“employed by CIS, which does not accept government money”
Is it not the case that there is a special section of the Income Tax Assessment Act which makes donations specifically to the CIS tax deductible (along with donations to a particular left leaning think tank)?
That’s commenter Spiros on the issue of who pays my CIS salary.
The argument here is that because donations to the CIS (please make one:)) are tax deductible that is a loss to the government and therefore the CIS (and through it, me) is in receipt of government money. In broad terms, this is a widely accepted type of analysis with the Budget papers providing estimates of ‘tax expenditures’ and my fellow critic of big government Des Moore including them in his estimates (pdf) of the size of government.
I don’t dispute that tax expenditures are a significant aspect of government policy – like ordinary taxing and spending, and like much other regulation, tax exemptions, deductions and concessions are (desirably or not) distortionary in that they steer behaviour towards particular activities and (implicitly) away from other activities. Tax expenditures are criticised for receiving less scrutiny than direct expenditure. And as the government still has to raise a certain amount of money to meet its outlay commitments, it means that other tax rates have to be higher to bring in the required amount of revenue.
I am not, however, entirely convinced by the standard analysis. Calculations of the level of tax expenditure are based on the ‘revenue foregone’ approach. So the ‘benchmarks’ against which tax expenditure is measured are the otherwise prevailing tax rates. For example, say a person had a taxable income of $1,000 and there was a flat tax of 30%. His tax liability would be $300. This would be the benchmark. But say that person made tax-deductible charitable donations of $100, leaving a taxable income of $900. His tax liability would be reduced to $270, creating a tax expenditure of $30.
However, if these rates are at those levels because tax expenditures are known to be at a certain level then this becomes circular. If the government needed to raise a specified sum for its own outlays, it would not need a 30% rate except for the tax expenditures eating into the revenue raised. In this example, the ‘true’ tax rate benchmark is somewhere below the official 30% rate, depending on how many taxpayers claim the deductions and how much they claim. If all taxpayers had the same income and claimed the same deduction as my hypothetical taxpayer, the ‘real’ income tax rate would be 27%, since the required revenue could either be raised by a 27% tax rate with no deductions or a 30% rate with deductions.
Another difficulty is that it is assumed there is a baseline amount the government wants to spend and this drives tax rates. This is true up to a point, but the last few years have seen a situation in which even slightly reduced rates produce far more revenue than the government knows what to do with – despite some dubious handouts that would never have happened in a tighter Budget situation there are still billions being stashed away in the Future Fund and the Higher Education Endowment Fund.
We can think of governments as rather like people in the wallet experiments reported on Andrew Leigh’s blog. In this experiment, 100 wallets were left for people to find and for the experimenters to discover how many people were ‘dishonest’ and not return them to their owners. As it turned out, 26% of the wallets were not returned. A much lower proportion of the ‘dishonest’ would have stolen a wallet out of the pocket of someone walking along the street, but as the money was just there they took advantage of it. The Howard government has been fortunate in finding lots of very fat wallets, only some of which they returned. But I am pretty sure they would not have increased tax rates to fund $4,000 baby bonuses or future higher education capital works. In this sense, by cutting tax revenue the various tax expenditures avoid additional unnecessary outlays rather than increasing the total burden of government.
In general, I subscribe to the view that the tax system should be as simple as possible and marginal rates should be as low as possible. This would mean cutting tax expenditures and tax rates. But in the current environment, tax expenditures have probably helped restrain the growth of government, by generating less of the tax revenue that government would have spent now or deferred to spend later through the Future Fund or Higher Education Endowment Fund.