How stage 3 tax cuts will combine with interest rate hikes

The world is holding its breath as American market interest rates start rising again.

Australia will be impacted, but we have our own interest rate time bomb – an unprecedented “money shower” set to boost the spending power of middle to higher-income Australians in just over eight months time.

Already, new Reserve Bank governor Michele Bullock is bracing Australia for possible interest rate rises as a result of the oil price and other shocks arising from the Middle East war. And she must be viewing with alarm the intensity of the 5 per cent annual wage rise demands from people in essential industries which is a clear sign that higher inflation is becoming embedded in Australia just as appears to be happening in the US.

Accordingly, the combination of the global flow on from rising US rates with current events in Australia means we are looking at a resumption of higher interest rates, which could start either next month or early in the new year.

As the nation begins to adjust to the higher interest rate environment of early 2024, Australia will look skyward at the looming “money shower” that will see middle to high income consumers racing to open their wallets and further stimulate the economy.

This will almost certainly trigger a new round of interest rate rises – some estimates have them increasing by another 1 per cent.

The “money shower” is better known as the big tax cuts that were legislated by the Coalition government, so do not require any action by the current government. Indeed, on many occasions, the Albanese government has firmly vowed to allow the tax cuts to proceed. Politicians are well known for going back on their word, and the current government is no different.

But the damage the referendum campaign has done to the Albanese government’s credibility means they will be reluctant to change the legislation in the year prior to the 2025 election.

Moreover, thanks to the high iron ore and gas prices, the Australian budget is set to be in surplus, so the government can cover the $22bn required to inject into the economy via the tax cuts.

Because they were legislated so many years ago and taxpayers are always reluctant to believe there will be tax reductions until they actually take place, most of the population does not have a $22bn “money shower” in their forward plans.

But as the trigger date of July 2024 approaches, the “money shower” will become embedded in their planning.

The legislated tax cuts which were part of a three stage reduction in income tax – with the first two stages already implemented – are constructed this way:

• Marginal tax rates for those earning between $45,000 to $120,000 are cut by 2.5 per cent to 30 per cent.

• The marginal rate for those earning $120,000 to $180,000 cut by 7 per cent to 30 per cent.

• The threshold for the top 45 per cent marginal rate is lifted by $20,000 to $200,000.

Following the stage three tax cuts, 94 per cent of people will have a maximum 30 per cent tax rate, which also happens to be the tax rate planned for superannuation balances above $3m starting a year after the tax cuts.

In 2024-25, middle to higher-income Australia is set to rejoice and will spend up big at about the same time as the current wage push hits the inflation rate.

But a year later, a large and increasing number will be facing much higher superannuation taxes, including a tax on paper capital gains.

So to tax modellers there is a symmetry emerging that focuses around a 30 per cent tax as the standard for the vast bulk of the population, and increasingly that rate will apply to superannuation.

In 2024 there will be endless debates about whether government will proceed with the tax cuts, and that debate will be finally settled in the May budget.

Meanwhile, those buying property and income-producing assets need to be fully aware that higher interest rates will be very much on the agenda in 2024-25 unless there is a sharp global slowdown.

But China is working feverishly to contain its property disaster while allowing developers to go broke and governments around the world, but particularly in the US and in Australia via the states, have massive spending agendas.

That spending is stimulating economies in direct opposition to central banks like the Federal Reserve and our Reserve Bank.

The spending in the US is a key factor in maintaining a strong US economy which, combined with the major borrowing required by the US government, is the single biggest factor pushing the American 10-year bond rate up to 4.9 per cent with other American bonds following in a similar pattern.

Australia is set to not only having to duplicate that pattern but intensify it. This is not good news for those under mortgage stress, and an increasing number will require banks to substantially reduce payments or foreclose.