Personal income tax cuts Discussion paper Matt Grudnoff and David Richardson May 2018 Personal income tax cuts 1 ABOUT THE AUSTRALIA INSTITUTE The Australia Institute is an independent public policy think tank based in Canberra. It is funded by donations from philanthropic trusts and individuals and commissioned research. Since its launch in 1994, the Institute has carried out highly influential research on a broad range of economic, social and environmental issues. OUR PHILOSOPHY As we begin the 21st century, new dilemmas confront our society and our planet. Unprecedented levels of consumption co-exist with extreme poverty. Through new technology we are more connected than we have ever been, yet civic engagement is declining. Environmental neglect continues despite heightened ecological awareness. A better balance is urgently needed. The Australia Institute’s directors, staff and supporters represent a broad range of views and priorities. 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Level 1, Endeavour House, 1 Franklin St Canberra, ACT 2601 Tel: (02) 61300530 Email: [email protected] Website: www.tai.org.au Personal income tax cuts 2 Personal income tax cuts 3 Table of Contents Introduction ...................................................................................................................... 5 The Government’s tax plan .............................................................................................. 6 The income distribution of the proposed income tax cuts .............................................. 8 Conclusion .................................................................................................................. 13 Method ....................................................................................................................... 13 Inequality ........................................................................................................................ 14 Australia’s experience .................................................................................................... 19 Discussion ....................................................................................................................... 25 Progressivity ............................................................................................................... 25 Vested interests? ........................................................................................................ 26 Tax and prosperity .......................................................................................................... 27 Theory ............................................................................................................................. 29 Higher tax rates as a disincentive to work ................................................................. 29 The optimum top marginal tax rate ........................................................................... 30 Surcharges on unearned or property income. ............................................................... 32 Appendix: How the property income tax surcharge worked ......................................... 38 Polling ............................................................................................................................. 35 Conclusion ...................................................................................................................... 36 Personal income tax cuts 4 Introduction This paper examines the government’s 2018 personal income tax proposals by presenting a distributional analysis of the tax cuts and then looking at some general tax principles and considerations that we can use to assess the present proposals. We begin in the next section by outlining exactly how the government intends the tax cuts to operate. Personal income tax cuts 5 The Government’s tax plan This section is taken from Budget Paper No 1 and has not been edited in any way. Any non-neutral sentiments are in the original text. Step 1 – Tax relief to low and middle-income earners This first step targets personal income tax cuts to low and middle-income taxpayers, helping to relieve cost of living pressures. A new, non-refundable tax offset, in addition to the Low Income Tax Offset (LITO), will provide tax relief of up to $530 to low and middle-income earners for the 2018–19, 2019–20, 2020–21 and 2021–22 income years. The offset will be received as a lump sum on assessment after individuals lodge their tax returns. This low and middle-income tax offset will assist over 10 million Australians, with about 4.4 million taxpayers with incomes between $48,000 and $90,000 receiving the full $530 benefit for 2018–19. Step 2 – Protecting middle-income Australians from bracket creep The second step will ensure Australians take home more of their wages, rather than being penalised through a higher marginal tax rate as their wages grow (bracket creep). As part of the second step of the plan, the following changes will be made to the personal income tax system: • from 1 July 2018, the top threshold of the 32.5 per cent tax bracket will be increased from $87,000 to $90,000. This will provide a tax cut of up to $135 per year to about 3 million taxpayers and will prevent about 200,000 people from facing a marginal tax rate of 37 per cent in 2018–19. This is expected to prevent average full-time wage earners from facing a higher marginal tax rate of 37 per cent in 2019–20; • the top threshold of the 32.5 per cent bracket will then be further increased from $90,000 to $120,000 from 1 July 2022, providing tax relief of up to $1,350 each year. This change is projected to prevent about 1.8 million taxpayers from facing a higher marginal tax rate of 37 per cent in 2022–23; and • the benefits provided by the low and middle-income tax offset will be locked in by increasing the top threshold of the 19 per cent bracket from $37,000 to $41,000 and increasing the LITO from $445 to $645. Increasing the top threshold of the 32.5 per cent bracket builds on the change in the 2016–17 Budget which increased it from $80,000 to $87,000. Personal income tax cuts 6 Step 3 – Making personal taxes simpler and flatter The Government is simplifying and flattening the tax system from 1 July 2024 by reducing the number of income tax brackets from five to four. By increasing the top threshold of the 32.5 per cent bracket, thereby removing the current 37 per cent bracket, working Australians will face the same marginal tax rate for incomes between $41,000 and $200,000. The top marginal tax rate of 45 per cent will remain for incomes above $200,000. This change is projected to prevent about 1.8 million taxpayers from paying a marginal tax rate of 37 per cent or more in 2024–25. Australia has a progressive tax system which ensures that those with the greatest ability to pay contribute a larger share of all personal income tax revenue. In 2015–16 the top 20 per cent of taxpayers paid about 61 per cent of all personal income tax. Under the plan, this cohort is projected to continue to contribute a broadly similar share. When completed, the plan ensures that about 94 per cent of taxpayers are projected to face a marginal tax rate of 32.5 per cent or less in 2024–25. This compares with a projected 63 per cent of taxpayers in 2024–25 under current settings if there were no changes. The plan provides certainty to the majority of taxpayers that they will face the same marginal tax rate into the future, encouraging Australians to take on additional work, seek advancement and improve their skills. Table 1: New personal tax rates and thresholds 2018–19, 2022–23 and 2024–25 Current tax New tax thresholds New tax thresholds New tax thresholds Rate (%) thresholds From 1 July 2018 From 1 July 2022 From 1 July 2024 Income range ($) Income range ($) Income range ($) Income range ($) Tax free 0 - 18,200 0 - 18,200 0 - 18,200 0 - 18,200 19 18,201 - 37,000 18,201 - 37,000 18,201 - 41,000 18,201 - 41,000 32.5 37,001 - 87,000 37,001 - 90,000 41,001 - 120,000 41,001 - 200,000 37 87,001 - 180,000 90,001 - 180,000 120,001 - 180,000 - 45 >180,000 >180,000 >180,000 >200,000 Low and middle income tax offset - Up to 530 - - LITO Up to 445 Up to 445 Up to 645 Up to 645 Personal income tax cuts 7 The income distribution of the proposed income tax cuts In the 2018 Budget, the government announced a radical plan to reshape the income tax system over the next seven years. While the first stage of the plan largely involves tax refunds for low and middle income earners, stage two and three would remove the 37 per cent tax bracket – and, as a consequence, flatten