It was an Arabian desert outside, but the cool interior of the Canberra bar was a welcome oasis, full of bureaucrats having a lunchtime drink amongst potted palms. I looked at the shadowy figure opposite me and took a thoughtful swig of my beer.
He opened up a battered blue cardboard folder and pulled out a sheaf of graphs. "Here", he said, "This shows the problem."
I leafed through them. If what he said was right, then everything I had ever learnt about our tax system was flawed, and the Government was sitting on a keg of dynamite.
A gaggle of public servants came in and headed over to our corner. The conversation turned to the weather, the footy, anything but work. I finished off my drink, casually picked up the blue folder and strolled off.
Let's have a look at what I discovered.
Firstly, we have to understand the concept of the "Effective Marginal Tax Rate", or EMTR in bureauspeak. Everybody knows what the marginal tax rate is, it's the income tax on each additional dollar that you earn, and it goes up as your income goes up, the idea being that the rich pay a higher rate of tax than the poor.
So let's look at marginal tax rates.
$1 to $5 400 0%
$5 401 to $20 700 20%
$20 701 to $38 000 34%
$38 001 to $50 000 43%
$50 001 and over 47%
So if you are on only a few thousand dollars per year, you pay no tax. If you earn $25 000, you will pay nothing for the first $5 400, 20% of each dollar over that to $20 700, and 34% of each dollar over that, for a total of $4 522. If you get a raise, you will continue to pay 34% on each dollar until you get to $38 000, when it leaps to 43%.
So, if you earn $25 000, your marginal tax rate is 34%. If you double your salary to $50 001, perhaps by putting in a huge amount of overtime, your marginal tax rate will be 47% and for every additional dollar you earn, you will pay almost half to the government.
But this is only half of the story. There are a range of Commonwealth entitlements, such as unemployment benefit, sole parent pension, family payments, parenting allowance and so on. These are not regarded as earned income, and if (say) you are a sole parent with two children earning no income at all, you will receive around $16 000 annually in government benefits.
These payments are, of course, means tested, so if you begin earning income, perhaps from a part-time job while the children are in school, you will lose a certain amount of benefit for each dollar you earn above a threshold of around $10 per day. This is fair enough, but the effect of this is to add another marginal tax rate on top of the income tax system.
This can be pretty savage. If you are a sole parent with two children and your income is $4 000, you lose 50c of benefit for every additional dollar you earn. This is higher than the highest marginal income tax rate!
But wait, it gets worse. At $8 704 income, you pass a tax threshold, and your effective marginal tax rate climbs to 67 cents in the dollar. So not only are you losing benefits, you are also paying income tax on the additional income, and you only get to keep 33 cents of every extra dollar you earn.
But the story doesn't end there, not by a long shot. At $23 975 annual income, you are paying around 88% effective marginal tax rate, and between $26 353 and $28 801, you actually go backwards, as your EMTR soars to 104%. You end up paying every additional dollar you earn back to the government, plus a little bit more!
The effect of means testing slackens off after this peak, and at around $35 000 income, you are back to paying income tax only, with a comparatively modest 34% marginal rate.
My shadowy informant had included a frequency distribution, showing numbers of families in each income range. I looked up the table for a sole parent with two children. Not surprisingly, the vast majority of families earnt less than $4 000. There were very few in the middle ranges, and the next bulge was from around $35 000 onwards. Very few people, it seemed, were prepared to pay high effective marginal tax rates, and the choice was stark -- they either earnt little or no income and relied entirely on government benefits, or they earnt a relatively high income.
I browsed through the tables for each family type. They all showed a similar story -- the effective marginal tax rate was highest at low or medium income levels. 90%, 108%, even 120%, and tended to decline as income rose, rather than the reverse one might expect.
These figures were based on the standard government entitlements, and other costs of working were not included, such as transport to and from work, clothing, maintenance to former spouses and repayments of HECS debts.
The poverty trap is obvious. Why should anybody bother to get a job, when they are going to lose a large amount of the income to the government, even going backwards over some ranges, not to mention having to pay the incidental costs of working? Unless you get a good enough salary to get over the EMTR "hump", it's far less trouble to simply sit at home and watch daytime television.
The incentive to work on the black economy and conceal income is also obvious. If you declare income and have to pay a high effective marginal tax ratre on it, then why not accept payment in cash and keep all of it, rather than hand over anything from 30 to 120% of it to the government?
The combined effect of relatively high government benefit levels for low income earners, means testing and income tax is to "flatten out" the available money over a range of incomes.
For example, a couple with two children can gain around $22 000 annually from government benefits alone without earning a cent of income. If one of the couple works and grosses $35 000, then the family income is $28 000 after tax. In other words, out of the $35 000 salary, the family sees only a $6 000 increase, and the breadwinner is effectively working for $3 per hour.
After looking at the graphs and working it all out, the problem was readily apparent to me. But I could well understand the frustration of the average worker, busting a gut, working long hours, struggling for a promotion or a raise, yet somehow not making any real progress. By one trick or another, the government has its hand in his pocket, and he simply cannot work out where the money's going.
No wonder the unemployment rate is so high. No wonder the cash economy flourishes. No wonder people get into trouble with credit cards. No wonder the average Australian feels that he's carrying the rest of the country on his back.