(Image via @jarrapin)

It's a tricky sort of conservative leader who can propose taking us back a century and claim it is a visionary policy, says former ATO Assistant Commissioner John Passant.

AUSTRALIA FIRST had Commonwealth and State income taxes in 1915. It is a special type of conservative leader who can propose taking us back a century and claim it is a visionary policy, something for the future. It is nothing of the sort.

While the details are not yet clear, it appears that what Prime Minister Malcolm Turnbull is proposing is cutting health and education grants to the states and territories and as a consequence cutting federal income tax, and saying to the states and territories that they can set their own income tax rates to make up the shortfall.

The Turnbull Government has followed the Abbott Government and its 2014 Budget. That Budget trumpeted it

“will achieve cumulative savings of over $80 billion by 2024-25”.

The "savings" (aka cuts) by then would be a bit over $50 billion from health spending and a bit under $30 billion from schools. What Turnbull’s tax sleight of hand does is lock in those cuts (with perhaps a few crumbs from the table to buy off the premiers and chief ministers before the election) and shift the blame for cuts to health and education from the Commonwealth to the states and territories.

The proposals will present real problems for the poorer states, Tasmania and South Australia, and for the Northern Territory. At the moment the richer states and the ACT subsidise them. This ensures, to some extent, except for those in rural areas and especially for Aboriginal people in remote communities, that Australians receive equivalent standards of health care and schooling irrespective of where they live. The Turnbull tax trashing would undermine that.

Tasmania and South Australia are poorer than New South Wales and Victoria. They don’t have the same population or industry base to be able to fund health and education to the same extent as the richer states, unless they increase taxes. Given their population is poorer relative to other states this means the impact of any poor state income taxes will be to make the overall tax system more regressive. This possible tax burden itself might drive younger people to the wealthier states.

The alternative of course is for these poorer states and the Northern Territory to cut health and education funding so we end up with three tier education and health systems, namely private schools and hospitals, public schools and hospitals in the richer states and public schools and hospitals in the poorer states.

But the pressure in the richer states and the ACT will also be to cut funding to deliver lower individual tax rates. This tax competition will lead to a race to the bottom — an ever worsening health and education systems and lower and lower state and territory taxes.

In the 1970s, both states and the Commonwealth levied estate and gift duties (i.e. death duties). In 1977, Queensland Premier Joh Bjelke Petersen abolished the duties in Queensland. The other states feared residents, especially older ones, would move to Queensland. Tax competition forced them to abolish their death duties and abandon the revenue from them. Malcolm Fraser went to the 1977 Federal election with a promise to abolish Commonwealth estate and gift taxes and on re-election did so in 1978.

Something similar may well happen if the states and territories have the ability to set income tax rates. It would take only one latter day economic Joh to cut income tax in his or her state to set in place a race to the bottom. The consequence would not be economic benefits – a caged pet rate running on a hamster wheel goes nowhere – but less money for health and education spending.

There are other problems. With eight states and territories competing on income tax rates there will be a lot of tax arbitrage and avoidance around residence and source. What rules will be in place for a New South Wales resident earning income in Victoria? What about FIFO workers? What about workers in Tweed Heads who live in Queensland? Albury residents who work in Wodonga? On and on this stupid Turnbull idea goes.

Not only that but the proposal appears to apply only to personal income tax rates, not company tax rates. (Does it cover trusts too? Who knows?) If it is good enough for salary and wage earners why isn’t it good enough for companies Mr Turnbull? More importantly about two in three small businesses from memory are unincorporated. You could imagine one or more states doing special small business relocation rates, a la Singapore or Luxembourg, to entice them if possible to their jurisdiction.

Maybe some unincorporated business will incorporate to avoid paying state or territory income tax.

The new regime will be a nightmare for businesses with employees in different states and territories. There will presumably be slightly different rates between different jurisdictions so they will have to take out different tax amounts from their employees’ wages depending on which jurisdiction they live in, or perhaps work in.

Even if they are only in one state or territory the remitting of the base income tax amount from their employees’ wages will be to the Commonwealth, with the top up going to the state or territory.

There is something else in this Turnbull tax trashing. The PM calls it a fundamental reform. Yet it is only tax rates he is devolving to the states and territories. If he were serious about tax competition (he isn’t) he’d allow them to develop their own tax bases. That was the situation from 1915 till 1942. It was a disaster waiting to happen.

There was a centralisation of tax in the hands of the Commonwealth in 1942 for a number of reasons. It was to pay for the war effort. It was to make those living in low tax states pay more for the war effort. It was to expand the Commonwealth government and its role in the economy.

Now Turnbull wants to turn back time. Capitalism has changed fundamentally and a return to 1915 is a retrograde step for workers, and for Turnbull’s beloved capitalist class.

We workers shouldn’t fall for this pea and thimble trick of higher taxes or underfunded school and hospital systems. There is an alternative — tax those many big businesses avoiding tax and tax the rich.

Maybe the $24 billion Turnbull is going to spend on planes that don’t work and the god knows how many billions he is going to spend on submarines could instead better fund public schools and hospitals.

This story was originally published on John Passant's website en Passant on 30 March 2016 and has been republished with permission. You can follow John on Twitter @JohnPassant. John is a former assistant commissioner in the Australian Tax Office. He was in charge of international tax reform. He has also been a tax academic although his 30 non-interviews for tax academic jobs in the last five years tells him 62 year old socialists are not in much demand in the conservative tax academy.

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