Media reporting of the budget office’s latest medium-term projections focused on its finding that, if there are no further tax cuts beyond the stage three cuts legislated for July 2024, the government’s collections of personal income tax may have risen 76 per cent by 2032-33.
The average rate of income tax paid by all taxpayers is projected to reach 25.5 cents in the dollar before the stage three tax cut drops it to 24.1 cents. But then it could have risen to 26.4 cents by 2032-33 – which would be an all-time high.
Why? Bracket creep. Income is taxed in slices, with the slices taxed at progressively higher rates. So, as income rises over time, a higher proportion of it is taxed at higher rates, thus pushing up the average rate of tax on all the slices.
Like the sound of that? No. Which is why the media gave it so much prominence. But there’s much more to be understood about that prospect before you start writing angry letters to your MP.
The first is that, according to the projections, even with such unrestrained growth in income tax collections, the rise in total government revenue wouldn’t be sufficient to stop the budget deficit growing a bit, year after year.
Why not? Because of the strong projected growth in government spending. That’s the first thing to register: the reason tax collections are likely to rise so strongly is that government spending is expected to rise so strongly.
Why? Because that’s what we want. The pollies know we want more and better government services – which is why no election passes without both sides promising to increase spending on this bauble and that.
What neither side ever does in an election campaign is present the bill: “we’re happy to spend more on your favourite causes but, naturally, you’ll have to pay more tax to cover it”. Indeed, they often rustle up a small tax cut to give you the opposite impression: that taxes can go down while spending goes up.
The budget office’s projections suggest that total government spending will rise from 26.2 per cent of gross domestic product in the present financial year to 27.3 per cent in 2032-33. This may not seem much, but it’s huge.
Nominal GDP – the dollar value of the nation’s total production of goods and services, and hence, the nation’s income – grows each year in line with population growth, inflation and any real increase in our average standard of living. So, for government spending to rise relative to GDP, it must be growing faster even than the economy is growing.
Briefly, the spending growth is explained by continuing strong growth in spending on the National Disability Insurance Scheme, the growing interest bill on the government’s debt, and the rising cost of aged care.
This being so, there seems little doubt we’ll be paying a bit more tax – a higher proportion of our income – most years over the coming 10, and probably long after that.
But that’s not to say things will pan out in the way described by the budget office and as trumpeted by the media. For a start, it’s unlikely any government would go for six years without a tax cut.
It’s true that governments of both colours rely heavily on bracket creep – aka “the secret tax of inflation” – to square the circles they describe during election campaigns; to ensure two and two still add up to four.
But they’re not so stupid as never to show themselves going through the motions of awarding a modest tax cut every so often – confident in the knowledge that continuing bracket creep will claw it back soon enough.
The next point is that the overall average tax rates the budget office quotes are potentially misleading. Every individual taxpayer has their own average rate of tax, with high income-earners having a much higher average than people with low incomes.
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But when the budget office works out the average for all taxpayers – the average of all the averages, so to speak – you get a number that accurately described the position of surprisingly few people. It’s like the joke about the statistician who, with his head in the oven and his feet in the fridge, said that, on average, he was perfectly comfortable.
There are plenty of things a government could do to reduce the tax concessions for high income-earners (like me) and to slant any tax cuts in favour of people in the bottom half, which would allow it to raise much the same revenue as the budget office envisages without raising the average tax rate paid by the average (that is, the median) individual taxpayer by nearly as much as the budget office’s figures suggest.
Fearless prediction: just such thinking will be what leads the Albanese government to make a start next year by rejigging the size and shape of the stage three tax cuts.
