The Silent Tax Hike: How Bracket Creep is Costing You More Every Year
Bracket creep is one of the most insidious parts of our tax system. Each year, without any legislation or debate, there is an automatic tax increase that drives up tax revenue by billions of dollars, creating a built-in bias towards ever-larger government.
This secret tax hike should be a scandal.
Honest commentators from across the political spectrum have demanded an end to this automatic annual tax rise, but most politicians from the major parties remain strangely quiet. They apparently prefer to secretly rake in billions of dollars of extra tax each year so that they can hand that money back in handouts or nominal tax cuts in the hope of winning extra votes. This needs to change.
Bracket creep occurs when higher wages push people into higher tax brackets. This means that tax revenue increases quicker than wages.
The most egregious example of this is “inflation bracket creep”, where inflation pushes up nominal wages, leading people to pay extra tax on their income even though they are no richer in the real world. For example, if a hypothetical worker on $100k income and $100k expenses faces 10% inflation then they would soon have $110k income and $110 expenses. Their economic situation is effectively unchanged, but they now face a higher tax burden, which means that inflation bracket creep actually makes workers poorer. To make matters worse, this situation actually creates an incentive for governments to create inflation so that they can financially benefit.
There is also “growth bracket creep”, where a growing economy leads to growing real wages, pushing people into higher tax brackets. At first glance this sort of bracket creep seems more reasonable, since the higher tax comes from people who are genuinely earning more money. This is only half true. Growth bracket creep doesn’t make workers poorer, but it still automatically increases the size of government. This raises a pointed political question – if workers are getting richer, then why do we need a system that automatically increases the power of government? Given that government spending is often justified on the basis of helping people in need, why would we need more government spending at the exact time that there are fewer people in need?
Even if activists believe the government should be bigger, they should make that case explicitly to the voting public instead of sneaking it through via hidden bracket creep.
As an alternative, the ATA proposes the government to choose one of the following:
1. Index tax brackets to inflation. This would remove the unjustifiable inflation bracket creep, while allowing growth bracket creep to continue boosting government revenue.
2. Index tax brackets by 2.5% each year, as the mid-point inflation target of the Reserve Bank of Australia (RBA), as suggested by former RBA assistant governor. This has the benefit of simplicity, but the indexation would not be directly matched to bracket creep, and there would still be a warped incentive where the government benefits from high inflation.
3. Index tax brackets to both inflation and (non-negative) real wage growth. This would remove both inflation and growth bracket creep, removing all automatic tax increases and ensuring that the government would not grow without explicit legislation.
4. Retain bracket creep but require the automatic tax increase to be published annually in the budget, and scheduled tax cuts that offset that bracket creep.
All options would be a substantial improvement over the status quo. Most recent suggestions have been along the lines of options #1 or #2, though these have proven difficult to sell to the major parties. The 3rd option is arguably the most transparent, simple and efficient, though may be even harder to sell to a tax-hungry government.
The 4th option is arguably less exciting for tax experts, but it may also be the most politically achievable. By requiring automatic tax cuts to offset the automatic bracket creep tax increases, the problem of automatically growing government would be addressed. At the same time, by giving politicians the freedom to frame their own regular tax cuts, they would maintain some political benefit from their actions and would have the freedom to shift the tax burden according to their priorities.
The exact size of bracket creep (and therefore the budget cost of removing bracket creep) varies depending on how you choose to measure it and the specific level of inflation and wage growth in each year. In an average year it is at least $3-$4 billion, though during years of high inflation it can be much higher.
Regardless of which of the above options is taken, all would help to address the blight of bracket creep, slow the drift towards ever-growing government, and make our political system more transparent and honest.
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If we want real tax reform, we have to make it happen. With the federal election now confirmed for May, we have a limited window to pressure MPs and candidates to back policies that lower taxes and stop hidden tax hikes like bracket creep. The Fight for Real Tax Reform fund will help us take this battle directly to decision-makers, ensuring that tax relief is on the agenda before Australians head to the polls.
Chip in today and help us make tax reform a reality.