What we all care about in the budget - tax cuts! But who really benefits?

Budget Tax Changes Image 2018-05-09.jpg

There's already a lot of budget articles floating around - predominantly informative, with dot-point lists and regurgitated statistics. I thought long and hard before writing this article because I didn't just want to be another page of the same old same old.

No doubt you know that 'tax cuts' are coming in some way or another. If you're particularly active on social media you may even have tweeted #keepmytendollars to point out that no one is in any doubt that this is an election year budget (although depending on your income level, a more accurate hashtag might be #keepmyfivedollars - more on that later).

What I want to do here is write an article that creates a new perspective - information and analysis on a level that I have yet to see, laid out in a way that helps you to form your own opinions based on your personal situation and your personal politics.

Wait, you say. News without agenda and minus dramatic language?! HOW CAN IT BE TRUE?(Well, actually it's not, because this paragraph is your dramatic language - but I hope you'll give me licence for that).

That said...you may want to overthrow the government by the end of this.*

If you've ever heard the words 'bracket creep' or 'marginal tax rate' and wanted a better understanding of how that affects you (and everyone) in a real world sense, this article is what you need.

What I'm going to do is first outline how tax works (just in case), and what exactly was announced last night. Then, this is where it gets different - I'm going to provide some information on taxation over the past 10 years or so that outlines the real-world position that we're currently in, and how that compares to the past and the potential future.

Buckle in - we start with a lot of information before we get to put it together and analyse some real world results (both historical and forecast).

* Blue Ribbon Accounting accepts no responsibility for any government overthrowing actions as a result of this article.

Individual tax basics

I'll keep this short and sweet - we need to make sure we're all on the same page about how tax works, to make sure you follow everything I write below here.

Individuals in Australia are taxed at 'marginal' rates. What this means is that your income is segmented and taxed at different rates on different dollars.

At the moment, if you earn $18,200, you pay zero tax. BUT, if you earn say, $25,000, you pay zero tax on the first $18,200, and 19% tax on everything above $18,200 (that is, on $6,800) - for every taxpayer in Australia, the first $18,200 is segmented off, and has no tax.

The 19% tax rate applies up to $37,000 - so the next $28,800 over and above your un-taxed $18,200 is all taxed at 19%. If you earn more than that, both your $18,200 and your $28,800 are segmented off at these rates, and you don't have to think about them again.

The next $50,000 - up to $87,000 taxable income - is taxed at 32.5% - are you beginning to follow the pattern?

The next $93,000 after that - up to $180,000 taxable income, is taxed at 37%. Every dollar above $180,000 is taxed at 45%.

The way this system works ensures that, if you earn $37,200 and your friend earns $36,900, you're not paying all your tax at 32.5% - only the little bit extra over $37,000. It ensures that, on a basic level, no person who earns more money ever ends up receiving less money cash in hand.*

The way marginal tax works also means that as you earn more dollars, you pay a higher 'effective tax rate' - an averaged rate of tax across all your income. As an example:

Tax on $37,000 = $3,572 = 9.65% effective tax rate
Tax on $70,000 = $14,297 = 20.42% effective tax rate
Tax on $120,000 = $32,032 = 26.69% effective tax rate
Tax on $180,000 = $54,232 = 30.13% effective tax rate

This concept of 'effective tax rate' will come into play later.

* On a non basic level, there are a bunch of ways this can happen, but I think I'll leave that for another day.

What was announced in the 2018 budget

The 2018 budget included a three-stage process to overhaul tax brackets and tax rates over the next 7 years.

Stage 1

Stage 1 is fairly basic - from 1 July 2018 it takes the $87,000 upper limit of the 32.5% tax bracket, and moves it up to $90,000. In addition, it introduces a 'low and middle income earners tax offset' which phases in, then phases out.

If you earn less than $37,000, you will receive a $200 tax offset.
The offset then slowly increases from $200 to $530 as your income increases, and between approx $50,000 and $90,000 of taxable income you will receive a full $530 offset.

Above $90,000, the offset then slowly phases out so that if you earn $125,333 or more, you receive no offset.

Stage 2

Stage 2 doesn't kick in until 1 July 2022 - essentially, Stage 2 is dependent on the current government winning at least one election and continuing the same taxation policy over the next 4 years, or any new government proceeding with this taxation policy.

Essentially - it's a 'don't count your chickens' stage, but we'll look at it anyway.

From 1 July 2022, the $37,000 upper limit of the 19% tax bracket becomes $41,000, and the $90,000 upper limit of the 32.5% tax bracket becomes $120,000.

In addition, there'll be a $200 increase in the low income tax offset (the original one that already exists, not the new one from Stage 1 above).

Stage 3

Stage 3 doesn't kick in until 1 July 2024 (at least two elections away), so if Stage 2 is a 'don't count your chickens' stage, Stage 3 is a 'when pigs fly' sort of likelihood of being implemented exactly as we've seen it announced.

From 1 July 2024, the upper limit of the 32.5% tax bracket becomes $200,000, and the 37% tax bracket disappears entirely (up to $200,000 - 32.5%; over $200,000 - 45%).

What this means in actual numbers

The details of the tax savings for each stage is outlined below for various income levels. We're gonna call these people our scaled income crew, and we're gonna imagine they're all friends who never argue about politics or welfare or social and economic policies (HAH).

Fig 1: Tax Savings from current tax positions.

Fig 1: Tax Savings from current tax positions.

Before we directly analyse this, let's jump into some history. I'll try to keep it short and interesting!

Historical tax rates

Historical is, admittedly, a loose term here as I'm going to restrict this to the past 10 years (the period of time for which I've been an accountant and been involved in preparing tax returns for individuals).

The table below outlines the major tax bracket and tax rate changes from the 2008 tax year to the current 2018 tax year. Overall there was some tinkering with the tax rates and brackets - particularly, more recently, for middle income earners - however the major change occurred in 2013 when tax free threshold was more than tripled, while the Low Income Tax Offset was significantly reduced. The tax rates on the next two thresholds were also adjusted.

Fig 2: Historical tax rates from 2008 to present.

Fig 2: Historical tax rates from 2008 to present.

The overall effect of this main change in the taxation system over the past 10 years was significant tax savings for low income earners (over $1,000 better off at the $37,000 income level, for example), with these savings slowly phasing out to be on par with the old rates for taxable incomes over $80,000.

Inflation adjusted taxable incomes

A word you may have heard many times is 'bracket creep' - this is the idea is that if tax rates stagnate, wages will increase with inflation, and people will slowly be pushed into higher tax brackets because these brackets are not in turn being adjusted for inflation.

Below is a table of inflation adjusted taxable incomes. The bold column is the current income of our scaled income buddies from earlier in the article, and we've calculated what their income for exactly the same job would have looked like in 2008, and what it might look like in 2025.

Fig 3: Inflation adjusted taxable incomes 2008-2025

Fig 3: Inflation adjusted taxable incomes 2008-2025

Looking at this when compared to the tax brackets listed above, you can get an idea for how bracket creep has had an effect over the past 10 years - for example, a person earning just over $37,000 (and only just creeping into the higher tax brackets) around 2008-2010 is now earning $50,000, with a significant portion of their income taxed at 32.5%.

We're nearly up to the good bit now, I promise! We're about to see what the actual real-world results are of all these tax changes in the past, and the forecast changes in the future.

Essentially - we're up to the bit where you get to have OPINIONS!

Putting it all together

I'm going to save you the EPIC MATHS of this bit, and you're gonna have to trust me that I've done a step in the background.

This table is where we put it all together. In the background, I've calculated the tax payable for each of the scaled income buddies for each year of the table - but what I've done with that is turned it into an 'effective tax rate'. Remember that from right at the start? It's the effective percentage of tax each person pays.

The ideal position of effective long term tax law is that any person earning the same effective amount of money (after adjusting for inflation) should pay the same effective percentage of tax - particularly at the lower income levels.

Anyway - on to the table!

Fig 4: Effective tax rates 2008-2025

Fig 4: Effective tax rates 2008-2025

So what can we determine from this? Let's start at the very beginning (a very good place to start!):

1. Looking at 2008 and 2013 together, we can see that the major tax overhaul in 2013 created a significant reduction in effective tax rates for everyone - but that the most significant reductions occurred for incomes of around $60,000 or less.

2. Looking at 2013 and 2017 together, we can see that bracket creep is already having a significant effect on most people. Interestingly, the majority of this impact is again on the lower incomes. The only bracket change during this time was increasing an upper limit from $80,000 to $87,000 - only giving a benefit to people earning over $80,000.

3. Looking at 2017 and 2019 together, we can see that the new 'low and middle income tax offset' doesn't even offset the bracket creep since 2017. In fact, again, the only bracket change is increasing the $87,000 bracket to $90,000. Are the changes better than nothing? Of course! Anything is better than nothing. But the changes don't even offset the bracket creep of the past 2 years, let alone the past 5 years.

So these are the things that have happened, or will very likely happen. What about the 'don't count your chickens' and the 'when pigs fly' changes that might occur in another 5 years time?

This is where it gets interesting. The coloured column of the table shows the net change in effective tax rate from 2019 to 2025 (note - this is displayed as a percentage of taxable income, so each percentage is 1% of total income).

While the low and middle income earners experience the usual bracket-creep that one can expect from tax policy, the high income earners experience significant tax savings compared with current tax rates.

This is further indicated in the very first table of this article, where we first met the scaled income buddies. Come 2023, the high income friends suddenly end up with a whole lot more money back in their pocket while the low income friends get no additional savings of note. Weren't we saying they never fought about social and economic policy? Maybe they're about to start.

So what does it all mean?

Well... this is where I shelve my opinions on social policy and allow you to form your own conclusions about the results of this article on that level.

From an economic policy level, this is what I can tell you about the data. These are the facts (both explicitly outlined and able to be inferred) as they are demonstrated in the above tables:

1. Every tax payer will be slightly better off, bottom line financially from 1 July 2018, compared to if nothing was done.

2. The additional tax offsets and changes to tax brackets are not enough to fully offset the effect of bracket creep for any tax payer.

3. The effect of bracket creep over the next 5-7 years is going to be most significant on those earning approx. $40,000-$60,000 currently.

4. Most significantly, the increase of the 19% bracket limit from $37,000 to $41,000 does not keep up with inflation, and leaves those earning incomes in the $40k and $50k brackets vulnerable to significant additional taxes.

5. The removal of the 37% tax bracket will create significant savings in the future for those earning $90,000 or more.

6. The effect of the above two items is that the proportional tax burden swings significantly away from high income earners and directly effects low and middle income earners.


...so! Who wants to overthrow the government?