Lost in the tax debate are the billions hidden in the cash economy, and the complex systems concealing the incomes of the very rich. By Mike Seccombe.
The rich people who pay no tax
In this story
Only the little people pay taxes. For a small, select cohort of rich Australians, the famous quote of New York property billionaire Leona Helmsley rings not as an outrage but as an inspiration.
In the most recent documents released by the Australian Tax Office, there were 55 people who had a reportable annual income of more than $1 million, but who managed to reduce their taxable income to zero.
In total the untaxed 55 had incomes totalling more than $129 million, at an average of $2.35 million. But that was before they – or, more correctly, their tax planners – went to work on reducing their liabilities. After various deductions, they reported a combined loss of $12.866 million.
I don’t pretend to understand how they did it. The tax office spreadsheet that breaks it down includes about 100 separate items, a long string of arcane descriptors, many with very large figures attached. Such as “net primary production distribution”, which was worth $9.87 million to 15 presumably rural-based members of the rich 55, and “net non-primary distribution” which was worth $33.1 million to 35 of the group.
The ATO stats serve to enumerate but not to enlighten. Don’t worry if you don’t understand the next couple of paragraphs; their point is to show how the seriously rich can bypass the responsibilities that saddle the rest of us.
To wit: We are informed these rich “losers” collectively received $8.8 million in franked dividends, which allow the recipients to cut their taxable incomes to take account of company tax already paid. But they received only about one-tenth as much in unfranked dividends, which do not have the same tax benefit. They also got $3.8 million in franking credits and received $3.9 million interest. They claimed “deferred non-commercial business losses, primary production” of almost $3.3 million, and “deferred non-commercial business losses, non-primary production” of $19.2 million.
Some recorded healthy capital gains, some huge capital losses. Under the heading “capital gains net capital losses carried forward to later income years”, 15 recorded a total $27.5 million. Ten of the rich 55 shared “assessable foreign source income” of more than $2.6 million.
But no category included all of the untaxed 55. One of the few things to emerge clearly is that there are many paths to zero.
Other things also are clear. First, the untaxed 55 earned very little through actual “work”, as most of us ordinary folk would define it. Just 6 per cent of the total income for the group was recorded as wages or salaries, and that $9.1 million was split between only 15 of them.
Only 10 reported making gifts or donations, although those did total more than $10 million. One wonders how much of that went to political parties.
Five of them even managed to claim pensions, totalling $33,500. Sure it’s not much, but worth mentioning on principle. As is the fact that five of these people – whether the same five, we can’t say – also got “government allowances and payments” totalling $4740.
Of course, it may be that at least some of these people really did suffer major financial reversals. But there is cause to be suspicious, not least because one of the biggest items recorded was “cost of managing tax affairs”. Forty of the untaxed 55 millionaires spent a total of $42.5 million on this.
And that, really, is perhaps the most perplexing figure of the lot. Why would someone spend more than 30 per cent of his or her income on tax advisers, simply to avoid paying tax that would amount to less than 30 per cent of their income?
It makes no sense unless the claimed expenditure on “managing tax affairs” was overstated, or the advice related to sums much, much greater than those recorded in these ATO statistics for the 2012-13 financial year.
Let’s leave this little cohort of mendicant multimillionaires at this point, for while their story is startling, it is but a part of something much bigger. They are the tiny tip of a very large iceberg of wealthy people who, by various means, manage to avoid paying many billions of dollars in tax every year.
The seriously rich are not helped by high-priced tax advisers alone, but also by an army of propagandists in the right-wing think tanks, sections of the media and in politics, who constantly suggest Australians are heavily taxed and that the wealthy in particular are overtaxed.
Many examples could be cited, but one will do, a headline that ran above a particularly specious piece of tax analysis a year or so ago in The Australian, the flagship publication of that international heavyweight of corporate tax avoidance, Rupert Murdoch’s News Corp. It read: “No, the rich don’t pay a ‘fair share’ of tax. They pay all of it.”
But Australians are not heavily taxed by international standards. Only six of 34 developed countries in the OECD take less of their citizens’ money than Australia. On average, the governments of the OECD take almost 34 per cent of GDP in taxes. The Australian government takes a bit over 27 per cent.
As for the suggestion that the wealthy are overtaxed, the complainers on the political/economic right invariably focus on income tax, and they have half a point. No doubt the income tax take is on the high side in this country. It makes up close to half of the total tax revenue going to the federal government. Those relatively wealthy folks in the top marginal PAYE tax bracket have some cause to think they are carrying a heavy burden of tax.
But when conservatives talk about redressing this situation, it is usually in terms of either reducing the total tax take by way of spending cuts, or by increasing taxes on consumption.
And those options are not politically tenable, as we have seen in the public’s rejection of the spending cuts proposed by the Abbott government, and the Turnbull government’s hasty abandonment of the idea of increasing the take from the goods and services tax.
Another option, if the government is to address the widening gap between its revenue and expenditure, what it used to call the “debt and deficit disaster”, is to get serious about taxing capital. Shifting the tax focus from income to wealth.
Australia’s tax system is very gentle with wealth. It does not touch the family home, for example, even when that home is worth tens of millions of dollars.
Australia has not imposed death duties for almost 40 years. Former Queensland premier Joh Bjelke-Petersen led the charge for their abolition. But they apply in many other developed countries, including the United States and Britain. A 35 per cent death duty or inheritance tax, applied to just the top 1 per cent of the population, would raise some $5 billion a year, according to recent calculations by the Community Council for Australia.
And this is just one area. We have not taxed land in any serious way, although a couple of jurisdictions are moving tentatively in that direction. Land tax is particularly efficient, highly progressive and impossible to avoid. There are other examples, too, of areas where capital could be taxed
But the problem is not just with what we don’t tax. It is the inconsistency of the way we do tax, says Miranda Stewart, director of the Tax and Transfer Policy Institute at the ANU’s Crawford School.
“The uneven treatment in our tax system of different kinds of income and gain – franking credits on shares, superannuation taxation, capital gains tax, trusts and companies, et cetera – allows people to find loopholes,” she says.
It’s not hard to see why addressing these issues is hugely problematic for Australia’s current government. The eternal truth of Australian politics – at least until the rise of the post-materialist altruists, represented by the Greens – was a binary division between the political representatives of labour and of capital. Given that the key to almost all tax avoidance, as one tax law expert tells us, “is to turn income into capital”, it follows that the parties of capital are reluctant to act against avoidance. Tax dodgers overwhelmingly are their voters.
Former prime minister Tony Abbott knew his base well. That’s why, despite the crying need for reform and his commitment to deliver it, he quickly took off the table several of the most obvious options for change.
Malcolm Turnbull put them back, where they sat undisturbed for five months, before he too started taking them off.
We’ll come back to the politics. First let’s look at some of the manifold ways in which tax gets minimised. Several of Australia’s leading experts in economics and tax law were kind enough to supply The Saturday Paper with lists – remarkably similar lists – of the biggest problem areas.
Let’s start with outright tax evasion. This is what makes a lot of small business people – the tradie who’ll do it cheaper for cash, the fish shop owner who won’t accept credit cards – very rich.
“The cash economy taskforce estimates it to be worth about $10 billion,” says Ann O’Connell, director of tax studies at Melbourne Law School.
Other estimates suggest it is much bigger than that. One credible proposition suggests 14 or 15 per cent of the whole economy is black.
The introduction of the GST by the Howard government was supposed to curtail the cash economy but has actually served to foster it, O’Connell says.
Dale Boccabella, of the school of taxation and business law at the University of New South Wales, agrees. Now theses dodgers evade both income tax and GST.
“The main area is the provision of services to the household sector,” he says. “And try as hard as they do, the ATO has limited capacity to make inroads.”
The aspect of it that particularly nettles Boccabella is the “complete deafening silence” on the part of politicians about widespread tax evasion in the small business sector. He contrasts this with the strong criticism of the tax practices of large corporates and multinationals. But small business is a bigger problem, he says.
Ultimately, the biggest threat to the cash economy is technological change. In other countries, notably in Europe, cash is fast disappearing. The amount of krona in circulation in Sweden has fallen 25 per cent in the past six years, and there are predictions that in about a decade it will be the world’s first cashless, all-digital economy.
The black economy is illegal, even if governments seem lax on enforcing this. But there are also legal, if questionable, tax rorts, starting with superannuation.
Over the decades, successive governments have made numerous changes to the rules governing who gets super, the amounts that can be put into super accounts, and the way contributions, earnings and payouts are taxed. These measures were largely aimed at limiting the scope for wealthy people to take advantage of the concessional tax treatment of the system. Without getting too far into the detail, these were measures such as contribution limits and limits on what were considered reasonable benefits.
In 2006, however, the Howard government made a couple of outrageous changes. Between May that year and June 2007, they set the amount that could be put in as undeducted – that is, after-tax – contributions at $1 million. Next, they announced they would scrap reasonable benefit limits and make benefits tax-free for those aged 60 and over.
The smart money flooded in. That year contributions to self-managed super funds increased fivefold to $56 billion. The amount going into other super funds went up threefold to $95 billion.
In significant part it is because of this decision that Australia now has a large number of superannuation accounts holding huge sums and paying out huge benefits to ageing Australians. All tax free.
“There are more than 500,000 self-managed super funds. More than 3000 have assets greater than $10 million and six have assets greater than $100 million,” says Ann O’Connell. “All legal, but appalling policy and inequitable.”
At the same time, she notes, “only about 10 per cent of the population have super balances over $100,000”.
The system has been tightened up somewhat since then, but the wealthy can still sock away large sums each year – depending on age, up to $35,000 at concessional rates and $180,000 at non-concessional rates. And the flat 15 per cent tax rate that applies to contributions is obviously regressive, in that it gives a much greater tax benefit to those on higher marginal tax rates, and provides no benefit at all – indeed effectively imposes a higher rate of tax – on those earning up to about $37,000, whose average rates of tax are below 15 per cent.
The perception that the government is only looking after the rich is enhanced by the fact it axed Labor’s low income superannuation contribution scheme, which had the effect of refunding the 15 per cent contributions tax for earners with income up to a threshold of $37,000.
All of which means the cost of concessions will continue to rise, yet large numbers of people will still have to rely on the aged pension.
Now to another great rort, also made greater by Howard and his treasurer, Peter Costello: negative gearing.
Their decision in the 1999-2000 financial year to halve the rate of capital gains tax saw the rate of negative gearing take off. Since then, the number of taxpayers owning negatively geared property has more than doubled. Some 1.3 million people racked up a collective $12 billion losses in 2012-13.
The Labor opposition has proposed to deal with the problem by limiting negative gearing to new properties – thus encouraging growth in the supply of housing, and reducing the capital gains discount from 50 to 25 per cent, while grandfathering existing investments.
The proposed reforms to negative gearing have been widely acknowledged by economists and tax experts – at least those who are not beholden to vested interests and who are not BIS Shrapnel – to be a significant improvement. Not perfect maybe, but much better.
The government has run a ferocious scare campaign, contradictorily arguing, before it got its talking points straight, it would drive up the cost of houses and drive down the cost of houses. They’ve also argued it will negatively affect people on modest incomes who are “just trying to get ahead” by buying a place or two and renting them out at a loss.
There is very little truth in either argument, for several reasons. The first is that just as with superannuation, you only get the full benefit of negative gearing if you are at the top marginal tax rate. As a result, more than a third of all tax benefits from negative gearing go to the top 10 per cent of owners. Only 20 per cent goes to the bottom half of the income distribution.
Second, current negative gearers of modest means will not be affected at all and would-be negative gearers can always buy a new dwelling.
Furthermore, says Miranda Stewart: “People who are negatively gearing at the bottom end of the market, who maybe have one or two properties in the $350,000 to $450,000 range, make very little from it.
“People say negative gearing only makes sense because of the capital gain benefit, and the reality is that at the moderate end of the market, there is not much capital gain, once you take inflation into account. Those people are making almost no capital gain. They’re just buying a tax shelter.”
And a pretty flimsy tax shelter at that, if they earn average incomes.
Finally, the current negative gearing regime appears to be encouraging people to take on dangerous levels of debt.
“The trend over the past five years is that net rental losses have just kept going up,” says Stewart. “That suggests that even though interest rates are going down, people gear up more.”
It’s interesting to note that during the years of the Howard government, all the massive tax cuts, skewed heavily to the rich, and all the tax rorts, also skewed towards the rich, did not make the average household more financially secure.
Household income per person went up 25 per cent in real terms, but the ratio of household debt to income went up almost 200 per cent, with most of that debt on housing. Australians are now the most indebted people in the world.
Former treasurer Peter Costello has warned against making any changes to negative gearing, capital gains tax or superannuation. And he is still viewed with respect within the Coalition parties, even if a lot of economists consider him a bit of a dud, or worse. One described him to me this week as “possibly the most reckless treasurer in our history”.
John Howard, even more influential, has cautioned against changing negative gearing. And an ever-growing number of current members of the government are doing likewise.
West Australian senator Chris Back was one of the quickest out of the box, telling ABC Radio on February 29: “I don’t see any reason at all to change the negative gearing processes.”
He repeated his views in parliament and also answered the obvious question, saying he had negatively geared in the past, but his two investment properties now were positively geared.
We’ll have to take his word for that. The register of parliamentarians’ interests records investment properties and any loans attached to them, but says nothing about gearing status. That’s a pity, because it would be useful to know who in the current debate had a personal interest.
At least we know Chris Back is no longer in on that rort. He is, however, in on another one. He has a family trust.
Family trusts, more properly called discretionary trusts, are a huge rort. Yet the government has been totally silent about whether they are on or off the reform table.
My bet is they are off. Here’s why.
Back in April 2011, in a speech to the Institute of Chartered Accountants, then shadow treasurer Joe Hockey floated the idea trusts should be taxed in the same way as companies, at a rate of 30 per cent.
There was outrage among his colleagues, a large proportion of whom – 45 of 102 in the current parliament, I am told, though I haven’t counted myself – have trusts.
Reportedly, Hockey was the subject of a stern conversation with then Nationals leader Warren Truss. Two days later, he abandoned the idea, never to mention it again.
Trusts are the great tax avoidance tool and succession planning vehicle of rich families. Their purpose is simple: they serve to protect the assets of a family and hold them for future generations – which is why they are endemic among Nationals wanting to protect the family farm – and they allow income to be distributed among members of a family in such a way as to minimise tax.
Miranda Stewart explains further: “Say you have a trust with a couple of million in income. At the end of the year it is distributed – allocated and sometimes paid out – to as many members of the family as you want to. That reduces the tax bill, because each family member has a tax-free threshold and all the various incremental rates.”
Any money that is not distributed, and is left in the trust, attracts tax at the top rate of 49 per cent.
For that reason, she says, there is almost always a company, as well as individuals, designated as a beneficiary.
“It is a separate taxpayer, and any residual amount left over goes into that bucket company, where it is taxed at the company rate of 30 per cent.”
Trusts are common to other countries, too, but there are aspects of their operation here that are peculiar to Australia. For instance, trusts can control other companies that actively trade and whose profits feed back to be distributed.
“Most countries do not allow businesses operated in trusts,” Stewart says. “In the United States, for example, if there was such an arrangement the business would be taxed as a company. In the UK, too.”
The rules here increase the prospect of great rorting.
“There might also be aggressive tax planning in their businesses, claiming very large deductions. It’s possible some of them, a small proportion, are actually evading, hiding money offshore,” Stewart says.
She agrees with Joe Hockey circa 2011. “We should be dealing with discretionary trusts. We could treat their income as we do for companies and tax it all at 30 per cent, which is still a lower rate than the top marginal rate.”
But she concedes that isn’t going to happen.
Just as it appears increasingly likely little is going to happen in the way of tax reform in the other areas that need fixing. Maybe a little tweak to superannuation. Likely nothing on negative gearing and capital gains tax.
We’ll see. It would be good for the country if Malcolm Turnbull proved the cynics wrong.
But, as Leona Helmsley said, little people pay their taxes. And conservative governments answer to the big people.
This article was first published in the print edition of The Saturday Paper on Mar 12, 2016 as "The rich people who pay no tax".
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