The dangers of a two-tiered tax system

Labor has thrown its support behind the Morrison government’s tax cuts for small businesses, and while such reforms should be embraced, creating a two-tiered tax system will have negative consequences for the Australian economy.

Under the proposed legislation, businesses with revenue of less than $50 million will be subject to a 25 percent business tax rate while those earning over the threshold will be taxed at 30 percent. Business tax cuts have become highly politicised in Australia, and the parliament’s unwillingness to budge on the issue puts us at odds with other developed countries who have implemented cuts over recent years.

Lowering the business tax rate would be a great policy, but creating a tiered system is not. There are two ways in which high business taxes will harm the economy. They reduce the savings rate by increasing prices, and they hamper economic growth, job creation, and wages by stifling business growth. The latter will become even more of a problem if Australia is home to a tiered tax system.

Firstly, taxes are paid for by consumers and workers. While the left side of politics are ideologically opposed to such taxes, and many on the right refuse to present alternative policies, keeping them as high as they are in this country is depressing wages and harming consumers.

As Mark Littlewood from the Institute of Economic Affairs recently noted, you can send companies the bill, but they won’t pay the taxes. Once taxes are ‘imposed’ on businesses, they just pass on the cost to consumers. And that’s fair enough; what people need to understand is that high prices are caused, in part, by high taxes.

This can be seen in the recent Transport Levy in Western Australia, a terrible policy to bail out taxi-plate owners, which Uber have confirmed they will be passing on to consumers in its entirety. The alternative to passing on the tax to consumers is to cut into wages, which are usually a business’ biggest cost. This means people have their hours cut, or in the worst case, they lose their job.

Secondly, creating a tiered system is an inherently disincentivising and destructive activity. This style of tax is often labelled ‘progressive’; we should instead call it restrictive. The main danger arises from an effect called ‘bunching’, which is well observed. When there are a number of tax rates, there is a natural tendency to bunch up just below each threshold. The reasons for this are clear, as the Institute of Public Affairs recently pointed out and as can be seen below: why would businesses grow if they will be hit with a higher tax burden?

Implementing a tiered system is dangerous as many businesses may simply shut down when they get too close to the $50 million turnover mark. Companies should not be punished for being successful, especially seeing as their movement from small to medium sized is what increases employment and wages. Businesses should be able to grow, and implementing a tiered tax system will create an unnecessary barrier to a local firm being able to scale up.

The debate over tax cuts often becomes an ideological battle. Some claim to be fighting for the average person by making corporations pay their ‘fair share’, while others argue about encouraging foreign investment to create jobs. Both of these positions are simplistic, and the conversation should also consider who actually ends up paying the tax, and what the unintended consequences of the tax may be.

When governments try to appropriate money from businesses, they must realise that all they are doing is increasing the burden on the people. If those who claim to care about the ‘little guy’ thought this through, they would realise that higher taxes hurt ordinary citizens.

Taxes are unfair by definition. Whether its a marketing levy applied to mushrooms (yes, that’s a thing) or personal income tax, when governments take money from people it is a destructive and disenfranchising exercise. A flat rate of tax is, in reality, the least unfair tax. If taxes are going to exist, they should be at a low and equal rate for all.

Cian Hussey

Latest posts by Cian Hussey (see all)