If we're doomed to incremental tax reform, we need to pick the best change first

It's fine to be annoyed. Nobody likes paying more tax, even if you are (*checks statistics*) very rich. And taxing unrealised gains is particularly annoying.

What's not fine, however, is that the people attacking the Treasurer and suggesting that this reform will end the Australian economy as we know it are the same people who constantly wonder out loud: why won't the government implement more ambitious, wide-ranging tax reform?

The answer is obvious: if this is how business commentators react to a relatively minor reform that only impacts very wealthy people, imagine the reaction to holistic tax reform which, if previous tax reviews are anything to go by, would involve abolishing negative gearing, the capital gains tax discount and franking credit cash refunds, while increasing and broadening the GST and creating a super profits tax and a carbon tax.

The result of hysterical backlashes like what we are seeing around superannuation is incremental tax reform: where governments pick off one reform every three years, if you're lucky.

Reform at a snail's pace is a bad outcome. But it raises a key question: if we're going slow, what reform should be prioritised?

The tax system is very broken, so there are plenty of options. But I would argue that there is one thing which makes many existing problems worse: trusts.

To see why, I'm reminded of when a friend from Europe once asked me: how much tax do you pay on your income in Australia?

It's a simple question. It should have a simple answer. Sadly, however, the answer is anything but simple.

The answer goes something like this.

If the income comes from a wage, then the top marginal tax rate is 47 per cent.

If the income comes from renting out an investment property, the tax rate is probably negative if you have a mortgage (thanks to negative gearing) or still much less than your marginal rate if you don't have a mortgage.

If the income comes out of (or is generated within) your superannuation account, it can be anything from your marginal rate to 22 per cent, 15 per cent or zero.

If the income comes from a capital gain, the tax rate is 50 per cent, unless you held the asset more than 12 months (then the tax rate is 25 per cent) or if the asset is the family home (then the tax rate is zero).

If the income is from a company (i.e. dividends), then the company pays 30 per cent and you only pay the difference between that and your marginal rate (thanks to franking credits) - unless your marginal rate is zero in which case the government gives you free money for some reason (thanks to franking credit cash refunds).

If the income comes from an inheritance, the tax rate is zero.

The list goes on and on.

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The moral of the story is that although, generally speaking, income should be taxed at the same rate regardless of where it comes from, the reality is that income is taxed at a patchwork of different rates.

This is where trusts come in. Trusts, particularly when combined with a corporate structure, allow people to shift income from high tax channels to low tax channels.

For example, if your taxable income is in the highest tax bracket and your partner's taxable income is zero, it would be better if any of your additional income goes to your partner rather than you since less tax will be paid.

Trusts allow this to happen.

Instead of the income being paid to you, it can be paid (tax free) into the trust. The trust can then distribute the money to your partner at their much lower marginal rate (or zero for the first $18,200).

In sum, trusts (combined with a corporate structure) allow you take advantage of Australia's patchwork of tax rates. It is this patchwork of tax rates which is the core problem, but trusts are one of the key vehicles that allow people to exploit the problem.

Trusts can purchase investment properties, they can purchase an owner-occupier property, they can purchase shares, bonds and currencies. When it comes time to cash-out those returns, the money can be directed to the person with the lowest tax rate, or it can be tied up for so long that by the time it gets paid out you are retired and your taxable income is low or zero.

ANU Professor Bob Breunig has a clean solution: have a rule which says that any money which comes out of a trust is taxed at either the company income rate (30 per cent) or the recipient's marginal tax rate (up to 47 per cent), whichever is higher.

As Professor Breunig notes, "this will disable most trust-related tax dodges without undermining trusts' legitimate roles".

Reigning in trusts will raise billions each year. More importantly, it means we can reduce the burden on taxing workers while improving the integrity of our tax system.