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Saturday, December 2, 2023

Stage 3 Tax Cuts are a Terrible Idea

Even neoclassical ideologues have to admit stage-three tax cuts aren’t the answer

Tax cuts area bad idea

In the past 12 months, low-income earners have seen their real wages fall faster than ever before, their mortgage interest rates rise faster than ever before and, here’s the real kicker – their average tax rates actually increase.

To be clear, someone working on the minimum wage has seen the amount of tax they pay rise from $66 per week in 2017 to $96 per week in 2022.

While the announcement that the stage-three tax cuts that deliver $9075 to those earning over $200,000 will stay is great news for the top 4 per cent of income earners, they literally give nothing for those earning below $45,000, including those working full-time on the minimum wage of $21.38 per hour.

Needless to say there was no announcement that taxes would increase for the lowest-paid workers, so commonly found in our food services and retail industries.

The tax increase comes as a result of the so-called ‘bracket creep’ that the $243 billion stage-three tax cuts are supposed to fix.

But sadly for the six million taxpayers who earn less than $45,000 per year, despite the enormous cost of the stage-three tax cuts, they aren’t broad enough to help those who need them the most. Whoops!

Over the next 10 years around one-third of the $243 billion stage-three tax cuts will go to those earning over $200,000 per year.

But while the $80 billion cost of this generosity is jaw dropping, what is more surprising is that, according to the economic models used in Treasury, this $80 billion gift will deliver zero boost to Australia’s economic growth or productivity. Nada. Zip. Zilch.

A cynic may argue the reason some economists focus so heavily on cutting income taxes for high-income earners is that economists are among the highest-paid people in Australia.

Tax cuts

But those economists do rely on theoretical arguments to support such self-interested policy as well. The problem is that theory is, shall we say, flimsy.

The ‘neoclassical’ theory of labour markets is based on a number of assumptions, but the key one is that individuals have lots of discretion about how many hours they work and how much leisure they would like to have.

That is, the theory assumes ‘rational’ workers regularly look at the wage rates and tax rates and decide what the benefit of working an extra hour or having an extra hour of leisure would be.

So according to this theory, when wages rise, or taxes fall, people will work extra hours (as the benefits of work just increased), and in turn ‘choose’ to have less leisure.

It gets weirder. Neoclassical economists – the kind that keep arguing that income tax cuts will boost GDP – also assume it’s not the total amount of tax you pay that matters, but only your ‘marginal tax rate’, that is, the amount of tax you pay on the last hour you work.

Despite the fact that few, if any, full-time workers have a boss that lets them regularly adjust their hours of work in line with small changes in wage and tax rates, the economic models used to ‘prove’ tax cuts are good for the economy are specifically built on the assumption that when income taxes are cut, disposable wages increase and more people will work more hours. And people choosing to work more boosts GDP.

Little evidence it works

To be clear, this theory has enormous problems and there is little if any evidence that it works in the real world.

But that has never stopped neoclassical economists from pushing it, and the tax cuts it justifies. So, back to the $80 billion gift we are about to give those earning over $200,000 per year.

According to the economists who argue tax cuts boost GDP it’s only the marginal tax rates that matter, as they determine how much we work.

But while the stage-three tax cuts deliver an $80 billion gift to those earning over $200,000, because it doesn’t change the tax rate they pay on their last hour of work, that enormous gift can’t boost their hours of work or GDP.

Put another way giving $9075 to each of those earning over $200,000 per year will do nothing to help the economy. Nothing.

If we were to take neoclassical economic theory at all seriously (and that’s a big if), we would be focussing on lowering the tax rates for low and middle-income earners, not just because it’s fair, but because it’s those workers whose real wages are falling and whose marginal tax rates are rising as they drift into higher tax brackets.

But we aren’t taking neoclassical economic theory seriously at all. And, the economists who usually do are being strategically silent about the poor design of the stage-three tax cuts which give $80 billion to those who won’t work more and nothing to the millions earning below $45,000 who might.

While you could argue that the $80 billion gift to high-income earners will be ‘good for the economy’ as it will lead to more consumer spending the simple fact is if that same money was given to millions of low-income earners they would spend it too.

And if the money being given to our highest-income earners was instead spent on bringing back free childcare it would drive a big increase in the participation of young parents, most of whom are young women – as opposed to the older men who will get most of the stage-three tax cuts.

Australia does need tax reform and does need to look at the impact of inflation on the efficiency and equity of our tax system, but it doesn’t need the stage-three tax cuts which will deliver nearly a third of their benefits to people that even the architects of the tax policy privately admit will not work an extra hour as a result. It’s time we had a real debate about tax reform.

Dr. Richard Denniss is the executive director of independent public-policy think-tank, the Australia Institute

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