Opinion & Commentary
Taxation rhetoric and reality
In the 2008 Budget the government outlined its plan for future tax cuts. In light of the current economic downturn, there is growing pressure on the government to bring forward these tax cuts. This seems like a bright idea, but there is a sting in the tail.
If the government brought forward all of its proposed tax cuts, the good news is that the marginal tax rate would be reduced for people who earn between $14,000 and $16,000, for people earning between $34,000 and $37,000 and for people earning between $80,000 and $180,000. All of these changes should be applauded.
The bad news is that the government’s proposed changes would actually increase the marginal tax rate for people who earn between $60,000 and $67,500.
This information has been hidden because the government does not report the complete marginal tax rate. Official Treasury papers report that our tax rate has marginal tax rates of 0 per cent, 15 per cent, 30 per cent, 40 per cent and 45 per cent which, while high, seems like a sensible tax system.
The true marginal tax rates are 0 per cent, 15 per cent, 25 per cent, 16.5 per cent, 20.5 per cent, 35.5 per cent, 31.5 per cent, 41.5 per cent and 46.5 per cent.
The reason for the difference is that the official marginal tax rates do not factor in the Medicare Levy and the Low-Income Tax Offset (LITO). Both of these are fundamental parts of our income tax system and there is no reason to hide their impacts.
Many people know that the Medicare Levy is charged at 1.5 per cent of income. However, the Medicare Levy actually adds 10 per cent to the marginal tax rates of people earning between $17,309 and $20,363, making it a regressive tax.
The LITO is rightly praised for increasing the tax-free threshold from $6000 to $14,000 for low income earners. However, it is less widely reported that the withdrawal of the LITO benefit also adds 4 per cent to the marginal tax rates of people earning between $30,000 and $60,000.
Under the proposed reforms, the 4 per cent LITO impact will be extended to people earning incomes up to $67,500 — increasing their marginal tax rates from 31.5 per cent to 35.5 per cent.
Many people will benefit from the proposed tax cuts, and they are certainly better than nothing. However, it is the marginal tax rates which affect work incentives and create the economic distortions that slow down our economy. Any increase in the marginal tax rate should be a cause for concern.
Two things are clear from the above information.
Firstly, the government needs to be more transparent about real marginal tax rates and we urgently need to have a robust debate about how our current complex rates could be made more simple, efficient and equitable.
Secondly, the government should ensure that its changes do not increase the marginal tax rates for anybody. This means that it should re-think the proposed changes to LITO.
There are various more appealing options for the government to consider. One easy way to provide tax relief to all Australians is by simply increasing the tax-free threshold instead of increasing the LITO. Another option would be to remove the regressive Medicare Levy, which is not linked with Medicare anyway.
Or the government could reduce the 30 per cent tax bracket (the rate most Australian workers pay) to 25 per cent, providing an immediate 2.8 per cent increase in after-tax income for a worker on $60,000 per year. This would be the same as a wage increase of 3.2 per cent, with the added benefit that it wouldn’t hurt job creation.
The government is on the right track when it talks about cutting taxes. Unfortunately, the complexity and lack of transparency in our income tax system makes it easy to produce unintended consequences. Instead of adjusting LITO, the government should cut tax in a more meaningful way.
John Humphreys is a Research Fellow at The Centre for Independent Studies.
