By Rachel Clun
Stage three tax cuts have reentered the debate after a spectacular U-turn from the UK’s new prime minister and chancellor on a plan to cut income tax for wealthy Britons. Treasurer Jim Chalmers says the government has not changed its tax policy, but he will “put the economics before the politics”.
What exactly are the stage three cuts?
The tax cuts, due to take effect from July 1, 2024, will abolish the 37 per cent marginal tax rate for those earning over $120,000. It will also reduce the 32.5 per cent tax rate to 30 per cent for people earning between $45,000 and $200,000. Every dollar earned over $200,000 will continue to be taxed at the 45 per cent tax rate.
It was the third part of a plan legislated in 2019 to change the income tax system, Grattan Institute chief executive Danielle Wood said. Its estimated the cuts will cost $243 billion over 10 years.
“They are the biggest stage in terms of their fiscal cost. And also the most significant in terms of the shift in the tax scales because they remove a tax bracket,” she said.
Why were they brought in?
A large reason was to address “bracket creep”. Barrenjoey senior economist Johnathan McMenamin pointed out that since 2008-2009, income tax growth has been running at about 6 per cent a year, while wages have grown at about 4.5 per cent.
“The bracket creep is substantial and has been weighing on household income growth for quite some time. So there is a real argument for doing something,” he said.
So will these tax cuts solve bracket creep?
Yes, but mostly for people earning over $180,000, McMenamin said.
“Across the rest of the income spectrum, it actually doesn’t address bracket creep that well,” he said.
However, EY chief economist Cherelle Murphy said the effects of the cuts will flow through the whole economy.
“It puts more money back in the pockets of consumers. If consumers are benefiting, clearly, business is benefiting,” she said.
Is it a similar plan to the tax idea scrapped by the UK this week?
The UK government has withdrawn plans to cut income tax for the highest earners. But those tax cuts were going to come in during a period of high inflation, McMenamin said.
By mid-2024 when Australia’s tax cuts are meant to kick in, the Reserve Bank expects inflation to be around 3 per cent - far lower than the 9.9 per cent in the UK currently.
Professor Miranda Stewart, director of the tax group at the University of Melbourne, said what was interesting about UK events was that the proposed tax cut was “politically unacceptable”.
“The electorate does believe in fairness, and in higher income people paying higher rates,” she said.
Even with lower inflation in Australia, will the tax cuts be inflationary?
Yes. By giving people back more of their income, some of that will be spent on things like groceries or clothes, increasing demand and putting upward pressure on prices.
But because these cuts flow more to higher income earners, Murphy said it’s not as inflationary as it could be.
“High-income earners have a lower propensity to consume, which means that they’re more likely to save some of it rather than spend it all,” she said.
Given the government’s large debt, are these tax cuts affordable?
Stewart said the fiscal situation has “completely changed” since the tax cuts were legislated five years ago. Since then, the government has taken on much more debt, thanks largely to the pandemic, while also increasing spending on programs including aged care, child care and the NDIS.
Wood said this showed it made no sense to legislate tax changes so far in advance.
“It’s madness. It effectively booby traps the budget and the tax system, and it was entirely unnecessary,” she said.
So should the government keep the tax cuts as currently planned?
Stewart said they should keep the 37 per cent rate, but really the money from the tax cut would be better spent on delivering universally free childcare.
“Delivering childcare essentially does deliver a tax cut to particular workers who will actually respond by coming into the workforce,” she said.
McMenamin said a redesign was probably the best approach. Some options could include keeping part of the low and middle-income tax offset, or adjusting the tax-free threshold.
Wood said the tax cuts should stay but be offset by other reforms such as reducing the capital gains discount or changing negative gearing. Murphy said the current economic circumstances give the government room to talk about alternatives.
“We do have to think, is this the absolute optimal use of government revenue loss?” she said.
Can we leave the tax system like it is?
No.
Former head of the Australian competition watchdog, Rod Sims, will use a speech on Thursday to argue the government needs to raise more revenue to cover its growing expenditure.
But he will point out it can’t be through higher taxes on personal or company tax. If you keep relying on them, businesses and people will go out of their way to avoid them.
“Australia has likely maxed out on raising corporate or personal taxes,” he will tell the Australia Institute revenue summit.
“We are already heavily reliant on these two taxes as they amount to more than 70 per cent of our tax revenue, and high tax rates encourage unfortunate behaviour to minimise tax as Australian rates are generally higher than those levied overseas, or can become a disincentive to effort.”
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