An Australian was on holidays in the south of France.

Strolling along outside his hotel, the Aussie was suddenly attracted by the screams of a young woman kneeling in front of a small child.

The Aussie knew enough French to determine that the child had swallowed a coin.

Seizing the little boy by the heels, the Aussie held the boy up and gave him a few good shakes and out popped the coin.

“Oh, thank you sir, thank you,” cried the woman.

“You seemed to know just how to get that coin out of him, are you a doctor?”

“No madam,” replied the man, “I’m with the Australian Tax Office.”

In my last post, Prison Break, I spoke of rights and responsibilities.

… when taxation rates are reduced revenues do not fall.

Regulations that prevent people from working under terms and conditions which suited them, was, I said, an infringement on liberty, freedom and dignity. It violated a person’s right to get a job and their responsibility to provide for their families.

I will now add a further hazard – it prevents them from paying tax to cover the many services the state provides to that person.

Rights … responsibilities … and tax. They are all linked.

Jean-Baptiste Colbert, Finance Minister to King Louis XIV of France, famously declared that “The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.”

A modern finance minister might rephrase this as, “The largest possible amount of revenue with the smallest possible amount of economic and political damage.”

Which brings me to a man called Arthur Laffer.

I had the privilege of meeting the famous US economist in Parliament House in 2015. Dr Laffer was in Australia on a speaking tour.

Arthur Laffer is of course most famous for his Laffer Curve.

It is self-evident that tax revenue would be zero if tax rates are set at 0% (bottom left corner of the graph).

Revenue would also, of course, be zero if rates were set at 100% (bottom right corner).

Starting at 0%, as tax rates rise, revenue also rises until at some point on the graph it starts decreasing as it heads towards that 100% point.

Eminent Australian and UK economist Colin Clark once said economic growth declines if taxation is more than 25 per cent of GDP.

It’s also been said, “When the taxes of a nation exceed 20% of the people’s income, there is a lack of respect of government. When it exceeds 25%, lawlessness.” 

In Australia it is close to 30%.

Take one example of this lawlessness – the cash economy, currently estimated at 15 percent of GDP, one of the largest in the developed world. An underground economy of that magnitude requires the involvement not only of a lot of businesses, but also of millions of consumers.

As we know, laws only work when people believe in them and clearly, they have no respect for our tax laws.

It’s also been said, “When the taxes of a nation exceed 20% of the people’s income, there is a lack of respect of government. When it exceeds 25%, lawlessness.” In Australia it is close to 30%.

Despite what many advocating tax increases would have us believe, the total tax take in Australia is quite high. They say that compared with other developed economies, Australia is a low tax country, and that workers and companies could comfortably pay more. Not so.

When it comes to taxing incomes, Australia is up there with the Europeans and is way ahead of most of our neighbours in the Asia-Pacific region.

A paper published by the Adam Smith Institute stated, “If you look at the experience of those who have introduced a single-rate flat tax, and also the tax reforms of the 1980s which took place in Britain and America, reducing tax rates causes revenues to rise.”

As Arthur Laffer showed, and as has been demonstrated many times, when taxation rates are reduced revenues do not fall. When the Australian company tax rate was cut from 39 to 30 percent, revenues went up, not down. The famous Reagan tax cuts from 70% to 30% in the 1980s produced a $9 billion increase in revenue when a $1 billion shortfall had been forecast.

When Sweden halved its company tax rate from 60 per cent to 30 per cent, company tax revenue tripled.

Nobody enjoys paying taxes, but in the 1950s and 1960s relatively low taxation and a comparatively simple set of tax rules meant that most people paid what was due without too much complaint.

Today, however, the Government and the ATO find themselves locked into a destructive relationship of repression and resistance with ordinary taxpayers.

Where people can avoid tax by exploiting loopholes, they will do so; where they can’t eg PAYG taxpayers, they become resentful at the unfairness of it all.

It goes without saying that rules and sanctions should be clearly specified in advance so people know how they are supposed to behave and what will happen to them if they don’t.  Also, importantly, rules must apply equally to everybody.

But the rules governing tax liabilities have become so tangled and complex that nobody can be sure any longer what they are or how they will apply in any given case. And behind the vast volume of laws – the actual legislation – looms an equally massive array of ATO public determinations, public rulings, bulletins, interpretative decisions, policy papers, circulars, administrative guidelines and practice statements. Some of these are supposed to be binding on ATO officers, and in general ATO staff rely on them rather than on the legislation. In practice that gives them something close to the force of law.

But the ATO no longer simply implements a known set of rules; it develops and amends the rules case by case. In effect, the ATO makes its own rules. As a consequence, we have tax laws which have lost their intelligibility, certainty and predictability. It is not real law as we’ve come to understand that term.

The resulting attitude of many taxpayers is to treat the law and the courts as irrelevant. “Forget legal advice, just give me an ATO ruling that will protect me from penalties or prosecution,” they say. Many taxpayers, of course, just surrender and pay up.

Systems which are complex in their application, debilitating in the sense that the more you earn the less of each dollar you keep, and unfair and unreasonable in the sense that people feel penalized for working, are destined to fail in the long term.

Take Australia’s cash economy, estimated at 15 percent of GDP, one of the largest in the developed world. An underground economy of that magnitude requires the involvement not only of a lot of businesses, but also of millions of consumers. As we know, laws only work when people believe in them; clearly a lot of Australians have no respect for our tax laws.

Despite what many advocating increases in tax would have us believe, the total tax take in Australia is quite high. Some say that compared with other developed economies, Australia is a ‘low tax’ country, and that workers and companies could comfortably pay more. This is ridiculous. When it comes to taxing incomes, Australia is right up there with the Europeans and way ahead of most of our neighbours in the Asia-Pacific region.

High tax rates undermine enterprise and destroy the will to work.

You don’t have to be a Laffer Curve true believer to accept that behavioural response is a reality. When you add to this the corrosive effect on the moral relationship between the state and its citizens, the case for fundamental tax reform becomes even more compelling.

There comes a point when the prospect of giving up half or more of any additional earnings leads people to decide that it is simply not worth it.

Taxation then starts to produce gross inefficiencies as people stop working as much or as hard as they used to, and governments find their taxes are not producing the revenue they expected. Politicians and bureaucrats who lack real world experience and an understanding of how an economy and markets work are drawn into a vicious spiral, jacking up tax rates to try to compensate for the falling revenues that their high tax demands have created.

Similarly, many on welfare reject opportunities to work because of the punitive effect that small earnings and high tax rates have on the security of their benefits and the value of extra work.

And people on very low incomes fare worst of all, for as they increase their earnings, higher rates of income tax combine with the loss of means-tested benefits deprive them of up to 80 cents of every extra dollar they earn.

If we are to extricate ourselves from this dysfunctional system, the goodwill of the public needs to be restored by getting tax levels back to something which most people would see as reasonable. To achieve this, we need to remove one of the most significant tax avoidance avenues and align personal tax rates with company tax rates.

There is certainly a pressing need to reduce the current company tax rate (25% for companies with turnover below $50m, 30% above that). I accept it can’t be done overnight, but the Government would do well to start cutting the rate by one percentage point in this Budget, and then announce its intention to make a similar reduction every year while in office. That would hold out the prospect of a 20 per cent company tax rate and, if it is really serious about an internationally competitive tax system, a 20% personal tax rate.

Nobody enjoys paying taxes but in the 1950s and 1960s, relatively low taxation and a comparatively simple set of tax rules meant that most people paid what was due without too much complaint. Today, however, the Government and the ATO find themselves locked into a destructive relationship of repression and resistance with ordinary taxpayers. Where people can avoid tax by exploiting loopholes, they will do so; where they can’t eg PAYG taxpayers, they become resentful at the unfairness of it all.