Fairness, and which party is more committed to it, will be a big theme in the federal election. There has already been lots of argument about whether the May budget was fair, particularly in its changes to personal income tax. But as is so often the case, “fairness” depends on your perspective.
Treasurer Scott Morrison announced just one change to personal income tax in the Budget. From July, the $80,000 tax bracket will rise to $87,000. As a result, those earning over that amount will pay $315 less in tax each year. Those earning under $80,000 get no relief. In addition, the Temporary Budget Repair levy, which puts a 2% impost on personal income earned above $180,000, was not extended and will expire in June 2017.
Opposition Leader Bill Shorten thought these changes and non-changes to personal income tax were an unfair gift to the rich. In his Budget Reply, he said:
Was this really the point of the Turnbull experiment? Tax cuts for high income earners – and nothing for families. Not one cent for ordinary working Australians.
The Labor leader is right that fewer than a quarter of taxpayers will receive any tax relief from lifting the $80,000 threshold to $87,000. By definition they are the quarter of taxpayers who earn the highest incomes. And the expiry of the Temporary Budget Repair Levy only helps the 3% - 4% of taxpayers with taxable incomes above $180,000.
However, the picture is a little more complicated than Shorten makes out. To understand it requires a grasp of the phenomenon known as fiscal drag, commonly called bracket creep.
Fiscal drag occurs when wages increase at the rate of inflation or faster, but tax brackets don’t change. The extra wage is taxed at a worker’s marginal tax rate (the tax rate that applies to the highest tax bracket they are in), not at the worker’s average tax rate (the tax paid divided by their total income).
As a result, inflation results in the worker paying a growing share of their income in tax each year, even if their real income doesn’t rise. Like any increase in income tax, this reduces the incentives to work.
In 2013-14, an individual on the median income paid 13.1% of income in tax. By 2015-16, bracket creep had pushed the figure up to 14.5%.
Fiscal drag, while having no impact on the incomes of those remaining below the income tax free threshold, nevertheless tends to make the income tax system less progressive. That is because people on middle incomes suffer the fastest increase in the percentage of their income paid in tax.
Even a government with the best of intentions and flawless execution cannot reverse bracket creep perfectly. Income growth tends to be smooth, while the effect of fiscal drag can be sharp for those who move into the next tax bracket as a result of wage rises.
The chart below shows how fiscal drag affected taxpayers, measured in percentiles of income, between 2013-14 and 2016-17. It is based on the actual tax they paid in 2013-14 and projects forwards given inflation and the tax scales that will apply. It shows that fiscal drag most affected those just below the median income (at the 45th percentile). They paid almost 2% more of their incomes in tax. By contrast, someone earning $170,000 – in the top 4% of taxpayers – paid only an extra 0.8% of income in tax.
The chart also reveals that lifting the second highest tax bracket from $80,000 to $87,000 only helps the top 25% of taxpayers – and not those who have suffered most from fiscal drag over the last three years.
Authors: The Conversation Contributor