Australian Treasurer Joe Hockey claims taxpayers are already paying 50 cents in the dollar of their income to the government and that bracket creep will push the average income earner into the second top marginal tax rate in a few years.
This week in an interview with 3AW’s Neil Mitchell, Hockey said:
“When Australians spend the first six months of the year working for the government with tax rates nearly 50 cents in the dollar it is a disincentive. You’re working July, August, September, October, November, December just for the Government and then you start working for yourself and your own household income after that for another six months, it is a disincentive. We’ve got to bear that in mind. We’ve got to bear in mind that bracket creep is going to put middle income Australians into the second highest tax bracket over the next few years which is a disincentive for people to work…”
There are a number of problems with this statement. The most obvious is the confusion of marginal and average tax rates. Nobody in Australia pays 50% of their income as personal income taxation. According to NATSEM modelling, around 3.5% of those who have a tax liability actually face a top marginal tax rate of 49 cents in the dollar. Around 25% of taxpayers are paying a top marginal tax rate of at least 39 cents in the dollar. By 2020 this would be expected to increase to between 30 and 35% depending on how strongly wages grow.
The top marginal tax rate says little about the average rate of tax a person pays. The taxpayer is of course only paying that highest marginal tax rate on the dollars over and above the dollars earned beyond A$180,000 per annum.
Using NATSEM’s STINMOD model of the Australian tax and transfer system which is also used by Treasury the median taxable income for Australians (who actually have a tax liability) is currently around A$55,000. This taxpayer would have a personal income tax liability of around A$10,347 per annum, or 18.8%. Their top marginal tax rate will be 34.5 cents in the dollar including Medicare.
By 2020, assuming 3% wages growth, their taxable income will grow to A$63,760 and their average tax liability will increase to 21.2%. Their top marginal tax rate will be unchanged. Bracket creep is not just about moving into higher tax brackets.
The real bracket creep
Only around 3% of taxpayers earn more than A$200,000 each year. Their average tax rate from personal income tax would be 34% for this financial year. Even though their top marginal tax rate is unchanged bracket creep will be an issue for this individual as their expected income by 2020 (A$231,855 assuming 3% annual growth) attracts an average tax rate of 36 per cent. They pay a higher share of their income in the higher tax brackets.
The greatest disincentives for work are felt by women returning to the workforce after having children. They face the prospect of losing government benefits, paying income tax and child care fees. It is this group where some of the greatest challenges are for the Treasurer. A recent AMP.NATSEM report shows that for a middle income family as the mother returns to work (in Australia it is still mostly the mother) she loses 45 cents in the dollar of earned income over her first 20 hours and 75 cents in the dollar between 20 and 40 hours work in lost government benefits, higher personal income tax and net child care costs.
Tightening welfare payments through tighter means testing may save money for the government but this can lead to higher “effective” tax rates as mothers will lose benefits more quickly for every dollar they receive from private sources – predominantly work.
The Australian federal government over the previous financial year collected around A$360 billion in tax revenue which is 22.8% of total income in the economy (according to the Mid Year Economic and Fiscal Outlook). Since the GFC this share declined from around 25% (2007-08). In 2011-12 the government’s revenue dipped as low as 21.5% of national income.
Very large personal income tax reductions through the last decade (around A$20 billion per year), and changed economic circumstances, such as lower terms of trade and capital gains substantially reduced government revenue. In lieu of genuine tax reform any time soon, for right or for wrong, bracket creep will be an important tool for returning tax revenues to levels that sustainably pay for the services the community expect from the government.