Would Labor’s tax rise plan crush incentive?

By Leith van Onselen

Prime Minister Malcolm Turnbull will address the Committee for Economic Development of Australia summit today, whereby he will reportedly argue against Labor’s push to retain the temporary deficit levy – which would result in the highest marginal tax rate remaining at 49.5% – by claiming that it would deter people from striving to “get ahead” and will act as a “handbrake on prosperity”. From The AFR:

“If we recognise that we are all born equal, then surely it follows that everyone deserves an equal chance of improving their stocks in life. One of the marks of an advanced society and a developed, well functioning economy, is that each generation strives to improve on the last, and has a good chance of doing so,” he will say.

“Liberals not only believe in this ideal, we believe that it is the government’s duty to help enable it.

“You cannot reduce inequality of opportunity by putting up barriers that stop people getting ahead. Rather, these barriers entrench the wealth or poverty that people are born into”…

“The last time the top rate plus the Medicare levy was higher was in 1988-89, when it was 50.25 per cent,” he will say.

“Returning to that bygone era would send a very poor signal to all Australian workers: don’t bother trying to earn just over two times average full time weekly earnings.

“Because once you do, half of every additional bit of effort; half of every extra hour you work; half of every new idea you generate – indeed, half of your extra perseverance, determination and enterprise – belongs to the government.

“This undermines aspiration and fairness, while worsening incentives and economic efficiency.”

Turnbull’s logic around cutting the top tax rate has an inherent flaw. Just because you have lowered tax rates at the upper end doesn’t mean these people will work more. Most people earning over $180,000 are salary earners, and the amount they work is unaffected by tax rates.

Even if these high income earners have have flexibility in their work arrangements, they are just as likely to choose to work less, play golf, and receive the same take-home pay. So the impacts on labour participation from cutting their taxes are uncertain.

The impacts on economic growth from cutting high income earners’ taxes are also uncertain. Higher income earners have a higher ‘marginal propensity to save’ (MPS). That is, they are more likely to save any tax cut than poorer people. Hence, lowering their taxes could actually lower growth compared to the government spending the same money on services or infrastructure, or giving a tax cut to those on lower incomes, who have a lower MPS.

So, if the goal of tax cuts is to boost aggregate demand, growth and jobs, then it would be better to fix-up incentives at the lower end of the tax scale to encourage would-be second income earners to move into the workforce, thus boosting labour participation. It would also be more equitable.

While Turnbull’s logic around cutting the top marginal tax rate is dodgy, it is true that Australia is becoming far too reliant on personal income taxes.

As shown in the below Treasury chart, Australia more reliant on income and profits taxes than it was in the 1950s, and will become even more so over the coming decade as bracket creep (aka “fiscal drag”) increases workers’ tax burdens:

Treasury has also noted that this bracket creep is highly regressive and inefficient, with those on lower marginal tax rates to be most affected by ‘bracket creep’:

…average ordinary full-time earnings were around $75,000 in 2013-14, and are expected to be around $104,000 in 2023-24 (see Chart 2.8). Someone on average full-time earnings therefore had an average tax rate of 22.7 per cent in 2013-14, increasing to 27.4 per cent by 2023-24. By contrast, someone with only half that income earned $37,500 in 2013-14, increasing to $52,000 in 2023-24. However, their average tax rate will increase from 10.3 per cent to 17.8 per cent. Someone earning twice the average full-time wage is on $150,000, increasing to $208,000 in 2023-24, but their average tax rate will only increase from 30.5 per cent to 34.3 per cent.

Ultimately, genuine tax reform requires broadening the tax base and building it around more efficient and equitable sources. It also requires unwinding Australia’s many world-beating tax concessions (e.g. superannuation, negative gearing and capital gains tax discounts, and fringe benefits), which cost the Budget billions of dollars in foregone revenue and are skewed towards the wealthy and higher income earners.

Sadly, neither Labor or the Coalition have offered comprehensive plans for tax reform, and have instead offered piecemeal measures.

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