Two growing tax loopholes that are exploited by the rich – and how to plug the leaks

Those on big incomes have a lot more capacity to avoid tax. Let’s look at two ways they are increasingly using and how we can close these loopholes and make them pay their fair share. 

Those on more than $1 million per year earn their income in very strange ways. Ways that mean they pay less tax. Let’s look at how they earn their income and what it means for how much tax they pay. 

Most people earn most of their income from wages. They might earn a little bit from investments and earn some bank interest, but the overwhelming majority comes from wages and salaries. Retired people get their income mostly from super (investments) and from the government supplied age pension. 

But those on very high incomes have very different sources of income. 

To begin with a lot of rich people spend a lot of money hiring very smart accountants to work out how to avoid paying tax. This is not unique to Australia; it happens all over the world. It is also not unique to now; it’s been happening for as long as people have been paying tax. 

The taxation statistics released each year by the Australian Tax Office give us a wonderful, detailed insight into how this is happening. The most recent release for the financial year 2022-23 shows that those on very high incomes earn money very differently to most Australians. 

Taxpayers get the overwhelming majority of their incomes from salaries and wages. It makes up 75% of the average taxpayer’s income. Remember that includes a lot of retired people who are bringing the average down. 

If we look at just those who earn between $45,000 and $150,000, which is likely to exclude most of those on a government pension, then they get 86% of their income from wages. 

But people earning more than $1 million per year get only a fifth (18%) of their income from wages. 

Instead, their biggest source of income is from capital gains. This makes up a quarter (26%) of their income. For everyone who doesn’t earn more than a $1 million it makes up only 2%. 

A capital gain is where you sell an asset for more than you brought it for. For example, if you bought a bunch of shares for $200,000 and later sold them for $300,000, then you have made a capital gain of $100,000. 

It may seem odd for capital gains to be their largest source of income. But this is where incentives come to the fore. Half of these capital gains are tax free. If you earn $100,000 in wages, all of it is income for tax purposes. But if you earn $100,000 from a capital gain only $50,000 is income for tax purposes. 

The other big source of income for those earning more than $1 million is from partnerships and trusts. This also made up a quarter (24%) of their total income. Trusts are tax structures that have grown in popularity, particularly discretionary trusts. Discretionary trusts are very effective ways for high income earners to reduce the amount of tax they have to pay. 

A discretionary trust is a trust where the number of shares held by each beneficiary isn’t fixed but is rather up to the discretion of the trustees. When income-earning assets are put into a discretionary trust, the income stream can be split between these beneficiaries in anyway the trustee wants. The trustees can direct income to beneficiaries who have smaller incomes and hence face lower tax rates, such as an adult child. Discretionary trusts have been growing in popularity as a tax loophole for high earners since 1996. 

We can also see from the taxation statistics that people earning more than $1 million are increasingly using capital gains tax discount and trusts. In 2011-12 they earned just 14% of their income from capital gains. That has almost doubled to 26%. For partnerships and trusts the proportion of income has doubled from 12% in 2011-12 to 24% in 2022-23. 

The good news is that reform is not difficult. There is no good economic reason for the capital gains tax discount to exist. Treasury figures show that the top 10% of income earners get over 80% of the benefit. 

The government should scrap it. This would raise $19 billion in revenue, overwhelmingly from high income earners. And as an added bonus it would go a long way to making housing more affordable by discouraging speculators (people who purchase assets with the hope of it growing in value quickly for a short-term sale). 

Like the capital gains tax discount, there are no good reason for discretionary trusts. The government should get rid of these too. 

Society works best when we all pay our fair share of tax. Those on million-dollar incomes should not be able to manipulate the tax system to avoid paying their fair share. Cracking down on two growing tax loopholes will raise tens of billions of dollars and make Australia a fairer place.