What are the stage 3 tax cuts,and why are they so controversial?

What are the stage 3 tax cuts,and why are they so controversial?Credit:Marija Ercegovac

The Prime Minister will on Thursday unveil the changes to the largest and most controversial stage of the previous government’s tax reforms,after getting cabinet support to give bigger cuts to workers earning up to $150,000 a year.

So what are the stage 3 tax cuts,what is controversial about them and why is the government willing to face political heat to change them?

What are the stage 3 tax cuts?

The income tax system now has four tax brackets:workers pay 19 per cent tax on annual earnings between $18,201 and $45,000,32.5 per cent for earnings between $45,001 and $120,000,37 per cent for earnings between $120,001 and $180,000,and 45 per cent for every dollar earned over that.

From July 1,under the stage 3 tax package,the 37 per cent marginal tax rate will be abolished for those earning more than $120,000 a year,and the 32.5 per cent tax rate will be reduced to 30 per cent for people earning between $45,000 and $200,000.

Every dollar earned over $200,000 will continue to be taxed at the 45 per cent rate.

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It’s the third part of a plan announced by the previous Coalition government in 2018. Stage 1 of the tax cuts introduced the temporary low- and middle-income tax offset,which ended in June 2022.

Stage 2,which kicked in from 2020-21,increased the existing low-income tax offset – a tax refund for those earning up to $66,000 – from $455 to as much as $700.

It also lifted the upper threshold for the 19 per cent rate to $45,000 (from $37,000 previously),and changed the thresholds for the 32.5 per cent bracket to $45,001 to $120,000 (from $37,001 to $90,000).

Why are the tax cuts happening?

The tax cuts were brought in to reduce bracket creep,where rising incomes lead to people paying higher average income tax rates.

Bracket creep occurs because the income tax system is not indexed,which means the tax brackets do not rise along with inflation. According to theindependent Parliamentary Budget Office, it has the largest effect on people who earn just above a tax threshold.

Bracket creep helps federal budgets – a high income-tax take helped Treasurer Jim Chalmersdeliver the first budget surplus in 15 years – but when governments can afford it,they periodically adjust the tax thresholds to return some of that bracket creep to workers’ pay packets.

But while stages 1 and 2 benefited low- and middle-income households,those on higher incomes stand to gain the most from stage 3,at a time when inflation will still be high and as lower-income households in particular struggle with high interest rates and price pressures.

Anglicare Australia analysis shows the stage 3 changes by themselves would give people earning more than $180,000 an extra $234 a fortnight,and people on more than $200,000 would get an extra $349,while those earning $60,000 would get less than $15.

What are the risks of changing the tax cuts?

There are both political and economic challenges here.

The Reserve Bank and federal government are still working to get inflation down to the central bank’s 2-3 per cent target range. While iteased to 4.3 per cent in November,the RBA governor has previously noted it is falling slowly.

ANZ’s head of Australian economics,Adam Boyton,said the economic impact of the tax cuts as planned would be the equivalent of about half a percentage point worth of interest rate cuts.

Not all the money returned to workers through higher pay packets would be spent,he said,and some would be used overseas,which would limit its impact on inflation.

Any additional economic stimulus,through increased support to lower-income households,would need to be closely assessed,Boyton said.

Politically,the pressure is piling up – despite the fact there has been no concrete announcement from Labor.

Albaneseas recently as last Wednesday said the stage 3 tax cuts would go ahead as planned in July,but this week the prime minister did not deny when asked if he was about to break an election promise and change the tax cuts.

“I’ll be taking a proposal on economic policy to the party room this afternoon. This proposal will be all about supporting middle Australia,” he said on Wednesday morning.

“We know there are cost of living pressures on middle Australia and we’re determined to follow the Treasury advice to provide assistance to them.”

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The Coalition has seized on reports the tax cuts are changing,with shadow treasurer Angus Taylor saying it was an “egregious betrayal” of Australians.

“The prime minister and treasurer lied to the Australian people over 100 times by saying they were committed to these tax cuts,” he said on Sky News on Wednesday.

At the same time,the Greens have urged the government to scrap the cuts altogether,following the release of modelling showing thecost of the cuts has increased to nearly $324 billion over the next 10 years.

What else could the government do?

Changing already legislated tax policy is far from the government’s only option for cost-of-living support for low- and middle-income households.

It could adjust the low-income tax offset to give more back to those earning the least,and finance some of that assistance by lifting the Medicare levy for those who are better off.

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Lifting the maximum rate of Commonwealth rent assistance is another option,popular with economists and advocacy groups as a way to help those struggling as rents continue to skyrocket.

Further increases to other government payments such as the single parenting payment or JobSeeker could also help.

Reducing the cost of healthcare by providing more funding for bulk-billing could also provide relief to many households,as would extending energy bill rebates.

Cut through the noise of federal politics with news,views and expert analysis from Jacqueline Maley. Subscribers can sign up to our weekly Inside Politics newsletterhere.

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