Articles – The Centre for Independent Studies

Budget should abolish low-income tax offset by bringing forward cuts

Robert Carling

25 April 2021 | Financial Review

With two weeks to go to the budget, the informed reports, rumours and speculation have started, with one suggesting the low and middle income tax offset (LMITO) will be extended for another year.

If this is true, it is misguided, and confirms Milton Friedman’s astute observation that “Nothing is so permanent as a temporary government program”.

On budget night, Frydenberg will likely announce a reduced deficit for next year and a declining deficit for the following three years.

That he can do so without politically difficult measures is thanks to the magic of an improving economy and the extra tax revenue it generates. But it’s also because so much of the fiscal support the government provided during the pandemic was temporary and the cost will disappear from the budget. The government won’t frame this as “budget repair”, but that’s what it is – and it has already started with the termination of JobKeeper.

However, the politics of temporary measures and their termination can be as tricky as a cut to an ongoing program. Temporary measures can gather a constituency in favour of their continuation. We saw this with JobKeeper, but in that case the government did not cave in to those calling for a second extension.

The LMITO was another temporary measure, and if the government doesn’t let it end in 2020-21 – as currently legislated – it will have to accept an $8 billion annual budget burden it wasn’t counting on.

The benefit of LMITO is not reflected in lower PAYG deductions through the year, but is calculated by the Tax Office after you submit your return, and then becomes part of your refund. In that sense it’s like a lump sum payment to taxpayers, the amount of which depends on your taxable income. For everyone in the income range $48,000 to $90,000 it is $1080, and less for those below $48,000 or above $90,000, cutting out completely at $126,000.

There are already people portraying the end of LMITO as a “middle class tax hike”. However, when looked at properly in the full context, it is not a tax increase and the government would be unwise not to end it.

The context is the full bag of tax cuts the government announced in the 2018 and 2019 budgets, of which LMITO was stage 1. Stage 2, which included an increase in the $37,000 tax threshold to $45,000, wasn’t to happen until 2022-23. In the meantime, the government provided an equivalent dollar benefit to taxpayers through the LMITO device, but only up to a certain income level to limit the budgetary cost. Once stage 2 came into effect, LMITO was to disappear as stage 2 delivered the same via a different route.

The LMITO was like a means-tested version of the stage 2 cuts, and its original purpose disappeared when stage 2 came into effect. To have kept LMITO going would have duplicated the cut for a large number of middle-income taxpayers. Ending it meant they would receive the same tax relief under stage 2 as under stage 1. That was understood and nobody complained when it was launched.

But then the government changed the timetable in the 2020 budget, bringing forward stage 2 to 2020-21 but not bringing forward the termination of LMITO to the same date. As an economic stimulus measure, they kept LMITO going for another year; which meant the tax cut was effectively doubled for a year for a wide range of income levels. This was a surprising move, taken when the government was throwing money around like a drunken sailor.

Now the sailor is sobering up, he faces the problem of removing the double tax cut and reverting to what was intended in the first place. The problem is purely political and of the government’s own making by extending LMITO in last year’s budget.

Some economists are saying it should be extended again as a stimulus measure, but this is hard to accept; given that the extension would deliver no cash benefit to taxpayers before July 2022.

There is nothing wrong with tax cuts, but LMITO – and its older brother LITO (low income tax offset) – are complex and messy ways of delivering them. They produce a multitude and illogical pattern of effective marginal tax rates. The Henry tax review called for the abolition of LITO, but now we still have it and LMITO as well.

If, for whatever reason, the government wants to give new tax relief in this budget, instead of extending LMITO it should bring forward some or all of the stage 3 cuts from 2024, which include a reduction in the 32.5 per cent rate applying above $45,000 to 30 per cent.

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