Don’t tax and spend?

“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.

19 thoughts on “Don’t tax and spend?

  1. Damien – Indeed! And the CIS will always spend your money more carefully than the government, so better off giving it to us then them!


  2. The CIS wasted a bunch of money printing that worthless 30% tax/negative tax policy, even with the huge disclaimer on the front. That’s not value for money, that’s just waste and disinformation.


  3. Its probably worth noting that even if we ignore positive theories of government behaviour (lets label these public choice theories) and focus only on what an efficiency minded government would do, the optimal amount of government expenditure is unlikely to be independent of the costs of taxation (deadweight losses or resource misallocations). Presumably an efficiency minded government would want to equate the marginal benefit from government expenditure 9the benefit of a slight increase in public expenditure) with the marginal cost of raising the money for that additional expenditure (the marginal cost of public funds, which is related to both the marginal deadweight loss from taxation and the change needede in tax rates to fund the additional expenditure).


  4. David, I think you need to differentiate between ideas that you don’t agree with (or perhaps even that you don’t like) and the relative benefits from expenditure by different organisations. I don’t agree with every idea that the CIS publishes, but I value the fact that some of these ideas are being debated.


  5. Damien,

    The difference is that the CIS didn’t agree with it and the preamble attached on the front agreed it was flawed. Why bother publishing in that state? It’s just noise, not information.


  6. Hello from sunny South Africa. Just a quick comment on ‘tax expenditure’. The biggest problem I have is that it assumes all income really belongs to the government and them not taking your income constitutes a gift from the government to you. So the government not taking your money is equivalent to the government giving you money. Clearly this is a nonsense – it is long overdue that someone stand up and say so.


  7. SD: You should have said that yesterday — I could have agreed with you from a place where most people probably agree with you (HK). Alas, I’m back where they don’t, and it isn’t even sunny to compensate.


  8. Sinclair

    That’s one way of looking at it. The other way is to see what the government is doing is treating different parts of your income (or expenditures) differently for tax purposes, so it is the government making judgements about what’s good for you and trying to influence you to do certain things (like donate money to CIS or have a lot of superannuation). From the point of view of a libertarian (not mine) I would have thought that this was objectionable.


  9. Jacob – I’m not sure of the exact story behind it. It dates from when Howard was Treasurer, ie late 1970s or early 1980s. It’s one of dozens of organisations listed in the Income Tax Assessment Act for deductible donations, and is listed in a part called ‘specific research recipients’, almost all of which do politically-oriented research. The Institute of Public Affairs is not there, though their website claims that they are eligible for tax-deductible donations. The Australia Institute is not there either, and their website does not claim deductibility so (gasp) they may have the strongest claim not to receive any government largesse (though it is not clear whether they pay market rates for their offices at the ANU). In what amounts not just to deductibility for a specific institute but also to a specific individual (ie Frank Lowy) the Lowy Institute for International Policy is part of a list of ‘specific international affairs recipients’.


  10. My comment to that the other day is the same as Sincs. It’s about time this this type of slop was knocked on the head and killed off forever.

    The money donated to the CIS , any foundation or tax exempted organization has been given by someone who owns the money and has earned it.

    It truly is amazing how this thinking keeps lifting itself out of the coffin when you least expect it. We saw that with the superannuation discussion in an earlier thread.


    I love David’s comment.

    The shorter David …. if it doesn’t agree with my personal preferences it’s money wasted.

    How about that hey.


  11. I’m all in favour of tax deductions for donations to organisations who apply those funds towards public policy ideas, whether or not I agree with the particular ideas or not – the more ideas out there in the “ideas marketplace”, the better!


  12. JC wrote:
    shorter David… if it doesn’t agree with my personal preferences it’s money wasted

    Peter Saunders in the forward:
    and some readers will inevitably have misgivings about various aspects of what Humphreys is saying. But a paper like this serves an important purpose, for in setting out an ideal, it challenges us to think about what we are trying to achieve and how we might move closer to realising our aims.

    Which indicates to me that “bad” Peter Saunders thought it was a load of bollocks too, but published it as a water muddying spoiler piece to confuse debates about taxation and welfare.

    If I was foolish enough to donate money to an organisation committed to publishing useless garbage, I would likely be very unhappy.


  13. Andrew, so in the current environment, any tax exemption is not a bad thing because it helps restrain the growth of government spending? I half buy it. The question is whether the granting of exemptions creates vested interests that then oppose broader-based reform. For example, it’s quite possible that organisations presently entitled to tax deductible donations would be worse if deductibility were removed even if marginal rates were radically reduced. While the CIS might stand on principle, others probably would not.
    Still, perhaps this is the masterstroke behind the super tax reforms that Ken Henry commended? Cripple future tax receipts by entering into a hugely ‘costly’ commitment that is politically extremely difficult to renege on.


  14. so, tax deductions for CIS are OK but tax deductions for children on the other hand are anathema.

    Andrew. – you actually believe this?


  15. In a totally reformed system, I would abolish them both. But the so-called FTB, while some people get it by reducing their tax, is mostly a payment, ie tax dollars are collected and then paid out as welfare. The government sets how much you get, based on the number of children. I think it is mainly called a ‘tax’ benefit because the PM was trying to avoid it being seen as what it is, an expansion of the welfare state.


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