An Optimal or Comprehensive Income Tax?
| Date | 01 September 1994 |
| Published date | 01 September 1994 |
| Author | Graeme S Cooper |
| DOI | 10.22145/flr.22.3.2 |
| Subject Matter | Article |
AN
OPTIMAL OR COMPREHENSIVE INCOME TAX?
Graeme S Cooper"
The
purpose
of this
paper
is to pose one question -should the Australian income tax
system of the twenty-first century belong to the descendants of
Henry
Simons or to
those of Frank Ramsey?
Put
another way,
my
topic is
whether
future tax policy
should
continue to
be
framed according to notions of comprehensive income tax1 or, instead,
should
be
directed towards the goal of
an
optimal income tax.2
It
is clear that the Australian Treasury regards the Haig-Simons or comprehensive
tax base tradition as the system implemented
by
the Australian income tax regime.3
It
is also reasonably clear that,
when
allowed to reconstruct a definition of "income" free
from the peculiarities of the
way
the meaning
has
developed in the Income Tax
Assessment Act 1936 (Cth), (the Assessment Act),
modem
Australian judges
understand
this to
be
the concept they are pursuing.4 This is
true
even though, it
has
*
1
2
3
4
Associate Professor, Sydney University Law School.
The
use
of this
term
springs from the
work
of Robert
Haig
as elaborated
by
Henry
Simons.
Haig's definition of income as the
money
value of the
net
accretion to economic
power
between
two
points of time
was
later elaborated
by
Simons as
the
sum
of the value of
consumption
plus
net
accretion to savings
during
a period. See R M Haig, "The Concept of
Income"
in
R M
Haig
(ed),
The
Federal
Income
Tax
(1921); H C Simons,
Personal
Income
Taxation
(1938). For a general discussion of the Haig-Simons tradition, see H M Groves,
Tax
Philosophers
(1974), ch
8;
M Mcintyre, "Implications of US Tax Reform for Distributive
Justice" (1988) 5 Australian
Tax
Forum
219 at 234-246.
A similar definition of the
meaning
of optimal tax analysis is difficult to construct.
An
approximation
of a definition will emerge in this
paper
from a discussion of
the
principal
concerns of
the
style of analysis.
See Australia,
Tax
Expenditures Statement
1993
(1993) at 1
and
55-60.
The
best
example of this is seen in
what
is commonly referred to as default assessments
where
the
administrator
has
to estimate the taxable income of a taxpayer
without
direct
knowledge
of
the
taxpayer's income; the process occurs precisely because
the
administrator
disbelieves
the
information
provided
by
the taxpayer. See, for example, L'Estrange v
Federal
Commissioner
of
Taxation
(hereafter FCT) (1978)
78
ATC 4744. The case concerned
the
calculation of
the
income of a taxpayer assessed
under
an
"assets
betterment
assessment".
The calculation
used
by
the Commissioner
and
approved
by
the
judge
was
to reconstruct
the
taxpayer's income from his estimated consumption increased
by
net
changes in
the
value
of his assets,
reduced
by
realised capital gains
and
increased
by
realised capital
losses. Tht! last
two
adjustments
were
necessary because of
the
overlay
of
the
lawyers'
notion
of
income,
and
the structure of
the
Assessment Act
at
that
time,
which
did
not
include
capital gains.
Now
the similar calculation
would
require the elimination of fringe
benefits
and
realised capital losses from the employee's income
and
the
inclusion of
realised capital gains.
1994
An
Optimal
or
Comprehensivive
Income
Tax?
415
been
argued,
the Australian definition of income for tax
purposes
evident
in
court
decisions
can
be
traced to such unlikely sources as the English
trust
and
proferty
law
of the
nineteenth
century
and
the English schedular system of taxation. Despite
important
adjustments
made
for administrative convenience,6 the Haig-Simons
model
is still the
dominant
force
in
tax reforms
proposed
by
the Australian
government?
And
if
one
were
to look
beyond
these shores, it is
evident
internationally as well as
in
Australia
that
the comprehensive tax base tradition remains the
dominant
leitmotiv
in
tax reform proposals.
In
the 1960s
and
1970s, it influenced the Carter Commission
in
Canada,
8 the Asprey Committee
in
Australia9
and
the Blueprints
proposal
of the
United
5
6
7
8
9
SeeR
W Parsons, "Income Taxation:
An
Institution
in
Decay" (1991) 13 Sydney L
Rev
435.
However,
while
the
Australian income tax
system
may
be
based
on
the
Haig-Simons
concept,
many
important
differences
remain
when
the
Haig-Simons
net
accretion concept
of income
and
the
notion
of
income actually legislated
are
contrasted. First,
the
tax
base
is
different. The Haig-Simons definition clearly includes capital gains, gifts
and
windfalls, a
proposition
which
has
been
excluded
by
the
schedular
approach
to income,
derived
from
the
English system,
at
least as it
has
been
interpreted
by
Australian
judges. This
approach
need
not
have
been
taken
and
is quite
contrary
to
our
global income definition - a
matter
which
the
High
Court
acknowledged
in
State
of South Australia v
Commonwealth
of Australia
(1992) 92 ATC 4066,
but
decided
was
now
too
entrenched
in
Australian
tax
law
to
be
capable
of
judicial rectification. See generally R E Krever, "The Ironic Legacy
of
Eisner
v
Macomber"
(1990) 7 Australian
Tax
Forum
191. Secondly,
the
judicial income
notion
is also
linked
to
a realisation requirement.
In
fact,
so
important
is
our
realisation
notion
that
the
High
Court
in
FCT
v
The
Myer
Emporium
(1986) 163 CLR 199
managed
to find income
from
the
mere
fact of realisation
without
either flow
or
gain
to
the
taxpayer.
With
minor
exceptions
such
as
the
trading
stock
valuation
rules
and
depreciation rules, realisation
was
invariably
required
under
the judicial notion
of
income, but, as
our
legislation becomes
more
sophisticated
and
Treasury exerts
more
direct influence
over
the
direction
of
tax
policy formation, realisation is seen as less
important
and
more
exceptions to
the
realisation
requirement
appear, for example,
in
the
treatment
of
discounted
bonds
under
Division 16E,
the
taxation of controlled foreign subsidiaries
and
portfolio offshore
investments
and
the
taxation of financial instruments. Realisation is a relic
of
the
flow
concept
of
income (which requires
the
severance
of
income from capital gain),
not
the
accretion concept
which
is
based
on
gain. Economists
in
the
Haig-Simon
tradition
concede
that
it is necessary to
have
a realisation element
in
the
definition
in
order
for
an
income tax
to
be
simple
to administer,
but
as Parsons observed (above n 5), if
one
concedes
the
realisation
requirement
it means
that
the
Haig-Simons
net
accretion tax as
defined
can
never
be
implemented. Realisation is invariably
required
before income will
be
regarded
as
derived,
and
although
(unlike
the
position
in
the
United States) a realisation
event
is
not
a
constitutional requirement, it is still invariably
required
in
Australia. Thirdly,
in
the
treatment
of
outlays, losses
and
expenses, it is necessary to exclude
net
dissavings from
the
income tax
base
but
to leave
consumption
expenditure
within
the
base. This
means
rules
are
needed
to
distinguish
consumption
from dissaving: is a
home
office, travelling,
entertainment,
child
minding
or
a business
lunch
consumption
by
the
taxpayer
or
an
expense
of
earning
income? The
treatment
of
expenses generally gives rise to
problems
for
the
judicial notion
of
income because almost
any
expense
can
be
related
in
some
way
to
the
derivation
of
income. These issues are discussed further
below
at
423-428.
See, for example, Australia, Consultative Document,
Taxation
of
Financial
Arrangements
(1993)
at
5. The
Document
says: "The proposals
in
this
document
are
directed
towards
a
system
for taxing financial
arrangements
that
is
more
comprehensive
...
"
Royal
Commission
on
Taxation,
Report
(1966) (the
Carter
Commission).
Taxation Review Committee,
Full
Report
(1975) (the
Asprey
Committee).
416
Federal
Law
Review Volume 22
States Treasury.l0 More recently, the almost universal tax reform strategy of the 1980s
was
the
widespread
reduction
in
marginal income tax rates accompanied
by
continued
broadening
of the income tax
base.ll
Praise for this strategy
emphasised
its
impact
in
reducing
tax-induced economic distortions
on
investment
and
work
patterns,
reducing
the deleterious effects of
high
inflation rates
in
tax systems
where
rates
and
thresholds
were
generally unindexed, controlling tax evasion
and
unproductive
investments
in
tax
shelters
and
reducing
pressures
on
administrators.12 These
intended
outcomes of the
tax reform strategy
were
those generally attributed to the virtues of the comprehensive
tax base tradition.
And
in
so far as the strategy
was
criticised, it
was
generally
not
because of
any
doubt
about
the
wisdom
of the comprehensive tax base model. Rather,
most
criticism
was
of the reductions to tax rates (rather
than
expansions of the tax base)
and
concentrated
on
the deleterious consequences of
reduced
levels of
government
revenue
-the
diminished
ability of governments to
provide
sufficient public goods
and
to
maintain
sufficient
spending
levels in welfare programs,
and
the implicit
accompanying shift
in
the tax
burden
away
from the wealthy
when
marginal
rates
were
uniformly
reduced.13
Yet, despite its immanence, the comprehensive tax base orthodoxy is currently
being
challenged. As
two
commentators
have
put
it: "[L]ess
than
two
decades ago, there
was
a
broad
consensus
among
economists concerned
with
the design
and
reform of tax
systems.
Today
this consensus
has
broken down.''
14
The challenge to the existing
orthodoxy
comes from optimal tax theorists
who
have
expressed quite radical, almost
heretical, views on, for example, the desirable shape of the tax rate scale,15 the
definition of the tax unit,16
and
aspects of the tax base. That challenge
has
not
gone
entirely unnoticed. Indeed, it
has
produced
a
stout
defence of the comprehensive tax
10
11
12
13
14
15
16
United
States Treasury, Blueprints
for
Basic
Tax
Reform
(1977).
For example, the top marginal income tax rates declined in the United States
(50
per
cent to
33
per
cent),
United
Kingdom
(83
per
cent to 40
per
cent),
Canada
(34
per
cent to
29
per
cent)
and
Australia
(60
per
cent to 47
per
cent). The
trend
to
reduce
income tax
worldwide,
whether
by
decreasing marginal rates, increasing exemptions
or
adjusting thresholds, is
discussed
in
a large literature. See, for example, R M Bird
and
S M Cnossen,
Personal
Income
Tax:
Phoenix
From
the
Ashes
(1990); M Boskin, "New Directions
in
Tax Policy"
in
M J Boskin
and
C E McLure (eds),
World
Tax
Reform:
Case
Studies of
Developed
and
Developing
Countries
(1990); V Tanzi, "Trends in Tax Policy as Revealed
by
Recent Developments
and
Research"
(1988) 42 Bulletin
for
International
Fiscal
Documentation
97;
J M Mintz
and
J Whalley (eds),
The
Economic
Impacts
of
Tax
Reform
(1989). For a general
survey
of developments
in
Europe,
see F Vanistendael, "Trends of Tax Reform in Europe" (1988) 5 Australian
Tax
Forum
133.
See M Boskin, above n
11
at
3-4; C McLure, "Appraising Tax Reform" in M J Boskin
and
C E McLure , above n
11
at
282.
See F Block
et
al,
The
Mean
Season:
The
Attack
on
the
Welfare
State
(1987); L McQuaig,
Behind
Closed
Doors:
How
the
Rich
Won
Control
of
Canada's
Tax
System (1987).
W Hettich
and
S Winer, "Blueprints
and
Pathways: The Shifting
Foundations
of Tax
Reform" (1985) 38
National
Tax
Journal423 at 423.
See, for example, J Slemrod, "Do We Know
How
Progressive
the
Income Tax System
Should
Be?"
(1983) 36
National
Tax
Journal
361; J K Seade, "On the Shape
of
Optimal Tax
Schedules" (1977) 7
Journal
of
Public
Economics
203.
See, for example, P Apps, "The Tax Unit:
An
Australian Perspective" in J
Head
(ed),
Taxation
Issues
of
the
1980s
(1983) 133.
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