The Albanese Government’s proposed change to the Stage 3 tax cuts is clearly a broken promise; or, put another way, where was the political courage to offer an alternative when Stage 3 was announced (well ahead of the 2022 election)? But for the purposes of this analysis, let’s put those genuine integrity issues aside.
While the Government’s new proposal does reduce the benefit at the top end and redistribute the money to the lower end and the middle, inflation will mean that some of those at the low end will still pay more tax in 2024-25 than they did before Stages 1 and 2. With only those on middle incomes who will truly benefit, it is hard not to be a little cynical about the Government’s motives.
In earlier Austaxpolicy commentaries (2018 and 2019), I demonstrated that the Stage 1 and 2 changes essentially compensated for bracket creep from 2017-18 and argued for an alternative to Stage 3. My commentary last year, demonstrated that Stage 3 would more than compensate those on high incomes for bracket creep (with an additional effective tax cut of around 2% of income for those on about $200,000) but would fail to compensate at all those on low incomes (with an effective tax increase of around 2% of income for those on $45,000 and below).
Those at the bottom end left behind
Rather than just compare the Albanese proposals to Morrison’s Stage 3, it is important to compare them to the pre-Stage 1, 2017-18 scale indexed to 2024-25 to see exactly how the income tax burden will have shifted overall under the changes now proposed by Labor. The following comparison draws on ANU’s PolicyMod database indexing the 2017-18 scale by 22%, an estimate of price changes between December 2017 and December 2024. (My analysis last year used a higher indexation factor and some rounding of tax points.)
The first graph below shows the dollar gains and losses from the Albanese scale compared to the indexed scale. It may surprise many that those on incomes between $22,000 and $50,000, a not small number of taxpayers, pay more tax under the Albanese proposals than the indexed scale.
Graph 1: Tax saved ($) under Albanese scale compared to indexed 2017-18 scale
Source: PolicyMod, ANU Centre for Social Policy and Research (POLIS)
This is because, taking the Low Income Tax Offset (LITO) into account, the Albanese proposal lifts the effective tax threshold only slightly from $21,884 in 2023-24 to $22,575 (because of the reduction in the first marginal rate from 19% to 16%), while the effective tax threshold under the indexed 2017-18 scale is much higher at just over $25,000. The difference is worth around $400.
Even with the lower 16% first step in the Albanese scale than the 19% in the old (indexed) scale, this loss is not overtaken until incomes reach just over $50,000.
The gains under the Albanese scale, beyond those under the indexed scale, then increase steadily until incomes reach $135,000: they are then around $3,500. They only begin to fall when incomes exceed $190,000, with those on incomes above $220,000 still paying about $1,200 less tax than under the indexed scale. (If we use a higher estimate of the indexation factor – say, 24% rather than 22% – the gains at high incomes would be less and the losses at low incomes a little greater.)
The second graph shows the gains and losses as a percent of income. The losses are as high as 1.5% of income; the gains reach a peak of about 2.6% of income before falling to under 0.5%.
Graph 2: Tax saved under Albanese scale compared to indexed 2017-18 scale as % of income
Source: PolicyMod, ANU Centre for Social Policy and Research (POLIS)
More reform is needed, including an increase in the tax threshold
In summary, the Albanese proposal maintains full compensation for bracket creep at the top end, provides substantially more for those on middle incomes (including quite high incomes), but leaves those at the bottom end behind.
It is difficult to understand why the Government is reluctant to increase the tax threshold, given that it is the most obvious way to address the excessive tax on low incomes, and the threshold is the central feature of the personal income tax scale’s progressivity. Increasing the tax threshold by $4,000, rather than reducing the initial step from 19% to 16%, and tweaking the higher tax scale points, could more closely and equitably address bracket creep.
(The Government claims that reducing this initial step will increase workforce participation by women, but a far better approach to removing obstacles to their participation (in particular, the high effective marginal tax rates many women with children face) would be to relax the means tests on family payments.)
An even greater increase in the tax threshold could allow the abolition of LITO and its complex means test, greatly simplifying the effective tax scale (consistent with the changes Wayne Swan made when he was Treasurer).
There is also a case for further simplifying the income tax scale to subject the majority of taxpayers to the same marginal tax rate, which was a feature of the Stage 3 tax cuts as originally proposed by the Morrison Government. As I have argued in the previous articles, this would be possible, but only with a higher tax threshold if the system’s progressivity is to be maintained. That was what the Henry Tax Review proposed (and what existed under the Fraser Government), but the standard marginal rate would need to be higher than the 30% proposed by Morrison (it was 32% under Fraser).
The Teals, including Kate Chaney, Zoe Daniel and Allegra Spender, have also argued for the Government to lock in indexation of whatever scale is introduced for 2024-25, to put a stop to Australia’s increasing reliance on personal tax. Indexation would also put a stop to much of the politicking about tax, requiring our political leaders to focus on the policy reasons for changes. Indexing the income tax scale might also force current and future Australian Governments to start addressing more fundamental tax reform as the nation needs to find the revenues to fund increasing public services while still rewarding innovation and effort and productivity.
Interestingly, such more fundamental reform, whether to broaden or increase the GST or to find other broad tax options, will require further adjustments to the personal income tax scale (as well as to social security) to ensure the overall burden of tax is equitably distributed: as happened in 1985 with the Hawke-Keating changes and in 2000 with Howard’s GST, the central adjustment would almost certainly involve a further increase in the tax threshold.
Which brings me back to a key message: the tax threshold is a central feature of our personal income tax system and it is very disappointing that the Albanese proposals, like Morrison’s Stage 3, effectively reduce it in real terms. The other key message is the need to index whatever scale is introduced for 2024-25.
I am grateful for Ben Phillips and Richard Webster’s assistance for PolicyMod modelling.
Excellent assessment of both effects of the different reforms and of more sensible policy options.
I guess there will remain open debate about the socially or political best redistribution pattern. Andrew takes the 2017-18 scale as a base. Arguably Albanese takes the actual current 2023-24 as his base.
Some random thoughts,
To my mind the essential question is what is the purpose of the tax threshold. Is it to just exempt some low income persons from tax from an administrative simplicity purpose, or to try to reduce the scope for interaction with some income support payments – or for some bizarre reason to have lower average tax rates on some low incomes – at the cost of higher marginal tax rates for the group (and indeed across the tax system)?
While there is merit in thinking about indexation bracket creep has been a useful tool for addressing opportunistic tax cuts of the past – and do we really think that politicians will stop the politicking when elections come and the short term impact is all that concerns them.
The other big question is who are the low end taxpayers – and to what extent are they voluntary part-time workers, and if they are what is the merit of a low rate of tax on them?
This is not to argue that the need for fundamental reform is not needed – but not just of the tax system – there is strong merit in making FTB (A) a universal payment – which of course brings back a concept of horizontal equity.
For the vast majority of taxpayers (up to $135,000 and above under the Albanese scale), it is mathematically the tax threshold more than anything else that delivers progressivity. The role of the threshold is not just about tax relief at very low incomes (I accept some of these could well afford paying some tax).
If we were to rely less on income tax (as I believe we should, at least to some extent), progressivity overall would almost certainly be reduced unless both social security payments AND THE TAX THRESHOLD are increased. Such a shift towards indirect taxes would impose an additional impost on those at incomes below the threshold which I would not oppose, recognising most (including retirees and students and second income earners in families) can probably afford that. It might also allow a reduction in the marginal rates of tax as occurred in 1985 and 2000. But without an increase in the threshold, progressivity overall would be reduced.
I agree there is strong merit in making FTB(A) universal – that would reduce emtrs where they hurt the most, and far more effectively than reducing the first marginal tax rate above the threshold from 19 to 16%.
Thanks for the article!