The Treasurer Joe Hockey has outlined the case for change in Australia’s tax system, particularly personal income tax rates, in a speech to the Tax Institute and Chartered Accountants Australia and New Zealand.

Bracket creep

Mr Hockey said the starting point for tax reform must be bracket creep, when people are pushed up into higher tax brackets as a result of inflation and rising wages. He said he did not accept the view that “we can sit by and allow bracket creep to cover rising government spending”.

Apart from the increase in the tax free threshold in 2012, personal income tax brackets have not been significantly adjusted since the changes announced by the government in 2007 — and not since 2000 has the average full-time wage been in the second top marginal tax bracket, Mr Hockey said. In the next two years, without action, about 300,000 Australians will move into the second highest tax bracket and in 10 years, and if tax cuts don’t happen, almost half of all taxpayers will be in the top two tax brackets, a jump from 27% to 43%.

Mr Hockey provided the example of the average income earner on around $77,000 each year who is just below the second highest tax bracket of 37 cents in the dollar which kicks in above $80,000. At their current wage, they are taxed a marginal rate of 32.5 cents plus the Medicare levy. However, should they pick up an extra shift or receive a promotion, for every extra dollar they earn, they will be taxed at 39 cents including the Medicare levy. So the reward for effort is to move into a higher tax bracket to pay more tax, he said.

Mr Hockey said it was clear that governments give periodic tax cuts to maintain the incentives that reward effort. He pointed out that the burden of bracket creep falls disproportionately on low and middle income earners. For example, in 2010, a nurse would have been earning just over $50,000 and also paying less than 18%. Five years on, and with a salary of about $60,000, they are paying more than 20%. Mr Hockey said these people are deserving of income tax relief especially if they are earning significantly more as a result of increasing skills and seniority.

Personal income tax

Mr Hockey said that the problem is that Australia relies heavily on personal income tax. It is our largest source of tax revenue, raising around $170b per year, and when combined with corporate taxes makes up around 60% of tax revenue — compared with an average of 34% across the world’s top economies in the OECD, he said. To put it another way, Australia relies on revenue from income tax more than any other country apart from Denmark and this reliance is reflected in the high rates of tax, particularly at the top level. Australia’s highest marginal tax rate of 47 cents for each extra dollar earned, compares with New Zealand’s at only 33 cents, Singapore’s at 20 cents, and Hong Kong’s at only 15 cents.

In addition, Mr Hockey said Australia’s top rate kicks in relatively quickly, at $180,000, only 2.3 times the average full-time wage. This is extremely low when compared with other OECD nations, he said. In the United Kingdom, the top rate kicks in at 4.2 times their average wage. Mr Hockey said this matters because our existing personal income tax rates make us uncompetitive.

Mr Hockey pointed to research showing that high personal income taxes — along with company taxes — are particularly harmful for economic growth. A study of 21 OECD countries found that the proportion of tax revenues raised from taxing personal incomes is negatively correlated with growth. That is, it has an economic cost because it diminishes the capacity of individuals to use their take home pay for consumption, investment, innovation or job creation.

Even though governments have vital social spending responsibilities in areas such as social security, health, education, law and order, “we should not pretend that everything government spends taxpayer money on has an economic benefit”, Mr Hockey said. He also highlighted a social cost associated with high income tax rates, arguing that gradually but increasingly high personal income tax rates will become a major incentive for Australians to live and work overseas.

Mr Hockey said that while most of the world economy is lagging the performance of Australia’s economy, New Zealand has been performing well in recent years and is one of the fastest growing economies in the OECD. He said it is also making itself a more attractive investment destination with a top personal tax rate of just 33% and no payroll tax, suggesting this as a workable model to follow.

Other competition for our economy in the region — places like Hong Kong and Singapore — will become more and more attractive for service delivery exporters to relocate to with their very low income tax rates, according to Mr Hockey. Further, as Australia increasingly integrates into our region, more and more Australians will have the opportunity to participate in the wider Asian economy, he said. This could not only result in Australians physically moving offshore, but making investments in assets and capital moving from Australia to our Asian competitors, while they remain in Australia. This scenario poses a high risk not just for tax revenue, but for Australian business profits and Australian jobs, he said.

At present, 2.7% of Australian taxpayers fall into the top income tax bracket and they are paying more than 28% of all personal income tax. The top 10% pay almost half of all personal income tax, Mr Hockey said. This shows that Australia’s redistributive tax system has created a situation in which we as a nation are over-reliant on a very narrow base, he said.

Mr Hockey said that not only is our personal income tax system uncompetitive — it is increasingly penalising lower income or secondary earners in our society. This is particularly the case when our tax rates are mixed in with the transfer system for social security and can create some strong disincentives for working extra hours and, in some cases, working at all, he said.

Budget impact

Mr Hockey said the government is still committed to balancing and repairing the Budget. He said the Budget will be managed through continued discipline on spending decisions and pinpointing government waste.

States and territories

Mr Hockey said that the “authors of tax reform” must come from all quarters, from every state and territory government, and from across the political divide.

He said he was pleased to have made some progress in this area, having recently met with state and territory treasurers to discuss the future of Australia’s tax system. He cited the decision reached to abolish the GST low-value threshold on goods imported into Australia and discussion on the sustainability of Australia’s revenue base and the economic merit of particular taxes.

Mr Hockey concluded that the government’s forthcoming options paper on tax reform will therefore include options for cutting personal income tax.

Source: Treasurer’s speech to the Tax Institute and Chartered Accountants Australia and New Zealand, “The economic case for personal income tax cuts”, 24 August 2015.