Ease income tax burden automatically, says Westpac’s Ellis

Dr Ellis, now Westpac’s chief economist, said the “extraordinary” squeeze on real household incomes was due more to the rising tax burden than the RBA’s 13 interest rate rises, which affect a narrower set of households.

“The consequences of this squeeze include weak consumption and rock-bottom consumer sentiment,” she said.

Total tax payments by the household sector were the highest share of household gross income (17.75 per cent) since the quarterly national accounts were first compiled in 1959.

Dr Ellis said automatically increasing income tax thresholds by 2.5 per cent annually would help relieve some pressure.

This would be more prudent than fully indexing the income thresholds to the inflation rate, which some countries such as the United States and Canada do.

Indexing the thresholds to the higher inflation rate would pump more money into the economy at a time of high inflation, putting more pressure on the central bank to impose “significantly higher policy rates” during inflationary periods than was currently required, she said.

“More of the burden of combating inflation then falls to monetary policy,” she said.

“Instead of the polar choices of no indexation or indexation to inflation, policymakers may want to consider a third choice of automatic indexation at a fixed rate of 2.5 per cent, the midpoint of the RBA’s inflation target.

“Anchoring tax indexation consistently with the RBA’s target might even help anchor people’s inflation expectations.”

Dr Ellis said the government’s income tax take would still rise over time.

But at times when inflation was below the 2.5 per cent goal (such as in 2014 to 2019), people would receive more real tax relief and this would help push up inflation back towards the target.

Australian National University economist Ben Phillips said it seemed like a sensible proposal.

“Historically changes in tax rates and thresholds have been mostly ad hoc and seemingly unrelated to the economic cycle,” he said.

“Howard’s tax cuts in mid-2000s and Rudd’s in later 2000s [copied from Howard] were very stimulatory at a time of increasing interest rates and a strong economy.”

“The lack of indexation through Gillard and early Coalition governments presumably was more about returning the budget to surplus than any serious macroeconomic management considerations.”

Australia is among the cohort of 21 OECD countries that does not index tax brackets for inflation. Seventeen OECD countries automatically adjust their brackets to compensate for higher prices.

Local politicians have preferred to control the timing of tax cuts to give back bracket creep, often around the time of elections.

Treasurer Jim Chalmers this week firmed his support for the $20-biliion-a-year stage three tax cuts, saying they would help with the cost of living as well as pare back bracket creep.

“Obviously, if people are getting tax cuts, if people are keeping more of what they earn, that will make it easier for them to make ends meet,” he said.

“But there are other motivations as well. I think governments of either political persuasion, when they can afford to, should be looking to return some of this bracket creep.”

The package will abolish the 32.5 per cent and 37 per cent brackets, introducing a single 30 per cent rate for incomes between $45,000 and $200,000, costing about $250 billion over 10 years.

Capital gains tax extension

Dr Ellis suggested her policy idea could be extended to capital gains tax.

The 50 per cent discount applied when selling an asset held for longer than 12 months could be scrapped, with capital gains discounted each year by 2.5 per cent and a person’s full marginal rate applied on the remainder.

This would eliminate the “distortion of taxing capital gains at a lower marginal rate than rental or labour income”, she said.