Inflation down, now tackle bracket creep and spending

The sharper-than-expected slowdown in inflation, from a peak of 7.8 per cent in December 2022 to 4.1 per cent at the end of last year, is encouraging for home and business borrowers. The fall has all but ruled out another interest rate rise when the Reserve Bank of Australia board meets for the first time this year on Tuesday. Should the downward trend continue, borrowers can anticipate a fall in rates in the second half of the year, with some expecting a rate cut by June. The inflation news sparked an intraday record high on the ASX 200, which rose by 0.5 per cent within a couple of hours of the ABS announcement. After 13 rises in rates since May 2022, another is unlikely this cycle. That expectation is reinforced by tumbling retail spending, which contracted by 2.7 per cent last month. Hard-pressed consumers shut their wallets after buying up at the Black Friday sales in November.

Responding to the data, Jim Chalmers was correct when he said many people remain under financial pressure. But he told only one side of a bigger, more complex story when he said the government’s tax cuts were “so important … because people still need relief from these cost-of-living pressures’’. For many households, however, those pressures stem as much or more from high personal taxation, including the effect of bracket creep, than from interest rates.

Comparing national accounts data over the two years from September quarter 2021 to September quarter 2023, income taxes were a bigger drain on household disposable income than interest payments, Judo Bank chief economic adviser Warren Hogan told Paul Kelly on Wednesday. The reality, Kelly wrote, is that working middle-class people are destined to be “throttled on higher personal income taxes many years into the future’’. That is borne out in Treasury’s latest intergenerational report, which notes that personal income tax will boom from contributing a record 50.5 per cent of total tax receipts in 2022-23 to 58.4 per cent in 2062-63. A quarter of a century ago, when John Howard was in office, the personal income tax share of total tax was just over 40 per cent. What is more alarming is that as Australians age, the percentage of people contributing PAYE tax will shrink, leaving a declining proportion to carry the burden.

The case for tax reform and for winding back government spending is becoming ever clearer, as the likelihood of either fades. Anthony Albanese’s reneging on his promise to implement stage three to force a redistribution has set back the prospect of tax reform. Nor do the government’s objectives encourage the kind of spending reductions that would fund extended PAYE tax relief. The decision to permanently increase the federal share of public school funding by $3bn a year is the latest example.

Education Minister Jason Clare, to his credit, has tied the money to improvements to teaching and student wellbeing in state schools. These include catch-up tutoring for struggling students, the use of evidence-based teaching methods, and greater professional support for classroom teachers. In tandem with curriculum improvements and reform of teacher training, such measures are designed to correct the nation’s long-running school malaise. Had the extra billions of dollars poured into schools over the past decade been better spent to arrest falling literacy and numeracy standards, there would be no need for such, extra investment. Time will tell if it works.

As demands increase for more spending on schools, aged care, health and the National Disability Insurance Scheme, as well as defence, a tax system increasingly reliant on the PAYE taxes of a shrinking percentage of workers is not fit for purpose.

Containing inflation matters. Lower interest rates will encourage borrowing for investment. But government and opposition policies must focus more on the reform of spending, IR and the tax system to drive productivity and grow the economic pie.