Tax cuts: who needs them?

10 Apr 2011

WE ALL like more money in our pockets – it helps to pay the bills, get the things we need or want, and makes life that bit easier for us. Even better is when we don’t have to do any more work for the additional money, which is what a tax cut provides. More money, same job, same responsibilities – it’s an all win situation.

However, some recent analysis done at NATSEM points out that it isn’t as simple as that. The table below shows who gains from increasing the tax free threshold from $6,000 to $10,000 per year in 2011.

Table 1: Estimated increase in family disposable income as a result of increasing the tax free threshold from $6,000 to $10,000, $ per week in 2011, by income decile

1 – $0
2 – $0
3 – $1.60
4 – $4.10
5 – $8.20
6 – $11.60
7 – $14.00
8 – $16.20
9 – $18.80
10 – $20.20

Source: STINMOD09/A

The surprising result from this table is that those in the bottom 2 deciles of income receive nothing from the change in the tax free threshold, while those earning in the top decile get an extra $20 per week in their pocket. This is because those in the bottom 2 deciles of the income distribution are usually on government benefits, like the aged pension, disability support pension or newstart allowance. They therefore will not pay tax, and so the change in the tax free threshold has no effect on them.

However, those in the top income decile pay the greatest amount of tax, so any change to the thresholds has the greatest effect on them, even if it is a change to this bottom tax free threshold. Because Australia (and most developed countries) use marginal tax rates, this is money they would previously have been paying 45 cents in the dollar tax, and they are now paying no tax on another $4000 per year (assuming they are earning more than $180,000 per year).

So it can be seen that even a change to the threshold at this low end of the tax scale doesn’t benefit everyone, and benefits those in the top decile of the income distribution the greatest. This is why, when the Gillard Government recently considered tax changes in response to a tax on carbon emissions, the adjustment was understood to be a low income tax offset rather than a tax cut. This offset uses a tax rebate to target low income earners, rather than a change to the tax thresholds or tax rates which affects everyone paying tax. The tax offset can provide tax cuts to low and middle income earners without delivering tax relief to high income workers.

Having said this, the low income tax offset still only affects low income workers, and has no effect on people on allowances and benefit payments. So if the policy is to help those on low incomes pay for increased power bills as a result of a tax on carbon emission, then those on Government benefits also need assistance through rebates on their power bills or increases in pensions and allowances, and this has also been suggested by the Government.

What this analysis has pointed out to me is a couple of things. One is the complexity of the tax system. If you asked someone in the street who would benefit most from an increase in the tax free threshold from $6,000 to $10,000, my guess is that they would say low income earners would gain most. Yet this analysis shows that they gain the least.

And the second thing is the importance of doing some modelling before implementing any policy. To their credit, the Government knows this, and has been crunching the numbers on this policy, and there are models that allow this type of analysis for the tax system (including NATSEM’s STINMOD model, which is used by Treasury for most of this Tax/Transfer analysis).

So who needs tax cuts? Certainly not those on very low incomes who are not working, as a tax cut won’t provide any additional money in their pockets. The main beneficiaries of tax cuts are those who don’t really need the additional money – those in the top decile of the income distribution.

Robert Tanton is Principal Research Fellow at the National Centre for Social and Economic Modelling (NATSEM)

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