All political parties are aware of bracket creep and Governments

of all persuasions  have come to rely upon it as a means of “least resistance” revenue raising.  The most galling thing is their pretence that the  return of a proportion of this stealth tax represents a genuine tax cut for which we should be grateful!

Introduction

The Government has given us all a pre-election tax cut of miniscule proportions , so we should all be grateful, not really, this so-called tax cut represents a return of some of the additional taxation Australians have paid due to bracket creep  Bracket creep, often referred to as a “stealth tax,” has significantly impacted Australians over the past few years. It occurs when rising wages and inflation push individuals into higher tax brackets, even though tax rates and thresholds remain unchanged. This results in people paying more tax without any changes to their real income.

The stage 3 tax cuts will do little to reverse bracket creep

The stage 3 tax cuts in Australia came into force on 1ast July 2024. Under these were

• Reducing the 19% tax rate to 16% (for incomes between $18,200 and $45,000)
• Reducing the 32.5% tax rate to 30% (for incomes between $45,000 and $135,000)
• Retaining the 37% tax bracket but increasing its threshold from $120,000 to $135,000

These changes appear to offer up substantial tax benefits for lower to middle income earners. However, modelling undertaken by the Centre for Future Work shows that in the absence of tax  indexation the benefits of tax cuts are short lived. The diagram below shows that by 2031/32, bracket creep would have clawed back More than 50% of tax gains for those 0n 72,000 or below and 40% of those earning $120.000 per year.

How much more are we paying?

Recent analyses suggest that Australians have been paying approximately $3,500 more in tax annually due to bracket creep. For dual-income households, this figure rises to around $7,000 per year. This has been particularly burdensome for lower- and middle-income earners, who bear the brunt of this phenomenon (https://au.finance.yahoo.com/news/7000-stealth-tax-hitting-aussies-every-year-will-become-worse-024901912.html)

Why should we have tax rate indexation?

The fundamental reason is that it is undemocratic to allow a ‘stealth tax” to occur. If Governments need more revenue they should, in a democratic society raise taxes and charges openly  or cut spending and with sufficient justification.  As well there are strong economic and social reasons for honesty in taxation policy trough tax indexation, Including

• Indexation helps avoid bracket creep, where inflation pushes taxpayers into higher tax brackets without an actual increase in real income
• Indexation maintains purchasing power: By adjusting tax rates according to inflation, taxpayers’ purchasing power is preserved, ensuring they are not unfairly taxed on inflationary gains
• Indexation provides a more predictable and stable tax environment, which can be beneficial for both taxpayers and government planning
• It improves fairness by ensuring that the tax burden is distributed more fairly, as taxpayers are not penalized for inflation

Why politicians don’t want to change  

It is often claimed that tax rate indexation would be too complex. However, anyone wading through the  Australian Master Tax Guide (Wolters Kluwer Australia | CCH | Australian Master Tax Guide) would realise that unnecessary complexity is already a feature of the system  . As a result The Australian System has been referred to as a tax accountants  paradise (It’s not just unfair it’s immoral)https://www.abc.net.au/news/2024-02-12/tax-reform-unavoidable-income-tax-workers-ageing-population/103445138.  . However, there is no complexity in implementing tax indexation, a 3-year automatic  underlying inflation adjustment ( probably applied proportionally across the various s tax brackets would be sufficient. It might also speed up the long overdue flattening of the tax rate range. What is the main constraint to the adoption of a tax indexation system is not the mechanism but the will for Governments to give up an easy revenue source.

• There can be a lag between inflation changes and tax rate adjustments, which might not fully protect against bracket creep in real-time
• Governments might experience reduced tax revenues during periods of high inflation, as tax brackets are adjusted upwards
• While indexation aims to be fair, it might benefit higher-income individuals more than lower-income individuals, depending on how the adjustments are structured

None of these arguments are convincing. Initial lags can exist, but regular automatic indexation removes that issue longer term. Governments will experience a revenue drop requiring the courage to cut spending and or be honest about the need for tax increases. Finally, in terms of equity, tax indexation is not an income distribution device, it is simple a way of bringing some honesty back  to the tax system

Conclusions

Bracket creep is an inevitable problem of tax rates based on money value rather than real value of income. It is well known way of Governments increasing revenue without appearing to raise taxes or increase charges. They like it, it causes few issues politically and more importantly it allows the politicians to play Robin Hood periodically and pretend to be low taxing.  The unfairness and  stealth it produces could easily be stopped by automatic and periodic tax rate adjustments for underlying inflation. Tax indexation, while bringing in some of the teething problems discussed above  is relatively simple to introduce and restores some fairness and integrity to a notoriously porous tax system.  Surely in a democratic society, taxpayers have a right to know what is their real rate of tax.