27 September 2023

The pros and cons of standardising tax deductions

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Nassim Khadem* says tax deductions favour those ‘gaming’ the system and a standard deduction could help.


Those who call for a standard deduction argue it creates simplicity.

For many Australians, tax returns can be enormously complex, and taxpayers need to keep detailed records and receipts to substantiate their claims.

It is unsurprising the bulk of people who oppose a standard deduction are accountants.

They argue the system should not deter Australians from being able to legally claim the maximum refund they are entitled to.

Although the Tax Office reckons many Australians claim more than they’re entitled to.

It’s been doing random audits of a sample of taxpayers and it’s best guess puts this lost revenue in the billions per year.

It can also be costly to change the status quo, and not just in terms of the direct revenue impact.

As Kevin Rudd discovered with his ill-fated plan for a $500 standard deduction, changing the rules for work-related deductions could result in behavioural changes.

In a submission to the 2016 Standing Committee on Economics Inquiry into Tax Deductibility, Treasury warned the change could “provide a greater incentive, where possible, for employees to re-characterise themselves as contractors”.

Contractors are essentially sole-trader businesses who can claim work-related expenses as business costs and offset them against their income.

Treasury also cautioned that any changes to the arrangements for deductions would need to take account of the fringe benefits tax (FBT) regime, which allows certain benefits to be provided from employers to employees.

But even if the proposal for a standard deduction doesn’t get up this federal budget, don’t be surprised if the rules about what people can and can’t claim do get tightened up.

Australians cherish their tax deductions

Three-quarters claim tax deductions totalling $37 billion a year, with 70 per cent using an accountant to file their return.

The average total deduction is $2,576, even though half of all taxpayers claim less than $674.

The majority of the $37 billion claimed is for work-related expenses.

Tax office statistics show that in 2017-18 there were almost 9 million taxpayers claiming a total of $21.7 billion in work-related expenses.

But look further into the data and you will find the bulk of deductions aren’t just going to people on higher incomes, but specifically to higher-income men.

The average higher-income woman (earning more than $100,000 a year) claims less in deductions than a man earning the same income.

This difference is partly due to the occupations men and women are employed in and the type of deductions they claim.

As an example, women are proportionately more likely to be working in administration.

Men, on the other hand, are more likely to be in the trades, labouring, or machinery operation.

Reviving the ‘standard deduction’ idea

Think tank the Blueprint Institute this week revived calls for a standard tax deduction set at $3,000.

The idea was first floated in the Henry tax review and gained attention under the Rudd Government.

The then-treasurer Wayne Swan had announced a $500 standard deduction for workplace expenses in 2012-13, rising to $1,000, but it never saw the light of day. In the end, the cost was seen as outweighing the benefit.

The idea was once again put on the table two years ago by the tax ombudsman.

The inspector-general of taxation’s review into the future of the tax profession said such a move would make it easier for millions of Australians.

Under Blueprint’s plan, the $3,000 standard deduction would be claimed automatically — people would just submit a form that was already pre-filled rather than spend hours completing their tax return.

The think tank says the change would see 80 per cent of taxpayers getting a “tax cut” of typically $400 to $600 per year.

It estimates this would reduce federal tax revenues by around $5 billion per year.

For the 20 per cent of taxpayers with high work-related expenses, they would still have the option to fill out a full tax return and potentially get a bigger return.

Under its plan, gifts and donations and personal superannuation contributions would still be able to be claimed on top of the $3,000 standard deduction.

Its reasoning for this is that there is “a social interest in maintaining public support for charities”, and including personal super contributions in the standard amount would “conflict with the conceptual basis of the super system as a pre-tax saving vehicle”.

According to its report, “some taxpayers at the margin will choose the standard deduction even when their expenses surpass $3,000 to reduce their compliance costs”.

It estimates about three million taxpayers with deductions greater than $3,000 would continue to itemise.

It also argues a standard deduction would narrow the gender divide as it would equalise deductions between the half of higher-earning men and women who opt into the policy.

“Lower-income women tend to claim a little bit more than lower-income men, so [they] have a tiny bit more to gain from the policy,” the Institute’s chief economist, Steven Hamilton, says.

“Higher-income women have a lot more to gain than men, but there are many fewer of them.

“So the two effects on dollars going out the door overall nets out, and women and men end up in total with the same amount of dollars.”

Work-from-home claims on the rise

The institute’s proposal comes at a time when more Australians have been working from home due to the COVID-19 pandemic and are claiming more in work-related tax deductions.

Accountants reported a dramatic increase in people claiming home office equipment and electronics amid COVID lockdowns.

The trend of people working from home is here to stay.

In response to more people working from home during the pandemic, in April last year the Australian Tax Office (ATO) announced a new “shortcut” where people could claim 80 cents per hour for all their running expenses, rather than needing to calculate costs for specific running expenses.

At the time, accountants warned many people may be seriously short-changing themselves and getting lower refunds by using the shortcut method.

But they predicted many people would still choose the shortcut since they wouldn’t need to provide detailed documentation in the way they would if they wanted to use traditional claiming methods.

The Blueprint Institute has also suggested tightening deduction rules, claiming “vagueness of the deduction criteria leave it exposed to intentional gaming of the system”.

It said Australia’s loose requirements were out of step with comparable nations.

Other nations, it argued, have stricter, narrower, and clearer requirements that limit expenses to those that are necessary and exclusive to income production.

For example, New Zealand mostly does not allow any work-related expense deductions for employees.

It scrapped them in the late 1980s to broaden the tax base and fund a reduction in personal tax rates.

In Britain, claimable expenses must satisfy a stringent test of being incurred “wholly, exclusively and necessarily in the performance of an employee’s duties”.

Australian Governments have previously considered the NZ model- that is doing away with tax deductions and lowering personal tax rates.

It’s possible this option gets revisited at some point.

*Nassim Khadem is a business reporter with the ABC.

This article first appeared at abc.net.au.

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