Income tax

53. There are two principal Commonwealth Acts governing income tax in Australia: the Income Tax Assessment Act 1936 (Cth) and the Income Tax Assessment Act 1997 (Cth).^[58]

54. In general, individuals face the same tax requirements regardless of their activities or status. There are two key departures from this approach, one of which is age-based taxation evident through available tax offsets such as the Senior Australians Tax Offset.^[59] This means that people of different ages may have different average tax rates for the same level of income.^[60]

55. As recognised by the Tax Review, the imposition of income tax, together with reductions in income support payments (‘transfers’) as people earn more income, reduces the financial rewards from work, which may make work less attractive.^[61] Higher tax rates can act to reduce incentives to work since people have a smaller marginal gain from employment. However, others may work more to achieve a certain target level of income that they consider adequate for their needs.^[62]

Effective Marginal Tax Rate

56. An Effective Marginal Tax Rate (EMTR) is the percentage of additional income lost due to the withdrawal of means-tested benefits (such as social security payments) and additional income tax payable as a result of working. A higher EMTR may discourage mature age persons from seeking to work. For example, research has found that one in five pensioners who wanted to work declined part-time employment opportunities because it would cause a reduction in pension entitlements.^[63] The Tax Review suggested that ‘one of the most effective ways to improve financial incentives … is to set effective tax rates that support part-time work’.^[64]

57. However, as noted in the Tax Review, some people may not change their work effort in response to a higher EMTR.^[65] Other factors may have a greater influence on a person’s decision to work or not to work, such as the cost of child care, lack of public transport, absence of support services and poor health.^[66] External factors such as these are beyond the scope of this Inquiry.

58. Calculation of a person’s EMTR is very complex due to the number of factors that contribute to it, including means testing, Work Bonus and tax offsets. There may be circumstances where a person decides not to work as it is simply too complex to determine whether it would be more financially advantageous to work or not. Therefore, the complexity of the tax-transfer system itself could act as a barrier to work.

Exemptions

59. Tax is levied on the taxable income of a taxpayer derived during the income year. Taxable income is calculated by deducting all allowable deductions from the taxpayer’s assessable income.^[67] An amount of income will not form part of a person’s assessable income if exempt.^[68] Tax offsets (or rebates)^[69] are not deducted from the assessable or taxable income but from a person’s computed tax to determine the final tax payable.^[70]

60. Most social security payments are assessable, with a portion of the payment exempt.^[71] A tax exemption applies to Disability Support Pension (if the recipient is under Age Pension age), Wife Pension (if both spouses are under Age Pension age), and Carer Payment (if the carer and care receiver are under Age Pension age).^[72] Only supplementary amounts of these payments, such as rent assistance, are exempt if a person is of Age Pension age or over.^[73] Similar exemptions apply for certain Veterans’ Entitlement Act and war-time compensation payments.^[74] The Tax Review recommended that, to improve simplicity, all pensions should be tax exempt.^[75]

Offsets

61. In certain circumstances, tax offsets (or rebates) are available to reduce or eliminate the tax assessable on pensions and benefits. Tax offsets are subtracted from the tax calculated on a person’s taxable income.^[76]

62. A number of offsets are available for persons of Age Pension age depending on their particular circumstances. These include: the Senior Australians Tax Offset; the Pensioner Tax Offset and the Low Income Tax Offset. These tax offsets are designed to encourage workers to delay retirement and/or to make a more gradual transition into retirement by effectively increasing the returns from work.^[77]

63. Certain low income aged pensioners and self-funded retirees are entitled to the Senior Australians Tax Offset (SATO).^[78] The SATO increases the effective tax-free threshold for people of Age Pension or Veterans Service Pension age.^[79]

64. Certain social security or veterans affairs pensioners may be eligible for a separate offset, commonly referred to as the Pensioner Rebate or Pensioner Tax Offset.^[80] This offset may apply to a person whose ‘rebate income’^[81] falls below a certain threshold and includes the Age Pension or another listed income support payment.^[82] However, a person cannot claim the Pensioner Tax Offset if he or she is entitled to the SATO.^[83] From July 2012, the Pensioner Tax Offset will be merged with the SATO to create the Senior Australians Pensioner’s Tax Offset.^[84]

65. A non-refundable Mature Age Worker Tax Offset is available to taxpayers, aged 55 years or over by 30 June of the relevant year, who have net income from working of less than $63,000. It provides a maximum offset of $500.^[85] Only net income from working is eligible for the offset. Accordingly, taxpayers with only superannuation, social security benefits, rental income, interests or dividends will not be eligible. This offset is also aimed at encouraging older workers to remain working or to rejoin the workforce.

66. Other tax offsets that may be available to mature age workers include the Low Income Tax Offset^[86] and the Beneficiary Rebate.^[87]

67. The Tax Review recommended that, to simplify the income tax system, these tax offsets should be removed as separate components of the system and incorporated into the personal income tax rates scale.^[88] However, this may also remove incentives to work for those eligible for the offsets.