Home > Economics, Environment > A closer look at the income tax changes

A closer look at the income tax changes

July 10, 2011

The government has announced their plans for a new carbon tax, and the related compensation payments and tax cuts. The good news is that the government is increasing the tax-free threshold and winding down the confusing and misleading “low-income tax offset” (LITO). Next year the tax-free threshold will increase to $18,839.

Unfortunately, the government continues to hide the actual marginal tax rates by reporting the LITO and medicare levy separately from the “headline” marginal tax rates. The actual marginal tax rates for 2011, 2012 and 2015 are at the bottom of this post. As you can see, they are as confusing as ever. Some points to note…

  • The government is claiming to increase the tax-free threshold from $6000 to $18,200 and have an effective tax-free threshold of $20,542. This is misleading for a number of reasons. First, the current TFT is actually $16,000 and so the increase is not as large as they say. Second, while normal income tax may not kick in until $20,542 the medicare levy kicks in at 10% for people earning over $18,839. This was a great opportunity for the government to scrap the mis-named medicare levy, or at least get rid of the regressive 10% bracket ($18,839 to $22,163). So the actual change in the TFT is from $16,000 up to $18,839. That’s the first bit of good news.
  • In winding down LITO the government has had to adjust some other tax rates. It has been reported that they are increasing the 30% bracket up to 33%, but that isn’t right. In reality (as seen in Table 1 below) the current rate is actually 35.5% for people on $37 – $67k, and that doesn’t change under the new scheme. Also, the current rate is actually 20.5% for people on $30 – $37k, and that doesn’t change under the new scheme. People earning between $30 – $67k will be paying about $300 less tax per year and will not face higher marginal tax rates. That’s the second piece of good news.
  • But not everybody is so lucky. People on $20.5 – $22.2k will see their marginal tax rate increase from 25% to 29% and people on $22.2 – $30k will see their marginal tax rate increase from 16.5% up to 20.5% (see bold tax rates in the tables). As can be seen, these rates remain regressive due to the absurdity of the medicare levy 10% bracket. While these low-income earners will actually be paying less tax thanks to the higher TFT, they will be facing a higher marginal tax rate. This is important because it is the marginal tax rate that determines the incentive to work. Somebody on $21k/year will now have an effective marginal tax rate (EMTR) of 72% (up from 70%) once you factor in the 60% withdrawal of welfare. These high EMTRs create a disincentive to work and can lead to a “poverty trap”.
  • The other group who face higher marginal tax rates are those earning between $67 – $80k, who will see their marginal tax rates increase from 31.5% up to 34% and then 34.5% in 2015 (see bold tax rates in the tables). It is worth noting that these people will not be paying more tax (indeed, somebody on $80k will be paying $3 less tax per year), but they will be facing a slightly bigger disincentive against work.
  • It is worth remembering that income taxes are implicitly increased every year due to bracket creep, where inflation pushes people into higher tax brackets even through their real (inflation-adjusted) income hasn’t improved. As Clinton Mead has shown, when you factor in bracket creep over the next two years, these tax cuts are mostly gone, and anybody earning over $40k will see a tax increase. (Note that Clinton does not include the medicare levy, and so his tax rates can’t be directly compared to the rates I provide below.)
  • It is also worth remembering that these tax cuts are supposed to be compensation for a new carbon tax. However, while the carbon tax is designed to increase (from $23/tonne to over $100/tonne if government modeling can be believed) the tax cuts will not continue to increase. There is a tax cut in 2012 and another small cut in 2015, and then no further scheduled tax cuts.

In summary, these tax changes are a bit hit and miss — helping people on  about $18k or $50k, but decreasing the work incentive for people on about $25k or $75k. The biggest problem with these tax cuts is that they are far too small. The tax cuts are enough to compensate for 2-3 years of bracket creep, but then after that there is no compensation for the ever-increasing carbon tax or future years of bracket creep. The government has also missed an opportunity to index income tax brackets (ie stop bracket creep) or to entirely phase-out LITO or to remove the absurdities of the medicare levy.

Some people are seeing that the government is churning a lot of  money around the economy, and they are accusing the government of simply engaging in wealth redistribution. I think that accusation is missing the point. If the government wanted to redistribute from rich to poor, then they wouldn’t use a carbon tax — which is a regressive tax that hurts poor people more than rich people. The main redistribution from the proposed carbon tax is from people (both poor and rich) to the government.

I have previously said that a carbon tax could be a benign policy if the rate remained low & fixed, and it was matched with real tax reform. The changes proposed today to not meet that requirement. The government is introducing a growth tax and billions of dollars of new spending, and offering token income tax cuts that will soon disappear in bracket creep, while actually making the work incentive worse for many people. I have an open mind to including a carbon tax in tax reform… but the carbon tax proposal we saw today is no good.

UPDATE 11/07: The original version of this article incorrectly stated that EMTRs for people on 21k were now 89%. This was incorrect, and it has now been fixed. Thanks to Prof Peter Whiteford for pointing out the error.

Table 1: Actual marginal tax rates (2011)

MTR Tax paid

$0

$16,000

0.0%

$16,000

$18,839

15.0%

$426

$18,839

$22,163

25.0%

$1,257

$22,163

$30,000

16.5%

$2,550

$30,000

$37,000

20.5%

$3,985

$37,000

$67,500

35.5%

$14,812

$67,500

$80,000

31.5%

$18,750

$80,000

$180,000

38.5%

$57,250

$180,000

$250,000

46.5%

$89,800

Table 2: Actual marginal tax rates (2012)

MTR Tax paid Tax cut

$0

$18,839

0.0%

$18,839

$20,542

10.0%

$170

-$256

$20,542

$22,163

29.0%

$640

-$616

$22,163

$30,000

20.5%

$2,247

-$303

$30,000

$37,000

20.5%

$3,682

-$303

$37,000

$66,667

35.5%

$14,214

-$599

$66,667

$80,000

34.0%

$18,747

-$3

$80,000

$180,000

38.5%

$57,247

-$3

$180,000

$250,000

46.5%

$89,797

-$3

Table 3: Actual marginal tax rates (2015)

MTR Tax paid Tax cut (from 2011)

$0

$18,839

0.0%

$18,839

$20,979

10.0%

$214

-$212

$20,979

$22,163

29.0%

$557

-$699

$22,163

$30,000

20.5%

$2,164

-$386

$30,000

$37,000

20.5%

$3,599

-$386

$37,000

$67,000

35.5%

$14,249

-$564

$67,000

$80,000

34.5%

$18,734

-$16

$80,000

$180,000

38.5%

$57,234

-$16

$180,000

$250,000

46.5%

$89,784

-$16

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  1. July 10, 2011 at 8:23 am | #1

    Good to see you are still quick of the mark.

  2. July 10, 2011 at 10:01 am | #2

    Thanks for the very informative post.

    It took me quite some time to work out that the 15% rate will increase to 19% and the LITO will be reduced to $445 in 2012 and then $300 in 2015. very little about the changes in rates etc has been talked about in the mainstream media.

    Will the changes to the carbon tax and other taxes be Janurary or April or July 1st 2015? I asume that the coalition will win the 2013 election and could make further changes, but if Labour/Greens keep the Senate things could get interesting

    Hopefully one day a future government can be brave enough to remove GST exemptions, increase the rate of GST to 15%, abolish the Medicare levy, the LITO, and reduce the 19% tax rate back to 15% and maybe slightly increase the tax free threshold to compensate for abolishing the LITO. That would be real tax reform.

    • Clinton Mead
      July 11, 2011 at 3:17 am | #3

      Real tax reform would be abolishing the GST, LITO and Medicare Levy. The gain from removing the LITO would more than cover removing the Medicare Levy, with a little left over for a rise in the tax free threshold.

      And GST revenue just goes to the states anyway, so instead they can raise their own revenue how they see fit. If they want to continue the GST, they’re welcome to do so voluntarily, but states such as WA could opt out.

  3. July 11, 2011 at 3:22 am | #4

    @Nicholas — I believe the changes will occur on 1 July. If the Greens keep balance in the Senate then it may not be possible to remove the carbon price, but it will be interesting to see whether a Coalition government is able to adjust it so that the price remains low and fixed (which would be an improvement).

    @Clinton — our constitution doesn’t allow state governments to raise “excise or customs” which has been interpreted to include the GST (as a “general excise”). I would prefer to see income tax decentralised to the state government level, and GST kept by the federal government as their only tax.

  4. July 14, 2011 at 12:48 pm | #5

    Thanks for this post. I’d been searching for a while to work out what the real tax changes were, but it’s not been easy to find.

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