Fixing bracket creep

By David Hughes

First published in the MRC’s Watercooler newsletter. Sign up to our mailing list to receive Watercooler directly in your inbox.

Imagine if every year Australia had a political debate to determine the age pension rate. 

Thankfully, the age pension rate is shielded from political meddling. It increases each year in the fairest manner possible — aligned with inflation and the cost of living.

There is beauty in the simplicity of this arrangement. And it gives pensioners the certainty to plan ahead. 

Within the OECD, there are 17 countries that adopt this same principle for income tax — automatically adjusting tax brackets to offset inflation.

Contrastingly, Australia's tax system is swayed by the election cycle and political agendas, leading to unpredictable outcomes. Tax cuts are often designed by politicians to win over the public at strategically important times or drive a wedge between political opponents. We have seen this recently where tax rates were tinkered with in the hope of swaying voters in a crucial by-election. 

It is no wonder many of our readers are frustrated. I’ve been asked repeatedly by MRC subscribers to examine the systems that exist outside of Australia where tax cuts are linked to inflation and somewhat protected from these political whims.

Our latest analysis from this week demonstrates the benefits of such a system. As the table below shows, if our tax brackets had kept pace with inflation since 2020 then the lowest tax bracket would have increased from $18,200 to $21,073.

Under such a system, every taxpayer would be guaranteed a modest tax cut at regular intervals each year. These modest improvements in take home pay would be equally matched to inflation making them the fairest form of cost of living relief for workers. 

Without doubt, our tax system would be enhanced by applying an objective measure (the inflation rate), rather than an over reliance on the subjective measures currently applied by politicians and parliaments. Consider Labor’s recently announced changes to the Stage 3 Tax cuts where the final determining factor in the rates and scales will be the Greens and Senate crossbench.

Automatic adjustments would represent a baked-in solution to bracket creep. This frees up governments to focus their tax reform efforts on more significant changes to our tax system —  such as abolishing entire tax brackets. Or looking at other inefficient forms of taxation across the economy. 

A system with automatic indexation would also prevent the Government from benefiting financially at your expense through bracket creep. As a result it would encourage the Government to demonstrate greater discipline on spending by putting a brake on the revenue the Government collects each year.

There is a looming structural issue that only continues to grow with the Government’s dependency on personal income tax as a way to prop up budgets and spending. To be so reliant on one stream of income leaves it vulnerable to immediate changes in the economy and disproportionately punishes workers.

Automatic indexation isn’t the only solution to a broken tax system but it should be central to discussions on meaningful reform. It represents a way to instil the values of fairness, aspiration and reward for effort into the system — values that we all share.