Income tax: initially temporary tax on super-rich, now permanent tax on middle class: Bracket Creep

June is tax-planning time in Australia, plus there is heated debate over proposed big changes to the tax system, so it’s time to inject some facts and context into the fray.

Australia’s top marginal tax rate is high, but has been much higher in the past!

• Australia’s top marginal personal income tax rate of 47% is one of the highest in the world (Denmark is highest with 57%, while Finland, Luxembourg, Austria, Belgium, Slovenia and Israel also have top rates of 50% or more. However, Denmark’s top CGT tax rate of 45% is lower than Australia’s 47%.)
• Australia’s 47% top marginal tax rate (‘MTR’) may appear high, but it is actually only HALF what it once was! (chart A).
• The top tax rate for Australia was 92.5% during 1943/44 to 1945/46 under the Curtin/Chifley governments. (At that time, the top tax rate in the US was 99% on incomes above US$400k, and 99.25% in the UK).
• It was even worse for companies: in Australia the company tax rate was 100% of all profits above their 1939 profit levels – to ensure companies supported the war effort without profiting from it. Yep, every cent of corporate profits above the 1939 profit level for each company (not even indexed for inflation) was siphoned off by the government!)

Income taxes started out as temporary but now permanent:

• Federal income taxes were introduced in the 1915/6 year as a TEMPORARY measure to fund WW1 spending.
• That was before Canberra even existed (Federal parliament sat in Melbourne). Unfortunately, the feds decided to build Canberra (parliament shifted to Canberra in 1927), and we have had to endure Canberra and income taxes ever since.

Top tax rate initially targeted just the super-rich, but now hits the broad middle class -

• The income level for the top tax rate has fallen dramatically over time (in real terms), catching more and more taxpayers (chart C).
• This has been a combination of deliberate reductions in the income thresholds (to catch more and more tax-payers at the top MTR), and also the impact of ‘bracket creep’ – where inflation silently drags taxpayers into higher tax brackets each year.
• Initially, the top the Marginal Tax rate of 25% in 1915/6 was only paid incomes above £7,600 ($960k in today's dollars). This was 48 times the average wage, so it only hit the super-high earners.
• The 92.5% top personal income tax rate in the 1940s applied to incomes above £5,000 ($450k in today's dollars) which was 15 times the average wage, so it still only targeted the super-high income earners. The 1940s tax grab was mainly to fund the government’s WW2 spending, but it was also part of the Curtin/Chifley socialist plan to tax and nationalise just about everything.

Income threshold for top tax rate relative to average incomes (chart E):

• Chart E shows the dramatic decline in the income threshold for the top tax rate as a multiple of average wages, as the tax grab has broadened from just the super-rich to everyday middle class taxpayers.

• The income level hit by the top tax rate started at 48 times the average wage in 1915/6, hitting just the super-high earners.
• Today the top the tax rate of 47% cuts in at just 2.3 times the average wage, so it hits the broad middle class.
• It has been ‘worse’ than this (ie top tax rate reaching further to catch more lower-income taxpayers). The lowest multiple of income for the top tax rate was just 1.5 times the average wage. That was under the Howard/Costello coalition government in 1999/2000, when the top tax rate was 48.5%. That was the year Howard/Costello replaced Hawke/Keating’s inflation-indexed Capital Gains Tax to the 50%/33% discount system we still have today. 

Bracket Creep – easy to solve, but governments are addicted to it -

• Along with the deliberate reductions in the income threshold for the top tax rate, the real silent killer is Bracket Creep, where the impact of inflation silently drags more and more taxpayers into higher tax brackets without them noticing.
• Governments of both flavours routinely exploit bracket creep by handing out ‘tax cuts’ before elections to look good and buy votes, but all they do is partially correct the sinister effects of silent bracket creep.
• Ending bracket creep by indexing the income thresholds for each tax bracket would be the simplest and most effective tax reform. But governments hate that idea as it removes the ability to hand out fake ‘tax cut’ election bribes, and it requires them to reign in run-away government spending.

‘Till next time – have fun doing your tax planning and tax returns - and stay healthy!