Brian Fallow: When income tax creeps into theft

Bracket creep, Michael Cullen declared to a KPMG seminar last Friday, has been "a small but significant irritant to a large number of taxpayers".

But not all that small an irritant, to judge by the scornful reaction that the Budget's modest measures in this respect have encountered.

There is more to that reaction than disappointment engendered by false hopes raised in the days before the Budget, although, as the Finance Minister appeared to concede on Tuesday, he blundered in not hosing those expectations down.

It reflects a deeper sense of grievance, a recognition that bracket creep, or fiscal drag, is a kind of stealth tax increase.

It arises when you have a progressive income tax regime in which people on higher incomes pay a larger proportion of the last dollar they earn in tax.

Unless the thresholds for higher tax rates are adjusted for inflation, even someone experiencing no increase in real income can find himself pushed into a higher tax bracket just by inflation.

So the Budget included plans to inflation-index the thresholds in the tax scale, increasing them every three years at a rate of 2 per cent a year, the mid-point of the Reserve Bank's inflation target - but not retrospectively, and it will be 2008 before anyone gets any benefit from it.

It will be worth just $35 a year to those in the 21c tax bracket, $314 for those in the 33c bracket and $534 for those in the 39c bracket.

Even that will cost about $360 million a year, which illustrates, Cullen argues, how fiscally expensive more significant adjustments would have been.

The flipside of that proposition, of course, is that the gain to the taxman from bracket creep over the years has been equally costly to taxpayers.

Westpac's economists have helpfully injected some numbers into the debate.

The lower thresholds have not been adjusted since 1996 and the top threshold, $60,000 for the 39c rate, was only introduced in 2000.

Between the year to June 2000 and the year to June 2006, the personal income tax take will have risen an estimated 35 per cent.

Average earnings, on the other hand, will have grown a more modest 22 per cent over the same six years.

Someone on the average wage of about $42,000 is now well above the threshold for what used to be the top tax rate.

"To restore the $38,000 threshold at which the 33c tax rate cuts in to where it was in relation to average earnings six years ago would require it to be lifted to $46,406," the Westpac economists say.

"Likewise, the $60,000 39c threshold would have to move to $73,273."

Would that have been ruinously expensive?

A quick look at the Treasury's guide to the revenue cost of threshold adjustments suggests not.

It would cost about $1 billion a year, which is about half of the projected increase in new Government spending in each of the next three years, and slightly less than last year's Working for Families package costs.

It would be about two-thirds of 1 per cent of gross domestic product, or about 2 per cent of Government revenue.

Reflecting bracket creep, the average proportion of income going in income tax has been rising relentlessly, from 21.7 per cent in 2000 to 23 per cent now.

Even if that ratio increased no further over the next three years, the non-adjustment of the tax thresholds until 2008 would result in an extra $1.4 billion of tax being paid while we wait, Westpac calculates.

If the tax-to-income ratio had been held steady at the 2000 level of 21.7 per cent, people would have paid $8.7 billion less in income tax by 2008 than they will, in fact, pay.

Six years ago when the new top rate was still a campaign promise, it was supposed to apply to just 5 per cent of taxpayers. But now more than 10 per cent of all taxpayers are in that bracket and about 20 per cent of full-time wage and salary earners.

Collectively, they contribute 47 per cent of the total income tax take and 22 per cent of all Government revenue.

By 2008, it is estimated 13 per cent of taxpayers will be in the top bracket and they will be contributing 53 per cent of the income tax take.

The proportion of taxpayers in the 33c bracket will have increased from about 18 per cent in 2000 to 29 per cent in 2008.

The problem with all this is, in a word, Australia.

Treasurer Peter Costello's Budget last month included tax cuts worth A$21.7 billion ($23.3 billion) over the next four years, on top of the A$14.7 billion in last year's Budget.

The Australian income tax scales are even more steeply progressive than ours. But the effect of higher marginal tax rates than New Zealand's on higher incomes is diluted by the fact that the first A$6000 of income escapes tax altogether and the next A$15,600 is taxed at 17c in the dollar, falling to 5c on July 1.

The net result is that Australians on incomes up to A$95,000 pay less income tax than New Zealanders earning similar amounts.

Even before the latest Budget, average after-tax incomes in Australia were about $9000 a year higher than here. That gap will widen again next year as further lifts in Australian tax thresholds kick in.

On top of that is Australia's compulsory superannuation system, which requires employers to put money into individual retirement savings accounts for their employees.

In the context of a common labour market and Australian concerns about skill shortages, that sort of remuneration gap across the Tasman suggests the increasingly top-heavy structure of the New Zealand income tax regime is unsustainable.

Perceptions of fairness are all-important and perhaps that's true most of all among those who - forgetting the substantial taxpayer subsidy they receive - are aggrieved that their university degrees come with a student loan attached.

On Budget day, a small group of young protesters were waving placards outside Parliament proclaiming "Taxation is theft". Thirty years ago, the slogan was "Property is theft".

In a global labour market that shift in attitudes among those who can realistically aspire to be in the top income decile or two holds a warning for the Government.

Greedy Government

* Six years ago, tax of 39c in the dollar was supposed to apply to just 5 per cent of taxpayers. Now more than 10 per cent of all taxpayers are in that bracket.
* Collectively, they contribute 47 per cent of the total income tax take and 22 per cent of all Government revenue.
* By 2008, it is estimated 13 per cent of taxpayers will be in the top bracket, contributing 53 per cent of the income tax take.
* The proportion of taxpayers in the 33c bracket will have increased from about 18 per cent in 2000 to 29 per cent in 2008.