Whether the Interest on Savings Should Be Taxed at a Low Flat Rate or Not? Free Essay

Interest in savings or income of an individual derived from a financial institution provides significant benefits to households, private individuals, and the whole society. Savings usually allow people and families to counteract unforeseen income volatility over their lifecycles and even grow or accumulate wealth before retirement. Savings are also passed on to future generations through bequests and gifts. Most importantly, for the economy and the broader public, savings are considered sources of money for an investment crucial for future well-being and economic growth. On the other hand, Tax collection is a framework used by legislatures to gather taxes from individuals and organizations in exchange for their pay, resources, or exchange equities. The primary role of tax assessment is to raise income for the administration. Savings taxes are an essential revenue source for both the federal and state Governments. Savings taxes are Australia’s fourth-largest tax base yielding up to 6% of total Australian tax revenue. Therefore there is a need for criteria for taxation reform on savings. This paper critically analyses whether interest income derived by an individual from a financial institution (savings) should be taxed at a low flat rate of tax or not.

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Criteria for reform

The primary criteria for assessing a tax system are simplicity, equity, and neutrality. Generally, an equitable tax system is crucial in attaining economic objectives and maintaining essential regard for the tax system from which a higher degree of voluntary compliance begins. The Australian government should attach particular importance to achieve a more equitable sharing of the tax burden. With a more neutral tax system, resources will be more likely to be distributed equally into activities where they will equally and significantly generate economic gains. A simpler tax system means that fewer resources are more likely to be devoted to socially unproductive activities such as tax litigation and tax planning. Therefore, an excellent taxing system should incorporate simplicity, equity, and neutrality.

Equity

Tax collection equity is the rule that taxes ought to be reasonable. In any case, there are a few standards for figuring out what is fair. Equity or fairness usually has two dimensions, including horizontal equity and vertical equity. Horizontal equity implies that individuals in similar economic circumstances should generally be treated similarly. Vertical equity suggests that individuals in different situations should often be treated differently; those who are better off should bear a more significant share of the tax burden.

A tax system that places notable different burdens on taxpayers in similar economic conditions is considered unfair. Generally, taxpayers with the same or comparable taxpaying capacity will not be taxed equally if some specific expenditure is treated preferentially, or when some income classes are excluded from the tax base.

Different savings types need to be taxed at close to the equal effective tax rate. People should be investing in assets that best suit their risk preferences, liquidity, and return rather than minimize tax. However, unequal taxes on savings generally reduce the ability of people to invest in savings. The uneven tax rate on savings may significantly diminish long-term savings. Therefore, savings need to be taxed at a lower rate since they have usually been taxed once as wages or other labour incomes. At the same rate, taxing various asset classes may also encourage the efficient use of capital throughout the economy, resulting in long-term growth.

Higher taxes on savings discourage investment and may reduce national income and productivity. The elasticity of savings concerning the tax rate is comparatively low in Australia; this reduction may not be neutralized by international investment. Currently, inflation makes the real tax rate on savings extremely higher than on labour income. Therefore, taxes on savings should be more economical to restrict taxation of the inflation component of the return to savings.

Rates on savings further combat inequality. Increasing taxes on wealth and savings may reduce disparities in the short-term. However, the extent and method of taxing savings have a significant impact on inequality in the longer term. Inequality should, therefore, be assessed in the context of the transfer and broader tax system. Horizontal and vertical equity should be applied appropriately. Again, savings like superannuation should be taxed at a lower rate than other savings; otherwise, individuals won’t save enough for retirement.

Neutrality

Neutrality is the state of helping or not supporting either side in impartiality. Tax assessment should try to be neutral and impartial between types of savings. The tax system can generally affect economic efficiency and, eventually, living standards in several ways. Therefore, the government should be committed to pursuing tax reforms that do not increase the overall tax burden. In other words, the tax system should be neutral.

Neutrality has effects on the total tax burden, and the way any given amount of tax revenue is raised. Bias tax system usually tends to discourage the activity on which it is imposed; a tax system that is not neutral may reduce savings. Savings taxes lessen the urge to accumulate savings and the effective tax system between current and future consumption. Therefore, These are solid arguments for taxing the return to savings at a rate lower than other income since they are held for long periods.

Since neutrality requires a tax system that is helping or not supporting either side in impartiality, all similar asset types should be taxed at the same effective rate to allow individuals to choose the assets that best suit their savings needs than the ones that incur the least tax burden. Neutrality can also improve productivity and horizontal equity by decreasing distortions in resource allocation. Balancing the tax treatment across asset types can significantly improve asset allocation and, thus, productivity in the Australian economy. Taxes on savings should be set at a neutral or similar rate to other income to avoid individuals from reclassifying other income as savings income to get favoured tax treatment.

Simplicity

An excellent tax system should be as simple as possible. A complicated tax system often makes it challenging for individuals to understand the law that applies it to their circumstances. The Australian tax system has become so complex, thus challenging individuals to convey its meaning on tax return forms. Complex tax laws may result in socially unproductive and costly tax litigation. It may also impose high administrative costs on the tax authorities and high compliance costs on the whole society. Therefore, these considerations imply that tax reform measures should be preferred over more complex alternatives where possible.

This review allows an opportunity to see alternatives or what can be done to overcome the burden of record-keeping on average taxpayers. It increases the certainty of what is or is not taxable, thus increasing the tax system's clarity.

A comprehensive tax system is considered to reduce the incentive to reclassify labor income as savings income. Although this substitution may occur, integrity measures limit the extent to which it can happen. However, it mainly applies where savings income is taxed at the full rate of labour income; currently, it only applies to a small share of total revenue. Therefore, a reduced tax rate on savings may help robust a comprehensive tax system.

A comprehensive tax system is simpler for taxpayers to understand. However, the existing Australian savings tax system is more complicated than a dual income tax would be. There is a need to reform the tax system into a simpler system that is easy to understand by all the taxpayer.

Conclusion

The objectives of equity, neutrality, and simplicity may sometimes conflict. For instance, measures to make the system more equitable may also cause economic distortions and might require a complex legislative provision. However, The Australian, government should implement a tax system that will encourage savings.

Generally, savings should be taxed at a lower rate than other labor income. As evidenced, savings usually demand a different tax treatment to income from wages; this is because savings have generally already been taxed once as wages. Again, the impact of savings taxes compounds over time; thus, the effect of savings on future consumption can be much larger than the headline rate of tax. Therefore, the savings tax rate should be more economical, neutral, same, and simpler to understand to all taxpayers.

Bibliography

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