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Simplified Personal Tax: Can Australians Be Trusted to Do the Right Thing?

Published: June 26, 2012 in Knowledge@Australian School of Business
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Tax return time is approaching, which for millions of Australians means setting aside a weekend or two to fill out the form or complete e-tax online, with the hope of receiving a quicker refund. For the Australian Taxation Office (ATO), it's time once more to warn about dodgy deductions.

It's a familiar but time-consuming ritual that Jason Kerr, a researcher at the Australian School of Business (ASB), argues needs simplification, particularly for the 60% of taxpayers with straightforward returns who have their tax deducted by employers and claim few deductions. In New Zealand and the UK, most people no longer have to file a return, and interest and dividends are taxed at source by banks and companies. Likewise, in most Organisation for Economic Co-operation and Development (OECD) countries, tax offices do all the work. They send a statement to taxpayers to tick off, or amend with extra income or deductions. Why doesn't Australia follow suit instead of making nearly everyone fill out a tax form?

Popular arguments contend Australians are too timid to change or just love the ritual that precedes those tax refunds. The British claim they trust their citizens more. But Australia's colonial past has bequeathed it with a diehard tradition of rules and regulations that the ATO embodies. This approach has won conservative political support. Some Republican Americans, for example, have claimed the annual tax return process should be as painful as possible, to remind people of how much money big government is "stealing" from them.

Australian governments have talked about reform for years but little has happened. In the lead-up to the introduction of the Goods and Services Tax (GST) in 1998, then treasurer Peter Costello told the Committee for Economic Development of Australia (CEDA) that if Australia "had a strong pay-as-you-earn tax system with a strong interest-withholding tax system, we could kick most Australians out of the necessity to file income tax returns."

In a reform paper that year, Treasury said an income statement would contain the income details that have been reported through the new withholding and other systems. Taxpayers could simply confirm the information by telephone to receive their refund, or add details of any other income and claims for rebates or deductions as appropriate. Conceptually a statement approach would apply to 3.5 million taxpayers, with more straightforward rebates and deductions for those whose income is derived from wages and salaries, dividends and interest investments. An ATO-generated income statement was explored at the same time, with Treasury planning to pilot these statements for the 2001-02 income year. This did not eventuate in Australia.

New Zealand's Big Bang

However, in New Zealand (NZ) most taxpayers there were relieved from the need to lodge tax returns in 2000, with the introduction of a personal tax statement, which summarises a salary and wage earner's income and tax deductions for the year. The NZ government said the measures would "significantly reduce the compliance burden on taxpayers", removing "many of the onerous, repetitive requirements that the current tax system places on salary and wage earners and employers" and reducing "the extent to which the tax system intrudes on the lives of most individual taxpayers".

NZ took a "big bang" approach to deregulation in the wake of radical economic reforms in the 1980s brought on by then finance minister Roger Douglas who urged: "Implement reform in quantum leaps, using large packages. Do not try to advance a step at a time. Define your objectives clearly and move towards them by quantum leaps. Otherwise the interest groups will have time to mobilise and drag you down." This contrasts with the cautious approach of Australian governments. As Australia's Treasurer, Wayne Swan, told the 2011 Tax Forum: "Tax reform is about the long, hard slog of tackling one difficult reform after another." The forum raised the issue of simplification of tax returns, but "reduced filing" of tax returns held less sway than those arguing in favour of the alternate approach of "pre-filling" a taxpayer's return with information available to the ATO.

Australia's Future Tax System Review, chaired by former Treasury chief Ken Henry in 2009, canvassed pre-filling and framed it as "abolishing returns", though the final report fell short of outlining any such bold recommendation. It opted for a more status quo approach, recommending "pre-filled personal income tax returns should be provided to most personal taxpayers as a default method of settling their tax affairs each year". As international tax expert Graeme Cooper commented: "While the review of Australia's future tax system proposed some measures which would reduce the compliance burden for individuals, it was insufficiently bold in its recommendations." He told the tax forum that "most people would prefer to be freed from the tax system altogether – having satisfied themselves that the system is fair or fair enough, to let it run its course and live in considered ignorance of it and not to pursue 'timely information' about its impact in their lives thereafter."

Even though simplification was at the forefront of Henry's thinking in recommendations for reform of the personal income tax, "these have hardly been touched by the government to date", according to Richard Highfield, senior advisor to the OECD and ATO, and adjunct professor in the School of Taxation and Business Law (Atax) at the Australian School of Business.

"Notwithstanding this inaction, the case for simplification remains strong and a system of fully completed pre-filled tax returns for the majority of personal taxpayers would seem to me to be a key part of any future efforts to streamline the personal tax system," Highfield says. "By its very nature, the use of pre-filled returns embodies a level of engagement with taxpayers which many tax administrators would strongly advocate. And there is no reason why tax refunds cannot also be an end component of such arrangements, activated once taxpayers have confirmed the details in pre-filled returns sent to them."

Pre-filling should be a stepping off point to reduced filing by most taxpayers who have straightforward affairs, asserts Chris Evans, a professor of Taxation at the Australian School of Business, who also notes the government's inertia, despite some 10 inquiries into simplifying the Australian tax system in the last 20 years.

"Frankly most people would prefer tax at source," Evans says. "I am not a better person because I have to spend two weekends every year doing my tax return when I could be taking my wife to the Blue Mountains. I think pre-filling your information into the online tax form in e-Tax is as far as (the policymakers) will go. Reduced filing (by the 60% with straightforward tax affairs) is not on the agenda. We are not heading to taxpayers' heaven. They are not trying something they should be. There is a degree of timidity here. Of course there is the effect on tax advisers – 70% of us rely on them, almost more than anywhere else in the world."

The Question of Refunds

Kerr sees best practice in future tax administration to be a hybrid system where elements of both reduced filing and pre-filling co-exist; so people with simple tax affairs will not have to lodge tax returns and those with more complex arrangements will tick off pre-filled returns. "The debate as to whether we should have tax returns or not for people with simple tax affairs may therefore be a moot point," he says. The real question worthy of further research is whether revenue authorities should continue to issue refunds to the majority of taxpayers, Kerr suggests.

Going against the tide of tax simplification, the UK is looking at using more pre-filled tax returns (for taxpayers with complex affairs) and online individual client accounts. From 2014 annual personal tax statements will be sent to more than 20 million UK taxpayers who will be expected to confirm the amount of tax they have paid. Under the new system, the government will also outline how their taxes are being used. "The UK personal tax system is often lauded for the lack of engagement, [which] some academics have advocated from time to time in an Australian context, but it now seems to be moving more in the direction seen elsewhere with more engagement, but imposing minimal obligations on taxpayers," notes Highfield.

The UK's aim is to build awareness of the tax system and accountability to it. In Australia, however, opponents of simplification fret about a potential collapse of engagement by citizens if they were relieved of the obligation to file tax returns. Accountants and tax agents have a vested interest in the current system, helping most Australians fill out their returns. Some argue that tax is an important civic duty, it requires a ceremony "and the filing of one's tax return is that ceremony", a requirement that leads to greater awareness of the cost of government and transparency of tax burdens.

A 1996 survey of 393 personal taxpayers in Melbourne found that a belief the system is inefficient correlated with a propensity to evade taxes. Kerr says a review of the research shows general satisfaction with government influences the willingness of taxpayers to comply with tax obligations. Government can have an impact on tax compliance in three key ways: efficiency in revenue expenditure (including how it collects tax), the fairness of the system and the direct interaction of government with citizens. "This third point may indeed include the annual interaction through lodgement of tax returns, as taxpayers may be generally satisfied with a government interaction that is simple – even when that engagement is no longer required," he says.

At the same time, a reduced filing tax system – with the majority of taxpayers not lodging returns – may promote taxpayers' belief that the government respects their ability to do the right thing. Behavioural economists suggest there is a tax contract between taxpayers and administrators. This implies that "genuinely" rewarding taxpayers in an exchange relationship will increase tax compliance.

The Psychology of Taxation

There's a growing role for psychology in understanding tax. Aspects such as fairness in taxation, and how people frame their decisions, limited attention spans, and an aversion to loss, all impact on the administration of a tax system.

Evidence suggests that many taxpayers do not act in their own immediate self-interest to evade tax and so do not have to be tightly regulated, says Simon James, a professor in Economics at the University of Exeter, who spoke at a recent Atax conference at the Australian School of Business. "Rather, there may be significant advantages in shifting the emphasis of tax compliance policy towards treating the majority of them as responsible citizens and using the insights of behavioural economics to assist them in the most effective ways," he says.

The rationale behind the recommendation for default pre-filled tax returns is founded in analysis of human behavioural research, which suggests assisted decision-making and choice "nudging" helps taxpayers to make complex decisions and alleviates the burden of complexity, says Kerr. The UK Cabinet Office established a behavioural insights team in 2010 to "find intelligent ways to encourage support and enable people to make better choices for themselves". When they sent letters to taxpayers in selected regions saying that most people in their local area had already paid their taxes, the upshot was a 15% increase in repayment rates.

The role that tax refunds play as incentives or rewards for keeping Australian taxpayers onside with its complex tax system is not clear. The lesson from NZ is that they are important. Refunds have sparked an erosion of the simple NZ system, where most people do not need to file a return. Now a "tax refund industry" has emerged which charges a fee for requesting a personal tax statement from the NZ tax office and lodges a return only when the taxpayer is entitled to a refund (and not when they have to pay tax). Further complication comes from the increased use of the tax system to administer other policies, particularly student loans, family benefits and KiwiSaver (retirement income) schemes.

The tax climate in a society can vary between antagonism and working together. Tax paying can be seen as an onerous duty, but also as a well-accepted civic duty. Kerr argues that taxpayer engagement would increase with greater tax simplification.

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