Anthony Albanese’s tax changes show that old Labor habits die hard

For Anthony Albanese, it appears old habits die hard, writes Judith Sloan. Picture: NCA NewsWire / Martin Ollman

The decision to dump the legislated stage three tax cuts is about politics, not good policy. I’ll leave the political assessment of a blatant broken election promise to others. From an economic viewpoint, the changes announced by the Prime Minister to the income tax schedule are a backward step.

It’s worth recalling the key features of the stage three tax cuts here. Between $45,000 and $200,000, a 30 per cent rate of tax would apply. For the majority of taxpayers, this would have meant there would be a known fixed marginal tax rate as taxable incomes rose – by dint of salary adjustment, promotion, doing overtime or changing jobs.

Not only did this impart a high degree of simplicity to the schedule, it also sharpened incentives relative to the previous scales. The rate of 37 cents in the dollar was to be eliminated.

(Interestingly, the last time a whole rate was eliminated from the income tax schedule was done by Labor when Paul Keating was prime minister.)

To be sure, the $200,000 figure was a compromise on what the top cut-off figure would have been had the Coalition decided to fully index the figure. Somewhere between $250,000 and $260,000 would have achieved this, but this was clearly seen as a bridge too far even for the Coalition. Having said this, it is extraordinary that the $180,000 figure has been in place since 2008.The bottom line is that the Coalition’s stage three tax cuts met the test of simplicity as well as substantially clawing back the effects of bracket creep, effects that have accelerated as inflation has picked up. Whereas the first two stages had favoured low- and middle-income earners, stage three was targeted at middle- and high-income earners. But the last stage was not just about slightly redistributing the burden of income tax, it was also about growing the economic pie given the impact on efficiency.

Turning to the changes outlined by Anthony Albanese last week, the emphasis is now simply on altering the distribution of the tax burden in favour of particular groups of voters who might be inclined to vote Labor. By reinserting the 37c-in-the-dollar rate, the tax schedule is made more complex relative to stage three. The proposed top cut-off income of $190,000 is even further from where it should be had the real value been maintained over time.

It is also particularly telling that the government’s proposed changes will generate $28bn more in revenue over a decade compared with stage three. This is the result of more bracket creep, hitting in particular those earning more than $135,000 per year.

Treasury’s prediction that the revamped package is not inflationary is a case of wishful thinking. All economics graduates understand that the marginal propensity to consume of lower-income groups is much higher than high-income groups. As a result, the tax cuts secured by those earning between $18,200 and $45,000, in particular, will be quickly spent.

In point of fact, the Treasury’s advice on the changes reads more like a political pamphlet than serious economic analysis. Issues about fairness are essentially subjective and the bureaucrats should leave these judgments to politicians.

A key feature of the new package is reducing the rate of 19 cents in the dollar for those earning between $18,200 and $45,000 to 16 cents. Bear in mind here, taxpayers in this income range pay very little tax at the moment. After adding in transfer payments, the vast majority pay no net tax at all. The point here is if this change is such a good idea – some economists think taxpayers in this income range will work substantially harder, particularly secondary income earners in households, if the tax rate is lower – it could have been accommodated while keeping the other features of the stage three tax cuts intact.

But the reality is much more complicated than this because of the interaction of the tax and transfer system, which can spin off very high effective marginal tax rates when one of a couple decide to work longer hours.

Because family tax benefits are means tested as well as other benefits such as childcare fee relief, couples can encounter some thorny financial predicaments when one or both partners could increase their incomes. The broader point is that analysing the income tax system alone without reference to the transfer system is a mistake, leading to unreliable policy conclusions. While Treasurer Jim Chalmers claims former treasurer and prime minister Paul Keating is one of his heroes – he even wrote a whole thesis on him – Chalmers’ actions in office have been in complete contrast to Keating’s.

Keating embarked on a journey of reforming the tax system with a view to making Australia a modern and competitive economy. Lumbered initially with a top marginal income tax rate of 60 per cent, he was eventually able to lower this to 47 per cent. He understood the negative consequences of having such a high punitive rate. He also introduced capital gains and fringe benefits taxes, both measures to deal with the manipulation of the tax system by high-income earners caused in part by the extremely high top rate.

Keating saw the benefits of having an efficient tax system to encourage hard work, investment and saving. As late as 2019, Bill Kelty, former ACTU secretary and partner in the Keating reform project, called for a top marginal tax rate of less than 40 per cent.

Sadly, Chalmers has failed to understand the principles that drove Keating to reform the tax system as well as other parts of the economy. Rather, he has opted simply to reconfigure a tax schedule with the aim of hoovering up as many votes as possible.

Other interesting options are now effectively ruled out. One such option would be the New Zealand model with its absence of a tax-free threshold and much lower marginal rates leading to high workforce participation. The reality is that bracket creep really hammers households, with the burden of poor government decisions – ineffective spending, the build-up of government debt – falling on hardworking families. As the Parliamentary Budget Office notes, “relying on bracket creep to contain the growth in debt is one approach to fiscal repair. But it would come at the cost of reduced efficiency and equity in the tax system”.

The stage three tax cuts were an attempt to offset some of the impact of bracket creep. It was not a perfect solution, accounting for around 80 per cent of the implied bracket creep had the income tax schedule remained untouched. They did a better job than the government’s proposed changes.

The share of personal income tax paid by the top 10 per cent of earners has been on an upward march for many years, particularly in the first decade of this century. The stage three tax cuts would have marginally reduced that proportion. Under Albanese, this will not occur.

From his university days, Albanese has been steeped in the rhetoric of the class war – them versus us, workers versus companies, the poor versus the rich. Old habits appear to die hard.