Here's my big dangerous tax idea: let us keep our money

Suddenly we’ve wised up. As far back as any of us can remember, all the way back to the beginning of income tax, we’ve been easy to bribe.

Here’s how it has worked in every election and in almost every budget: “You’ve been working hard and paying too much tax. We feel your pain. We’ve magically found some money from somewhere. We’re pulling a tax cut out of a hat. You can thank us later.”

That the rabbit was our own money, taken from us in ever-increasing amounts through an automatic process known as bracket creep, and then only partly returned, was the trick we weren’t invited to dwell on.

Here’s how it will work this time. In the year ahead wages will probably climb 2.1 per cent. It’ll push a greater proportion of our pay into the highest rate of tax we pay. All by itself that will push up the total amount of tax we pay by around $6 billion, even though our actual buying power, our inflation-adjusted wages, might not much change. The budget tax cuts will give us back some of it: around $4.4 billion.

Hey presto. We’re supposed to be awed.

Even after 10 years, after the third and most expensive phase of the Morrison tax cuts announced on budget night, middle earners will still find themselves paying 3 per cent more of their income in tax than they do right now: 18 per cent instead of 15 per cent, according to the Grattan Institute. Only the very highest earners - the top 10 per cent - will get their bracket creep back.

(We need to rely on organisations such as the Grattan Institute and the Parliamentary Budget Office for the calculations because the government won’t provide them for us. It wants us to be in awe of the trick without seeing how it's done.)

It helps that bracket creep isn’t widely understood, certainly not by shock jocks such as Sydney’s Ray Hadley (“it simply means that people who were formerly taxed at the lower income rate through no fault of their own go on to the next income rate”), Nor, on the face of it, by the Treasurer himself, who on Monday said that the third and final stage of his plan that levelled the tax rate between $41,001 and $200,000 meant that “for most Australians, who will earn over their lifetime somewhere between $40,000 and up to $200,000, they will never face bracket creep again”.

Bracket creep happens even if you don’t change brackets. Whenever your income climbs, a greater proportion of it ends up in your highest tax bracket, leaving a lower proportion of it in your lower brackets and beneath the tax-free threshold.

Imagine you had been earning $75,000 and inflation pushed up your wage to $77,000. Your buying power wouldn’t much improve and you wouldn’t change tax brackets, but your tax bill would climb from $15,922 to $16,572. The chunk of your salary lost in tax would climb from 21.2 per cent to 21.5 per cent. A lower proportion of it would be protected by the tax-free threshold.

It’d be easy to fix. You would index the tax-free threshold and each of the other thresholds to the general rate of wage increases, or to the general rate of inflation, both of which at the moment are near 2.1 per cent. So the $18,200 tax-free threshold would climb to $18,582 and then to $18,972 and so on.

It would be devastating for the budget and devastating for politicians. Without automatic tax increases they would no longer be able to announce regular 'tax cuts' that only partly returned our money in return for applause.

But the applause has stopped. This week’s Fairfax-Ipsos poll found that 57 per cent of voters didn’t want the cuts they were offered. They would have rather had the money used paying off government debt. Only 37 per cent wanted the tax cuts, and many of them would have regarded them as unsurprising. It’s probably Peter Costello’s fault. By repeatedly cutting tax rates under prime minister John Howard, he destroyed the magic.

Indexation would make the magic real. And it would make budget choices real.

At the moment we grant the government leeway for indulgences such as spending $50 million commemorating the voyage of Captain Cook, or $247 million keeping chaplains in schools. If those indulgences meant an explicit increase in tax rates we would indulge our politicians less.

As it stands, most of the promised $80 billion cut in the company tax rate is to be funded by bracket creep. If indexation removed that option it would have to be funded by an explicit increase in income tax or another tax, and we would be less accommodating.

On the other hand, we would become keener to accept tax increases where they were the only way of getting things we wanted, such as they were with the National Disability Insurance Scheme. Without bracket creep, if we wanted more spending on something like health we would have to agree to pay for it. Or disagree, in which case we wouldn’t get it. We would become prepared to pay more tax where we had to, and keener on getting value for what we paid.

We would start treating our money as if it was ours.

In The Age and Sydney Morning Herald

Read more >>

How maths killed the company tax cut

The company tax cut is dead. Maths killed it, last week.

It happened with the release of an innocuous-looking report from the Parliamentary Budget Office entitled Changes in average personal income tax rates: distributional impacts.

Those changes were baked into, but not spelled out in, the May budget.

They are needed for it to whirr back into surplus by 2020-21 as promised.

They come about because, aside from boosting the Medicare levy to help pay for the National Disability Insurance Scheme, the budget proposes to do nothing about the income tax scales whatsoever. Nothing. For four years. That's how it whirrs back into surplus.

Normally budgets cut income tax every few years. They have to, because otherwise wage increases would push more and more of our incomes into higher tax brackets. The misleading term for what happens is "bracket creep". But it happens whether or not we are pushed into a higher tax bracket. Any increase in wages, even within a bracket, pushes more of our income into our highest brackets, pushing up the total amount of tax we pay and pushing up our total tax rate.

Here's how it would work if you were on $50,000. If your pay climbed 3 per cent to $51,500 you wouldn't change brackets but your tax bill would climb from $7797 to $8284. More tax would be taken out at 32.5 cents in the dollar and proportionately less at 19 cents. Your average rate would climb from to 15.6 to 16.1 per cent.

To prevent this sort of thing happening, budgets repeatedly adjust income tax scales. Since the turn of this century, budgets have cut tax rates in 2003, 2004, 2005, 2006, 2007, 2008, 2009, 2010, 2012 and 2016. A gap of four years or more without cuts, as is baked into the 2017 budget, is unusual.

All the Parliamentary Budget Office did was calculate what the budget projections would mean for various types of taxpayers.

For middle earners (those in the middle 20 per cent) they will mean an extraordinary jump in overall tax payments from 14.9 to 18.2 per cent. Only 0.5 points of the increase would be due to the higher Medicare Levy.

For earners one rung up (the next 20 per cent) they will mean a jump in tax paid from 21.9 to 24.1 per cent. For those at the very top they will mean a jump from 32 to 33.9 per cent.

One rung below the middle (a rung centred around $28,000) the tax take will jump from 5.5 to 8 per cent. Only at the very bottom (a rung centred around $8000) would there be little change. That's because most of the bottom rung would remain below the tax-free threshold.

The figures are projections out to 2021-22. It's true that we might get extra tax cuts not accounted for in the budget projections. But if we do, there won't be a budget surplus, not without an unexpected mining boom-style windfall or something else to fund them.

And there will have to be. A ramp up in the tax taken from middle Australia from 14.9 per cent to 18.2 per cent is unthinkable.

The only obvious place to grab the kind of money that will be needed is a program that hasn't yet become law.

Only half of the government's $50 billion program of company tax cuts has become law. The Senate passed $24 billion of it. Company tax is set to fall from 30 per cent to 25 per cent for small and medium size businesses, but not for big ones.

Forced to choose between finishing the job in order to help big business and cutting tax rates for individuals in order to stave off implausible bracket creep, there's no choice.

Businesses don't suffer bracket creep. Individuals do. Businesses don't vote. Individuals do.

And despite all the talk about how uncompetitive Australia's company tax rate is, or would become if Donald Trump succeeded in convincing Congress to cut the US tax rate to 20 per cent (the Business Council put out another brochure this week), and despite all the talk about how dynamic Australia would become if the company tax rate was cut to 25 per cent, the truth is the cut wouldn't pay for itself. The Treasury says so. The cost, to be paid for somehow, would be $8 billion per year.

It might well be that wages don't increase by anything like as much as is forecast and that bracket creep is less severe. But that would just create another set of problems. The government would fall well short of its targeted surplus and be under further pressure to find money from somewhere, most likely the yet-to-be legislated tax cuts.

The most important insight from economics is that actions have costs, often opportunity costs. Richard Thaler won a Nobel Prize last week in part for pointing out how little that is understood. There may well be great benefits from cutting the company tax rate. But there would also be great costs. One of them would be the lost opportunity to support middle earners, who'll need it.

In The Age and Sydney Morning Herald

Read more >>

Bracket creep is code for cutting high-end taxes

I've never complained about being pushed into higher tax brackets. In fact I've been quite pleased.

I've seen it as a sign that I've made it, that I've moved up another notch.

And it has never meant that I've paid much more tax.

Work it out for yourself using the $80,000+ tax bracket. Put to one side the Medicare levy. If you had been earning $79,000 and then got paid $81,000, the tax rate on the last few dollars you earned would climb from 32.5 to 37 per cent.

But that doesn't mean you would pay 37 per cent of your wage in tax, or anything like it. It would mean your total tax bill would climb from $17,222 to $17,917. As a proportion of your (higher) salary it would climb from 21.8 per cent to 22 per cent.

It would be barely noticeable, but it would give you bragging rights.

And the strange thing is it would happen whether or not you moved into a higher bracket. Imagine you had been earning $75,000 and then got $77,000. You wouldn't change brackets but your tax bill would climb from $15,922 to $16,572. As a proportion of your salary it would climb from 21.2 to 21.5 per cent. Tax rates go up as income climbs whether or not people change brackets. The phenomenon shouldn't even be called bracket creep.

It happens because the more we earn, the more the proportion of our salary in the tax-free zone shrinks. "Crossing the threshold" matters symbolically but not practically.

But don't tell the Coalition, or talkback radio.

Here's Ray Hadley on Monday: "It is very hard to explain to people so-called bracket creep ... it simply means that people who were formerly taxed at the lower income rate through no fault of their own go on to the next income rate, taxable rate, and they are paying a lot more tax."

Here's Scott Morrison, agreeing with him: "Next year if you are on the average wage, you are going to go onto the second-highest tax bracket ... if we don't change the personal income tax rates you will end up paying more."

At this point you are probably feeling grumpy. The Treasurer has just told you the average wage is set to sail past $80,000. But your own wage probably isn't. Here's why. Most earners get nothing like the average wage. Right now the average full-time wage is $78,000, but the typical full-time wage is nearer $65,000. The average is pushed up by a comparative handful of high-earning megastars. In the real world three quarters of us earn less than that "average"...

Most are at no risk of crossing into the second-highest tax bracket. Morrison himself says over the next two years it'll be only 300,000 of Australia's 13 million taxpayers. And they'll hardly notice it. Again, don't take my word for it, listen to the Treasurer addressing economists last November:

"Income tax has become the silent tax for many Australians, particularly young Australians. When they go to the automatic teller machine to draw out their cash they do not see, as they do with the GST on their sales receipt, the 19 cents or 32.5 cents or 37 cents or 45 cents that has been deducted in income tax, let alone the extra 2 cents for the Medicare levy. They just take the cash."

Given enough time, bracket creep could hurt. But just at the moment wages are growing at their slowest sustained rate in memory.

Many of us would welcome bracket creep if it meant actually getting a pay rise.

It's as if the Treasurer picked up a script about the dangers of bracket creep and decided to use it just as if it mattered the least, a bit like Eric Abetz warning of a "wages explosion" as wage growth collapsed.

What's worrying is what he plans to do about it. Bracket creep hurts low-income taxpayers more than high income ones, yet Morrison says he is "deeply troubled" by the fate of those about to move into the $80,000 tax bracket. He "may be able to prevent that outcome going forward". It sounds as if he wants to adjust the $80,000 threshold to help them and leave the bottom three quarters of taxpayers alone.

The prime minister assures us that fairness will be at the heart of everything he does about tax. It would be good if Morrison ensured that it was.

In The Age and Sydney Morning Herald

Read more >>

There are worse things than a higher GST

So you’re frightened by the prospect of a higher GST? You shouldn’t be. The alternatives are worse.

One of them, outlined by Treasury secretary Martin Parkinson on Wednesday, is deceptively painful.

It’s doing nothing – just leaving the tax system on hold for 10 years and letting climbing revenues eat away at the projected deficits as inflation pushes more of our incomes into higher tax brackets.

It’s called “bracket creep”, although it can happen even if inflation doesn’t push your wage into a higher tax bracket. Every time your wage goes up, a greater proportion of it becomes taxed (above the tax-free threshold) rather than untaxed (below the threshold). It means that by doing nothing other than accepting ordinary annual wage rises, each of us is made to pay an ever increasing proportion of our income in tax.

It’s a sort of secret sauce for the politicians and officials who put together the budget. They can forecast ever-increasing revenue without needing to forecast anything unpopular. The latest projections assume 10 straight years of bracket creep, that’s 10 consecutive budgets without tax cuts. It’s something we haven’t had in generations.

Nine out of the past 10 budgets delivered tax cuts, one of them as compensation for the introduction of the carbon tax. That’s how dependent we have become on the annual or semi-annual ritual of higher wages, higher tax and then tax cuts that push our tax back down.

If the ritual was suspended for the next 10 years – and that’s what is planned to bring the budget under control – ordinary Australians would find themselves paying extraordinary amounts of tax.

Here’s what would happen to an Australian on $50,000. At the moment that person pays $7797 in tax, excluding the Medicare levy. That’s an average rate of 15.6 per cent.

After 10 years without tax cuts that person would be earning $70,500 and paying $14,459 in tax – an average rate of 20.5 per cent.

The purchasing power of that person’s wage would have done no more than keep pace, but the tax take would be dramatically higher.

Strangely enough, someone on a higher wage would suffer less. Someone earning $100,000 today will earn $141,000 in 10 years (assuming wage growth of 3.5 per cent). Their tax bill would edge up from 24.9 to 28.5 per cent.

But Australians on lower wages would get mugged. Someone earning $30,000 today pays 7.47 per cent of their wage in tax. In 10 years that person would pay 13 per cent. Their tax rate would almost double.

That’s the easy, apparently painless alternative to lifting the GST. That’s what will happen unless someone finds another way to bring down the deficit.

With such outrageous increases in tax would come tax avoidance, as it always does. People won’t respect laws they think are unfair. And low-income Australians considering whether to return to work or work extra hours would quite reasonably decide that it is not worth their while, or at least nowhere near as worthwhile as it was.

Lifting or extending the GST would also hurt low-income Australians, but it might not hurt them as much as would allowing inflation and unchanged tax scales to steal their wages.

As it happens, extending the GST to the presently untaxed categories of private education and private health wouldn't hurt very low earners little. It’s not where many of them spend their money but it is where most of the growth in spending is. The alternative to capturing it is to allow bracket creep to steal more and more of their wages.

Australia’s GST system works well, a lot better than doesour income tax system. Overseas experience suggests it could withstand an increase in its rate much better than could income tax. New Zealand lifted its GST from 10 to 12.5 per cent and then to 15 per cent with few complaints.

Of course, there are other alternatives.

The government could slash spending. But the really big government spending is on things we want, such as health, education and pensions. Or it could lift company tax. But if it did companies would relocate or be less keen to come here.

Or it could attempt to get at the billions we are missing out on from Apple, Microsoft, Google and the like who make money here but pay little tax. It’s trying, but it would be unwise to bank on success.

Or it could tax carbon emissions, resource rents and attack the obscenely generous superannuation tax concessions going to very high income earners. Oh wait, the last lot tried that and got voted out. So we better prepare for a higher GST.

In The Age and Sydney Morning Herald

Read more >>