A budget to build beyond the boom

Tax, tax and tax

While Ai Group’s agenda covers a lot more than tax reform, it is tax that is providing the lion’s share of pre-budget attention. This alone makes it worth while digging into tax questions in a little more detail.

There is certainly a strong case to do something on the income tax front. The recent Warburton-Hendy Report confirmed what had been known for some time:

• in proportional terms we raise about as much tax as the OECD as a whole;
• we have an unusually high reliance on income taxation; and
• we have high effective marginal tax rates on lower and middle income earners due to the combination of our tax and income support systems.

As far as this budget is concerned, it is very unlikely that either the overall level or the composition of our tax system can be changed to a significant extent. That is not so say that the possibility of some initial inroads should be ruled out of the question. Neither should we rule out the possibility of a budget announcement of some exploration of reform directions. Both of these would certainly be welcome. 

Income tax changes

More immediately, there is plenty of cash available for income tax reforms or benefit increases. There is no doubt that our top personal income tax rate is too high. Even though it will only apply from $125,000 after July 1, the policy of taking away 48.5 per cent of the extra income of high income earners still does more harm than good. Scrapping the top rate and instead applying the 43.5 per cent rate would be manageable move in the right direction.

A cut in rates lower down the scale would do even more good. There are several reasons for this.

High effective marginal tax rates, which are frequently above 50 per cent, stifle the efforts of many lower and middle income families to get ahead. Much of the problem comes from the overlap of the tax system and the withdrawal of family benefits. An extra dollar of income earned by many families will simultaneously attract tax at 31.5 and reduce entitlement to family tax benefit by 20 cents.

Cutting the tax rate from 30 per cent to 15 per cent between $21,600 and $30,000 would make a big difference to families with breadwinners along this income range. Instead of bringing home $48.50 from an extra $100 earned, this family would see $63.50. That is a sizable boost in the incentive to earn more income. The impact would be particularly beneficial for second-income earners in a family.

At a time when we are reshaping work tests to encourage single parents and disability support pensioners to look for work, it makes sense to add a healthy slice of incentive to the cause.

It also makes sense at a time when we are injecting more flexibility into workplace agreements partly to make room for more diverse and more family-friendly work conditions.

Slashing the 30 per cent rate to 15 per cent for people earning less than $30,000 and capping the top rate at 43.5 per cent would deliver tax cuts and constitute a substantial and fair reform of our income tax system.

Some would argue that these measures would be too expensive and would provide an unwelcome inflationary stimulus. Although these points do have some validity, there is nothing to stop the government phasing the changes in over a couple of years. A careful phasing of these changes may even fit with the government’s re-election strategy.

The case for income tax changes is strong. The government does not have to choose between tax cuts and tax reform: by slashing the 30 per cent rate to 15 per cent and by removing the top rate it can do both.

As mentioned earlier, tax is not the full story of the budget. The government should combine a serious reshaping of the personal income tax scale with other productivity-building measures. In particular it should set about laying the foundations for a more flexible, more knowledgeable and more innovative economy. We should not wait until the minerals boom unwinds. The time to embark on a these programs is now.