136 The Effects of Personal Income Taxation on Income Inequality in Australia Terry Alchin Department of Economics University of Wollongong ABSTRACT This paper attempts to show that the progressive income tax system in Australia is redistributing income towards those recipients in the lower quintiles. This distribution has been occurring over the thirty year study but has been dramatically expanded over the last six years by some of the changes to the income taxation system, for example, the introduction of a rebate system to replace the deduction system. Recommendations are presented here that a more progressive system would redistribute more income and reallocate the income into those areas where it will have most benefit. This may be accomplished by changing marginal rates of tax or increasing the number of taxation steps in the scale. INTRODUCTION The purpose of this paper is to show that the progressive income tax in Australia has achieved some equity in terms of income redistribution by personal income taxation. It is expected by the community that the government must help resolve important problems in the face of the inability of the market to achieve economically and effectively desired goals. The redistribution of income has often been categorised as one of the functions of government since there is fairly wide agreement on the need to modify the market s distribution of income in the direction of greater equality. According to traditional economic theory the market distributes income among individuals in accordance with the principle of marginal productivity or the value of a resource or service a person renders to other people in the economy. There has been a growing recognition that some individuals cannot contribute enough work or resources of a quality high enough to earn even subsistence incomes. The extent or form of income redistribution is really the debate.
137 There are many redistributional aspects associated with the actions and policies of governments. For example, public education is primarily a redistribution of income from the wealthy to the poor, from small families to large ones and from older to younger generations. Debate also centres on whether the redistribution should be in terms of public goods, cash benefits or progressive income taxes. The data examined in this study show that annual levelling of disposable incomes had occurred thorough taxation especially in the last decade. Thus earlier work in this area by Ternowetsky (1979) is supported although Ternowetsky argues that there is little room for optimism from his results. It is not the purpose of this paper to argue whether the primary (or pre-tax) income distribution is more equitable in 1979-80 than in 1950-51 as Harris (1970) attempts for the years 1955-56 and 1965-66. Rather comment is made on what can be established in terms of the incidence or redistributive impact of income tax, i.e., whether the secondary (or post-tax) income distribution is more equitable than the corresponding primary distribution. METHODOLOGY All data are taken from the Reports of the Australian Commissioner of Taxation starting with the 32nd Report (1953) and continuing annually up to and including the 60th Report (1980-81). Income tax statistics are used to make intertemporal comparisons year by year which could not be undertaken, if data was based on survey or census figures which are not available every year. It is recognized that taxation statistics are considered only a rough estimate since they underestimate inequality. This occurs because the better-off gain most from the non-reporting of incomes and receive more through non-taxable benefits in kind (Lenski and Lenski, 1978; Titmus, 1962). Also only a partial picture of total income is given since income from capital gains is not reported as it is not taxable in Australia, and those who do not earn enough money to pay personal income tax are not included 1 To obtain a full 30-year time series the primary Gini coefficients were calculated using taxable income figures. Actual or net income was not used because of the definitional changes implemented for 1970-71 and the rebate system introduced in 1975-76. These changes would not allow comparability between Gini coefficient calculated on net and actual incomes over the 30-year period. This study uses individual incomes only and does not segregate into sexes, ages or geographical distribution since the objective is to assess whether the progressive income tax system has coincided with greater equity.
138 RESULTS Table 1 represents the Gini coefficients from 1950-51 to 1979-80. Column 1 presents G. the primary Gini while column 2 presents G*, the secondary Gini. Column 3 shows the absolute reduction in the Gini coefficient due to personal income taxation. Column 4 presents the reduction as a per cent of the primary Gini. Table 1. Gini coefficients (calculated from taxable income) (Source: Calculated from data taken from the Report of the Commissioner of Taxation. 1953 to 1980-81).
139 Inequality in taxable incomes as measured by the primary Gini has decreased steadily over the 30-year period. No explanation is undertaken here except to comment that the rebate system introduced in 1975-76 to replace the deduction system has tended to reduce the primary Gini in the late 1970s. Every year some reduction in inequality of income has occurred and the reduction over the years 1954-55 to around 1969-70 shows considerable stability. During these years the tax system was not altered, wages were not rising at high rates and economic growth remained fairly constant. The years preceding and following these are the years to examine carefully. The first year examined is one that has generated considerable interest. Jones (1975) has stated that the year 1950-51 was one in which very high incomes were earned in the primary sector, mainly as a result of the wool boom and high prices for primary commodities (due partly to the Korean war). Consequently primary producers although only 11 per cent of taxpayers earned 28 per cent total taxable income. He warns that such changes can affect the distributions in one or two years and thus distort long run trends. In the years 1950-51 to 1952-53 very high maximum marginal tax rates (75 per cent) tended to redistribute income and the effect was reinforced by the low level of thresholds for the maximum rates ($20,000 compared with $32,000 introduced in 1953-54 and maintained until 1970-71). In 1953-54 the maximum rate was lowered 5 per cent and the maximum marginal rate threshold was raised substantially to $32,000, and this is reflected in the lower percentage reduction in the secondary Gini coefficient. A further reduction in the maximum rate was made in 1954-55 and the amended rate (66.7 per cent) was maintained until 1972-73. Changes in the tax schedule were implemented in 1970 when the number of steps was reduced by one, the minimum marginal tax rate was reduced slightly and the threshold for the maximum marginal rate reduced significantly. These factors were responsible for reducing the percentage change in redistribution through income tax to the smallest level in the 30-year period. The tax system introduced in 1970-71 was maintained only for one further year before major changes were made; changes include raising the maximum marginal rate threshold to $40,000. The changes in the 1970s, reducing the number of steps in 1974, 1975 and 1978 combined with raised thresholds (through rebates and indexation) for both minimum and maximum marginal rates and increases in the minimum marginal rate (20 per cent in 1975, 27 per cent in 1977, 32 per cent in 1978 and 33.07 pe: cent in 1979) redistributed secondary income in a fairly significant way over the years since 1973-74. The Gini coefficients provide a useful summary measure of whether
140 Table 2. Quintile shares of income before and after tax for the total tax paying population: 1950-51 to 1979-802 (Source: Calculated from data taken from the Report of the Commissioner of Taxation, 1953 to 1980-81). income redistribution has occurred and the indications are that income redistribution is increasing. By examining the quintile shares of primary and secondary incomes the source and the incidence of the redistribution can be revealed. Table 2 presents the quintile shares of income before and after tax for the total tax paying population for the years 1950-51 to 1979-80. The first quintile represents that one-fifth of the tax paying population who have the lowest incomes. For example, in 1950-51 this quintile
141 received 7.55 per cent of total primary income and 8.86 per total secondary income. The fifth quintile in 1950-51 reflects the primary producer problem of that income year but over the following years the distribution of income, especially primary, has remained relatively constant. For example, if 1950-51 is ignored, the primary share in the secondary category has varied only between 12.86 per cent and 15.05 per cent over the 30-year period with a similar non-variance in the secondary quintile. Substantial changes to the primary distribution of the top quintile are shown through a reduction from 43.08 per cent total taxable income (excluding 1950-51) in 1951-52 to 34.05 per cent in 1979-80. Following the wage explosions of 1974, wage indexation was implemented, at least in part to reduce the effects of fiscal drag on taxpayers. This had allowed the quintile percentages to remain fairly constant over the late 1970s as wages had continued to grow and the taxation thresholds had been adjusted except for 1979-80 when the thresholds were maintained at the 1978-79 levels. Table 3 is constructed using the percentage changes from primary to secondary income distribution from Table 2 and dissecting the changes into percentages among the quintiles. For example, 1950-51 shows that as a result of income tax the fifth quintile loses 6.80 per cent of cent of total income. This 6.80 per cent is divided amongst the other quintiles as shown, 1.31 (19.3 per cent of 6.80) goes into the first quintile, etc. Table 3 is significant in that it shows that redistribution due to income tax has increased over the period in terms of reallocating income from those in the higher quintiles to those in the lower. If the year 1950-51 is excluded, the first quintile receives 21.5 per cent in 1951-52 of the redistribution and this percentage has increased up to 51.1 per cent in 1979-80. The increase in the second quintile has remained fairly stable and does not show any definite trend over this period while the gain to the third quintile from taxation was reduced from 26.7 per cent in 1951-52 to 19.7 per cent in 1979-80. The fourth quintile received redistributed income in 1951-52 in the form of 24.6 per cent of the redistribution but this gain reduced over the years significantly until a low of 4.9 per cent gain was reached in 1977-78. The gain was reversed in 1978-79 when for the first time the fourth quintile experienced a loss, actually contributing to the gains in the first, second and third quintiles. Even without indexation in 1979-80 the reversed trend continued in that redistribution from the fourth and fifth quintile occurred resulting in changes in the secondary distribution in the lower 60 per cent of the tax paying population. It is interesting to note that the Howard-Fraser tax system has contributed very significantly to the redistribution of secondary income although it is often argued that the present tax
142 Table 3. Changes in quintile share of income (absolute and per cent )3 as a result of personal income tax (Source: Calculated from Table 2, expressing the changes to each quintile terms and, in brackets, as a percentage of that quintile). in absolute system favours those on highest incomes. The bottom two quintiles of taxpayers have benefited from more than 75 per cent of the redistribution from 1976-77 onwards and the trend is towards more redistribution, as shown from the redistribution from the fourth quintile. This is in contrast to the 1950s when the redistribution favoured the fourth and third quintiles. Table 4 presents the secondary share of each quintile as a percentage of primary shares of total income. In 1951-52, the first quintile gained approximately fourteen per cent of secondary income while the fifth quintile lost twelve per cent of income. The general trend is
143 Table 4. The effects of taxation: secondary shares as a percentage of primary shares of total income (Source: Calculated from Table 2 and expresses the secondary share as a percentage of the primary share). maintained. The gains to the first quintile increase over the time period from around 12 per cent to 17 per cent in the late 1970s. The gains to the second quintile remain fairly constant but the gains to the third and fourth quintile are progressively reduced. The losses in the fifth quintile do not show any long run trend and remain between about 8 per cent and 10 per cent. If one examines a specific income year, for example, 1973-74, it is important to note that 10 per cent reduction in the fifth quintile as a result of personal income tax is responsible for a gain in the first quintile of 16 per cent, in the second of 10 per cent, 5 per cent in the third and 2 per cent in the fourth. This suggests the possibility that a
144 revision of the progressivity of the system could provide a more egalitarian distribution of income. A more progressive income tax system would redistribute a greater share of income and reallocate income to those areas where it will have most benefit. Head (1980, 48) argues that the redistributional impact has been modest but it appears that the impact may be greater. To even further this the income tax system should be made considerably more progressive by either increasing the number of steps in the tax scale or increasing the maximum marginal rate or decreasing the minimum marginal tax rate or any combination of these. CONCLUSIONS Annual levelling of incomes has occurred through income taxation. The trend involves a redistribution in the long run from the fifth quintile (and lately the fourth) to the lower quintiles. This agrees with one of the principles of progressive income taxation in that those who can pay more do pay more. Thus redistribution has occurred and the results indicate that in the later years the lower income groups have received a larger share of total income. The possibility exists that, over the entire period of time, substantial changes in the taxation system have in part contributed to the redistribution. If income redistribution is to be an aim of economic policy then this trend should be continued and possibly extended by making the system more progressive, for example, by lowering the minimum marginal tax rate. NOTES 1. The limitations of income tax statistics in Australia are developed by Ingles (1981) who compares income tax data, census data and survey statistics. He argues that although limited, at least, income tax statistics are presented annually and this allows intertemporal comparison. 2. The most difficult problems of estimation are associated with the fact that the boundaries between the five groups fall within the income bracket used in the published statistics. For example, in Income Year 1967-68, 18.53 per cent of taxpayers had taxable incomes of less than $1,400, while 23.55 per cent had less than $1,600. To estimate the amount received by 20 per cent, it is assumed that the 5.02 per cent who received incomes between $1,400 and $1,599 were evenly distributed over this income bracket. 3. Per cent totals may not necessarily sum to one hundred because of rounding.
145 REFERENCES Commissioner of Taxation. (1953 to 1980-1981), Report to the Commissioner of Taxation, 32nd Report to 60th Report, Canberra, Australian Government Publishing Service. Harris, C.P. (1970), Income Tax and Income Distribution in Australia, in C.P. Harris (ed.), Selected Readings on Economic Behaviour, Berkely, McCuthen, 352-364. Head, B.W. (1980), Inequality, Welfare and the State: Distribution and Redistribution in Australia, The Australian and New Zealand Journal of Sociology, 16, 3, 44-51. Ingles, D. (1981), Statistics on the Distribution of Income and Wealth in Australia, Department of Social Security, Canberra. Jones, F.L. (1975), The Changing Shape of the Australian Income Distribution, Australian Economic History Reveiw, 15, 21-34. Lenski, G. and J. Lenski, (1978), Human Societies: An Introduction to Macrosociety, New York, McGraw-Hill. Titmus, R.M. (1962), Income Distribution and Social Change, London, Allen and Unwin. Ternowetsky, G.W. (1979), Taxation Statistics and Income Inequality in Australia: 1955-56 to 1974-75, Australian and New Zealand Journal of Sociology, 15, 2, 16-24.