Who pays from bracket creep?

As bracket creep is back in the spotlight, the principles of tax fairness need to be part of the policy debate.

With the federal Treasury projecting a decade of budget deficits, the major parties are offering billions in new spending initiatives ahead of the next election—without proposing corresponding offsets or new revenue measures. Some economists argue that bracket creep will quietly fill the gap.

Bracket creep occurs when inflation and real wage growth push taxpayers into higher tax brackets over time. Since tax thresholds are not adjusted annually, this gradual shift increases the proportion of income subject to higher marginal tax rates.

Against this backdrop, a group of independent MPs, led by Allegra Spender, has renewed calls for tax bracket indexation, arguing that it would prevent workers from being subjected to stealth tax increases as their wages rise.

Governments of both major parties have historically resisted automatic indexation, preferring to adjust tax settings through discretionary policy decisions. This provides flexibility in managing revenue but also enables bracket creep to function as an unlegislated tax increase.

The issue has sparked debate among current and former policymakers, highlighting the trade-offs involved. Treasury Secretary Steven Kennedy argues that bracket creep serves as a natural stabiliser, tempering the inflationary effects of rising wages. In contrast, former Treasury Secretary Ken Henry warns that successive governments have become too reliant on this passive revenue growth to fund new spending initiatives.

Bracket creep’s effects are also not uniform across people.

Other than the budget bottom line, who have been the winners and losers when it comes to changes (or lack thereof) in income taxation?

If left unchecked, bracket creep diminishes tax progressivity. Absent of changes to tax brackets, when two incomes rise by the same percentage, lower incomes experience a steeper increase in tax rates. This ultimately results in tax rates converging to a higher level across the income distribution.

What has been the effect of the past 10 years of tax settings across the income distribution? I investigated the ATOs taxation statistics across the income distribution between 2012 and 2022.

Holding income percentiles constant, nearly everyone is paying a higher average rate (1 per cent more) of tax than what they were in 2012. Notably, tax rates have also risen the most for the top quartile of earners, increasing the progressivity of the system. This is unsurprising, given that the threshold for the top tax bracket ($180,000) has remained virtually unchanged over this time, whilst Stage 1 and 2 tax cuts have targeted the middle of the income distribution.

Overall, progressivity has increased, even without accounting for government transfers. But there are still some horizontal inequities caused by bracket creep in the middle 50% of incomes – people earning just below median income saw a higher increase in average tax rates than those who were earning above.

At its core, the debate over indexation is about the broader fiscal philosophy underpinning Australia’s budget but should also consider principles of tax fairness.

If independents hold the balance of power after this year’s federal election, tax policy could become a central point of negotiations to win their support to form government or to pass legislation. The question for policymakers is whether they will confront bracket creep head-on or continue to rely on it as a quiet but powerful revenue tool.

by Elyse Dwyer

Elyse is a Research Economist at the e61 Institute, her research areas cover structural reform, labour markets, education and housing. Elyse holds a University Medal and First Class Honours in Economics from the University of Queensland.

For more information, please reach out to Elyse via email at [email protected]

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