In the search for easy tax revenue that causes minimal pain, cracking down on deductions for work-related expenses is often proposed as low-hanging fruit. Amid misconceptions that many taxpayers are using spending on dress clothes, long lunches and sleek cars to reduce their taxable income, it is tempting to limit the ability to claim deductions.
But limiting tax deductibility is a blunt instrument that can have major unintended consequences, particularly for small business operators unable to fund employee expenses and for people seeking to further their education. So policy makers, including the parliamentary committee currently looking into the matter, should tread carefully.
Deducting work-related costs from taxable income recognises that some people have less to spend on consumption because they incurred costs in earning their income, including spending on cars, travel, uniforms and self-education. The theory is uncontroversial but in practice it is hard to make sure that only legitimate deductions are claimed. So there are restrictions on what can be claimed and integrity measures create complexity and compliance costs.
Australia allows workers to deduct a wider range of expenses than do other countries. In Australia employees can generally claim expenses incurred in gaining or producing assessable income, whereas the United Kingdom only allows deductions for expenses incurred wholly, exclusively and necessarily in the performance of an employee’s duties.
Ken Henry’s tax review in 2010 recommended granting everyone a standard deduction, as well as introducing a “tighter nexus between the deductibility of the expense and its role in producing income” for expenses above the threshold, suggesting the new test could be similar to the UK approach.
A standard deduction would be simpler, removing the need for many taxpayers to collect receipts, but without other changes, this would come at a high cost to government revenue; everyone with expenses above the threshold would continue to claim it, and would now be joined by everyone with expenses below the threshold.
Pairing a standard deduction with a tighter nexus between expenses and work may still provide a significant boost to general revenue that could be used to lower overall tax rates.
But many of the expenses ruled out under a tighter nexus could be legitimate. For example, ruling out self-education expenses may lead to a substantial underinvestment in human capital and undermine efforts to improve the skill base of the workforce in an increasingly knowledge-based economy.
There is also a risk employers will be forced to fill the funding gap left by the removal of deductions. This may be problematic because often employers choose not to fund certain expenses because the goods or services purchased can be carried on to other employers if the employee moves jobs. This may be particularly acute for small businesses that have less negotiating power with their employees and where there are likely to be fewer internal promotion opportunities.
Any substantial change to deductions for work-related expenses would be premature without much stronger evidence to suggest a significant proportion of deductions are being inappropriately claimed. If evidence shows that a change is needed, careful consideration would also need to be given to whether to apply a blanket test along the lines of the UK approach or make special provisions for certain expenses.
Kate Carnell AO is chief executive of the Australian Chamber of Commerce and Industry.