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Unpacking the Labor government's proposed tax cuts
Today the federal Labor government announced proposed changes to the already legislated Stage 3 tax cuts which are due to take effect from 1 July, 2024. The Stage 3 tax cuts represent the final stage of a three-part process of tax reform that began in July 2019 under the leadership of the Liberal party, and primarily benefit higher income earners.
Under the current Stage 3 legislation, those with incomes of over $200k would receive a tax cut of around $9075, while someone on $100k would receive $1375. Workers on incomes below $45k would not receive any tax benefit.
Today’s changes to the Stage 3 tax cuts proposed by Labor will see anyone on incomes below $150k better off, while those on incomes above $150k would be worse off, relative to the existing legislation. This means around 90% of income earners are set to gain from Labor’s changes.
Under the new system, those on incomes of over $200k would see their tax cuts reduced by around $4500, while those earning between $45000 and $135000 will receive around $800 more in tax relief. The proposed changes to the stage 3 tax cuts will appeal to the traditional Labor heartland of low to middle income earners and could be seen as a political move. However, Treasury recommendations to redesign the tax cuts were based on the need to respond to the uneven impacts across income cohorts of cost-of-living pressures associated with unanticipated events such as the pandemic and ongoing global conflict. Low- and middle-income households have less capacity to absorb the increase in living costs compared to higher income households, as they are less able to reduce discretionary spending and typically have lower savings.
The tax changes do make sense economically, in the current environment. Importantly, the change to the distribution of taxes is expected to be budget-neutral, meaning the total cost should be the same and, hence, not impede the ongoing post-Covid budget repair and containment of government indebtedness. In addition, by maintaining the quantum of cuts, the government is limiting the inflationary impact of the tax cuts to that which is already anticipated by markets.
Although the government’s changes to the Stage 3 tax cuts remain budget neutral, they may still impact the economy. Typically, lower income workers have a higher marginal propensity to consume than higher income workers; that is, they spend comparatively more of their additional income.
Hence, by redistributing the tax benefits from higher income workers to lower income workers, the government ensures it gets more economic bang for its buck under the newly proposed tax changes. This could help cushion the economy over the second half of the year, when it is experiencing anaemic economic growth and rising unemployment.
Our modelling suggests that the currently legislated Stage 3 tax cuts, worth around $20b in the first year, would add 0.3 percentage points to Australian GDP over the first two years following implementation. Academic estimates of the marginal propensity to consume across different income cohorts indicate that the top 10% of income earners have a marginal propensity to consume which is roughly two thirds that of the average income earner. Reassessing the impact of the Stage 3 tax cuts for the changes proposed by Labor would increase this impact by 0.2 percentage points to GDP, to ½ percentage point of GDP.
But, what of the inflationary pressure that additional demand may generate? By improving the work incentives for marginal workers (such as low and middle-income earners who may be part-time, or working mothers whose hours worked are particularly responsive to changes in after-tax income), the tax cuts may also have a positive effect on supply, thereby helping to contain the inflationary impact of the tax change. Treasury estimates the labour supply response in the redesigned tax package to be 0.25%, more than twice as large as that of the currently legislated Stage 3 tax cut package, at 0.10%.
If we are correct about the supply response, the impact on inflation would therefore be negligible. Markets seem to hold the same view, having not moved significantly as the news was gradually leaked over recent days.