Bracket creep is a tax increase by stealth

Everyone seems to be worried about how a possible GST increase will affect low and middle income earners. But we should be more worried about the impact of an actual tax increase that is happening right now. It isn’t hypothetical and it isn’t under discussion — all Australian taxpayers are being affected by it, as we speak.

No discussion paper was released about this tax hike. It hasn’t been explicitly legislated, and there has been no advertising campaign telling us about it. No major party won or lost an election because of the tax increase. And yet every taxpayer, from the poorest to the richest, is being hit by this tax hike – and the tax increase broadly hits low and middle income earners harder.

I am speaking of bracket creep. Every year, the share of income you and I pay in personal tax is going up, because tax thresholds are not indexed to wages or inflation. If your (stingy) boss only gives you a pay rise of inflation, your average tax rate will still go up. You will pay more of your income in tax, and your take home pay will go down after inflation. You are basically worse off entirely because of bracket creep.

And yet bracket creep is not the focus of our national tax debate. Why is this? It is because it only hits you if your income goes up in dollar (or nominal) terms. The salary figure on your paycheck has gone up, but you can buy less with this income after tax. This makes it pretty hard to see the tax increase explicitly. A GST increase is obvious; the tax hike from bracket creep is not. As a result, bracket creep is often thought of as a stealth tax.

The costs of this stealth tax hike are substantial. We have modelled the impact since 2012–13, which is the last time tax thresholds were changed. On average, Australian taxpayers are already paying $450 each in tax due to bracket creep, or $6.4 billion in total. If nothing is done, we estimate this cost will grow to be $1,181 per taxpayer in three years’ time, or $16.7 billion in total. This average cost is about equal to giving up a year’s pay increase.

This is a large tax hike: we estimate it raises as much revenue in 2018–19 as raising the GST to 12.5%. Yet the public debate has been minimal compared to the debate over a GST increase.

The forecast cost of bracket creep for most taxpayers will differ from the average, as shown in the interactive graph below. This indicates the expected extra tax you will pay in 2018–19, or equivalently the reduction in your take home pay in that year, because tax thresholds are not indexed.

 

This loss is converted into a weekly figure in the graph below. The average loss in take home pay is about $23 per week.

 

These dollar figures don’t reveal an important point about bracket creep: it hits low income earners the hardest. This uneven impact is shown in the interactive graph below. A person earning around $37,100 (in today’s money) is estimated to face an increase in average tax rate of 4.2 percentage points due to bracket creep. This is well above the average increase of 2.3 percentage points. The smallest increase for taxpayers in the graph is at the income of around $154,000.

Forget the argument that a GST increase is regressive and unfair because it has a larger impact on low and middle income earners. The tax increase we are already experiencing is unfair. What is more, a GST increase could be made fairer by increasing welfare payments, while there has been no compensation at all for bracket creep’s unfair tax increase.

The problems with bracket creep don’t end there. It is also increasing our reliance on the fairly inefficient personal tax system. Australia has a very high reliance on personal taxes in the developed world, and we are increasing this reliance every day that the tax system isn’t fixed. This is harming the incentives for work, particularly for women; and it is harming the incentives for many small businesses to innovate, invest and hire new workers.

Despite all of this, we’ve only had talk about fixing the problem rather than doing anything. The priority should be for personal tax thresholds to be indexed, preferably to average wages growth. This will stop the stealth tax increase, ensuring that tax rates only increase on taxpayers who receive an above average wage increase – this is exactly how the tax system should operate.

While inaction on bracket creep may only have a small cost initially, the cost clearly becomes larger and larger over time. If politicians do want to increase taxes to close the budget deficit, they should have to bring explicit proposals to Parliament and subject them to full debate, as would have to occur with a GST increase. We should not – must not – have a tax increase imposed on us by stealth.

Michael Potter is Research Fellow in the Economics Program at the Centre for Independent Studies. He is co-author (with Robert Carling) of the report Exposing the stealth tax: the bracket creep rip-off, released this week.