The personal income tax scales have been fiddled with 18 times since 1983, seven of them big changes and 11 fairly small ones.
If income tax rates had not been changed in the past 40 years, and the wages at which they cut in had simply been increased with inflation, personal income tax revenue would be $170 billion more than it is now, there would be no budget deficit, structural or otherwise, and tons of money for government services.
Almost all of those changes were designed to gain political points by giving back bracket creep with a flag-draped flourish at a press conference, but they did much more than that.
Bracket creep happens when you get a pay rise that takes you into a higher tax bracket, so your tax increases more than your income.
There was a brief attempt by Malcolm Fraser in the 1970s to index the income tax scales so that CPI wage rises would not result in an increase in anyone’s marginal tax rate.
But that idea was quietly strangled behind the garage after just one year because it removed the option for politicians to win votes by giving tax cuts that simply give back CPI bracket creep.
Both sides of politics have been happily doing that ever since, so I decided to see what would have happened if they hadn’t, and tax indexation had continued.
Sure enough, I found they have been handing back much more than the impact of inflation. In the process, 40 years of fiddling has disastrously undermined the tax system for short-term political gain (what a surprise!).
How it works
First, a brief excursion into the economics and ethics of bracket creep.
The basic idea of a progressive income tax system is that those who earn more should pay a higher percentage of their income in tax.
The way it works is that every dollar of income above a certain threshold attracts a higher rate of tax than the dollar below it. There are usually two or three jumps before you get to the top rate.
In 1951, the top rate was 75 per cent. In 1955, it was cut to 67 per cent, where it stayed until 1983 when it was cut to 60 per cent, then 57, 49 and finally 45.
There are four ways to get a pay rise:
- Get a CPI increase
- Go on strike or otherwise negotiate a larger increase than CPI
- Get promoted
- Change jobs.
All of them result in bracket creep, but the only one that should be given back is the creep resulting from CPI increases.
The whole point of progressive taxation is that those who are better off should pay tax at a higher marginal rate, and that includes those who become better off over time. And by definition you become better off if your income increases faster than inflation.
So when wage rises greater than the CPI take people into higher tax brackets, that money should be kept by the Tax Office, and not handed back through tax cuts.
In other words, I agree with indexation of the tax scales, and wish that Malcolm Fraser and his treasurer Phillip Lynch had stuck with it. But they didn’t, and here we are.
Now to my calculations, and a warning: The numbers are simplified and ignore a lot of complexities, so they should be taken as a guide. I ran my sums past a contact in Treasury and he came up with a smaller difference, but it doesn’t change the basic point. And there’s a lot of numbers, so fasten your seat belt.
In 1983, the income scales were as follows:
- 30c for each $1 over $4595 up to $19,500
- $4471.50 plus 46c for each $1 over $19,500 up to $35,788
- $11,963.98 plus 60c for each $1 over $35,788
In other words, the top marginal rate was 60 per cent, cutting in at $35,788.
Total personal income tax revenue that year, by the way, was $24.8 billion.
In 1983, the consumer price index was 35; now it’s 128.4 – an increase of 3.67 times.
If we keep the 1983 marginal tax rates of 30, 46 and 60 per cent, and simply multiply the wages at which they start by 3.67, we get new thresholds of $16,410, $71,565 and $131,342.
So to be clear: If tax indexation alone had applied over the past 40 years, rather than the 18 fiddles, we would now have a top marginal rate of 60 per cent that kicked in at $131,342.
The ATO website contains detailed data on people’s taxable incomes.
It turns out that 6.9 million Australians earn between $16,410 and $71,565, and make a total of $317.7 billion; 3.3 million earn between $71,565 and $131,342 and make a total of $319.4 billion; and 1.1 million people earn over $131,342, and make a total of $278.4 billion.
If I apply the 1983 marginal tax rates to those amounts, I get total personal income tax revenue of $409.3 billion.
Quelle horreur!
According to the recent final budget outcome papers, income tax from individuals in 2021-22 totalled $239.7 billion – $169.6 billion less than it would have been had nothing but indexation applied from 1983.
The deficit in the year just finished was $32 billion; it could have been a surplus of $137.6 billion.
I tried this out on a dozen well-paid academics, lawyers and executives over lunch this week, and the idea of a 60 per cent top marginal tax rate was greeted with horror and cries that they would immediately emigrate.
And 60 per cent tax is right up there, it’s true. Only two countries do that – Finland and Switzerland (two of the happiest nations on Earth, as it happens).
Mind you, 40 years ago most countries had top marginal income tax rates of 60 per cent or more, but they were driven down by the wave of anti-government neoliberalism in the 1980s and ’90s.
But it would be a big call to join them and return Australia to an income tax rate of 60 per cent, although most of the countries with lower income tax rates have much higher GST rates. It won’t happen.
An alternative to keeping the same income tax scales and not having a structural deficit might have been to tax Australia’s resources profits properly, but that didn’t happen either – it was tried by Kevin Rudd, and torpedoed by the tax-cutting Coalition.
But it’s worth knowing, I submit, that the reason the Australian government has a long-term structural budget deficit is that successive governments – Labor and Liberal – have buggered up the tax system with short-term political decisions to hand back all bracket creep, not just the result of inflation.
At the very least, they should stop doing that – most bracket creep is just progressive taxation working as it should.
Alan Kohler writes twice a week for The New Daily. He is also founder of Eureka Report and finance presenter on ABC news
