A Progressive Direct Expenditure Tax

Melbourne Institute Working Paper No. 13/98

Date: June 1998

Author(s):

John Freebair
Rebecca Valenzuel

Abstract

Australians are again looking at the possibility of major tax reform, including a reexamination of options once taboo, such as the GST. But there is, in fact, a wider range of possible tax systems available to us. One major option not so far considered is the 'direct expenditure tax'. As a concept it is not new, although it is not familiar in the Australian debate. This is surprising, as it has strong potential benefits to offer. A progressive direct expenditure tax would replace the so-called ‘income’ tax currently levied on individuals and business enterprises. The sum to be taxed would be a measure of expenditure on final consumption. In effect, then, savings would be exempt from taxation. But when the savings, and the returns earned on them, were ultimately spent, they would be taxed. A progressive tax rate schedule, which reflected both capacity to pay and family circumstances, would be applied to individuals and perhaps also to business enterprises, to calculate tax payable. This proposal is not, in fact, as radical as it might first seem. Income from labour would be taxed as now. And even under the current system, much saving, and investment is effectively given an expenditure tax treatment-such as the treatment of owner-occupied housing, and business expenditure on human capital and on research and development. The current tax treatment of superannuation and accelerated depreciation allowances are as much an expenditure tax as an income tax. This expenditure tax offers two alternative options under its direct taxation scheme: the 'cashflow' and the ‘yield-exempt’ options. Illustrative simplified tax forms for individuals and for business enterprises using both options are presented, discussed. and compared with the present ‘income’ tax forms. In order to collect the same revenue as the current ‘income’ tax system it would replace, a direct expenditure tax would require higher tax rates. This is because the tax base would not include savings which are now subject to income tax. A slight increase in the degree of progressiveness of the current tax rate schedule would also be required, to maintain current notions of equity between richer and poorer taxpayers.

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