The commentariat has worked itself into a lather about the competing income tax policies proposed by the Government in its 2018-19 Budget and the Opposition's reply thereto. 'Bracket creep' came in for a lot of attention – if not actual policy to deal with it. One headline screamed 'ScoMo stops the creep'. He didn't. The Opposition ignored it completely.
Can we 'stop the creep'? What is it? It's not just about rising incomes pushing taxpayers into higher marginal income tax brackets. With a 'progressive' income tax scale, and fixed $ values for tax bracket thresholds, a taxpayer's average tax rate increases for every extra taxable dollar received. 'Bracket creep' is quantified by comparing average income tax rates, where tax thresholds are adjusted for wage increases, with those where they're not. See Chart 1.
As Chart 1 shows (see arrows), increasing taxable incomes increase taxpayers' average income tax rates unless the rate scale thresholds are automatically increased as incomes increase. The arrows show that, for somebody earning about $82,000pa now, with forecast wage increases from 2018 to 2024, incomes would increase by about 19.5% to about $98,000pa. Without tax bracket indexation, the average personal tax rate for that taxpayer automatically increases by almost 10%. Indexation of $ tax bracket thresholds to wage increases would 'stop the creep' permanently.
Major parties don't advocate tax bracket indexation. 'Bracket creep' revenue is used more selectively. See Chart 2.
As Chart 2 shows, the Government is proposing tax cuts greater than tax bracket indexation for taxpayers receiving more than about $128,000 from 1 July 2024. For everybody else, rate scale tax cuts are zero (on incomes from $0 to $37,000), or less than full tax bracket indexation (on incomes from $37,000 to about $128,000). Under Labor, 'the creep' hits all taxpayers. Its Budget reply leaves the current income tax scale in place, giving 'bracket creep' full revenue rein.
The percentage cuts in average tax rates across taxable incomes due to the 2018-19 Budget proposals, and wage-indexed tax brackets, can be compared with the current rate scale. See Chart 3. (Labor's policy is the zero % line.)
Comparing the percentage tax cuts from an indexed rate scale and the scale in the 2018-19 Budget, clearly the former delivers much larger % cuts below $128,000pa, and especially at the lowest taxable income levels (at least where tax is actually payable). An indexed rate scale delivers smaller % tax cuts in 2024 for those on incomes above $128,000.
Note that, under an indexed rate scale, everybody receiving $128,000 or more gets the full dollar benefit of all the indexation tax cuts from $18,200 up to $128,000, plus the cuts applying to any higher incomes that they receive.
There's the rub. Allowing for the distribution of taxpayers across taxable income (more lower, fewer higher), tax indexation is more revenue-costly than the Government's 2018-19 Budget proposal. So both the first phase of the Government's seven-year tax cut programme, and Labor's tax reply, comprise targeted 'low-income tax offset' tweaks. These are directed to lower income groups and limited or denied to higher-income groups, reducing their Budget cost.
There's another rub. Phasing out these low-income tax cuts as income rises produces 'effective marginal tax rate' increases in the phase-out taxable income range. The Government's increased low income tax offsets peak at $530pa for taxable incomes between about $48,000 and $90,000pa, after which this benefit is withdrawn over incomes up to $125,333pa. That 'claw back' means an additional effective tax rate of 1.5% between $90,000 and $125,333pa. Taxpayers in this income range face a marginal tax rate of (32.5+1.5) = 34%, not the heavily-promoted 32.5%. Above $125,333pa, the marginal tax rate drops back to 32.5%. This saves Budget revenue. The income thresholds for these low income offsets apparently are not indexed. 'Bracket creep' claws back these low-income benefits over time too.
Labor's alternative low-income tax cuts seem much worse. I'm having trouble getting precise detail, but Labor's tax offset ($928) is 75% more than the $530 offered by the Government. If it is 'clawed back' over a similar income range (or less?), the increment to the standard income tax rate would be over 2.6 percentage points, bringing the relevant marginal tax rate up from 37% to nearly 40% (using the current rate scale, apparently unchanged under Labor).
The Government has been 'selling' its tax proposals as a strategy to 'flatten' the income tax scale. A 'flatter' scale has a lot going for it. It reduces higher marginal tax rate disincentives to work and save. It reduces tax avoidance incentives (and the resource costs of that, especially with a company tax rate of 30%, and even more so if company tax is further reduced). For similar tax revenue, 'flattening' benefits higher incomes at the expense of lower incomes, however.
A 'flat tax', where every $ of income is taxed at the same % rate, would eliminate 'bracket creep', by eliminating different tax brackets. 'Flattening' thus helps weaken 'creep'. But getting to there from where we are now is politically difficult.
Here's one illustration. (The 2018-19 Budget proposals are a much less extreme, more delayed, more subtle example.)
Suppose policy required the current universal $18,200 tax-free threshold to be 'clawed back' as taxable income increases from $18,200 to $37,000 (the current 19% tax bracket). Suppose also that the 'claw-back' rate cannot result in an effective marginal tax rate above the current 32.5% rate applicable for incomes between $37,000 and $87,000. If the effective tax rate for income between $18,200 and $37,000pa is increased to 32.5%, then, compared with the present rate scale, the $18,200 tax-free threshold would be gradually 'clawed back', ultimately by about 73% to about $4,842, for taxpayers receiving more than $37,000pa. That would save the Budget. A 'flat tax' of 32.5% would apply from $18,200 to $87,000. Taxpayers on $18,200-$37,000pa would face an effective marginal tax rate of 32.5% rather than 19%, and a higher effective average tax rate than now. The present 19% tax bracket effectively becomes part of the 32.5% bracket.
Note that, under this 'claw-back' policy, everybody receiving more than $37,000pa absorbs the full dollar cost of the reduction in the tax-free threshold from $18,200 to about $4,842 in their average tax rates (up about $2,540pa).
The political arithmetic of 'winners and losers' (net) from such changes, compared with the status quo, is hard to sell.
Politicians pick and choose how they give some 'bracket creep' back to taxpayers and try to maximise their political kudos from doing so. This isn't honest or transparent. Politicians should legislate automatic indexation of personal income tax brackets to wage increases, and define future tax cuts (or increases) against that indexed tax base benchmark.
That would be more honest, transparent, and, on the expenses side, strengthen overall Budget discipline.
Bet they won't, though. They'll continue trying to minimise blame for tax hikes, by hanging on to bracket creep revenue, and claim credit for their tax 'cuts' if and when they decide to spend some of the 'creep' proceeds.
Plus ça change, plus c'est la même chose.