It’s what Malcolm Fraser dubbed “the secret tax of inflation”,but the punters call “bracket creep” and economists call “fiscal drag”.
Because our income-tax scales tax income in slices,atprogressively higher rates – ranging from zero to 45c in the dollar – but the brackets for the slices are fixed in dollar terms,any and every increase in wages (or other income) increases theproportion of income that’s taxed at the individual’s highest “marginal” tax rate,thus increasing theaverage rate of tax paid on the whole of their income.
By knackering the single most important device used to achieve fiscal consolidation,it’d be an act of macro management vandalism.
A person’s average tax rate will risefaster if the increase in their income takes them up into a higher-taxed bracket but,because what really matters in increasing their overallaverage tax rate is the higher proportion of their total income taxed at their highestmarginal tax rate,it’s not true that people who aren’t pushed into a higher tax bracket don’t suffer from what we misleadingly label “bracket creep”.
I give you this technical explanation to make two points highly relevant to the prospects of getting the budget deficit down. Both concern the third stage of the government’s tax cuts,already legislated to take effect from July 2024,at a cost of $17 billion a year.
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Although this tax cut is,in the words of former Treasury econocrat John Hawkins and others,“extraordinarily highly skewed towards high-income earners”,Frydenberg justifies it with the claim that,because it would put everyone earning between $45,000 and $200,000 a year on the same 30 per cent marginal tax rate,it would end bracket creep for 90 per cent of taxpayers.
First,this claim is simply untrue. For Frydenberg to keep repeating it shows he either doesn’t understand how the misnamed bracket creep works,or he’s happy to mislead all those voters who don’t.
What’s true is that the stage three tax cut would greatly diminish the extent to which a given percentage rise in wages leads to a greater percentage increase in income-tax collections,thereby sabotaging the progressive tax system’s effectiveness as the budget’s main “automatic stabiliser”. Its ability to act as a “drag” on private-sector demand when it’s in danger of growing too strongly.
In an ideal world,income-tax brackets would be indexed to consumer prices annually,thus requiring all tax increases to be announced and legislated. But in the real world of cowardly and deceptive politicians – and self-deluding voters – the stage three tax cut is bad policy on three counts.
One,it’s unfair to all taxpayers except the relative handful earning more than $180,000 a year (like me). Two,the biggest tax savings go to the people most likely to save rather than spend them. Three,by knackering the single most important device used to achieve fiscal consolidation,it’d be an act of macro management vandalism.
Think of it:by repealing stage three you improve the budget balance by $17 billion in 2024-25 and all subsequent years. Better than that,you leave intact the only device that works automatically to improve the budget balance year in and year out until you decide to override it.
Without the pollies’ little helper,fiscal consolidation depends on a government that’s still smarting from its voter-repudiated attempt in the 2014 budget,having another go at making big cuts in government spending,and a government that seeks to differentiate itself as the party of low taxes now deciding to put them up.
Good luck with that.
Ross Gittins is the Herald’s economics editor.