Why the government has to make the case for stage 3 tax cuts

The Morrison government’s stage 3 income tax cuts— still almost two years away from their legislated implementation — are dangling by a thread as the new government’s election promise to keep them is assaulted by a barrage of calls to abandon them.

There is a strong case for the tax cuts, but the problem is that nobody is making it. If the best the government can do is to say they have to stand by an election pledge, then its commitment is likely to crumble long before 1 July 2024.

The Prime Minister and the Treasurer have to make the case that it’s the right economic policy — even if this means swallowing past criticisms — and shoot down spurious arguments against the cuts.

The previous government’s phasing of the tax cuts made it likely that stage 3 would end up in limbo. They were first announced in 2018, leaving them exposed to political and economic exigencies for six years. The previous government foolishly passed up the opportunity to bring them forward when the stage 2 cuts were fast-tracked by two years in 2020.

If stage 3 had been similarly brought forward, it would have come into effect on 1 July this year and would now be part of the fiscal furniture, but the Morrison government seemed more interested in using prospective tax cuts as a political football.

The long separation of stage 3 in time from stages 1 and 2 has also resulted in the connection between them being lost. It was meant to be a single tax cut package in phases, but stage 3 is now viewed as a stand-alone cut favouring high income earners. The fact that stages 1 and 2 favoured lower income earners is overlooked.

The package as a whole is not especially large by the standards of past tax cuts and does little more than offset bracket creep over several years.

The case for the package as a whole is that it updates bracket thresholds for inflation — thereby preventing bracket creep from lifting average tax rates — and it has positive incentive effects by trimming some marginal rates; namely both the 32.5% rate and the 37% rate to 30%, thereby creating a wide band from $45,000 to $200,000 with a constant marginal rate.

Both the 32.5% rate and the 37% band are results of past tinkering with the tax rate scale, and combining them takes the scale back to the simplified four-band design that once existed. The marginal rate of 30% is the same as that adopted in 2000 as part of the GST compensation package.

Stage 3 also lifts the top rate threshold from $180,000 to $200,000 in 2024. Far from being too generous to high income earners, this is woefully inadequate. The top rate threshold was last increased in 2008. Merely indexing it to the Consumer Price Index since then would take it almost to $250,000 — and that doesn’t allow for inflation over the next two years.

The lower thresholds have had much larger percentage increases since 2008 than the increase in the top threshold currently set for 2024.

The main argument against the tax cuts is the loss of revenue at a time of budget deficits and upwards pressure on spending. The revenue loss has recently been given prominence with a misleading ten-year aggregation of $240 billion. In reality, the loss is less than 1% of GDP and even this makes no allowance for the positive feedback from higher economic activity and taxable income.

A related argument is that the tax cuts represent a demand stimulus when the economy is overheating.  However, this gets the timing wrong. The cuts will occur in 2024, when inflation and excess demand are likely to be abating.

In any case, cancelling stage 3 would be unlikely to benefit the deficit — the government would just spend the extra revenue over time. Conversely, stage 3 is already baked into the budget projections and keeping it there helps restrain government spending.

What is most at stake in the argument over tax cuts is not the deficit but the size of government, the revenue needed to finance it, and how the revenue is raised. Cancelling the stage 3 cuts would fit in with the view of those who think government spending needs to be higher and that extra revenue is needed, especially from the better-off.

Even if you accept that view, however, there would be better ways to raise the revenue than through higher income tax.

Robert Carling is a Senior Fellow at the Centre for Independent Studies and a former World Bank, IMF and federal and state Treasury economist.