Over the coming bazillion graphs, we will take a look at what elements make up Australian and US income taxes, and find our which country has the more greedy Government. But first, we need to set out some assumptions. Taxation is such a broad topic that without an extremely limited model, it becomes nigh on impossible to make reasonable comparisons. This is why the services of international tax professionals are expensive!
- We are going to compare residency in any state of Australia to that of the state of California (CA). CA is the most populous US state, and the one I currently reside in. That makes running this comparison easier!
- We are going to assume that our taxpayer is an employee of a company. Not a partner, not a sole-trader, not anything fancy - A regular old employee of a bog-standard tax-avoidance free company.
- Our taxpayer has private health insurance. In California, this means ignoring the tax effects of the Affordable Care Act, and in Australia the Medicare Levy Surcharge. Under both systems, those without private health insurance face additional taxes.
- Superannuation (Australia) and 401(k)s (United States) shall be banished from this realm. For Australia, this might at first seem odd, given the mandatory nature of superannuation contributions. However, compulsory superannuation contributions are not a tax. Instead, they are a mandatory savings measure under which the payer retains ownership of their contribution, and contributions, not benefits, are defined. Therefore, they should be considered separately from taxes, which have defined benefits. N.B. that the US Social Security taxes under the Federal Insurance Contributions Act are not comparable to Australian superannuation.
- Our taxpayer has no deductions. What? Again, a model must be limited in order to be useful. Delving into defining a set of deductions for a hypothetical taxpayer will make this article less generally applicable, and accelerate the greying of my hair.
- Australian dollars and United States dollars shall be referred to as AUD and USD respectively.
- It is the tax year 2014. This is important! If you are reading this article in a year other than 2014, all calculations, tables, and figures are likely redundant. Governments like to tinker with these things, you see. This assumption also means that we are comparing one Australian tax year (ending 30 June) to the United States tax year (ending 31 December) - The difference in year end has no effect on this model.
Without further ado, lets dive in to possibly the most entertaining article you have ever read!
The United States is supposed to be a low-tax capitalist paradise, looking down on all the dirty socialist Europeans, and Australians. In reality however, Uncle Sam does in fact collect some tax. Income taxes are generally levied by both Federal and State governments, and we will start with the former. The US Federal tax agency is called the Internal Revenue Service (IRS), and levies income tax through seven individual brackets:
|Fig1: US Federal Marginal Income Tax Brackets|
|Fig2: US Federal Income Tax on USD Income|
|Fig3: US Federal Income Tax on USD Taxable Income (Standard Deduction)|
In the graph below, note that we're not referring to gross vs taxable income anymore. Medicare Tax is levied on salary paid by an employer (There is also a payroll component, outside the scope of this article!) and therefore taxable vs gross income is not relevant to it. The Federal income tax component continues to assume taxable income using the Standard Deduction.
|Fig4: Selected US Federal Income Taxes|
Like the Medicare tax, Social Security tax is levied directly on salaries and wages. The individual component of the tax (Like Medicare tax, there is also an employer component) is 6.2% of salary and wages up to USD113,700. And so the graph grows:
|Fig5: Selected US Federal Income Taxes|
|Fig6: California Income Tax Brackets|
An interesting characteristic of US federal tax system is that state income taxes are deductible - For higher income individuals, Californian taxes will eventually overtake the federal Standard Deduction. All graphs and calculations from this point forward account for this, and assume that an individual paying more than USD6,200 in state taxes will choose to deduct those taxes, rather than take the federal Standard Deduction.
|Fig7: US Federal & CA Income Taxes (Selected)|
But wait, there's more! The CA FTB also levies a tax called California State Disability Insurance (SDI) which is drawn directly from salary and wages, and funds partial wage replacement for disabled workers. SDI is levied at 1% from the first dollar of income through to an upper limit of USD101,636.
|Fig8: US Federal & CA Income Taxes|
|Fig9: US Federal & CA Income Taxes, with effective tax rate|
AustraliaNow to drop down into the correct hemisphere, and examine the Australian side of this comparison. Until this point, all figures have been in USD. From here on, they will be in AUD. Keep in mind that this means that the figures above and below this point are not directly comparable. While the AUD has traded close to USD in the past few years, assuming a one-to-one relationship will generate a significant error at even lower income levels. Later on, we will look at comparable figures by using average exchange rates.
Australian states do not levy any income tax. This means we only need to consider federal income tax, administered by the Australian Tax Office (ATO). While the states do levy payroll taxes on high income earners, they are the responsibility of the employer and therefore beyond the scope of our concern. Federal income tax is broken into five brackets:
|Fig10: Australian Income Tax Brackets|
|Fig11: Australian Income Tax, with effective tax rate|
|Fig12: Australian Income Taxes|
Total effective Australian income tax looks like this:
|Fig13: Australian Income Taxes with effective rate|
Because Australia and California use different currencies, we can't just overlay their respective effective tax rate graphs on each other and be done. Instead, it is necessary to convert each one into a single currency. Let's start by presenting both Californian and Australian effective tax rates in USD.
|Fig14: Comparative Tax Liability in USD|
And for those playing down under, the same comparison in AUD:
|Fig15: Comparative Tax Liability in AUD|
Both graphs are quite similar, but the slight difference between them is very important. The difference can be large or small, and it depends on exchange rates. Here is a hypothetical AUD comparison, where the price of a single AUD is USD0.50:
|Fig15: Hypothetical Comparative Tax Liability in AUD|
This is a good moment to recall that this entire exercise is hypothetical. What figure 15 says is that in a hypothetical world, if AUD1 costs USD0.5, someone earning more than AUD70,000 would be better off as a CA resident. Conversely, an employee earning any income up to at least AUD100,000 is better of as an Australian resident at current 12 month average exchange rates.
In reality, very few taxpayers will be in the position of earning an income in a currency other than that of their state of residence. This exercise was never supposed to deal with reality, it is after all an examination of tax! And to close, why don't we depart reality all together, and imagine ourselves earning an income of AUD500,000 per year. What does the tax graph look like then?
|Fig16: Comparative Tax Liability in AUD|
Note: There is an error in graphs 5 to 9 causing US Social Security Tax to be understated by approximately $150 across all income levels. At the resolution of the graphs provided, this error is nearly imperceptible.