Individual income taxes in Australia raise nearly half of federal government revenue. Given their size and scale, getting the design of these taxes right is important. A poorly designed tax system disincentivises productive activities (efficiency), reducing overall incomes and unfairly places the burden on particular individuals (equity). 

This note offers a new perspective on the efficiency and equity implications of the individual income tax system. The findings paint two starkly different pictures of horizontal and vertical equity in effective tax rates at high and low levels of income.

Australia’s taxation of higher incomes exhibits substantial horizontal and vertical inequity and as a result is highly inefficient. It risks incentivising people to prioritise activities that are rewarded with capital gains over other forms of income even when they have a lower economic return. This unequal treatment may contribute to insufficient investment in more highly taxed activities such as human capital acquisition, that are important for the long-term performance of the Australian economy.

Key findings

• For the bottom 95% of individuals who account for 63% of income tax revenue (those with incomes below about $187,000), tax rates are highly progressive. Effective tax rates rise steeply with income, and individuals with similar incomes pay similar tax rates.
• For the top 5% of individuals who account for 37% of tax revenue (those with incomes above $187,000), there is a very wide range of effective tax rates and income bares almost no relationship with the tax rate faced by any one person.