Warning: this is an entire post about tax.

The Australian Financial Review today featured a cover story about the Henry Tax Review, that three-volume behemoth that landed with a thud in early May. Apparently Tony Abbott has promised to make some tax announcements in the coming days, drawing from the report.

That could mean just about anything. The review panel made 138 recommendations; some big (resource rent tax), some small (a few taskforces and ‘further reviews’), some timid (weak language on bequests taxes), some bold (congestion charges).

The Government ruled out a couple of dozen recommendations, but promised that the rest of the report represented a “long term agenda”, of which the package it announced in May was merely the “first wave”.

So, what might the Coalition have planned for its imminent announcements? Unless you’re wonkishly inclined, you might not be aware of what’s in the report. The coverage of the resource rent tax drowned out  discussion of the other recommendations made by the panel.

If they’re feeling particularly bold, Abbott might commit to  the panel’s recommendation for the personal income tax system. This recommendation, if implemented, would represent possibly the most radical reshaping of the personal income tax system since its introduction. It would be a big step towards that radical libertarian dream beloved by rich people everywhere: the flat tax.

Here’s my rough approximation of what the current income tax system looks like for a single income earner (not including benefits like Newstart):

The darker line is the effective marginal tax rate, the rate you pay on an additional dollar earned. The lighter grey line is the average rate, the proportion of your total income that you pay in income tax. So, if you earn $50 000, you would lose 35c of an additional dollar you earned, but all up you would pay less than 20% of your income in tax (bear in mind that these are more of less back-of-the-envelope calculations).

The picture is a bit messy because of the effect of things like the Low Income Tax Offset and the Medicare Levy.

The panel’s strategy for dealing with that messiness is to propose  a de facto flat tax. The panel thinks that if you get rid of the offsets, levies, and a lot of the deductions, you can raise the tax free threshold to $25 000 and get rid of the 37c marginal tax rate. Their proposed structure looks like this:

Simple!

What could possibly be wrong with that?

Plenty. You see that big flat section of the marginal rate curve, where it’s stuck at 35%? Well, 97% of income taxpayers would fit somewhere along that section of the curve. That means that almost all of us would face the same marginal tax rate. Whether you’re a junior admin assistant, scraping by on $30 000 a year, or a manager making $150 000, you’re going to face the same marginal tax rate. The elimination of the Medicare Levy also helps those at the top end; instead of facing a 46.5% marginal rate including the levy, they pay only 45c in the dollar.

This would make the income tax system a lot less progressive, a lot less redistributive. To see what the effect would be, have a look at this:

That squiggly line shows my estimate of the tax cut (or increase) you’d receive under the proposed system. There are some concentrated gains at the bottom end of the scale, and big gains to anyone earning more than about $95 000 per year. People on middle incomes would pay more tax.

Support for a flat tax is an article of faith in radical libertarian circles. It’s pure, with none of that lefty social engineering stuff that comes about when you tax poor people more lightly than rich people. The Henry Review panel recommends a big step down the path to a complete flat tax. How long would it take before that top rate was abolished altogether? After all, it would only apply to around 3% of taxpayers.

I doubt the Coalition would propose a policy so regressive, with the losers spread across the middle income ranges, in the middle of a close election campaign. Still, this recommendation will sit there for years, tempting the Tory side of politics to implement it.

I wonder if any journalists will ask them to rule it out.

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