Reforming Tax to Reduce Inequality - Australian Fabians

Reforming Tax to Reduce Inequality by David Richardson and Frank Stilwell


03 May 2024
Economy and Tax

Inequality has been growing in Australia in recent decades. While the tax system should be an instrument for reining this in, it has become part of the problem, not part of the solution. We need a radical shift in focus from taxing wages and earned income to taxing unearned income, wealth and capital gains. Although the political barriers will be formidable, they must be confronted.

Inequality of wealth is much greater than inequality of incomes, driving the widening rich-poor divide in Australian society.  Owning substantial assets, such as shares and real estate, yields extra income flows for the owners, typically coming as dividends, interest payments and rents. A big flow of incomes like these can enable the fortunate recipient to purchase yet more assets. So, there is a two-way connection between incomes and wealth.

This is evident in Australia, when looking at the data from the Australian Bureau of Statistics (ABS) that adjusts raw household income figures to take account of the differences of household size and composition. This ABS data shows that the 20% of households with the highest incomes get, on average, 5.3 times more income than the poorest 20% of households. For wealth, the top 20% of households have 154 times more than the bottom 20%. Clearly, while the distribution of incomes between households is markedly uneven, the distribution of wealth is very, very much more unequal.

What would happen if current trends were to continue? Extrapolating over the next 40 years, the ratio of total wealth to total income (as in the GDP data used in the national accounts) would increase from 7.5 times to 15.6 by the 2060’s. In other words, the increase in privately held wealth would be more than twice as rapid as the increase in national income. The higher ratio of wealth to income would effectively eradicate any semblance of equality of opportunity from Australian society. The wealth and power of the very rich - ‘the 1%’ economic elite - would become ever larger and the inter-generational transfer of wealth even stronger in shaping economic and social inequalities.

Some of the broader societal implications of these processes were explored by Thomas Piketty in his widely cited book, Capital in the Twenty-First Century. This showed that, if the increase in a society’s wealth exceeds the growth in its national income, the wealth becomes more concentrated and family dynasties loom increasingly large relative to the size of the economy. That is already happening now in Australia, undermining any residual claims to egalitarianism and a ‘fair go’ for all.

The current cost of living stresses in Australia relate directly to the economic inequalities. People living in relative poverty and struggling to make ends meet are hit hard by the rising prices of things they need to buy. Concurrently, wealthy people benefit from inflation in the value of things they own. Housing rents are the most striking example of this dualism. Rapidly rising rents make it very hard for low-income people to cope, while the owners of rented properties benefit from higher rental incomes as well as the rising market value of their assets.

The social stresses intensify as economic inequality increases. Consequently, there can be no resolution of the current cost-of-living crisis and the ongoing housing crisis without tackling the causes of the growing inequality. In this sense, poverty and wealth are the flip sides of each other.

Putting capital gains and wealth in the picture

To tackle this trend, deep and enduring tax reforms must focus on the capital gains and huge accumulations of private wealth that currently create cumulative advantages for a minority within the society but make life more difficult for the majority. Because capital gains and wealth are either lightly taxed or completely untaxed, the overall tax burden falls more heavily on to the bulk of wage-earners who can least afford it.

A capital gain arises whenever an asset's market value increases. The asset may be a house, a yacht, shares in a company, bonds, or cash held in a bank deposit, for example. It is the ownership of assets like these that is the key to wealth accumulation. Wealth in this sense is quite different from income. Wealth comprises a stock of assets, whereas income is a flow that people receive, sometimes as government income support, sometimes as dividends, interest or rent, but primarily as wages.

Regrettably, most discussion of inequality in mainstream media and politics ignores capital gains and their interaction with wealth, even though capital gains have been the major factor driving huge increases in wealth for the rich. A recent research report by the Productivity Commission, for example, fails to look adequately at the interaction between income and wealth. Redress of this situation is necessary if the tax system is to become fit for purpose in dealing with current economic realities.

Capital gains are currently running at almost half of other sources of Australian household income and they are on track to become even more influential than wages in shaping ‘who gets what’ in Australian society. We need to establish a more central place for capital gains and wealth tax reform in considerations of how our tax system can be made more equitable and sustainable.

Thrifty households increase their wealth by saving but, in practice, the overall impact of this on total wealth in Australia is now tiny. ABS data shows that there was no significant increase in household savings out of conventionally defined income during the 10 years to March 2023. By contrast, capital gains have added, on average, an additional 42.9% to Australian household incomes. Total capital gains were around $1,000 billion during the last calendar year, creating a massive flow that increased the total stock of private (non-governmental) wealth in Australia to around $15,000 billion. Because most households get very little or no income through this channel, it follows that the wealthiest households must be receiving prodigious amounts.

Again, the ABS data enables us to see the connection with inequality. Capital gains boosted the income of the bottom 20% of households by 4.4%; but boosted the incomes of the top 20% by a massive 144%. Looking over a longer period of the last 34 years (from September 1989 to March 2023), the same source of data shows that wealth increased by a compound 7.3% per annum, compared with household income which increased by 5.4% per annum. Over the same period, inflation as measured by CPI increased at an annual average rate of 2.7%.

Extrapolating current trends over the next 40 years, capital gains will, on average, have grown to be 1.1 times household income, as measured by the usual definition of income. Adding these capital gains to income, especially because they incur little or no tax, will make the distribution of income and wealth so much more unequal.

Two important inferences may be drawn from these observations. First, wealth and capital gains are important when considering the nature and sources of economic and social inequality, especially because capital gains operate as both cause and effect of increasing inequality in the distribution of wealth. Second, achieving a more sustainable and equitable set of tax arrangements therefore requires making wealth and capital gains the principal focal points for tax reform.

Creating a tax reform agenda

How can these concerns be tackled? Three types of tax reform would address them most directly: making the taxation of capital gains more comprehensive; introducing an annual tax on holdings of wealth above a specified threshold; and introducing taxation on transfers of wealth. Any one of these would make a big difference: all three would be transformational.  

First, what about taxing capital gains more effectively? Capital gains tax (CGT) has existed in Australia since 1986, courtesy of the Hawke government. It has always allowed the ‘family home’ – more formally, one dwelling and the land on which it sits – to be exempt from any taxation. Capital gains on other assets were fully taxable at standard income tax rates until 1999 when the Howard government introduced a 50% ‘discount’ on the rate of tax payable. Since then - for the subsequent quarter century - capital gains have been a major focal point for tax minimisation by those wealthy enough to have significant asset holdings. A massive distortion has thereby existed in the nation’s taxation and investment arrangements for nearly a quarter of a century.

The implication for tax reform is blindingly obvious – to terminate the ‘discount’ which results in capital gains being taxed at half the rate of wage incomes. The discounted tax rate has neither ethical nor economic justification. Some housing economists go further in arguing that the distorting effect on housing markets resulting from the exemption of the family home from CGT should also be reconsidered in reforming the tax system, but it is hard to imagine any politician in the land being willing to embrace that policy. No matter: removing just the CGT ‘discount’ concession would be a thoroughly justifiable reform. After all, who could seriously argue that income from the ownership of capital should be more lightly taxed than income from labour?

Second, what about a more general annual wealth tax? That would shift the focus from taxing flows of income to taxing stocks of private wealth. There are precedents in Australia, in that local government rates and the land taxes levied by state governments are both taxes on specific forms of wealth. A more general tax could be levied by the Commonwealth on households owning assets whose combined value currently exceeds a threshold of say, $3 million, indexed annually for inflation. Levied annually at a rate of no more than 2%, it would generate considerable revenue but only impact about 1 in 20 Australian households. It would be potent, efficient, and equitable.

Third, what of taxing wealth transfers? On first hearing, this sounds innocuous enough, but the penny quickly drops: it means the introduction of inheritance tax, sometimes called estate taxes or death duties, as well as taxing large gifts (including those made by rich parents to their children for house purchase). Shock, horror! Again, however, there are precedents. Many nations have wealth transfer taxes of this sort; and Australia did so before PM Malcolm Fraser and the reactionary Queensland premier Joh Bjelke-Petersen kick-started the process of dismantling them in the 1970s.

The socio-economic and ethical cases for inheritance taxation are strong: it would help to create a more level playing field inter-generationally; it has no work disincentive effects; it would capture wealth from those who no longer need it; and reduce windfall gains otherwise going to recipients irrespective of any productive economic contribution to society. It would also substantially reduce the inter-generational transmission of inequality. In other words, it is a form of tax that ‘ticks all the boxes’ for those believing in a meritocratic and more equitable society.


Dealing with flak

The federal Labor government recognized the unfairness of our tax system when it began the year by modifying stage 3 of the program of income tax cuts that the Morrison government initiated. The modifications gave more tax relief to the low and middle-income earners, while trimming back the huge benefits previously promised to the top income recipients.

This was a socially responsible and politically astute move, leaving the overall economic size of the tax cuts unchanged. But much more needs to be done to drive deeper fiscal reform. Small tweaks to the income tax rates cannot suffice. Addressing the growing economic and social inequalities in Australian society requires that asset ownership and capital gains be brought out of the shadows and into the spotlight.

Of course, a massive campaign to depict any such tax reform initiatives as ‘unfair’, ‘economically damaging’, even ‘un-Australian’, could be expected.  Courage is therefore necessary when entering this territory, whatever the soundness of the economic and ethical arguments. This is especially so for politicians who are understandably fearful of massive disinformation and scare campaigns that enormously wealthy backers would fund. But enter it we must unless, as a society, we are to passively accept the ongoing slide into much greater inequality and all its attendant adverse social, economic, and environmental consequences.

A large and growing volume of social science research shows the nature and extent of these adverse effects. Countries with the highest inequality tend to have worse macroeconomic performance; they create bigger ecological footprints and disproportionately large climate change impacts; and they experience more intense social problems, ranging from poorer physical and mental health to more violence and prison incarceration. Moreover, the international evidence indicates a generally negative correlation between economic inequality and people’s self-reported well-being and happiness. Evidently, greater inequality produces less contented and less cohesive societies.

That is the prospect for Australia if the last decade of public policy drift is allowed to continue because of excessive caution about ‘rocking the boat’ with substantial tax reform. Of course, the political aspects of the reform process need to be carefully managed. But ain’t that the case for everything! Fortunately, we currently have a Prime Minister and Federal Cabinet with considerable expertise in making political judgments on practical matters.

We therefore hesitate, as mere analysts, to end this article by being prescriptive about the political management process. Just two suggestions may suffice. One is to consider getting the process of reform started with an official inquiry into the causes of increasing wealth inequality in Australia, followed by a tax summit at which potential key reforms are presented.

The other suggestion is to ensure that the discussion of possible tax reforms is linked to public expenditures. Modern monetary theorists are right when they say that government spending is not limited by the revenue from taxes, but taxation remains an integral part of the government funding equation. Popular perceptions of tax tend to be more positive when combined with desirable improvements in the range and quality of the items on which the tax revenues are to be spent. For that reason, linking tax reform with public sector spending on crucially important social services and infrastructure - as well as redressing unjustifiable inequalities - can make the process seem more palatable, even essential.



About the Authors

Frank Stilwell is a critic of conventional economics and worked for forty years to establish and develop an alternative political economy program at the University of Sydney, becoming its first professor in 2001. He continues as Professor Emeritus in Political Economy at the University of Sydney and coordinating editor of the Journal of Australian Political Economy. He has written and co-edited twenty books on political economic issues, including Changing Track: a New Political economic Direction for Australia; The Political Economy of Inequality; and Alternative Theories of Political Economy. He is an elected Fellow of the Academy of Social Sciences in Australia, a long-time member of the Fabian Society, the SEARCH Foundation, and the executive of the Evatt Foundation.

David Richardson is a senior researcher at The Australia Institute. His research interests include macroeconomics and international economics. David has worked in Parliamentary Committees on various economic issues before Parliament. During the Hawke/Keating Governments David worked for Ministers Brian Howe and Senator Nick Bolkus.

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