Stage three tax cuts: Most important reform in 20 years

Stage three income tax cuts represent Australia’s most important piece of microeconomic reform in 20 years. From 2024, the marginal tax rate will shrink from 32.5% and 37% down to 30% for most taxpayers, creating a simpler, more efficient tax system that will help boost productivity and promote long term wage growth.

The Liberals should be applauded for introducing this tax reform and Labor should be applauded for promising to keep it. Unfortunately, there is now a concerted campaign to pressure Labor into backtracking on this promise. This campaign is coming from left-wing media, Greens & Teals, the union movement, welfare groups, and rogue Liberal (sic) backbencher Russell Broadbent.

The campaign for higher tax stems from a central piece of poor economic analysis. Tax rate changes affect taxpayer behaviour, but this is ignored in modelling used by the Greens. The plain fact of reality is that many taxpayers do change behaviour when tax rates change, often significantly. It may seem like an unimportant squabble about methodology, but this oversight fundamentally warps the argument for tax reform by ignoring the benefits and exaggerating the costs.

Australia desperately needs a renewed round of microeconomic reform. During the 1980s and 90s there was a golden age of reform, leading to high productivity growth—the only sustainable driver of higher wages. This point is worth stressing. The goal of microeconomic reform isn’t to boost share prices or corporate profits; the goal is to increase productivity so that working people can benefit from higher wages and lower prices.

Australia has lacked meaningful reform during the past couple of decades. It’s no wonder we’ve seen productivity and wages stagnate. These so-called “stage three” tax reforms promise to reinvigorate the economy and represent a welcome return to microeconomic reform.

As the name implies, the stage three tax reform follows two other stages of tax changes. They involved larger tax offsets and tax bracket adjustments. While the first two stages directly benefited some taxpayers, they did little to improve the efficiency of our tax system and were not meaningful tax reform. Stage three alone has the capacity to improve and simplify our income tax system in a way that will noticeably change behaviour and boost productivity.

Increased productivity from changed behaviour is a cardinal benefit of stage three. The modelling used by the Greens assumes that taxpayers do not change behaviour, which implies there is no productivity benefit from tax reform. They have simply assumed it out of existence. Further, this oversight will also exaggerate the fiscal cost of tax cuts because it fails to consider the increase in economic activity.

These aren’t partisan talking points. There is a large and well-established body of knowledge regarding the size of behavioural changes that come from tax changes. The behavioural change is captured in the “elasticity of taxable income”, which can be used to create a dynamic tax model that factors in behavioural changes. While there is still some debate about the size of the elasticity, there is no doubt that some taxpayers do change behaviour, and a consensus that high income earners show a higher behavioural response.

Indeed, the change in behaviour is the whole point of microeconomic reform. Good tax reform encourages more efficient allocation of labour, more innovation and entrepreneurship, less tax avoidance and evasion, and more investment. All these behavioural changes manifest as a growing economy with higher wages and lower prices. To assume these benefits out of existence is a dishonest rhetorical trick.

To give an example, static modelling of stage three tax cuts suggests a benefit to taxpayers of roughly $18 billion and a cost to the budget of $18 billion in 2024/25. Based on these numbers, the political debate is entirely about distribution and who is most deserving of the $18 billion benefit. It is this faulty premise that underpins almost all media and commentary on the issue. Dynamic modelling tells a very different story, indicating a benefit to taxpayers of roughly $32 billion and a cost to the budget of just $10 billion in 2024/25. Even these numbers likely underestimate the benefit, as it doesn’t factor in the future benefit from higher investment and innovation.

Australian political debate is too often caught up on the issue of distribution. It’s an important issue in certain contexts but Australia also needs to address productivity. We need microeconomic reform that boosts productivity and that is exactly what the stage three tax cuts offer. Rather than shying away from tax reform, our political leaders (from both major parties) should dedicate themselves to a renewed agenda of microeconomic reform, where the focus is on growing the economy instead of simply redistributing a shrinking economy.