The seemingly imminent passage through Federal Parliament of extensive income tax cuts over the coming few years is a welcome reform, as it will give back substantial “tax drag” that has accumulated in recent years and help lower marginal income tax rates for many Australians.
As seen in the chart below, growth in taxes on income has been running ahead of pre-tax income growth in recent years, such that the tax-to-income ratio has been creeping up.
In the past year alone – at a time when gross household income has been particularly weak – the RBA recently noted taxes paid by households increased by around 8 per cent, or more than double the rate of growth in gross household income of 3½ per cent.
Not only has there been the usual tax drag (as rising nominal income pushes more households into higher income tax brackets, raising their average tax rate), but lower interest rates have reduced the negative gearing tax deductions used by property investors, and there’s been an increase in capital gains tax paid owing to the earlier run up in Sydney and Melbourne house prices.
High tax rates for high income earners
As evident in the chart below, moreover, Australia not only has a relatively high top marginal income tax rate (of almost 50%) but it cuts in at a relatively low multiple of only around to 2.2 times average full-time earnings. In the US and Japan, by contrast, the top marginal income tax rate cuts in at around 8 times average earnings, or around $650,000 is applied in Australia! Even in Canada, the top marginal tax rate cuts in a 4 times average earnings, or around $350,000.
Worse, without any income tax cuts over coming years, the Government projects this ratio would fall in Australia to only 1.7 time average full-time earnings. What’s more, even the Government’s plans to increase the top income tax threshold to $200,000 (from $180,000) would still see this ratio fall to 1.9 time average full-time earnings. So even after planned tax cuts, by global standards, Australia’s ability to compete for highly skilled global talent will continue to go backwards.
The now stark gap between the corporate tax rate (25%) and the top income tax rate – almost twice has high – also leaves a major anomaly in the tax system which lends itself to creative tax planning and economic distortions.
The top income tax rate – unfinished business!
Increasing the top income tax threshold and/or lowering the top rate- while not politically popular – remains unfinished business with respect to income taxation in Australia.
The fact that Australia’s top personal income tax rate will remain twice that of the corporate income tax rate – and will cut in at a half the multiple of average earnings than even in countries such as the UK and Canada – highlights how out of step Australian remains compared to its international peers.