Why Labor should scrap the Stage 3 tax cuts

Oct 22, 2020

The Government’s stage 3 tax cuts due to come into operation in 2024-25 should be scrapped. They are too costly and too biased in favour of the highest incomes. Instead, there are other better ways to support economic growth using the money, such as Labor’s recently announced policy of increased subsidies for childcare.

The first two stages of the Government’s revamping of the personal income tax scales are now operating – the second stage having been brought forward in the recent budget. However, the third stage is not due to become operational until 2024-25 – almost four years away and after the next election.

This third stage of the tax package involves:

· Removal of the present 37c bracket

· An increase in the threshold for the 45c bracket from $180,000 to $200,000

· A reduction in the 32.5c marginal tax rate to 30c

The big selling point of this third stage tax “reform” is that, as a result of these changes, everyone earning between $45,000 and $200,000 – and that is most full-time workers – will then all pay the same marginal tax rate of 30%.

The Grattan Institute has estimated that this stage 3 tax cut will reduce government revenues by $12 billion in 2024-25, and that number will grow each year beyond that. It also represents more than half the total cost of the overall tax package and is about the same as the amount the Government spends on subsidising medicines each year.

Furthermore, these stage 3 tax cuts are heavily biased in favour of the top fifth of taxpayers. The Grattan Institute has estimated that 60 per cent of the total benefits from the Government’s overall tax plan flow to the top 20 per cent of tax-filers with the top 20 per cent getting an extra $7k+ on average, from 2024-25.

The stage 3 tax cuts will definitely make the tax system less progressive. Although the Treasurer has argued that the share of tax will rise slightly for the top 5 per cent and 1 per cent of taxpayers in 2024-25, this is misleading. Indeed, the Treasurer’s own budget numbers show the share of tax falling for the top 20 per cent and 10 per cent of taxpayers and increasing for the middle 60 per cent of taxpayers.

In addition, the Government was irresponsible to lock in tax cuts so far as five years in advance. We just do not know with sufficient certainty how much revenue will be needed and how much will be available, that far ahead.

To its credit, Labor originally opposed this third stage of the tax package, and recently Shadow Treasurer Jim Chalmers indicated that Labor might re-consider these Stage 3 tax cuts after the next election if Labor wins.

Some revamping of the income tax scales might well be appropriate in four years’ time if only to offset the impact of bracket creep as people move into a higher tax bracket due to inflation. But that could be done at a much lower cost to the revenue than the annual $12 billion cost of these stage 3 tax cuts.

Nor, most importantly, will these tax cuts in favour of the top 20 per cent improve the performance of the economy. The empirical evidence just does not support the hypothesis, that the present tax rates are acting as a significant disincentive to either work or investment.

Instead, Labor’s proposal to subsidise 90 per cent of the cost of childcare will have a much more positive impact on the economy as it can confidently be expected to lift female workforce participation.

While Labor has still to settle the details of its childcare policy, the Grattan Institute has proposed a broadly similar policy. According to the Grattan estimates if the childcare subsidy is increased to as much as 95 per cent, but then gradually tapered out for families with income above $68,000, then the cost to the budget would be an extra $5 billion a year. However, the payoff would be an $11 billion increase in GDP from the boost to workforce participation.

In sum, the best outcome would be that Labor scraps the stage 3 tax cuts, if it wins the next election. Instead, Labor should promise to use a bit less than half the money saved for its childcare proposal.

What might happen to the other $6-7 billion saved is less clear at this stage. It depends upon how much more will be needed to restore the funding of other essential services that the Morrison Government has ignored. In addition, it will probably be desirable to undertake a much less costly and much fairer revamping of the tax scales to take effect in 2024-25.

It is probable, however, that Labor will need to consider other additional sources of revenue to meet all the legitimate demands. But that just reinforces why it is so important that Labor scraps the stage 3 tax cuts and uses this money better.

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