The Federal Government has taken the highly unusual step of seeking to lock in a series of income tax cuts over the next six years. The three waves of cuts are packaged together, but each stage is different in terms of its cost, economic rationale and distributional effects.
The unlegislated Stage 1 tax cuts – a boost to the Low- and Middle-Income Tax Offset – are temporary and targeted. They would provide a much-needed stimulus as the economy is slowing. Parliament should pass them as soon as possible.
The unlegislated Stage 2 tax cuts are smaller, largely give back bracket creep, and are likely to be affordable.
But the unlegislated Stage 3 tax cuts, scheduled to come into effect in 2024-25, would be a substantial impost on the budget – $85 billion of revenue would be foregone over the subsequent six years.
The Government has emphasised the economic benefit of the cuts in terms of boosting incentives to work. Over time, bracket creep erodes the incentives to work and invest. Income tax cuts stop this from happening.
But whether these are the right cuts at the right time is far less clear.
Locking in such substantial tax cuts in 2024-25 carries plenty of downside risk in Australia’s current highly uncertain economic environment. The economy is softening, the budget position is uncertain, and calls for the Government to use fiscal policy to stimulate the economy are growing. Tax cuts in 2024-25 are likely to come well after stimulus is needed.
And there are big question marks over whether the Stage 3 cuts are affordable. Unless the Government maintains unprecedented discipline on spending, it will struggle to reconcile tax cuts with its fiscal objective of balancing the budget on average over the economic cycle.
There is also a real risk that the size of the package – unmoored from other structural changes to the system – will ‘crowd out’ the chance to make more meaningful tax reforms for another decade.
The tax cuts as proposed will make Australia’s tax system less progressive: the top 15 per cent of income earners would pay a lower share of their income in tax than they do now, while middle-income earners would pay a higher share of their income in tax.
Indeed, we estimate that if the Stage 3 cuts pass, the income tax system in 2024-25 will be less progressive than it has been at any point since the 1950s. And Australia will go from having a relatively progressive income tax system by international standards to below average among OECD countries. Whether this is desirable is a value choice. But the Government should be transparent that this is the choice being made.
Ultimately the case for – or against – income tax cuts in 2024-25 will be clearer closer to that date. There are few benefits and big risks from the Government locking in major cuts now.