Australians should pay a lower rate of tax on their savings than their wages.

That’s the key message from a new report by the Australian National University’s Tax and Transfer Policy Institute.

The report argues that taxing savings at a lower rate than “labour income” would improve fairness and boost efficiency.

This is partly because savings have usually already been taxed as wages, and partly because taxing assets and savings at the same rate as labour income distorts people’s decision making.

Australia’s current approach to taxing savings is a mess at best and a serious driver of intergenerational inequality at worst,” report co-author Professor Robert Breunig said.

The report calls on the federal government to tax savings at somewhere between 5 and 20 per cent, with lower rates more efficient and higher rates better for raising revenue and achieving “more short-term redistribution”.

The report says everything from savings accounts and shares to investment properties and trusts should be taxed at the same rate “as this promotes the efficient use of capital throughout the economy”.

Individuals should be able to invest in assets that best suit their preferences for risk, return and liquidity rather than to minimise tax,” the report says. 

“There are arguments for a lower tax rate for superannuation, because it is held long enough for the compounding impact of tax to reduce returns and because of the interaction of superannuation income with the age pension means tests.

“There are also arguments for higher land taxes.

“However, these arguments do not justify the very large divergence in tax rates observed in the current Australian tax system.”

The report calls for a ‘dual income system’, whereby an individual’s salary has no influence on the tax rate they pay on their savings and assets.

“This removes the existing incentives to minimise taxes by shifting savings income from one financial year to the next, or [by] splitting it amongst family members,” the authors argue.

Source: Tax and Transfer Policy Institute, the Australian National University

The report also says that savings taxation should focus on the income an individual’s assets generate, rather than the total stock of their assets.

This would prevent people who are “asset rich but income poor” from being heavily penalised, as would happen if a wealth tax was introduced.

Dual income system could discourage negative gearing

The proposed ‘dual income system’ would discourage property investors from engaging in negative gearing, a policy that cost taxpayers $13.1 billion in 2017-2018, according to ATO figures.

Along with co-authors Peter Varela and Kristen Sobeck, Professor Breunig argues that negative gearing would no longer be ‘tax preferred’ relative to rental income, as capital gains ‘discounts’ would no longer apply.

Some savings tax arrangements are progressive, taxing higher incomes more heavily, and some are regressive. Some favour the old but are punitive for the young,” they wrote.

“The taxation of savings is politically contentious with strong lobby groups defending particular savings arrangements, whether that is negative gearing of investment property, dividend imputation or superannuation concessions.”

The ANU authors also argue the following short-term reforms would streamline the system:

• Improved targeting of superannuation subsidies towards younger people and those at risk of triggering the Age Pension Means Test
• Taxing dividends at a flat rate
• Moving to a broad-based land tax
• Including all assets in pension means testing.

Source: Tax and Transfer Policy Institute, the Australian National University

Dual income proposal modelled on Nordic example

The ANU authors said adopting the above four measures could see taxation in Australia move closer to systems seen in Nordic countries.

The region has implemented a series of reforms to simplify their systems over the past two decades, bolstering their social safety net and increasing public funding in education and child care.

But Nordic countries also have some of the highest tax rates in the world.

The ANU’s outlined changes would likely cause tax rates to decrease on higher-tax assets (including investment properties) and increase on lower-tax assets (including superannuation).

“This might seem radical. But in reality the reforms are reasonable and would bring us closer to the optimal tax system Australians deserve and this nation needs,” the authors wrote.

Australian tax reform hit headlines recently after a NSW government-commissioned review recommended replacing stamp duty with a higher and more expansive GST.

David Thodey, who headed the review, said the devastating bushfires and pandemic had provided a catalyst for a new conversation on tax reform.

But Treasurer Josh Frydenberg poured cold water on reform discussions at the federal level, saying states would have to go it alone if they intended to pursue change.