Recent tax debates have focused on proposals to index personal income tax thresholds to inflation to eliminate bracket creep. The proposals come in response to concerns that higher levels of inflation have increased people’s income taxes at a time when they are under financial pressure.
In this series, I estimate the fiscal cost of indexing the tax thresholds to inflation (Part 1) and its distributional impact (Part 2). I also take account of the 2026 and 2027 income tax cuts introduced by the Labor government.
The key findings are that indexing the thresholds would cost governments $38 billion a year by 2030-31, rising to $81 billion in 2034-35. Individuals with annual incomes over $125,000 in 2024-25 dollars (approximately the highest 20% of tax filers) would receive over half (54%) of the tax cuts; and 60% would go to men.
What are bracket creep and indexation?
Bracket creep occurs when inflation lifts more of people’s incomes into higher tax brackets. It increases the marginal tax rate on the next dollar of income and the share of income that attracts higher tax rates further down the scale (for example, more of an individual’s income is taxed at 16% rather than zero).
Therefore, to the extent that an individual’s real (after inflation) income remains the same, it is appropriate that in a progressive income tax system that the tax thresholds are also indexed to rise. Thresholds for the Medicare Levy and Low Income Tax Offset should also be indexed as they also suffer from bracket creep.
Indexation would require legislation to increase each tax threshold (such as the $18,200 threshold for the current 16% tax rate) by the Consumer Price Index (CPI) for each financial year. For example, the 16% tax threshold would rise by 3% to $18,655 in 2025-26.
Less attention has been paid to how tax indexation would be funded, who would ultimately benefit, and who could lose out. The last time tax thresholds were indexed, by the Fraser government in 1976, it was reversed within five years due in part to its budgetary cost and the risk that larger budget deficits would fuel inflation.
Modelling the impacts of indexation
Using the Parliamentary Budget Office’s Build Your Own Budget model, personal income tax thresholds were increased by estimated changes in the Consumer Price Index (CPI) for each year from 2024-25 to 2034-35 derived from the 2025 Budget projections. Thresholds for the Medicare Levy and the Low Income Tax Offset were also adjusted in the same way.
The model yields two outputs: the annual fiscal impact of policy changes and the distribution of income gains or losses across tax-filers registered with the Australian Taxation Office.
For our purposes here, there are two limitations of the Build Your Own Budget model. First, the output does not include average impacts on the disposable incomes of different individuals ranked by income, such as the change in their average tax rates. This is a better measure of distributional impact than the share of gains or losses going to each income group, since in a progressive tax system people with higher incomes already pay a larger share of overall taxes on personal income before any reform is undertaken.
A second limitation is that since this analysis is based on tax returns, it leaves out many people on the lowest incomes who are not required to file one. Approximately 30% of individuals are in households that don’t pay income tax, mainly because their incomes are too low. When those households are included in distributional analysis of personal income tax cuts, their impact is usually regressive since many people with low incomes miss out.
Findings: fiscal impact
Table 1 shows the cost to revenue and the Budget (including public debt interest expenses) of indexing the tax scales from 2024 to 2034, and the net impact if the cost of Labor’s tax cuts from 2026 is subtracted from these amounts as a ‘downpayment’ on restoring the proceeds of bracket creep to taxpayers.
Table 1: Impact of tax indexation on the Commonwealth Budget
Source: PBO (2025), Build Your Own Budget (2025-26 Budget version and 2024 MYEFO version).
In the absence of tax increases or expenditure savings to pay for it, indexation costs $38 billion in 2030-31, close to projected $39 billion of spending on Medicare benefits and more than $32 billion in projected spending on unemployment payments. The budget would be worsened by $81 billion in 2034-35 and $371 billion over the ten years to 2034-35.
If we treat Labor’s tax cuts as a down-payment on indexation, the remaining cost of indexing income tax thresholds is $28 billion in 2030-31, rising to $69 billion in 2034-45 and $288 billion from 2024-25 to 2034-35.
The tax cuts announced in the 2025 Budget would reduce the lowest marginal tax rate from 16% to 15% in 2026-27 and 14% from 2027-28.
In Part 2, I examine the distributional impact.
This two-part series is related to a project undertaken by the Australian Council of Social Service (ACOSS).
Recent Comments