Scrap the short-term tax cuts, bring forward the long-term ones

Surplus of $7.1 billion is mostly due to higher tax

The government has announced a small budget surplus of $7.1 billion for the coming year (2019/20) and slightly higher surpluses into the future. While balancing the budget is good news, unfortunately, this has been largely achieved through higher revenue, with tax receipts growing from 21.3% of GDP in 2013/14 up to 23.3% in 2019/20.

Spending continues to rise

Government spending continues to increase, despite rhetoric to the contrary. While the government correctly claims some credit for keeping real spending growth down to 0.7% in the coming year, it should be noted that most of this ‘spending restraint’ has come through parameter variations that are out of their control. Over the past year, the government has actually announced $6.2 billion worth of new annual spending. In addition, the government has committed to $100 billion of infrastructure spending over the next decade, much of which will be outside forward estimates, or off budget altogether.

Bad modelling exaggerates impact of tax cuts

The government has announced income tax cuts in two stages; which they value at $19.5 billion over the forward estimates (four years) and $158 billion over the next 11 years. These numbers are almost certainly an overestimate, as they fail to factor in behavioural change. The CIS has modelled the long term tax cuts and yesterday released more accurate estimates, based on our dynamic tax model.

Short-term cuts should be scrapped

The first stage involves an immediate increase in the ‘low and middle income tax offset’ (LMITO) from $530 to $1080 per year. Tax cuts are always welcome, but this type of tax reform is neither transparent nor efficient. Most commentators have focused on the dollar value of the change, but it is the marginal tax rates that determine the efficiency of a tax system. The good news is that the proposed changes will decrease the marginal tax rates for people earning between $37,000 and $48,000, from 33% down to 28.5%, but the bad news is that it will increase the marginal tax rates for people earning between $90,000 and $126,000, from 40.5% up to 42%. The government should scrap the first stage and jump immediately to their long-term plan.

Long-term tax cuts should be moved forward

To their credit, the government’s long-term tax reform is transparent, efficient, and much needed. These reforms involve scrapping the LMITO, increasing the tax threshold for the 32.5% tax bracket from $37,000 up to $45,000, and then lowering the nominal 32.5% tax rate down to 30% (not including the Medicare Levy).  However, this reform also relies on the government staying the course and in power so it’s not guaranteed.

The government had already planned to increase the 32.5% threshold to $41,000, but this has now been extended up to $45,000. People earning below the threshold would pay nominal income tax rates of 19%, plus the Medicare Levy. This tax reform is to be applauded and is a significant improvement over the status quo and the first stage. However, it should be moved forward and implemented immediately.

Bracket creep is still a problem

Unfortunately, the government again failed to index the tax brackets. If income tax revenue grew at the same rate as average wages growth, then we would expect income tax revenue in 2022/23 to be around $261 billion. However, income tax revenue tends to grow faster than wages due to bracket creep. Even factoring in the government’s proposed new tax cuts, income tax revenue is expected to grow to $264 billion by 2022/23. This highlights the need for the government to index the income tax brackets and remove the stealth tax of bracket creep.

Actual tax rates

The government claims their current income tax rates are as follows:

Income bracket	Marginal tax rate
0 – $18,200	0%
$18,200 – $37,000	19%
$37,001 – $90,000	32.5%
$90,001 – $180,000	37%
> $180,000	45%

This is misleading, since it does not factor in the Medicare Levy (ML), or the Low-Income Tax Offset (LITO), or the Low and Middle Income Tax Offset (LMITO). Following the 2018-19 budget, the actual tax rates were as follows:

Income bracket	Marginal tax rate
0 – $21,595	0%
$21,596 – $21,980	19%
$21,981 – $27,474	29%
$27,475 – $37,000	21%
$37,001 – $48,000	33%
$48,001 – $66,667	36%
$66,668 – $90,000	34.5%
$90,001 – $125,333	40.5%
$125,334 – $180,000	39%
> $180,000	47%

 

With the updated tax policy announced in the 2019-20 budget, if made into law, the actual tax rates would be as follows, with the changes highlighted in red.

Income bracket	Marginal tax rate
0 – $21,884	0%
$21,885 – $22,398	19%
$22,399 – $27,998	29%
$27,999 – $37,000	21%
$37,001 – $48,000	28.5%
$48,001 – $66,667	36%
$66,668 – $90,000	34.5%
$90,001 – $126,000	42%
$126,000 – $180,000	39%
> $180,000	47%