Fiscal stimulus wrong priority for tax cuts

Robert Carling

31 May 2019 | Ideas@TheCentre

When the re-elected Morrison government’s enlarged personal income tax cuts — as announced in the April budget — come before parliament for approval in July, they are likely to meet resistance in the Senate.

It would help if everyone approached the issue with a broad appreciation of the economic reasons for income tax cuts. Too often, tax cuts are viewed through Keynesian eyes as a form of short-term fiscal stimulus to boost consumer spending and aggregate demand in the economy.

While stronger consumer spending in the months ahead may be welcome, that is not the only reason — or even the main reason — for reducing personal income tax. What Australia needs more than a quick stimulus are structural reforms that will lift investment, productivity and competitiveness and thereby strengthen long-term growth in the economy and living standards.

In the arena of personal income tax, the most effective policies would be to lower marginal rates and increase the thresholds at which higher marginal rates apply. This will improve incentives and increase the reward for effort and self-improvement. Such polices will not produce quick results, but they will pay handsome dividends in the longer term.

In contrast, the first instalment of the government’s tax cuts — and at this stage, the only part certain of receiving broad political support — takes the form of an increase in the Low and Middle Income Tax Offset (LMITO). This reduces the tax-take, but it also creates an illogical mishmash of effective marginal rates through its phase-in and phase-out zones designed to deny any benefit to taxpayers above a certain income.

Under the government’s plan, LMITO will be replaced by reductions in marginal rates and increases in thresholds that will leave everyone at least as well off as under LMITO, but this does not happen in full until 2024. In particular, by then there will be a reduced 30% marginal rate applying across a wide income range of $45,000 to $200,000.

The weakness in the government’s plan is not that it costs too much — after all, it is only returning the proceeds of bracket creep to taxpayers, and revenue continues to grow significantly. Rather, it is that the real reform comes too far into the future.

Ideally, the cuts to marginal rates and increases in thresholds would be brought forward, but if this is a bridge too far, setting future changes in legislation now is the next best thing.

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