The Turnbull government has talked up the prospects for personal income tax cuts in the coming budget, but how it can reconcile anything more than derisory (‘hamburger and milkshake’) cuts with the return to balance is still a mystery to budget watchers.
The mid-year budget review in December suggested there was little scope for tax reduction, so the outlook would have needed to improve dramatically since then. Hinting at a rosier economy, Treasurer Scott Morrison has revealed that the income tax cuts will start small and be phased in over 10 years so as to prevent derailing a return to surplus. In parallel, plans to raise the Medicare levy by 0.5 per cent have been scrapped.
The exact quantity of the income tax changes will be revealed on May 8, but in the meantime we know that tax cuts can be delivered in different forms – hence we can set down some tests of quality for the budget.
The most disappointing action would be to do what governments have often done in the past: namely, slap a few one-off adjustments on to bracket thresholds, such as the tax-free boundary.
There may be a compelling case for some change of this kind, but it should not be the beginning and end of tax cuts. These cosmetic changes would merely hand back some of the proceeds of past bracket creep, yet ensure bracket creep keeps raising the tax burden by stealth in the future.
There is an easy way to stop this charade of tax cuts that don’t really cut taxes – and that is to put in place a system of automatic annual indexation of bracket thresholds, as many other countries have done.
This replaces governmental discretion with a legislated formula. It would be a real reform, not just a tax cut. One year’s cut from indexation would be of the ‘hamburger and milkshake’ variety and would cost the budget only around $2.5 billion, but the cumulative effect over several years is substantial and becomes a built-in discipline on government spending decisions. (Coalition ministers should give thought to how this would constrain a future Labor government.)
If indexation provides the hamburger and milkshake, the best way to add the bacon is to cut marginal rates of tax. Cutting marginal rates is the gold standard of tax cuts. It delivers the most enduring benefits and goes directly to the issue of how taxes affect people’s decisions at the margins of work, saving and investment.
The next-best option in cutting marginal rates is to put the 32.5 per cent middle-income rate back to 30 per cent, where it had been for many years until it was increased in 2012 to help pay for a massive increase in the tax-free threshold. This would benefit all taxpayers above $37,000 and cost around $6.7 billion a year. Other marginal rates also need to be cut, but will have to wait until the budget is in better health.
Finally, if there is more room left in the budget, the third priority should be to lift the current $37,000 threshold to $40,000 (in lieu of the first year’s indexation adjustment). Looking back over the past 20 years, the increase in this threshold has severely lagged the others and even the increase in average wages. Soon, a full-time minimum wage worker will cross into the next bracket and face a marginal rate of 32.5 per cent and the Medicare Levy.
These should be the priorities, if taking the broad structure of the personal income tax system as given. They do little more than tinker with a flawed system – and even how much the government can tinker will depend on the budget outlook.
There are more radical reform options worth considering, should the government be so minded: abolishing the tax-free threshold and slashing marginal rates; a flat or at least flatter tax rate scale; a bonfire of deductions, credits and offsets to fund much lower marginal rates; and tidying up the very uneven taxation of income from saving. Each of these has snags of its own, but they’re worth a fresh look.
But ultimately it’s expenditure discipline that will keep the tax burden down, not tax policy.
Robert Carling is a senior fellow at The Centre for Independent Studies, and author of the policy paper Cutting income tax: can we add the bacon to ‘hamburger and milkshake’ cuts?
Home > Commentary > Opinion > How to get more than a milkshake and burger from tax cuts
How to get more than a milkshake and burger from tax cuts
The mid-year budget review in December suggested there was little scope for tax reduction, so the outlook would have needed to improve dramatically since then. Hinting at a rosier economy, Treasurer Scott Morrison has revealed that the income tax cuts will start small and be phased in over 10 years so as to prevent derailing a return to surplus. In parallel, plans to raise the Medicare levy by 0.5 per cent have been scrapped.
The exact quantity of the income tax changes will be revealed on May 8, but in the meantime we know that tax cuts can be delivered in different forms – hence we can set down some tests of quality for the budget.
The most disappointing action would be to do what governments have often done in the past: namely, slap a few one-off adjustments on to bracket thresholds, such as the tax-free boundary.
There may be a compelling case for some change of this kind, but it should not be the beginning and end of tax cuts. These cosmetic changes would merely hand back some of the proceeds of past bracket creep, yet ensure bracket creep keeps raising the tax burden by stealth in the future.
There is an easy way to stop this charade of tax cuts that don’t really cut taxes – and that is to put in place a system of automatic annual indexation of bracket thresholds, as many other countries have done.
This replaces governmental discretion with a legislated formula. It would be a real reform, not just a tax cut. One year’s cut from indexation would be of the ‘hamburger and milkshake’ variety and would cost the budget only around $2.5 billion, but the cumulative effect over several years is substantial and becomes a built-in discipline on government spending decisions. (Coalition ministers should give thought to how this would constrain a future Labor government.)
If indexation provides the hamburger and milkshake, the best way to add the bacon is to cut marginal rates of tax. Cutting marginal rates is the gold standard of tax cuts. It delivers the most enduring benefits and goes directly to the issue of how taxes affect people’s decisions at the margins of work, saving and investment.
The next-best option in cutting marginal rates is to put the 32.5 per cent middle-income rate back to 30 per cent, where it had been for many years until it was increased in 2012 to help pay for a massive increase in the tax-free threshold. This would benefit all taxpayers above $37,000 and cost around $6.7 billion a year. Other marginal rates also need to be cut, but will have to wait until the budget is in better health.
Finally, if there is more room left in the budget, the third priority should be to lift the current $37,000 threshold to $40,000 (in lieu of the first year’s indexation adjustment). Looking back over the past 20 years, the increase in this threshold has severely lagged the others and even the increase in average wages. Soon, a full-time minimum wage worker will cross into the next bracket and face a marginal rate of 32.5 per cent and the Medicare Levy.
These should be the priorities, if taking the broad structure of the personal income tax system as given. They do little more than tinker with a flawed system – and even how much the government can tinker will depend on the budget outlook.
There are more radical reform options worth considering, should the government be so minded: abolishing the tax-free threshold and slashing marginal rates; a flat or at least flatter tax rate scale; a bonfire of deductions, credits and offsets to fund much lower marginal rates; and tidying up the very uneven taxation of income from saving. Each of these has snags of its own, but they’re worth a fresh look.
But ultimately it’s expenditure discipline that will keep the tax burden down, not tax policy.
Robert Carling is a senior fellow at The Centre for Independent Studies, and author of the policy paper Cutting income tax: can we add the bacon to ‘hamburger and milkshake’ cuts?
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