Why fairness is integral to tax policy

Pick up a first-year undergraduate economics textbook on tax and you’ll likely be apprised that there are three desired features of a tax policy: simplicity, efficiency and fairness.

The importance of the first two are somewhat obvious. Simplicity, because taxpayers need to understand how to comply with the tax system. Efficiency, because if people can easily change their behaviour to avoid paying tax, there won’t be much revenue to fund government expenditure. But fairness, the third desired feature of tax policy, is more nebulous.

Tax fairness is important not merely because economists tell us so. Rather, Australia needs to consider tax fairness for reasons such as: ensuring the continued political legitimacy of the Australian governments; because tax inherently deals with issues of inequality; and for the very practical reason of helping us deliver tax system reform.

In a liberal country such as Australia, a well-accepted norm is that restrictions on individual freedom must be justified. And in liberal philosophy, the dominate way to justify government restrictions is by considering a “public reason” test, well-articulated by influential twentieth century philosopher John Rawls’ liberal principle of legitimacy:

“Political power is legitimate only when it is exercised in accordance with a constitution (written or unwritten) the essentials of which all citizens, as reasonable and rational, can endorse in the light of their common human reason”.

Restrictions that are arbitrary, unfair, exploitative or focus on benefitting a few at the expense of the many, undermine political legitimacy because they cannot be justified. Prohibiting the Nazi swastika might be justifiable because people have a right not to be vilified or feel physically threatened. But prohibiting tattoos or facial piercings, dress wear, beach outfits or more sinisterly, citizenship based on skin colour, because they offend certain sensibilities, are not legitimate forms of government coercion because they cannot be reasonably justified using the public reason test.

Rawls considered the public reason test would apply to areas in the public domain relating to judges, government officials, and politicians. And the public reason test applies to taxation as much as any other act of government coercion. Taxation, the compulsory, unrequited payment to government, is quite literally nothing, if it is not coercive. In Australia we pay around $600bn in tax each year, over $40,000 per working person.

If the tax system is unfair, it cannot be justified. And taxation that is unjustified etches away at the political legitimacy of the Australian government and, in turn, Australian democracy.

The two primary functions of tax are:
1. to fund public goods such as military, transport, education, police and the judiciary
2. to redistribute wealth and income, through policies such as pension payments, unemployment payments, childcare and paid parental leave. Therefore, because tax impacts wealth and income distribution, as well as economic inequality, the tax system has inherent fairness implications.

Wealth and income distribution, the second function of tax, determines economic inequality, an inherent fairness issue. And to determine the required tax level requires consideration of the level of wealth and income inequality we consider fair. It might be said this issue is more relevant today than in other times in our recent history; Australian inequality measures have increased steadily since the 1980s. But even if we consider current wealth and income inequality levels as acceptable, presumably there is a limit. It is unlikely that Australia would still be considered a fair country if we were a nation of 20 billionaires and twenty million paupers.

One might be tempted to try and decouple tax issues from fairness issues by claiming Australia and our tax system is fair so long as we have equality of opportunity; instead of worrying about wealth inequality and tax, we should focus on realising Australian cultural values such as a “fair go”, a value synonymous (according to the citizenship tests new citizens take) with “equality of opportunity”.

However, a “fair go” isn’t free. For a rich child and a poor child to have the same opportunities with respect to education, learning and a successful career, we require tax. For equality of opportunity to exist, the rich parent needs to contribute more tax to fund our education institutions than what the poor parent can afford. Here, issues of tax and fairness are bound.

A less philosophical reason as to why it’s important for Australia to consider tax system fairness relates to tax reform. The consensus among economists is the Australian tax system is uncompetitive, inefficient, too complex and out of date. And they may have a point.

Australia hasn’t had meaningful tax reform for decades and is out of step with international best practice. The Federal Government deficit is large and growing, thanks in part to the former government’s COVID-19 splurges (some necessary, some arguably less so). And Australian government debt is forecast to reach a trillion dollars in the coming years, a level that may limit or preclude policy responses to future wars, pandemics, financial crises or property market crashes (and the implications of muted policy options is not merely no pink batts or no JobKeeper in time of catastrophe, but no jobs, high unemployment and potential social unrest).

Yet despite the arguments of a host of economic experts, such as ANU’s Professor Robert Breunig the former Federal Treasury head Dr. Ken Henry, OECD and IMF mandarins, to name but a few, the Australian tax system remains as it is. While tax reform by its nature is challenging (there is always a loser – someone will be paying more), it’s hard not to think the focus on tax efficiency, tax competitiveness, tax complexity and so on and so forth, has failed to create the “burning platform” needed to drive policy change. A greater focus on the fairness of the Australian tax system may be what is required to buttress the valid but sometimes technical economic arguments for Australian tax system reform.

Considering fairness of the tax system is important for political legitimacy, inequality and practical reasons. A tax system that is fair strengthens our democracy by ensuring taxation remains justifiable. Tax fairness helps us realise Australian cultural values such as equality of opportunity. And a greater focus on tax fairness might help us undertake meaningful tax reform, delivering a tax system that is simple, efficient and fair.