Budget top priority should be income tax cuts
The government didn’t plan to be giving today’s budget, and the opposition didn’t expect to have to give a budget response later this week. The original plan was most likely an April election, but Cyclone Alfred has changed the game, and now both sides of politics are struggling for something relevant to say in this rushed last-minute budget season.
Expectations are not high. The budget is predicted to have deficits into the foreseeable future despite runaway income tax revenue, with billions more in pre-election handouts, and no serious productivity reform. Thus far the opposition has been content to match the extra spending and reform shyness. This is the wrong approach.
There is a golden opportunity for whichever party is first to offer meaningful income tax cuts.
The economic case for tax cuts is overwhelming, and often repeated. Bracket creep is pushing more of our income into higher tax brackets, creating a hidden tax hike each year that is making the government bigger and workers poorer. At the same time, high taxes are leading to poor incentives, stagnant productivity, and lower real wages.
These arguments are true, but in the heat of an election campaign it’s fair to assume that most politicians will be more focused on the short-term politics rather than long-term prosperity of the nation.
The good news is that tax cuts are also good politics. Perhaps not the radical tax cuts that I would ideally prefer, but there are plenty of moderate reforms that would make for good policy and good politics. The Liberals have an opportunity to differentiate themselves as the party of productivity and working families. If the Liberals forgo that opportunity, then Labor could flip the script and wrong-foot the opposition with tax cuts that primarily benefit low-income workers.
Below are some tax proposals that would provide hip pocket relief to struggling families while improving productivity, simplicity, and fairness. Any one of them would be a step in the right direction.
Reduce the bottom marginal tax rate, with the aspirational goal of eventually reducing it to zero so that low-income workers are not caught both paying income tax while losing welfare payments at the same time. An immediate 1-2% cut would benefit all taxpayers and improve incentives for low-income earners, while costing less than the value of bracket creep – while the long-term plan would show vision and serious reform credentials.
Increase the tax-free threshold for families by $10k for each child. This would provide meaningful cost-of-living relief for millions of families, while (as above) reduce the amount of pointless tax/welfare churn and improve incentives. Ideally this would apply to all children, but if that is too ambitious then starting with just children under school age would only cost the budget $2 billion per year.
Replace the Low-Income Tax Offset (LITO) and Work-Related Expense (WRE) tax deductions with a higher tax-free threshold of $24k. This represents a tax cut for the overwhelming majority of workers, with low-middle income earners being the main beneficiary, while improving simplicity, efficiency, and fairness.
Allow families to choose joint tax treatment with a combined tax-free threshold of $50k while forgoing LITO and half of FTB-B. This option would benefit nearly all working families, but it would primarily benefit families that are attempting to survive on one income while bringing up children. This would also reduce the disincentives created by the current LITO and FTB-B withdrawal rates, and (once again) reduce pointless tax/welfare churn.
Introduce automatic indexation of tax brackets to remove the hidden annual tax hikes caused by bracket creep, with the option to replace that automatic indexation with any other tax cuts of equal (or higher) value. This would add transparency to the tax system and ensure that tax increases only happen after debate and democratic approval, while the “option to replace” gives politicians the freedom to change the tax mix and to take credit for the details. This proposal has the win-win of being serious structural reform that is both popular and achievable. For the Liberal Party the idea is win-win-win, since it would also force future Labor governments to either forgo their usual political tactic of reckless spending, or else publicly admit to an agenda of higher taxes and debt.
Remove the regressive 10% Medicare Levy that currently applies to people earning between $26k and $32.5k. This absurd and unnecessary tax bracket currently punishes low-income earners, worsening their incentives and increasing the pointless tax/welfare churn. It likely only persists because most people are unaware it exists, and whichever party is able to explain and fix the problem will be able to claim reformist credentials that improve both efficiency and fairness.
Increase the top tax threshold up to at least $500k. Our current top tax rate kicks in much lower than most other comparable countries, applies to a much larger group of taxpayers, and is a significant barrier to productivity growth. Ideally the top tax rate should be cut (as argued by Paul Keating), but if that is not politically feasible at the moment then it should at least be changed so that it only applies to people on seriously high incomes. Behavioural tax modelling suggests that this reform could boost GDP by over $30 billion per year, while costing the budget less than $1 billion per year, which would make it one of the most effective productivity reforms of the last two decades.
In an ideal world we could do all of the above and more. We do not live in an ideal world, but even in our current reform-shy age it should be possible to achieve at least one of the above ideas.
Several of the proposed tax cuts would suit a reforming Labor government that is serious about economic policy. The current Albanese government has so far shown little interest in economic reform, but embracing one of the above policies would potentially change that reputation and put the Liberals on the back foot.
Perhaps more realistically, the Liberals have repeatedly claimed to be the party of lower taxes, but so far have not added any substance to that vague rhetoric. Any of the above ideas would help the Liberals to clearly differentiate themselves from Labor, and allow them to campaign on a substantive policy agenda that both boosts productivity and directly benefits millions of workers (and voters).
The greatest living economist Thomas Sowell once famously remarked that “the first lesson of economics is scarcity … the first lesson of politics is to disregard the first lesson of economics”. Good economic policy and good short-term politics do not always align, but they have in this instance. Australia desperately needs income tax cuts, and smart tax cuts will be popular. The only thing missing is some political leadership.
Dr John Humphreys is the Chief Economist at the Australian Taxpayers’ Alliance. He formerly worked for the Australian Treasury and the University of Queensland