Tax cuts fail to deliver the incentive they could have

The Australian economy needed structural reform to boost investment and productivity growth even before the corona crisis struck – and needs it even more now. The crisis has been a short-term shock, but has imposed a longer-term cost in reduced investment, lower productivity and labour market scarring that will increase with every day it continues.

The budget’s failure as an instrument of structural reform is clear on the tax side. Sure, there are big tax cuts, but the focus is short-term.

The personal income tax cuts were already in the forward estimates and legislation. In their final (2024) form, the cuts will lower marginal rates over a wide range of incomes and increase incentive. They qualify as a structural reform but also support consumer spending whenever implemented.

Provisions like LMITO are a tax policy abomination, creating an incoherent mess.

Bringing them all forward should have been a no-brainer, but the government has left the final stage three to 2024 and kept the low and middle income tax offset (LMITO), on top of bringing forward stage two to 2020-21.

It looks like a victory for those who can’t accept that income tax affects incentives – and that when it is cut, the largest dollar benefits go to those who pay the most tax.

There is so much to regret about this that it’s hard to know where to start. It is stage three that holds the real reform in this tax cut: that is, the cuts in marginal rates that have such potential to improve incentive.

There are no marginal rate cuts in stages one and two, which are all about increasing thresholds and means-tested handouts in the form of the low income tax offset (LITO) and LMITO. Without stage three, it is a standard partial-return-of-bracket-creep adjustment.

But now stage three sits out there in 2024, a shag on a rock, exposed as a budget repair option like Paul Keating’s L-A-W tax cut after the 1993 election. Nobody should now count on stage three ever happening.

LMITO is to continue for one year alongside stage two. Provisions such as LMITO are a tax policy abomination, creating an incoherent mess of effective marginal rates as they are phased in and out.

You might think there will now be just three marginal rates up to $120,000 (zero, 19 per cent and 32.5 per cent), but in fact there will be 10 up to $126,000 once LMITO, LITO and the Medicare levy go into the calculations.

The antithesis of simplicity

Very few taxpayers would even know their true marginal rate. This is the antithesis of simplicity and transparency.

The business tax measures – particularly the 100 per cent investment allowance and the loss carry-back, both in place until June 2022 – are the right kind of elixir for the corporate sector’s ills as far as they go, but are not beyond criticism.

Why do companies with turnover above $5 billion have to be excluded?

Most importantly, the investment allowance is not a structural reform. It is not a solution to Australia’s internationally uncompetitive company tax system.

If a company tax cut is off the agenda because the politics are too hard, then an investment allowance is a second-best alternative. It doesn’t have to be 100 per cent, but it needs to be across-the-board and permanent.

The investment allowance announced in the budget is neither of those things. It will undoubtedly spark a surge in business investment up to June 2022 – some of it brought forward where that makes commercial sense. But then what?

Do we just revert to the current system with a two-tier 30 per cent/ 27.5 per cent company tax rate and no investment allowance?

That is not a recipe for the business investment and innovation needed to ramp up productivity and real wages year after year.

In both personal and business tax, the budget has splashed a lot of cash but left unfinished business and missed the opportunity for real reform.