Why people think tax reform is a knife, and why that’s a problem for Australia.

EDITED on Tuesday September 29 to make it better, fairer, more accurate.

My hypothesis is this: A large part of the Australian public does not understand the tax reform “debate” at all. a substantial part of the tax reform debate.

I hypothesise these people are smart, capable and have Australia’s interests extremely close to their heart. But they have no training in tax theory and therefore lack mental models to understand why, for example, Labor’s Chris Bowen, Shadow Treasurer, would be willing to consider cutting corporate tax to 25 per cent.

They just don’t see how tax affects growth.

The most mentally available model of tax is not one where tax is an ingredient in making the cake, but a knife to cut it up with at the end. This matches lived experience. As a worker and consumer, tax happens at the end of transactions. You get paid, then you pay tax. You buy something then you pay GST at the checkout.

So my hypothesis is the concept of tax as an input to the rate of economic growth is not one that is available to most people.

I’ve been thinking about this hypothesis for a while. Today I decided to test it. I chose the following four tax-related articles and read the comments in all of them.

The Age: Malcolm Turnbull halts tax white paper in major reset (163 comments)

Herald Sun: Imbalanced Tax system stunting growth, says Business Council of Australia (7 Comments)

The New Daily: Scott Morrison wants to give us tax cuts (22 comments)

SMH: Scott Morrison: Work Save Invest the Mantra for the new Treasurer (90 Comments).

If people understood that the tax reform was about boosting growth, I expected to see comments engaging on that topic – supporting the link or refuting it, talking about high-tax high-growth countries like Scandinavia, and low-tax low-growth countries too.

If people did not bring this frame of reference, I expected to see the comments focus on other topics, especially distribution.

I read about 280 internet comments. (Which – as you can imagine – meant deciphering a great number of garbled sentences and enjoying an even greater number of insults.)

I coded them according to whether they mentioned growth or output; distributional outcomes; loopholes; or ‘other’.  ‘Other’ accounted for over 200. The remaining results were crystal clear.

tax commentsDiscussion of growth was present in just over two per cent of total responses and was outweighed by discussion of distributional issues about 9:1.

I tried to be generous with the comments I coded as addressing issues of growth. Here’s one:

“The most important thing to do to fix the economy is to get the taxation right! Fact is the economy under Abbott and Hockey was a blatant disaster getting worse!”

Here’s another:

“Penalty levels of taxation combined with high levels of social welfare payments result in deficites, high borrowing costs and a downward spiral of he economy. That is exactly what is happening in Australia. Our economy is headed the same way as the Greek economy. To reverse this Australia needs to increase the incentive to work and invest and reduce the reward for not working.”

In the 61 comments about “loopholes” there were very many along these lines:

“No change in the policies, give the big end of town a tax cut, and spread the burden over everyone with an increase in the GST. Lower income people are worse off as a result.”

Please note that I am not criticising this last comment. Distributional issues are a crucial part of tax policy and that kind of comment is an important input to a well-grounded tax debate.

The point is we do not have a well-grounded tax debate until everyone is on the same page.

The broader tax debate does not address the impact of tax settings on the output capacity of the economy. It is far more focused on fairness.

The “elites” must work to understand the grip matters distributional have on the public imagination. If they still want to press on with tax reforms – and I think they probably should – they need to take two courses of action.

  1. Prioritise matters of distribution in their own thinking. No tax reform will be possible so long as it obsesses on output to the exclusion of fairness. Multinational enterprise tax reform was a very common thread in comments about fairness.
  2. Work to give people the mental models to understand how tax affects output. Without this very little tax reform will be possible at all.

Elites, building a case for reform does not mean repeating the phrase “We need reform!” It’s truistic to the people who understand it, while confusing and annoying to everyone else. It sounds like you’re talking in code, and that implies you’re plotting something.

Instead, talk about “changing tax law so businesses want to do more work in Australia and hire more people.”

If you hector people about tax by saying “it affects investment decisions!” you’re unlikely to cut through. “Investment decisions” sounds like it has something to do with Macquarie Bank.

The comments on the article about Scott Morrison’s “Work Save Invest” slogan showed “investment” was uniformly interpreted as being about buying shares. Many commenters pointed out they couldn’t afford to do that. “Foreign investment decisions” is probably even worse language. It conjures Chase Manhattan and Bank of China conspiring to rip us off.

Talk about economic growth in language people can understand. Use this language even among yourselves, so when it comes time to talk to “real people” it comes naturally.

One way to build capacity in the community is through using metaphors:

  • Tax is not just a knife, but also the yeast that grows the cake.
  • The economy is like a party and tax is adding water to the beer.
  • The economy is like a football match and tax is like adding more umpires ready to blow the whistle at any moment. They disrupt the natural flow of the game.
  • The economy is like a road and tax is traffic lights. If we put in too many in the road won’t be useful any more.

But that can’t be all. The explanation needs stories about business owners who expand their business once their returns meet a benchmark, and how returns are affected by tax. I can imagine an animation. A business owner making a business plan. Every time she does the maths she comes out in the red, until the tax percentage becomes lower. Then she opens her shop and hires some staff.

Understanding a concept requires knowing several mutually-reinforcing stories that illustrate the same point. The Australian people have not heard enough of these stories. And that is why Tax reform is going nowhere.
NB: In todays’ Fin Review, Laura Tingle talks about this exact issue:

Just as the tax reform debate threatened to choke itself on too many conflicting agendas – increasing the GST, lowering company tax, fixing bracket creep, doing something about superannuation tax concessions – our new treasurer has injected a rather important ingredient: the need to define a reason to do it all.Some of the contributors to the AFR Tax Reform Summit this week have made the observation that an organising principle for the tax reform debate has only rarely been seen amid the worthy, but perhaps too often repeated, calls for individual tax measures to be addressed.

The organising principle needs to be a political argument to voters about why you actually need to mess around with tax in the first place. An argument about corporate competitiveness isn’t really going to cut it out in the ‘burbs.

Yes, we all heard Tony Abbott and Joe Hockey talk ad nauseum about “lower, simpler, fairer” taxes. But they were never able to cut through to voters about why this was such a good idea: that it would – or should – help boost and transform the economy. Instead, it just sounded like a bit of conservative government ideology.”

So if Morrison wants to prosecute that case for tax reform he needs to formulate a story that’s as clear as “Stop the Boats” but for a much more complex concept. Good luck Scott.

Here’s a late-breaking caveat I decided to add.

Among the people who appear to not understand the nature of tax reform are a group who understand it perfectly well but oppose it. They fan the flames of the distributional arguments.

They’re not the only self-interested sorts in the debate.

The fact company tax cuts are now widely accepted  as the most growth-crucial tax cuts in our whole economy is very interesting. Of course cutting it would help growth. But at what revenue cost? And why is it #1? Self interest lurks in any issue where facts are complex.

A way to expand the GST and make it less regressive.

A fair way to broaden the GST, collect more revenue, and avoid increasing the burden of the less advantaged would be to extend it to education.

educ spending

Education spending shows more of an association with income than even alcohol, clothing, vehicles or holiday accommodation. 

Screen Shot 2014-10-06 at 1.09.29 pm
Alcohol
Screen Shot 2014-10-06 at 1.19.07 pm
Clothing
vehicle purchase spend
Vehicles
Accommodation spend
Accommodation

Taxing education has the potential to make Australia’s GST fairer. Perceptions that it is unfair are a major impediment to reforming the GST.

The GST is regressive. (nb. I had to figure this out the old-fashioned way after being unable to find a single publication that contained this data.) Lower income households pay more of their (equivalised disposable household) income in GST than higher income households, according to my calculations.

GST current burden
Calculated using ABS 6530.0 Household Expenditure Survey, Australia: Detailed Expenditure Items, 2009-10; ATO GST rulings; 6523.0 Household Income and Income Distribution, Australia, 2009-10

Lowest income households pay 11.5 per cent of their income in GST (higher than 10 per cent because some spend more than they earn). Highest income households pay 8.7 per cent.

In absolute terms, this means the highest income households pay four times as much GST ($148/week) as the lowest income households ($36/week). They can do so because they have 5.5 times the disposable income ($1704 vs $314).

This is not quite as regressive a tax as I had assumed. The exemptions agreed by the Democrats and the Coalition in 1999 make a difference. Without exemptions, the GST would be even more regressive.GST share without exemptionsThe definition of a progressive tax is one where the rich pay more as a percentage of their income. Levying GST on education will not turn the GST into a progressive tax. But it moves it in the right direction.

Screen Shot 2015-04-09 at 3.32.33 pm
Those are percentage points on the vertical axis.

You can see the comparison a different way in this next graph.

Screen Shot 2015-04-09 at 3.32.46 pm

The estimated revenue gain of taxing primary, secondary and tertiary school fees would be around $1.2 billion.

Two caveats remain.

One is pure politics. Education is seen as A Good Thing. Even though Australia would continue to provide free and universal school education, a decision to tax education expenditure would cause confusion and dismay. I wrote just yesterday about how insufficiently distinguishing sin taxes and revenue taxes causes trouble, and this would fall right into that trap. This government would also face the problem that its supporter base are more inclined to be patrons of private education. (I should note here that I am not biased against private schools, having attended one myself.)

The second comes to the exact question of fairness that prompted my investigation into how GST could simultaneously be extended and made less regressive.

The association between education expenditure and household earnings is not simply a matter of wealthy people sending their children to private schools. The period of peak earnings in a person’s life is also commonly in their 40s – the period where they have children in secondary school. In other words, the statistics insistence that education spending is a luxury good could be more of a life-cycle artefact.

Nevertheless, the same is true of many types of expenditure, and an opportunity to plug a hole in the GST – and do so fairly – is rare enough to be worth grasping.

Land Tax is having its annual meek and ineffectual resurgence. Can we give it some oomph?

Land tax is a great tax.

Just today, Treasury released a report that shows how much more efficient Land Tax is than all the alternatives.

land tax

I’ve previously argued that to promote land tax, we should emphasise that it is unavoidable. But I’ve gone cold on that idea.

It is true, but not a great argument when the government is going soft on tax dodgers. It simply encourages people to say we should enforce our existing taxes. [They’re right, we should. But we should have land tax too.]

Today the SMH economics guru Jess Irvine wrote a long and very welcome piece about land tax. But it conflated the hard-to-grasp concept of a low distortion tax with the easier-to-grasp concept of a tax that’s hard to “dodge.”

“Land tax is one of the most efficient taxes for precisely the reason it is unpopular: it is hard to dodge. They know where you live. You can hire as many accountants as you want, but it is difficult  to hide that mansion in Point Piper.”

I found myself wondering why land tax is not on the agenda. And I think I’ve figured out why. The conceptual framework you need to grasp its benefits is not commonly shared. And you can see that by flicking to the hundreds of comments that followed the article.

Screen Shot 2015-04-08 at 12.19.12 pm Screen Shot 2015-04-08 at 12.17.40 pm

The comments on the article were almost exclusively focused on fairness. Fairness is just one of the keys to good tax policy. Efficiency is the other. And there is a gulf of understanding between economists and the general public on tax efficiency, with economists to blame.

To get land tax out there you need to teach people why distortion is bad.

Economics students learn about a model of the economy like this: Trade is mutually beneficial. Taxes prevent trade. Therefore taxes prevent that mutual benefit. The amount of prevention (aka the distortion) is called deadweight loss.

deadweight loss
Deadweight loss from a price ceiling works much the same as a tax. From Wikipedia

The distorting effect of taxes is one of the great insights of microeconomics. It is counter-intuitive and hard to see, because deadweight loss is always a counter-factual. But can we transmit this flash of inspiration and insight from economics to the general public without messing around drawing supply and demand curves, or measuring utility?

A stumbling block is that the purpose of current taxation is so muddled.

We use taxes on “good things” to raise revenue. And we use taxes on “bad things” to change behaviour.

From observing the tax system, it may be unclear why smoking and working are both taxed. Does the government hate work?

The progressivity of the tax system – which I emphasise I support – doubtless contributes to this confusion. Being a low-wage worker, buying healthy fresh food and education attracts lower rates of tax. Being rich, buying luxury cars, eating at restaurants and making capital gains in shares attracts higher rates of tax.

It would be easy for some to see the tax system as a kind of moral agent, punishing bad behaviour and rewarding good. In this scenario, land tax makes no sense.

Explaining that taxes distort behaviour – but we want to minimise that! – is going to be a hard sell when the public sees we use taxes to distort behaviour all the time.

We tax all these things, and you want me to believe that’s because you want to stop some of these things, but you don’t want to stop others? 

Fixing this will be hard. The terminology is a good place to start.

It cannot be helpful to use one word – “tax” –  for both imposts on activities we actually want to encourage, like work, buying goods and services, making profits and owning land; and for things we actually want  to discourage.

I’ll accept suggestions for how we could rename these taxes – Maybe they could be divided into Detrimental but Oh Well, it’s Necessary Taxes and Useful Pricing Taxes (DOWN and UP)?

This distinction would help plant the seed that some – but not all – taxes should be designed in a way that minimises distortion.

The journey to give land tax a fighting chance will be a very long one. The first steps in that journey will be to help give people the capacity to grasp why land tax might be desirable.

Can we make Australians WANT a land tax?

If tax reform is boring, that’s because it’s run by boring people. Economists can spend hours sitting round teasing out the intricacies of an allocative efficiency improvement.

But when it comes to convincing others, economists tend to stroke their moustaches, repeat the word “productivity” and wave their laser pointers at a dense thicket of lines on a graph.

We need some marketing type thinking to help us economists. There is no other way the Australian public can be swiftly convinced of the merits of new taxes. And convinced they must be, because the economy needs all the productivity gains it can get to lift incomes.

Land tax is the best tax. Everyone who understands economics knows it. It’s minimally distortionary.

“Well-structured taxes on land … are a highly efficient means of raising revenue.” [Henry Tax Review]

 

“… raising the percentage of tax that falls on the unimproved value of land has few distortionary or adverse affects…” [Macrobusiness]

 

“We argue that there is a compelling case for the abolition of stamp duties and their replacement by a broad-based land tax” [Australian Housing and Urban Research Institute]

But people really hate the idea of taxing land, and whipping up a scare campaign could scarcely be easier.

“Call For Tax on Family Home.” [Headline in the West Australian]

 

“People will be paying between 20 to 40 per cent more in land tax. The bill will also diminish Queensland’s ability to attract interstate and overseas investment which will ultimately flow through to impact employment” [Property Council of Australia, cited in the Australian]

We need to change people’s beliefs about taxes. But more than that: we need to change people’s feelings about taxes.

At the moment, land tax is wildly unpopular, while the luxury car tax is wildly popular. I theorise that people like the idea of a tax they can avoid, hate the idea of a tax they can’t avoid.

So how do we change people’s feelings about unavoidable taxes? Do we lecture them about deadweight loss and distortion?

deadweight loss

I can feel the eyes glazing over already.

We need something far punchier, something that fires the emotions. Something a little bit like this…

The ad starts with the bespectacled taxman knocking on the door of a large mansion. “Tax time!” he cheerfully announces.

The door is answered by a butler, before a rotund, pinstriped individual arrives and pulls his pockets inside out. His face affects an attempt at sorrow that barely conceals a smirk.

The taxman’s brow furrows in disgust and we zoom out to see him walking back down the long gravel driveway, past an array of parked supercars.

Cut to an exterior shot of a big city accounting company. The voiceover intones: “They can hide income. They can hide capital gains. They can even hide the companies they own. But they can’t hide land. Land tax now for a fairer Australia.”

I’ve discussed this kind of idea before, with a “Trevors in Traffic” campaign to promote congestion charging. The point is that you can’t start arguing for a solution when people don’t even understand there is a problem.

“I remember reading about a behaviour change campaign to get kids to wash their hands. Rather than starting with facts about soap, they started with an ad that dramatised germ transfer. Everything the main character touched after leaving the bathroom turned green. Understanding the problem (even in a stylised way) came first.”

Teaching people about the allocative efficiency of various taxes is going to be expensive. You’d need TV ads, newspaper ads, a PR blitz. But if it greases the wheels of tax reform, it could be the best money ever spent in the Australian economy.