Minimum wage faces the brunt of bracket creep

All marginal rates of personal income tax are excessive and will become a bigger problem as bracket creep pushes more people into higher brackets. But whereas this point is often made in reference to the higher marginal rates, it is about to become dramatically more apparent at the other end of the income scale.

There is widespread awareness of bracket creep in general terms, but not of the fact that low income earners feel the impact more than others. This happens because most of the increase in marginal rates in the progressive scale (from zero to the 30% range) takes place over incomes up to $37,001. The Parliamentary Budget Office estimates that the average income tax rate will rise from 22.7% currently to 25.9% in ten years, which would make the income tax burden the heaviest on record. But for a minimum wage earner, assuming modest 3% a year wage increases, the average rate will rise even more steeply from 9.2% to 15.5%.

One of the most dramatic illustrations of this point will arise within the next year and is likely to make bracket creep a bigger political issue in the lead-up to the next election. Adult full-time minimum wage earners are now just below the $37,000 income tax threshold at which the headline marginal rate jumps from 19% to 32.5%. The current adult minimum wage expressed as an annual amount is $36,135. A worker on that rate is probably just one more annual increase away from $37,000 plus. Even worse than the headline marginal rate, the effective marginal tax rate above that threshold — including the present Medicare levy and the low income tax offset withdrawal rate — is 36%.

It is extraordinary that a minimum wage worker in this country will face a marginal rate as high as 36%. There are strong arguments as to why even the top marginal rate should not be that high, but at the minimum wage 36% presents a particularly powerful disincentive to the very people with the most scope for additional remunerative effort and self-improvement.

Discussion of the implications of bracket creep often focus on the marginal rate at average weekly earnings. Last year average weekly earnings were poised to move above $80,000.   This is why the government in the 2016 budget lifted the $80,000 threshold to $87,000 — and Labor even agreed. Up to now nobody has thought of the minimum wage as a bracket creep pinch-point.

Increasing the $37,000 threshold is much more costly to revenue than increasing the $80,000 threshold. One reason is that many more taxpayers benefit — around 60% of the total, compared with 20% at the previous $80,000 threshold. The other reason is that the uplift in the effective marginal rate is much greater at the $37,000 threshold (from 21% to 36%) than it was at $80,000 (from 34.5% to 39%).

Increasing the $80,000 threshold by $7,000 was relatively cheap in budgetary terms — a revenue loss of around $1 billion a year — which helps explain why the government was willing to do it in a very tight budget. At the $37,000 threshold, $1 billion will buy an increase of only about $1,000 and a ‘tax cut’ of around $3 a week, which in political terms would be derisory. However, there is a case for a substantial increase.

Looking back ten, twenty or thirty years, the increase in the second threshold has seriously lagged all the other thresholds. From that perspective, a comparable increase in the $37,000 threshold would take it to at least $45,000.

What, you may well ask, is the point of giving a tax cut of several billion dollars a year at the same time as increasing the Medicare levy to raise $4 billion a year? I am no fan of the Medicare levy increase — which, despite the label, is just another layer of income tax and will lift all marginal rates by 0.5 percentage points. It is the opposite of what tax reform needs to achieve. But whether or not it happens, the $37,000 threshold needs to be lifted to at least $40,000 as a small step in the right direction.

Mind you, the government would still have to come up with $3 billion or so a year. That should really not be a problem. They are relying almost entirely on revenue growth to balance the budget, and personal income tax revenue is projected to increase by 31% in the four years to 2020-21. Even a small shift in the balance from revenue increases to expenditure restraint over a number of years would yield billions for income tax relief.