Australia’s personal income tax and welfare system is overly complex and, I contend, needlessly so.

This piece summarises the work submitted to the Economic Reform Roundtable, aiming to demonstrate that a simple personal income tax and welfare system is possible for Australia. 

The current system combines a progressive personal income tax framework with a highly targeted social security system.

Significant simplification is achievable while preserving the system’s core structure and maintaining the financial position and work incentives of most Australians.

Over time, various components of the tax and welfare system have been introduced, modified, or eliminated in ways that often appear ad-hoc, politically motivated, or driven by short-term budgetary goals.

Many of these changes lack a clear rationale and, arguably, are unnecessary and have themselves added to complexity.

 

The personal income tax system

The personal income tax (PIT) system is strongly progressive and built around the main feature of four income thresholds with progressively higher tax rates applied.

This is a relatively simple and easy-to-understand element of PIT, and accounts for the vast majority of PIT revenue collected.

Added to this simple, progressive structure, are a number of other elements that could be folded into the main structure. These include the Medicare levy and the low income tax offset.

The Medicare levy is applied at a rate of two per cent of taxable income but is much more complicated than initially appears, with a shade-in area at the point at which individuals start to pay tax.

The amount of the Medicare levy paid is also subject to a complicated set of rules for families with children, seniors and interactions between partners and their Medicare levy amount.

The low income tax offset (LITO) was a more substantial element of the tax system prior to the 2012 carbon price introduction, when the tax-free threshold was substantially lifted.

Today, the offset is only worth $700, and is withdrawn at a rate of 5 cents in the dollar above $37,000 and 1.5 cents above $45,000.

There are other elements of the tax system such as the Higher Education Loan Program (HELP) debt repayments, private health insurance and deductions.

These elements will not be considered here, but they also add to the complexity of the PIT system that is hard to follow and over-engineered.

 

The social security system

Like the tax system, the current social security system is complicated and has evolved over time in a sometimes ad-hoc manner with unnecessary complexity.

The system is heavily means tested with the vast majority of payments going to low-income persons. The system is designed around providing a basic standard of living for those who are unable to provide for themselves.

The system is broadly split into two categories:

• A pensions system for those who are aged over 67, have a disability or caring/parenting responsibilities or are a veteran, which is generally more generous
• An ‘allowances’ system, where payments designed to be temporary are made to the unemployed, the sick, or those studying full-time.

 

The main payments include JobSeeker and Youth Allowance. In dollar terms, easily the most substantial social security payment is the age pension.

For families with children, there are family payments which are designed to cover the basic costs of children for low-income families.

These payments are all income and means tested, but certain payments such as disability support payments have additional requirements, ensuring recipients have long-term health conditions.

The JobSeeker payment recipients also have a range of other eligibility requirements and conditions that must be met to be eligible and to remain on the payment.

The focus here is on means-testing arrangements only.

 

A reform proposal

To greatly simplify the tax and social security system, the following changes are proposed.

The changes are modelled using the ANU PolicyMod model of the Australian tax and welfare system for the 2025-26 financial year.

The proposed policy is designed to show how a simpler system is possible. It is not necessarily the only way or even the best way to simplify the system.

It is used as one example of simplification and one that makes very little difference to vast majority of individual or household incomes – except that the system they interact with would be considerably simpler.

 

Personal income tax:

Remove the Medicare levy and the LITO. Increase the first two tax rates from 16 and 30 per cent to 19.5 and 33.5 per cent.

The 37 and 45 rates increase to 39 and 47 per cent which is the same as current rates including the Medicare levy.

Increase the first tax threshold from $18,200 to $22,500 as a replacement for LITO.

Family Tax Benefit (FTB): 

Remove FTB part B and the “base rate” of FTB part A.

Increase generosity of Part A to $8,000 per child per year and align them all to the same rate regardless of child age.

Remove the end of year supplement. This produces a similar overall FTB budget.

Parenting Payment Single: 

Increase the payment by around $150 per fortnight to compensate for loss of FTB part B for lower income single parents.

JobSeeker and Youth Allowance: 

Only retain the lower 50 per cent taper rate and remove the 60 per cent rate.

 

Financial impact

The overall proposal is budget neutral. The impact on income inequality is negligible with the Gini coefficient and average income by income quintiles (household) approximately unchanged.

Around 8 per cent of households would be worse off by more than $500 per annum, and 63 per cent would be no worse off or better off.

Figure 1 shows the limited impact on the effective marginal tax rate distribution comparing the current tax and welfare system with this simplified version.

 

Figure 1: Effective marginal tax rate (EMTR) distribution for working one extra day, working age population

Conclusion

The proposed system is just one example to simplify the existing tax and welfare system.

The goal was to focus only on improvements to the existing tax and welfare system without any change to the fiscal dimensions.

The proposed system retains the existing policy framework but with fewer moving parts and in such a way that is easier for people to understand and interact with.

Sometimes, the tax and welfare system is complicated for good reasons. But, the changes here demonstrate that sometimes the complexity is not required.

Plus, it’s likely that the added complexity has only limited benefit or is no longer required.