Tuesday, August 09, 2022

Stage 3 Tax Cuts

The so-called Stage 3 Tax Cuts are a conundrum for the Albanese Government. As a reminder the cuts were legislated as part of a package in 2018 (hence Stage 3) and will cut the rate applying to incomes over $45,000 from 32.5 cents in the dollar to 30 cents and will extend that low rate all the way up to $200,000, abolishing an entire rung of the tax ladder paid by the highest earners. For those very high earners, the part of their income that was taxed at 37 cents will be taxed at 30, as will part of the rest that was taxed at 45 cents.

It was politically necessary for Labor to promise to honour the Stage 3 cuts going to the election, and it is a mantra after the election that they will keep their election commitments. However, circumstances change. While we knew about the break-out of inflation just before the election (but well after Labor made the commitment), it has been even more severe than expected at that time.

The RBA has consequently been raising the cash rate aggressively. It has been doing tis earlier than its original timetable of 2024 because the economic conditions changed. As stated in the famous dictum "when the facts change I change my mind, what do you do sir?"*

It is reasonable to wonder why a government would legislate for a tax cut so far in advance. One possible reason is to obtain the stimulatory effect of a tax cut while not facing the immediate fiscal consequence. Recall that growth in Australia in (calendar) 2018 was sluggish at best. With interest rates already low and inflation below the target band, the RBA was urging government to stimulate the economy. 

So much changed with the pandemic's arrival in 2020. Interest rates further cut, stimulatory spending by government on an unprecedented scale and massive change to the structure of economic activity, including the now familiar "supply chain pressures". To this already explosive cocktail President Putin added a war that has sent energy prices soaring. 

From the perspective of the economy the facts have changed, so it would be reasonable to change one's mind on the tax cuts. But is it politically feasible.

The Essential Report today shows that 44% of rspondents are very concerned about inflation, while another 44% are somewhat concerned. In the same survey 42% supported "delaying" the stage 3 tax cuts, and only 25% opposed such a move. It is unclear what "delaying" the tax cuts would mean to voters.** 

What seems to be both essential for the economy and politically feasible is some fine tuning of the stage 3 measure. The first needs to be about more effectively addressing the effects of bracket creep at the bottom of the scale. The second needs to be about not excessively reducing tax for households that will spend extra on discretionary expenditure. 

That would entail a shift upward of the taxfree threshold of $18,200 and the top of the 19% rate from $45,000. The mathematics needs to work backward to calculate the point at which the revised tax free threshold would give a tax payer the same total saving from the reduction of the 32.5% rate to 30% as currently legislated. The most critical change is to not abolish the 37% rate, but its range should be expanded, possibly cutting in at $130,000 and cut out at $200,000. 

These need to be sold as temporary measures to address the immediate needs of targeting the benefits of tax cuts to the households most experiencing 'cost of living pressure.' The longer term tax policy needs to be grounded in yet another review, but this one should be premised on no changes to the tax system until after the next election. 

I wouldn't like to be Jim Chalmers, but no change to Stage 3 seems to be an untenable position. 

* Sometimes attributed to Winston Churchill or John Maynard Keynes, quoteinvestigator attributes it to Paul Samuelson. In doing so they note another case in which Samuelson referred to it as having been said by Keynes, but no other evidence has been found. It is notable that Samuelson's use was on the topic of inflation.

** The results of the Essential Report survey need to be handled with caution. 65% of respondents said that they had heard hardly anything or nothing at all about the proposed Voice to parliament in the last month, so they are possibly not a group most across contemporary political reporting, though this may be generally representative of the population. . Regardless of what they heard 65% supported the proposed voice.  

Life is what happens while you are busy making other plans JWL

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