Stage 3 tax cuts to impact budget in longer-term: Grattan Institute

Analysis by the Grattan Institute has found that the revised stage 3 tax plan may impact government spending in the longer-term and even make it harder for the government to implement tax reform.

Labor’s overhauled stage 3 tax cuts will see the lowest rate of income tax reduced from 19 per cent down to 16 per cent for taxpayers earning less than $45,000. The second tax rate will be reduced from 32.3 per cent down to 30 per cent. The threshold for the 37 per cent tax rate will be increased to $135,000, while the threshold for the top tax rate of 45 per cent will be increased to $190,000 from the current $180,000.

The Grattan Institute said the changes will see those with taxable incomes of less than about $146,486, or nearly 90 per cent of all taxpayers, get either the same or a larger tax cut under the new plan.

“Whereas the 10 per cent with higher incomes will get smaller tax cuts than under the original Stage 3,” it said in a recent analysis piece.

The tax cut for people who earn more than $200,000 a year – expected to be less than 5 per cent of taxpayers in 2024-25 – will be roughly halved, from $9,075 to $4,529 a year.

The Grattan Institute warned that bracket creep will erode the value of the revised tax cuts over time, which will see Australians paying a higher proportion of tax over time.

“One consequence of keeping the 37 per cent tax bracket for incomes between $135,000 and $190,000 is that average tax rates will rise more quickly for some upper-income earners than they would have under the original Stage 3,” it stated.

The share of people with a taxable income between $135,000 and $190,000 is expected to rise from 7 per cent in 2024-25 to 13 per cent in 2033-34 due to bracket creep, based on analysis by the Grattan Institute.

“The share of people in the top tax bracket – above $190,0000 – is expected to rise from 6 per cent next year to 12 per cent in a decade’s time.”

However, its analysis also showed that the vast bulk of Australian taxpayers benefit from the revised tax package, despite the impact of bracket creep over the next decade.

“For example, the typical taxpayer, who can expect a taxable income of about $59,000 in 2024-25, will pay $804 less in tax next year. As will someone on the average taxable income of about $79,000 in 2024-25, who earns more than nearly two thirds of Australians,” it said.

“Both can expect to still be receiving the full extra $804 a year in tax cuts in 2033-34. And they will have paid cumulatively $8,040 less in tax over the next decade, compared to if the original stage 3 tax cuts remained in place.”

Even higher-income earners who jump into the 37 per cent tax bracket that applies to incomes above $135,000 in the next few years will still be better off over the decade, the Grattan Institute said.

“So while the share of taxpayers facing a higher average tax rate each year under the new tax plan will grow over time – from about the top 10 per cent today to around 22 per cent by 2033-34 – the accumulated savings over time means many are likely to still be better off over the next decade,” it said.

The Grattan Institute warned that the federal budget may be “the biggest loser” from the the revised tax plan, however.

“The Government’s tax plan, like the original Stage 3 tax cuts, will cost more than $20 billion a year, or nearly 1 per cent of GDP,” it said.

“That budgetary cost would be larger still if a future Coalition government kept the Stage 3 benefits for high-income earners and kept the bigger tax cuts for low- and middle-income earners under the Labor plan.”

That would increase the cost from more than $20 billion a year to upwards of $30 billion a year, and by up to an extra $115 billion over the decade in the long term, it said.

The Grattan Institute said although the Budget is riding high in the short term on high commodity prices, Australia still faces a structural budget deficit of up to 2 per cent, or almost $50 billion a year in today’s dollars.

“These tax cuts will make it harder for this government, and future governments, to meet community demands for more spending in areas such as healthcare, aged care, disability care, and defence,” it cautioned.

“These tax cuts will also make it harder for governments to make other growth-boosting tax reforms, such as raising the GST to fund cuts to other, less efficient taxes.

"Such reforms typically cost the budget revenue as extra money is paid out to compensate the losers. The commitment of both major parties to big income tax cuts now, means there will be less money in future to ‘buy’ more worthwhile reforms.”