Death and Taxes: Are Stage 3 Tax Cuts a Certain ‘Snip’ at the Future of Equality?
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12:06pm 30 September 2024
Written by Tia Fitzpatrick
Describing Josh Frydenberg’s proposed stage 3 tax cuts in the 2023-24 budget as ‘heavily debated’ would be a blatent understatement. As the Albanese government’s chops and changes the proposed cuts in attempts to improve our nation’s equality, Tia Fitzpatrick delves into whether cutting taxes for the rich is really the next step towards improving Australia’s equality problem.
As the top 10% of Australians pocket 90% of pre-tax income, income inequality is rapidly increasing12. Whilst current progressive tax systems assist in improving equality, top-earner tax cuts commencing 1 July 2024 risk worsening the disparity. Income inequality can be measured using the Gini coefficient (GC), which ranges from 0 (complete equality) to 1 (complete inequality). Australia’s GC before any redistribution is depicted graphically using the Lorenz curve (figure 1), which plots cumulative proportion of income against cumulative proportion of income recipients, with a 45° line representing perfect equality11.
Where’s Australia’s Income Inequality at Now?
Unfortunately, Australia’s GC has increased by 6.48% from 0.303 to 0.324 between 2004 and 2020, indicating worsened inequality across the board (figure 2). This ranks Australia’s income equality as 20th out of 35 OECD countries, despite ranking 9th for GDP and 3rd for household income2. Surprisingly, despite Australia’s apparent progress as a developed nation, income inequality is largely attributed to “unequal education opportunities” and “stagnant wage growth for lower-income earners.” 11
Obviously, inequality harms the economy by reducing the purchasing power of lower-income individuals, leading to longer working hours and lowering their quality of life. It also contributes to economic instability as wealthier individuals can save more, reducing overall demand and potentially leading to government interventions like lowering interest rates, which can feed into asset bubbles, such as high housing prices7.
What’s Being Done to Help?
Income taxes are Australia’s largest source of government revenue (42.7%) and are used for redistribution through direct payments, increasing incomes for lower-income households and reducing inequality5. Australia uses a progressive taxation method, whereby the bottom 20% of earners receive 37% of redistribution benefits and contribute to 5% of taxes, while the top 20% of earners receive 11% of benefits but contribute to 50% of taxes paid4. Australia’s tax and transfer system has effectively reduced income inequality, particularly during COVID-19. A national household-based survey found that in 2020, income inequality fell to its lowest level since 2001, largely due to government interventions like Jobseeker payments and Coronavirus supplements6.
However, since the reduction of COVID transfer payments and the impending stage 3 tax cuts, concerns about increasing inequality have resurfaced. These tax cuts, set to take effect in 2024, will remove the 37% tax bracket and reduce the tax rate from 32.5% to 30% for those earning between $45,000 and $200,0008. As a result, while individuals earning over $180,000 contribute to 31% of total income tax, they will receive 48% of the tax cut benefits—disproportionately benefiting high-income earners9. While these cuts may boost investment, they reduce government revenue that could be used to assist lower-income earners, likely exacerbating income inequality.
What’s the Real Solution?
So, what should the government do? Rather than proceeding with the stage 3 tax cuts, they should consider increasing progressive taxation rates to maximize government revenue and fund adequate redistribution to lower-income earners, which would help reduce Australia’s Gini coefficient.
One successful example of progressive taxation is Sweden, which has the second-highest tax burden in the world (48.2% of GDP going to taxes). Despite this, Sweden ranks among the top 10 most equal OECD countries. In 2015, tax increases in Sweden reduced income inequality by 27%, showcasing how targeted taxation can effectively redistribute wealth and reduce disparities10.
What Are the Risks?
Though progressive taxation is an effective tool for reducing inequality, it comes with potential risks. Progressive taxation can be distortionary, as individuals perceive it as a reduction in their wage, which might alter their work behaviour. Whether increased taxes lead to more or fewer hours worked depends on whether the substitution effect or income effect is stronger, which relies on consumer’s indifference curves.
Figure 3 shows when income effect is stronger, if leisure is a normal good and wages decrease, individuals increase hours worked to minimise decreases to income level, consequently decreasing leisure from L1-L2. In figure 4, substitution effect dominates as increased tax disincentivizes labour. In response to lower labour returns, individuals work fewer hours, substituting labour for leisure, and increasing leisure from L1-L2.
Moreover, the Laffer curve (figure 5) highlights a critical consideration for governments: they must target an optimal tax rate to maximize revenue without disincentivizing work. If tax rates are too high, individuals may reduce their work effort or seek tax avoidance strategies, ultimately decreasing overall tax revenue. Striking this balance is crucial to maintaining a productive workforce while funding necessary redistribution efforts.
Moving Forward: A Balanced Approach
As Australia’s income inequality worsens, the potential long-term impacts on GDP growth and quality of life are a potent issue for policymakers to consider. A more equal society enjoys stronger economic growth, increased social cohesion, and a higher standard of living for all. However, achieving this will require more thoughtful and targeted policies. While Frydenberg might have argued that the stage 3 cuts would stimulate investment and economic growth, the evidence suggests that the wealthier segments of society will disproportionately benefit, leaving the most vulnerable even further behind.
To combat this, the government must focus on increasing progressive taxation rates, particularly for the highest income earners, to enhance its ability to fund social services and support lower-income households. This would not only decrease Australia’s Gini coefficient but also improve overall economic stability and social welfare. However, tax policy must be approached with caution. While raising taxes on the wealthy is a logical step toward reducing inequality, setting rates too high could quickly backfire. The key is to strike an optimal balance—targeting a tax rate that maximizes government revenue without discouraging economic participation. As shown by the Laffer curve (Figure 5), finding this equilibrium is crucial for to balance government revenue generation and effective incentivisation.
Cutting Inequality, Not Progress
Australia’s worsening income inequality presents a pressing issue that will require bold and decisive action. The proposed cuts risk undermining all the valuable progress that has been made in reducing Australia’s inequality, by disproportionately benefiting the wealthiest and further widening the gap. Instead, by abandoning these cuts and adopting a more progressive tax system, the government can strengthen its redistribution efforts and promote greater equality. However, in doing so, it must carefully navigate the risks of overtaxing, ensuring that tax policy supports economic growth while addressing the urgent need for a more equitable society. One thing is for certain: taxes cuts would snip the future of Australia’s equality.
Providing the right tools to the right people creates a more equitable society for everyone.
References
References
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2. AIHW. (2023). Measures of welfare and wellbeing for Australia and similar countries. Retrieved from https://www.aihw.gov.au/reports/australias-welfare/international-comparisons-of-welfare-data
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8. IFPA. (2023). COMMENTS ON THE 2023-24 FEDERAL BUDGET. Retrieved from https://ifpa.com.au/TSA/Resources/Federal_Budget_2023-24/TSA/Federal-Budget/2023-24/Federal_Budget_2023-24.aspx?hkey=7d96258a-c378-416f-b5a2-001324b4a9e3#:~:text=Personal%20Taxation%20Measures&text=The%20Stage%203%20personal%20income,entirely%20abolished%
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10. OECD. (2015). Sweden Policy Brief: Inequality. Retrieved from https://www.oecd.org/sweden/sweden-achieving-greater-equality-of-opportunities-and-outcomes.pdf
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13. Ziffer, D. (2023). Income inequality surges as richest group gets more than 90 per cent of the gains, Australia Institute finds. Retrieved from https://www.abc.net.au/news/2023-04-12/inequality-on-steroids-as-rich-take-more-of-the-gains/102200878
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