Devil in the Details

One of the many problems with a complex tax system of varying tiers, qualifications, handouts, exemptions, claimed dependancies and the like, is that it becomes increasingly bureaucratic by necessity.

We’re giving a handout… wait – what if they’re in prison, or overseas, or die before the cheque arrives?  We have a baby bonus… wait – what about adoptions – do adoptive parents get anything?  OK, so they do… what if someone puts their kid up for adoption the week after getting their bonus – do they have to give their bonus back, and do the new parents still get a bonus?

Supposing you want a consumption tax, but don’t want to tax food… wait, what about junk food?  OK, so we’ll only tax junk food… wait, are we going to have to legislate a receipe for bread?  When does it become cake?  It starts out innocent enough, but before you know it, you’re legislating the allowed shape of bananas and cucumbers.

These all might seem like rather silly examples, but they’re a symptom of an overly complex tax and welfare system.  In case you think they’re not considered, here’s an excerpt from the IRS website (the US version of the ATO):

Topic 357 – Tax Information for Parents of Kidnapped Children

You may claim a kidnapped child as your dependent if the following requirements are met:

  1. The child must be presumed by law enforcement to have been kidnapped by someone who is not a member of your family or a member of the child’s family, and
  2. The child had, for the taxable year in which the kidnapping occurred, the same principal place of abode as the taxpayer for more than one-half of the portion of such year before the date of kidnapping.

If both of these requirements are met, the child may meet the requirements for purposes of determining:

  • The dependency exemption
  • The child tax credit, and
  • Head of household or qualifying widow(er) with dependent child filing status.

This tax treatment will cease to apply as of your first tax year beginning after the calendar year in which either there is a determination that the child is dead or the child would have reached age 18, whichever occurs first.

How twisted is that?

Of course, a 30/30 tax system doesn’t seem to have these problems, as there is a flat effective marginal rate of taxation, and no deductions.

19 thoughts on “Devil in the Details

  1. That is rather funny.

    I don’t think you need a 30/30 system to get rid of most deductions incidentally, and I don’t see why it solves the problem of having odd rules for things — indeed, the 30/30 scheme seems rather complex to me, and it would need to specify things such as how you work out your benefits if you have intermittent work, what happens to already taxed dividends your receive etc. .

    It seems to me that one of the good parts of that proposal actually has nothing to do with the 30/30 system aside from being packaged with it, which is to eliminate all (or almost all) the various tax concessions.

    On this note, despite getting tax back for “work” holidays, refunds for book receipts I picked off the floor, etc. (and I’ll have to get into negative gearing too), I’d love to see the end of all of those. I’m actually really suprised that there is so little dissent against all these unnecessary freebies. It’s like people want a corrupt system — even those that don’t benefit from it. Thus perhaps people really like all these crazy rules.

  2. David — I’m not being cynical. That’s really what I believe.

    I think the problem with the 30/30 system is that it sucks everybody earning less than 30k into the welfare system (and hence endless rules, regulations, government “work” programs, etc.), which is a huge chunk of the population.

    As for the crazy rules — I simply can’t understand why people put up with them. It was great living in HK where there really was pressure to get rid of silly rules — whenever the government tried to bring them in, they would be endlessly criticized. On this note, I was pleased to be able to claim nothing each year I worked there and pleased to get nothing back. The tax form takes 10 minutes to fill in if you are an average worker. You stick in your name, address, and whether you have kids or look after an elderly relative (this latter one is very Chinese!).

    If people have any ideas why Australians put up with all the crazy rules, I’d love to know. The only reason I could think of was the one stated.

  3. If somebody has their child kidnapped it would be rather heartless to also then tie them up in endless tax arguments with beauracrats because there was no clarity with regards to whether the child is still a dependent or not. So long as the tax laws take account of dependents then in my book it is much better to have a clear determination as to the tax status of a kidnapped child.

    I don’t think the issues of complexity with 30/30 as raised by Conrad really amounts to much. It is far less complex than the existing system. I agree however that 30/30 does put everybody who earns less than $30k on a form of welfare. I don’t think this is ideal but it is a substantial improvement over the current system because it elliminates high EMTRs.

    Personally I think an even simpler system would be to elliminate income tax entirely by increasing the GST and/or land taxes. You could then provide a social safety net and a progressive structure by giving all citizens a fixed recurring handout (sometimes called a social wage). Of course this would mean that everybody was on welfare, however with no data on private personal income (something that should be a private matter in any case) any temptation to complicate such a system would be severely hampered. We could still give handouts to people due to having children or due to disability. So there would still be scope for complexity but not on an income contingent basis which in my view is the biggest problem with the current system. We should still abolish the minimum wage so that people with impaired ability have the maxiumum opportunity to participate in private sector employment.

    Few people reject outright the notion that the government has a role to play in welfare. The political focus in my book should be on achieving a high growth, low tax welfare state. Arguments about abolishing the welfare state are not going to find resonance with a wide audience. They are relevant to any cultural reform program but mostly useless in terms of politically driven reform in the current cultural context.

  4. “I don’t think this is ideal but it is a substantial improvement over the current system because it eliminates high EMTR”
    .
    My view is that a better solution would be to raise the tax free threshold as much as possible (paid for by getting rid of all the deductions and perhaps increasing GST). If you then get high EMTRs in certain bands, then it’s just bad luck — but the bad luck isn’t as bad as the current situation, since it would happen to people earning much more so, excluding people working on an hourly basis, it would still be worthwhile working versus getting benefits.

  5. Conrad — 30/30 has problems, but not the ones you mention.

    You say: “it would need to specify things such as how you work out your benefits if you have intermittent work, what happens to already taxed dividends your receive etc”

    It is very easy to work out your benefits. You get $9000, and then pay 30% on all income. Nothing could be more simple.

    And there is no drama with taxed dividends… as the dividend tax is exactly the same as your income tax.

    As for putting all people under $30k on welfare… they already are. And for people earning between about $20k and $50k they are seeing a total of about $80 billion being churned as tax & welfare. That would be entirely removed by 30/30.

    I can’t understand conrad’s preference. 30/30 amounts to (1) increasing the tax free threshold; (2) cutting the top rate from 45% to 30%; (3) decrease the welfare handout; and (4) decrease the phase-out rate for welfare.

    In contrast, conrad’s preference is to simply do the first part and then if EMTRs are high (a huge problem)… ignore it. How is that an improvement?

    My preference, like Terje, is to ultimately remove the income tax. And if that isn’t possible, then at least move it down to a state level so that we have competition between income tax regimes.

  6. JH,

    I’m not really thinking of the 30/30 scheme in terms of a comparison with the current system (I’d take your system any day), and things like a simple system should really be goals of any system (IMHO). I’m really thinking about it in comparison with systems like HK, where most of the population doesn’t pay any income tax, but I assume you must have EMTRs somewhere (in fact, they use a graded tax rate in a tiny band which I assume was initially designed to try and stop some of this, but since its so small, it’s now essentially irrelevant). Thus, it’s really the trade-off between EMTRs vs. a higher tax-free threshold and having to deal with the government that I think is important, and my feeling is that if the tax-free threshold is high enough, then EMTRs are not especially important.

  7. I am always a little unsure about how the “no deductions” rule works. Given that deductions are also known as “expenses”, and they are what business incur in the process of earning income. If you are taxing business on their gross turnover rather then profits, it isn’t going to work too well.

    So, we assume this “no deductions” rule applies only to individual taxpayers. So now we have an inconsistancy like the current difference between personal tax rates and company tax rates that encourages people to corporatise now – will we see a wave of “businessing” by individual tax payers? Only if the benefits exceed the cost, I suppose. And it isn’t as simple as saying that companies cliam deductions and individuals dont, because, for example, sole traders put all their business returns through their individual tax return.

    Just saying, this point needs a little expansion.

    Also, to Conrad’s objections, what John said. And all the rules, regualtions and programs of the current welfare system are abolished. It is $9,000 unconditional welfare, whether you are looking for work or lying on the beach – we don’t care, it isn’t our problem if you think $9,000 is a handy amount to live on. Goood luck to you.

    John – have you done any work updating 30/30 to current prices or something?

  8. “I am always a little unsure about how the “no deductions” rule works”
    .
    It seems to work fine in HK without the problems you mentioned, so empirically I think you needn’t worry too much.

    Perhaps what’s wrong with it in Australia is easier to see — we now have a situation where people can deduct all manner of work expenses without their work actually asking for them to be spent and nor do you have to even prove the things were a really work related. For example, if I buy a computer and go to a holiday/conference (including food) in Spain (both things which I have done before), then these are currently tax deductable, despite my work not asking for me to do it (excluding letting me take leave). There are also other things like negative gearing, which I would cut too.

    “There isn’t an inherent conflict between low EMTRS and a high TFT. Indeed, one way to lower EMTRs is to increase the TFT.”

    I agree.

  9. I wonder if the IRA (Sorry, I think I mean IRS) gives group discounts for kidnapees? If more than one child is held hostage, do you need more than one form? It’s good to know that a tax office has actually thought these things through. I never noticed such things on our tax forms!

  10. You can say “it won’t be a problem”, but I’d like to know why. It is pretty well known that one of the perks of running a small business is being able to write off a percentage of your personal costs as business expenses. This is added to just collecting cash and not declaring income as the most effective tax avoidance methods for small business. Unless tax rates are suitably low to make it not worth the effort, I fail to see why more people will not go down this route to keep getting the deductions.

    And historically, deductions for the individual were not some tax-loophole, it was established under common law in hundreds of fiercely fought battles that people were entitled to deductions for expenses that were intrinsically tied up with earning income. They aren’t rights that should be extinguished casually, the taxpayers should certainly get good value in trade by way of tax cuts.

  11. I ran a small business for ten years and there were not that many perks. At least not simple ones that were worth the grief. I did get to use the mobile phone for personal use paid for out of pre-tax income but so did my employees.

  12. Tim — I’m not going to update the numbers for 30/30. I prefer to explore new ideas now. But others are free to pick up where I’ve stopped.

    As the original paper made clear, what I am calling for is no “tax expenditures” (not deductions), which doesn’t cover business costs. In other words, I’m calling for an income tax with no deductions, not a revenue tax with no deductions.

    Of course, there is a grey area about what counts as a business expense. But that ambiguity is inevitable in any income tax system.

  13. So, because I’m not that bright, could someone explain the difference between a “tax expenditure” and a deduction? Or even what a “tax expenditure” is? And no, I never bothered to read the original paper.

  14. I have never understood a tax on income at all. It seems to me (as a member of the great unwashed) that it is a disincentive to achieving more. Surely a better proposition would be to tax spending by increasing the GST, removing all exemptions and doing away with income, and most other taxes altogther. That way saving is encouraged, compulsary superannuation, could probably be done away with, thereby making employing people more attractive. If you wanted to (you bleeding heart liberal)compensate welfare recipients juyst increase payments by the same amount as the increase in GST.
    I realise this would probably be political suicide for anyone trying to introduce this but could anyone tell me why it would not work?

  15. I suggested the a similar thing. Actually, small savings in reducing duplication and having just a 20% GST and no other taxes, split in thirds between Feds, State and Local from the localities the taxes were raised.

    We should move to just having the GST (at the current 10%) by slowly reducing and abolishing all other taxes, and eventually, halving the rate (from 10% to 5%).

  16. A tax expenditure is a deviation from how an income tax works. An income tax (by definition) taxes income (ie revenue – costs) and not revenue.

    So a deduction for business expenses is not a tax deduction, but an integral part of an income tax. However, a deduction for having children, giving to charity, buying whiskey etc are deviations from a basic income tax… and are tax expenditures.

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