Income taxes are too high

A recent report from the OECD shows that Australia has one of the highest level of income tax in the world. As reported in The Australian, for single people with no kids and average income, Australia has the 4th highest level of income tax in the developed world. Even worse, a four-person Australian family living on one average income pays the 2nd highest income tax in the developed world, only behind Denmark. See here for the full details.

High income taxes punish people for being productive. This is both morally dubious and economically inefficient, as it encourages people to shift into less productive activity.

The economic literature is often focused on a narrow measure of labour supply elasticity, which shows how tax rates impact the amount of hours worked. Advocates for high income taxes correctly note that the narrow labour supply elasticity is relatively low, which suggests that high income taxes have a relatively small impact on the economy.

The problem with this logic is that it overlooks many of the other ways that people respond to higher tax rates. In addition to changing their work hours, people respond to high income taxes by engaging in legal tax minimisation, illegal tax evasion, switching to the black or grey market, switching jobs and careers, changing their work effort, changing their pay structure, or moving their income into different jurisdictions. When all of these factors are included, the behavioural changes (and therefore inefficiency) from high income taxes are significant.

Australia’s income tax rates are too high, and significant tax reform should be part of the national discussion about ways to increase productivity and wages.

Having given you the bad news, it is worth putting this into some context. First, Australia’s retirement income system is very different to most other countries, which makes accurate comparisons difficult. More importantly, Australia has a smarter company tax system and lower consumption taxes than many other countries. Some proponents of tax reform argue that we need to reduce income taxes and increase other taxes. We agree with the first half of this proposal but not the second. While tax switching may be able to provide some marginal efficiency gains, the better option is to cut government spending along with taxes and generally decrease the size of government.