Bracket Creep: Raiding our wallets

Much of the commentary surrounding the Coalition government’s three-stage Personal Income Tax Plan (PITP) — as originally legislated in 2018 and embellished in 2019 — has focused on the magnitude of the Stage 3 tranche of tax cuts intended to commence on 1 July this year. Some commentators have questioned their affordability, while others point to the large differences in the dollar value of the tax cuts at high incomes compared with those for lower income earners.

However, this commentary typically fails to acknowledge the effective tax increases paid by all taxpayers through bracket creep, which is a constant force; increasing tax rates in Australia’s progressive personal income tax system. Critics of Stage 3 also typically fail to recognise the tax relief that low- and middle-income taxpayers received in Stages 1 and 2 of the PITP or the relativity of the dollar amounts of the Stage 3 tax cuts to the total amounts of tax higher income earners pay.

To assert it is unfair for higher income earners to receive larger tax cuts under Stage 3 than lower income earners, in absolute dollar terms, is to ignore that those on higher incomes have paid far more tax because of bracket creep than low- and middle-income earners.

The neutral benchmark for tax policy comparisons is not unchanged thresholds and marginal rates year after year — which would lead to ever-increasing average tax rates for all — but a tax scale with thresholds indexed annually for inflation.

On this basis, the ‘cost’ (reduction in tax revenue) of the Stage 3 tax cuts over the nine years from 2024-25 was never the $240 billion calculated by the Parliamentary Budget Office for the Australian Greens, but around $39.7 billion or $4.4 billion a year.

The use of an indexed tax scale as a benchmark also puts the distribution of tax cuts into perspective. Sensible judgements cannot be based on any single year’s outcome, but require analysis of the cumulative offsetting impacts of bracket creep and discretionary tax changes at different levels of real taxable income over a series of years.

When this is done using 2017-18 as the benchmark tax policy (the year before implementation of the PITP began) and up to 2024-25, we see that those on taxable incomes of roughly $50,000 to $224,000 (in $2024-25 terms) would have received tax cuts larger than bracket creep over those seven years under the Coalition’s PITP, while those below and above that range would have been under-compensated. The current government’s revision of the PITP lowers the range of over-compensation to around $48,000-$214,000. It mostly increases the over-compensation provided to those below $148,300 and increases the amount of cumulative tax paid of those above.

However, there is nothing special about 2017-18 as a benchmark against which to measure subsequent tax policy. An arguably more meaningful benchmark is 2010-11, which was the last year of major tax cuts and the last year in which high income earners received significant tax cuts before the three-stage PITP. The striking result is that all taxpayers above around $35,000 in 2024-25 terms would have been undercompensated for bracket creep over the 14 years from 2011-12 to 2024-25 even under the Coalition’s PITP. (Those below $35,000 were mostly over-compensated owing to a very large increase in the tax-free threshold in 2012.) The under-compensation would be largest as a percentage of taxable income at high incomes above about $220,000.

The current government’s revision of Stage 3 increases the degree of undercompensation at high incomes, but makes little difference at low and middle incomes because the redistributed dollar tax cuts are spread thinly; amounting for example to only $15 a week at and above $45,000 and less below $45,000.

The point here is not that 2010-11 or 2017-18 tax policy settings are necessarily the final word on tax policy. Rather, it is that — regardless of the level of one’s taxable income — the tax cuts received by a taxpayer in a single financial year need to 2 be viewed in the context of the additional tax payments they have made as a result of bracket creep.

On this view, the denial of some of the tax relief to higher income earners in the revision of Stage 3 is unwarranted, as that group would have been under-compensated for bracket creep even under the Coalition’s original plan. The assertion that these taxpayers stood to gain $9,000 in 2024- 25 — though broadly correct — tells us nothing about their cumulative tax burden, considering the bracket creep they have paid in preceding years.

If the argument against the original Stage 3 tax cuts is that high income earners benefit more in absolute dollar terms than those with lower incomes, this is tantamount to asserting there is some income level above which certain taxpayers should never receive compensation for bracket creep and be subject to increasing average tax rates in perpetuity.

If tax thresholds were indexed to the CPI, the tax liability of high-income earners as well as others would be fixed in real terms until the government legislated a change in tax policy. This would provide transparency for all taxpayers, and avoid the inane recurring debate about whether it is fair that high income earners receive larger dollar tax cuts than low-income earners while ignoring the fact that high earners carry most of the income tax burden.

Robert Carling is a Senior Economics Fellow at the Centre for Independent Studies and a former IMF, World Bank and federal and state Treasury economist.

Matthew Taylor is the head of the CIS Intergenerational research program.