. Practitioners will be relieved that they will not have to worry about the education tax offset for the 2012 income tax year. The Government announced in the 2012 Budget that the education tax refund (ETR) would be replaced by the new Schoolkids Bonus. The tax system will not be used to claim this offset for expenses incurred in 2011/12. Only taxpayers eligible for family tax benefit Part A are eligible to receive this offset.

What’s happening with GST?

The Henry review highlighted the need to remove inefficient taxes as well as the need to reduce income taxes in favour of higher consumption taxes. The GST represents our most significant consumption tax, yet only 60 per cent of all goods and services are included in its base. The other 40 per cent – including food, health and education – are growing sectors of our economy. But both political parties are lukewarm on the idea of increasing the rate or base of the GST for fear of a political backlash.

Apart from the political fallout, one of the reasons for not including the GST as part of the solution to reform our tax mix is its regressive nature. In terms of individual income and wealth, a regressive tax imposes a greater burden (relative to resources) on the poor than on the rich – that is, there is an inverse relationship between the tax rate and the taxpayer’s ability to pay as measured by assets, consumption, or income. It is ironic then that from 1 July 2012 we have a carbon tax which is itself a regressive tax. The Government will compensate low income earners to negate some of its impacts and the same process could be employed to deal with increasing the base and rate of the GST if there was the political will to do so.

If we cannot progress micro reform measures over the line then what hope do we have of getting the macro tax changes required to support long-term growth? Many recent studies have come to the conclusion that the removal of inefficient taxes will actually promote economic activity rather than the opposite. The problem for all governments is managing the transition and dealing with the winners and losers. This is the most challenging aspect of major reform. Our political cycles do not support long-term planning but this is what will be required to progress to the next level in a meaningful way.