Top end tax cuts fail economy and boost inequality: studies
The Age
December 21, 2020
The Morrison government's plan to flatten the tax system and cut taxes for high income earners may increase inequality and fail to boost productivity, ground-breaking international research suggests while leaving a future government with a multibillion-dollar budget headache.
Based on analysis of past cuts to Australia's top marginal tax rate and to rates in developed nations, the research raises doubts whether the government's plans will help boost economic activity enough to cover the costs left by the pandemic recession.
Planned tax cuts could increase inequality and do little to boost the economy, new global research suggests.
The global debate over income tax cuts for high income earners has grown since the global financial crisis but accelerated recently as some countries consider tax relief as a way to recover from the coronavirus downturn.
In the October budget, the government brought forward tax cuts for middle income earners including lifting the 32.5 per cent threshold from $90,000 to $120,000. It also continued for another year the low and middle income tax offset.
Larger and more expensive cuts are due to start in mid-2024. They include abolishing the 32.5 per cent threshold and extending the 30 per cent rate to incomes between $45,000 and $200,000.
Treasurer Josh Frydenberg has said the changes will maintain the progressive nature of the tax system, reward effort and "encourage aspiration".
But research by Enrico Rubolino and Daniel Waldenstrom and recently published in the The Journal of Economic Inequality suggests the cuts will benefit high income earners and do little for the rest.
Their work, which looked specifically at previous cuts in the top marginal tax rate in Australia, New Zealand and Norway, found they delivered "large and lasting" positive impacts to the top few per cent of wage earners and "almost zero" to lower income earners.
Not only was there little in the way of financial benefit to lower income earners, tax cuts also failed to boost the overall economy, instead increasing redistribution within the economy.
"We cannot find any significant impact by tax reforms on economic output or other efficiency indicators, which could indicate that the effect on top income shares was not driven by the generation of new resources but rather a redistribution of existing ones," they found.
Josh Frydenberg with Scott Morrison after the 2019-20 budget at which the Treasurer revealed plans to expand the government's long-term tax cut plan.
Professor Waldenstrom told The Sydney Morning Herald and The Age there may be an incentive impact from tax cuts that encourage younger people to change their study choices in a bid to maximise their working incomes.
But there was evidence that as higher income earners benefited more directly from lower taxes on capital, such as capital gains tax, there was an active incentive for tax avoidance.
"We find that the share of capital income of total income increases after the tax reforms and we suggest that lower relative taxation of capital and the possibility to steer incomes is part of the explanation for why lower tax progressivity leads to higher top income shares," he said.
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Separate research from the London School of Economics, covering 18 OECD nations over the past five decades, found reducing taxes on high income earners has added to inequality.
Economists David Hope and Julian Limberg found despite the arguments of tax cut proponents, reductions for higher income earners did not encourage these people to work longer or at a higher effort while they failed to boost overall economic activity.
Instead, tax cuts encouraged higher income earners to look for more ways to boost their incomes.
"Lower taxes on the rich encourage high income earners to bargain more forcefully to increase their own compensation, at the direct expense of those lower down the income distribution," they found.
Apart from boosting incentives, Mr Frydenberg has argued the tax cuts are necessary to protect ordinary workers from "bracket creep" where they pay a higher proportion of tax as their incomes increase.
But the independent Parliamentary Budget Office this month, in its report on the medium term outlook for the budget, noted that under the government's plan only those people in the highest 20 per cent of incomes will have a lower average tax rate in 2030-31 compared to 2017-18.
The biggest increases in average tax cuts are expected for the middle 40 per cent of earners.
"The effects of the stage three tax cuts legislated for 2024-25 are substantially more beneficial to those in the higher income quintiles, resulting in those taxpayers being the largest overall beneficiary.
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