Taxation and deductions

Introduction

This chapter outlines why we need to pay taxes and what our governments do with revenue raised from taxation. In addition, we discuss some of the ways we can reduce the tax amounts we pay through allowable tax deductions. Australia has a progressive tax system in which you pay higher proportions of tax as your income increases. Some argue that a flat tax would be more 'progressive', because it may encourage people to work harder and earn more money. This is a subject of debate.

Reasons for taxation

Tax is paid by individuals and other entities (corporations, trusts, partnerships) to governments. Governments provide a range of services with the revenue received. Taxation receipts are used, among other things, for the essential services of health, education, infrastructure (buildings, roads, bridges and railways), defence and social security. See image 1.

Most working people understand that tax is required to provide services in our community, so we don't mind paying our fair share of tax. Equally, most working people wish to minimise the tax they pay, in order to have more disposable income (which they can use to improve their lifestyle or pay off debts). Some people argue that our tax system is not really 'progressive', because there are limited incentives to work harder in order to earn more income. The reasoning is that even if you are earning higher levels of income, you are paying a higher proportion of tax (more tax by proportion than lower income earners). In this situation, working people may resent having to 'foot the bill' for others in our community; they feel they are working harder for others, not for themselves.

This is why it is often said that Australia has an inefficient tax system, with high costs on our economy. Critics argue that if we change to a single proportional (flat) tax system, we can reduce system complexity, reduce costs of compliance, and reduce the many ways that the system encourages tax evasion (failure to declare income and serious tax crime) and tax avoidance (using legal 'loopholes' to minimise tax). It may also be possible to have a higher tax free threshold under a flat tax system.

Modes of taxation

By far the largest tax is personal income tax (the tax individuals pay for the luxury of earning money). Within income tax, we need to look at different tax rates. Over the period from 1969-1970 to 2000-2001, the top marginal tax rate dropped from 66 per cent to 47 per cent, whilst the income tax amount (as a proportion of GDP: national income) has increased from around eight per cent to over 13 per cent. Over the same time period, income tax, as a proportion of total taxes, rose to over 40 per cent.

How much tax do people pay? The lowest 20 per cent of income earners pay roughly about 36% of their gross (before tax) income in tax. The highest 25 percent of income earners pay over 64% of their gross income in tax. Our 'progressive' income tax system judges this to be fair, because the more you earn the more proportion and amount of tax you should pay. Income tax is paid by both individuals and businesses. Income tax, or Pay As You Go (PAYG) withholding tax, applies to assessable income, which is the amount of income after allowable deductions (incurred through business). All businesses and individuals assessable for income tax must lodge an income tax return after the completion of each financial year (1 July to the following 30 June).

Capital Gains Tax (CGT) is declared as part of your income tax return. CGT is a tax on the gain or loss from such things as the sale of an asset (like a house). Fringe Benefits Tax (FBT) is a tax paid by employers based on benefits paid to employees. Excise duty is a tax payable on excisable goods made in Australia, such as tobacco, petrol and alcohol. The Commonwealth levies all of these three modes of taxation.

The Goods and Services Tax (GST) is a broad-based, consumption tax of ten per cent, paid on most consumer goods and services (excluding things like fresh food). GST revenue is collected by the Federal government and passed on to the States and Territories. Most businesses and individuals registered for GST are able to claim input tax credits for GST amounts paid on items used in the course of business. See image 2.

The Medicare levy is a type of tax that requires us to pay 1.5 per cent of our taxable income towards the cost of public health. This allows us greatly discounted costs when we visit the doctor or hospital system. When we pay for private health insurance, the tax system gives us a 30 per cent rebate (due to the savings made on the public system).

Property taxes are also known as rates; these generate revenue for local governments and they are a compulsory levy on the value of real (immovable) property. If your home worth $250 000, for instance was charged a property tax/rate/levy of one cent in the dollar, an amount of $2500 would be owed. Property taxes are generally used for such community things as local streetlights, park maintenance and waste management.

A second form of property tax is one based on the value of land. Land that is valued above a certain amount is often subject to taxation by State governments. State governments are forbidden, by section 90 of the Commonwealth Constitution, from levying excise or customs duty. There are other State taxes such as pay-roll tax which is paid by employers, when monthly wage payments to employees exceed a certain threshold. Stamp duties (taxes on transactions) apply on: motor vehicle registration or transfer, insurance policies, leases and mortgages, hire arrangements and transfers of property (when you sell a home).

Tax deductions

The Australian taxation system relies on individual self-assessment of their income and deductions for a financial year. This means, you must honestly declare the income types and amounts you have received, as well as keep records (receipts) of expenses to be claimed as tax deductions. If a person doesn't declare all their income, they may be investigated (audited) and fined.