Morrison plan shows who he thinks most deserves a tax cut

Scott Morrison wants this election to be all about his redoubled plan for lower taxes. But Treasurer Josh Frydenberg doesn’t want anyone saying it will stop income tax being “progressive”. He’s right. But his claim that the tax system will remain highly progressive is debatable.

In last year’s budget, Morrison announced a three-stage tax cut, spread over seven years. It had a cumulative cost to the government’s revenue of a massive $144 billion over 10 years, with most of that cost coming in the later years.

In the budget Frydenberg produced last week, he doubled down on last year’s plan. He doubled the early part and greatly increased the later parts, at an additional cost of $158 billion over 10 years, taking the total cost to more than $300 billion – an incredible sum in several senses.

I’ll explain the grand plan in a sec, but first let’s be clear on the meaning of three words you hear bandied about whenever tax changes are debated: progressive, regressive and (less commonly) proportional.

A tax is said to be progressive when it takes a progressively higher proportion of people’s income as incomes rise.

The key word here is proportion. You judge “progressivity” not by the dollar amount people pay, or the amount of the cut they get, but by how that amount compares with their income. When a tax takes a higher proportion of a higher income than it does of a lower income, it’s progressive.

Conversely, a tax that takes a higher proportion of lower incomes than it does of higher incomes is said to be regressive.

A tax that takes the same proportion of all incomes, whether high or low, is said to be (you won’t believe this) proportional. It marks the borderline between progressivity and regressivity.

The main progressive tax is personal income tax. The example of a regressive tax people always quote is the goods and services tax.

But, in fact, almost all other taxes are regressive – with the notable exception of tax on the value of land (such as council rates), which is progressive because people with high incomes tend to own more land and more valuable land.

What makes income tax progressive is that your income is taxed in slices, with each extra slice being taxed at a higher rate.

Under the present tax scale – which Morrison’s plan would change in coming years – the first $18,200 of your income goes untaxed, the next $18,800 is taxed at 19¢ in the dollar, the next $53,000 at 32.5¢, the next $90,000 at 37¢, and anything above that at 45¢ in the dollar. (All of which is before you add 2¢ in the dollar for the Medicare levy.)

The slice (or tax bracket) into which the last part of your income falls determines your “marginal” tax rate – the rate you pay on any increase in your income.

Your average tax rate is determined by adding up all the tax you pay on each slice, then dividing that total by your income. Your average tax rate will always be a lot lower than your marginal rate.

For an income tax to be proportional it must have only one rate and no first, tax-free slice. So any income tax scale with a tax-free threshold must be progressive, even if only mildly so.

Now the details of Morrison and Frydenberg’s grand plan. As I said, it cuts tax in three stages over seven years.

The first is an immediate, reasonably generous tax cut (equivalent to about $20 a week) to people on middle incomes, earning between $48,000 and $90,000 a year. Those below that range get a lot less, as do those above it.

The second stage, which comes in three years’ time, July 2022, offers nothing much for people earning below $90,000 a year. For those earning more, there’d be a new tax cut ranging from nothing to $26 a week for those on $120,000 and above.

The third stage, coming a further two years later, in July 2024, offers tax cuts for everyone earning over $45,000 a year, ranging from nothing to about $65 a week for those on incomes up to $180,000 a year – plus another saving of up to $58 a week for those earning up to $200,000 and above.

But here’s a tip. You can think of the first, immediate stage as almost certain to be received because, though it has been only partially legislated, Labor has pledged to put it through.

It’s uncertain, however, whether we’ll ever see the other two stages. It’s not just that they’re so far into the future. It’s also that, though last year’s stages two and three are legislated, Labor says it would repeal them. As for this year’s enhancements of stages two and three, they're not yet legislated, and Labor won’t have a bar of ’em.

But, assuming stages two and three actually come to pass, how would the plan change the tax scale’s progressivity?

Well, with marginal tax rates varying from zero on income up to $18,200 a year, to 45¢ in the dollar on income over $200,000 a year, there can be no doubt that income tax would remain progressive.

But Frydenberg’s claim it would remain “highly progressive” is debatable. Presumably, he bases this on the estimate that the top 6 per cent of taxpayers, those earning more than $200,000 a year, would still be paying 36 per cent of total income tax collections in 2024-25.

Given the (no doubt optimistic) assumptions about how fast wages grow between now and then, this may be arithmetically correct. But it ignores the way the introduction of a massive 30¢-in-the dollar tax bracket running from $45,000 a year to $200,000 would put a big kink in the tax scale, making it significantly less progressive than it was.

The proof: whereas people on incomes between $45,000 and $90,000 would have their average tax rate cut by about 2.5 percentage points, this then rises to a cut of 4.8 percentage points for those on $180,000, before jumping to a maximum cut of 5.8 points for those on $200,000 and above. It’s tough at the top.