You might not like it, but bracket creep is aiding the inflation fight: Treasury boss

Bracket creep has helped bring inflation down, Treasury secretary and Reserve Bank board member Steven Kennedy has argued, while warning the economy is yet to return to normal, with the risk of higher prices still on the horizon.

In an address to the Australian Business Economists organisation on Thursday, Kennedy also suggested a lift in competition could boost the economy by up to $80 billion, noting that the nation’s businesses were overusing non-compete clauses on their staff.

Treasury secretary Steven Kennedy says bracket creep has put downward pressure on inflation over the past three years.Credit: Dion Georgopoulos

Australian workers will start to benefit from the $23 billion stage 3 tax cuts from July 1. A person earning $45,000 will get an extra $15.46 a week after the tax cuts, while someone on $100,000 will receive an additional $41.90 a week.

The cuts follow a sharp increase in bracket creep – when a person’s average tax rate increases due to higher wages without any change to tax thresholds or rates.

Last week, former Reserve Bank senior official and now Westpac chief economist Luci Ellis said tax thresholds should be increased by 2.5 per cent a year – the midpoint of the central bank’s inflation target band – to end bracket creep.

But Kennedy said adjusting tax brackets for inflation during a period of rapid price increases would feed money back into the economy, making it more difficult to bring inflation under control.

He said that in Australia over the past three years, bracket creep had helped reduce inflationary pressures, which otherwise would have been amplified if tax thresholds had been pushed up.

“Bracket creep has been a helpful stabilising force over the past three years, contributing significantly to the automatic stabilising influence of the tax system,” he said.

“This stands in stark contrast to the US, for example, where the indexation of income tax brackets has worked against monetary policy and been pro-cyclical.

“Not indexing income tax brackets, within a medium-term fiscal framework, allows fiscal authorities to both assist in the management of business cycles and ensure fiscal sustainability.”

Kennedy said that in the United States, which automatically increases income tax brackets in line with inflation, the share of income tax paid as a proportion of household income had fallen by about 2 percentage points between mid-2022 and December last year.

In Australia, the share had increased by a percentage point, in effect reducing the spending power of wage earners.

The stage 3 tax cuts, however, would bring down bracket creep, which would account for only 10 per cent of the forecast increase in personal income tax collections in 2024-25. Without the tax cuts, bracket creep would have contributed a third of the tax increase.

Monthly inflation data this week showed a slight increase in inflation through April, with the annual rate now at 3.6 per cent. Financial markets have pushed back expectations of an interest rate cut to the end of the year.

Approvals for new dwellings fell through April as higher interests weighed on prospective builders.Credit: Glenn Hunt

Kennedy said inflation risks remained, noting that insurance and housing construction costs were still high, while energy and shipping prices could rise because of geopolitical tensions.

He said the March-quarter national accounts, to be released next week, were likely to show subdued economic growth, with household consumption particularly weak.

Data released on Thursday showed dwelling approvals fell by 0.3 per cent in April, with those for houses down by 1.6 per cent and approvals for units and apartments off by 1.1 per cent. Over the past year, house approvals have risen 9 per cent, but for units they are down by 8.5 per cent.

Kennedy said while the overall impact of the COVID-19 pandemic period was abating, economies were struggling to return to normal.

“It is too early to say if we are back in a more normal period, perhaps because no one is quite sure what normal is any more – and especially as unusual economic outcomes are persisting,” he said.

The federal government has commissioned a competition taskforce and recently announced the largest overhaul of merger laws in almost half a century.

Kennedy said more competitive markets meant resources flowed to where they delivered maximum economic benefit, with recent Treasury analysis finding the economy would be between $30 billion and $80 billion a year larger if competition returned to levels experienced in the early 2000s.

He said it appeared non-compete clauses were contributing to Australia’s lack of competition, hurting ordinary workers.

“It is likely that the overuse of non-compete clauses is restraining competition, reducing the efficiency of the labour market and suppressing wages,” he said.

The federal government is considering a ban or heavy restriction on non-compete clauses that stop workers from moving to better-paying jobs or more innovative competitors as part of its plans to boost the economy.

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