Every Budget has a narrative and a seduction: this was one of few surprises

Grant Wardell-Johnson, Lead Tax Partner, KPMG Economics and Tax Centre

Each Federal Budget has a narrative and a seduction. Sometimes the narrative resonates. The 1992 “One Nation” Keating Budget which sought to deal with the 1991 recession and the 2005 Costello “Future Fund” Budget which away funds from a terms of trade boost, are great examples.

For some budgets, there is a mismatch, rightly or wrongly. The 2014 Hockey Budget had the theme – “we all must contribute” – but it did not feel that way to many and was thus undermined.

The narrative of this budget is grounded in safety, stability, solidity with a touch of measured giving. The Treasurer has told us we will live within our means, keep safe, not touch essential services, back business and provide tax relief for all, but low to middle income earners first.

All budgets seduce. To minimise seduction, one can look at a Budget in a relatively simple manner.

In this Budget the Government receives the benefit of an additional $35b over the 4 year period based on what the economy is expected to provide. It intends to spend $26b in the form of personal tax relief: $13b on the first and second part of a broader $140b Personal Income Tax Plan and $13b on not increasing the Medicare Levy. The remaining $9 billion plus $8 billion from the Black Economy and $1 billion on revised R&D rules is used to reduce debt. There are a substantial number of smaller items that largely offset each other.

One could divide the personal tax items into seven. Only three of these impact the forward estimates.

The first is the decision not to increase the Medicare Levy. This decision increases the level of progressivity of the system as the levy is largely a proportional tax.

The second is the introduction of a tax offset which will be available until 2021-22. It starts at $200 rises to a maximum of $530 for those between $48,000 and $90,000 and tapers to nil at $125,333.  This also increases the progressivity of the system with an element of simplification in calculating the offset.

The third measure increases the top threshold of the 32.5 percent tax rate from $87,000 to $90,000 from 1 July 2018. This reduces the level of progressivity insofar as those below $87,000 do not receive the benefit.

Of the remaining four measures three start in 2022. There is a measure to expand the tax offset which is progressive, another to increase the threshold for the 19 percent tax bracket, which is less progressive and one to increase the threshold for the 32.5 percent tax bracket which is abolished two years later which is not progressive and lead generally to a flatter tax structure.

The narrative of the Budget justifies these changes on the basis of relief from the cost of living pressures for the lower income earners, bracket creep for middle earners and the need to simplify the tax system for higher earners.

All three justifications are not without merit, but the main systemic justification is bracket creep.

Indeed bracket creep impacts lower income earners more than middle and higher income earners. It involves not only about moving to a higher tax bracket, but it also impacts movement within a tax bracket as ones average rate changes. This occurs disproportionately for lower income earners and thus is highly regressive.

Bracket creep also increases the absolute burden of taxation in real terms. Other things being equal it increases the total tax take. It is hidden in the sense that it is stealthy. And is hidden in the sense that it unpublicised. The Budget does not state the level of bracket creep.

There has been some discussion about the obvious question of the trade-off between lower debt which reduces the burden on the next generation, provides additional security for an uncertain future and flexibility for new policies and bracket creep. That is an economic as well as a political trade-off. But it is not the only trade-off.

An alternative is to consider what would give you the greatest bang for your buck on productivity and efficiency in the personal tax system. Here is our real issue.

The interaction of our tax system and family payments and child care systems can produce highly problematic results whereby the effective tax rate on an additional dollar of earnings for a second earner, usually women, looking to move from 3 days a week to 4 or 5 days a week can be exceedingly high. Sometimes as high as 80 percent or even more than 100 percent.

Dealing with this should be a high priority. Not just because like bracket creep it is insidious, but it is also highly unfair to the extent that it tends to maintain the unequal burden of parenthood on women. We are silly if we don’t seek to fix this problem. The current structure is inefficient and less productive for society in the long term.

The narrative of this budget in one sense matches what it does. It provides us with changes that feel safe. It is seductive in the sense that we feel that personal tax cuts are something we can now afford. Probably that is true. But it would be good to embrace the bold with a view to the long term future. Maybe this is something for the first year of an election cycle.

Read our full analysis.

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