The tax cut menu

With the Turnbull government raising expectations of personal income tax cuts in the forthcoming budget, the question is whether it can deliver a cut that does not disappoint in both size and quality.

Forward estimates prepared as recently as six months ago suggest any income tax cuts will be of the ‘hamburger and milkshake’ size, to coin a phrase made popular by a Howard government minister in referring to a small tax cut in 2003.

The budget outlook would need to have changed dramatically in a short time for the Treasurer to be in a position on budget night to add bacon to the menu. Personal income tax is by far the largest revenue-raiser and cutting it significantly can easily cost $10 billion a year or more.

Budget-night commentaries will no doubt dwell upon the quantum of tax cuts, but the form they take is equally important.

The most disappointing would be to do what governments have often done in the past — namely, make a few one-off adjustments to bracket thresholds. These cosmetic changes would merely hand back some of the proceeds of past bracket creep, yet ensuring bracket creep kept raising the tax burden by stealth in the future.

This is why the first priority of income tax reform should be to legislate for a system of automatic annual indexation of tax bracket thresholds. This would put an end to the insidious process of bracket creep and act as a new discipline on government spending growth.

The second priority should be to cut marginal rates of tax, which set the tax disincentives people face in choosing how much to work, save and invest. All marginal rates need to be cut, but in a budget-constrained setting priority should be given to cutting the 32.5% middle income rate as it was increased from 30% in 2012.

These issued are discussed in more detail in a CIS POLICY Paper issued this week, Cutting income tax: can we add the bacon to ‘hamburger and milkshake’ cuts?