An Australian newspaper’s headline on the morning after the budget was SCOMO STOPS THE CREEP. The nation’s most ponderous political pundit intoned that the Treasurer would “eliminate bracket creep for the middle class”.
The man himself claimed his tax-cut plan “ran a sword through bracket creep”.
Sorry, yet another of Scott Morrison’s attempts to mislead us in a most misleading budget. He’s exploiting the public’s hazy understanding of what bracket creep is and how it works.
If you’re not paid to be treasurer, you can be forgiven for imagining that bracket creep occurs when pay rises or other increases in your income push you into a higher income tax bracket, causing you to pay more tax.
At present, the middle, 32.5¢-in-the-dollar bracket starts at incomes of $37,000 a year and runs to $87,000. Morrison plans to raise this upper bracket limit to $90,000 in July this year, then to $120,000 in July 2022, then $200,000 in July 2024.
At the moment, about 53 per cent of taxpayers have the last part of their income falling in that 32.5¢ bracket. But by the time he’s finished, he expects almost three-quarters of people to be in it.
Get it? Someone on $87,000 could see their income rise by 130 per cent before they were pushed into a higher tax bracket.
This is the basis for ScoMo’s claim to be pretty much killing off bracket creep. But it’s not as true as he wants you to believe.
Why not? Because chapter two of the The Idiot Politician’s Guide to Income Tax explains that you can suffer from bracket creep even if you don’t get pushed into a higher bracket. If that wasn’t true, people on the top, 45¢-in-the-dollar tax rate wouldn’t suffer from bracket creep – and I assure you we do.
How can it happen? It happens because everyone’s income is taxed in slices, and the rate of tax on each slice gets progressively (note that word) higher.
At present, the tax rates start at zero for the first $18,200 of annual income, then 19 per cent for the next $18,800, 32.5 per cent for the next $50,000, 37 per cent for the next $93,000 and 45 per cent for everything over that total of $180,000.
By the time ScoMo’s three-step, seven-year plan is intended to be in place in July 2024, however, it will be zero for the first $18,200 of annual income, then 19 per cent for the next $22,800, 32.5 per cent for the next $159,000, and 45 per cent for everything over that total of $200,000.
Ignoring the complication of the low-income tax offset, at that time someone on $41,000 would pay an average rate of tax on the whole of their income of 10.6¢ in the dollar, whereas someone on $200,000 would pay an average tax rate of 28¢ in the dollar.
Guess what? As the incomes of people at the bottom of the new, huge 32.5¢ bracket rose over time, their average rate of tax would rise from 10.6¢ in the dollar towards 28¢. And that would happen without them being pushed into a higher tax bracket. As an economist would say, their marginal tax rate would be unchanged at 32.5¢.
How can this happen? People’s average tax rate rises because, as their income increases, a smaller proportion of it is taxed at less than their marginal tax rate, while a higher proportion is taxed at their (higher) marginal rate.
For someone who, in 2024, is on $41,000 a year, 44 per cent of their total income would be taxed at zero, while 56 per cent would be taxed at $19¢ in the dollar.
By the time that person’s income has increased to $200,000 a year, however, only 9 per cent of their income is tax at zero, and 11 per cent at 19¢ in the dollar, leaving the remaining 80 per cent taxed at 32.5¢ in the dollar.
So the correct way to understand what economists call “fiscal drag” and punters call “bracket creep” is that it happens because people’s average rate of tax increases as their incomes rise.
What is true, however, is that actually moving into a higher (marginal) tax bracket accelerates the rate at which your average tax rate rises.
Bracket creep is an inevitable consequence of our “progressive” income tax. The term progressive means that as your income rises, the proportion of your income paid in tax gets progressively higher.
But what does most to make an income tax scale progressive is an initial zero-rate bracket. Say some crazed treasurer of the future decided to introduce a tax scale with just a single positive tax rate of 32.5 per cent. That would be still be a progressive tax scale provided it had a zero-rate bracket (a “tax-free threshold”) to start with.
Only if the 32.5 per cent tax rate started at an annual income of $1 would such a tax be a true “flat-rate” tax. Economists would say such a tax was neither progressive nor “regressive” (where the proportion of income tax paid declines as incomes rise) but “proportional”.
When you have a progressive tax scale, as every rich country does, the only way to (largely) eliminate bracket creep is to index each of the bracket limits to some measure of price or wage inflation no less frequently than once a year.
Except for a minor change in the 2016 budget, our tax scale has been unchanged since July 2012. Consumer prices have risen by more than 12 per cent since then, and the wage price index by 14 per cent. That’s a fair bit of bracket creep.
So what are Morrison’s plans for raising the bracket limits? The zero bracket would be unchanged, the 19¢ in the dollar limit would rise by 11 per cent, the 32.5¢ limit would rise first by 3 per cent, then a cumulative 38 per cent and then 130 per cent. The top, 45¢ bracket would rise by 11 per cent.
Whatever ScoMo’s objectives are, fixing bracket creep isn’t one of them.
