The following piece appeared in the AFR last Saturday. Apologies for the delay in posting it – Macgregor and I have been on the road.
Utah tales coming shortly…
What Will the Tax Cuts Mean for Households?
Dr Andrew Leigh
Oliver Wendell Holmes, of the US Supreme Court, once said that he paid his tax bills more readily than any other bills, knowing that they were the price of â€œcivilised societyâ€. Conservative British politician Edmund Burke took a contrary view: â€œTo tax and to please, no more than to love and to be wise, is not given to menâ€. Announcing $22 billion of personal income tax cuts over the next four years, Treasurer Peter Costello was clearly happier to throw his lot in with Burke than Holmes.
But how will the tax cuts be distributed across families, and what will their impact be on inequality? Australia taxes individuals, but welfare measures are based on comparisons between households. So to really see how the tax cuts will affect the distribution of incomes, we need to go beyond a simple comparison of tax tables, and also take account of household composition. For example, a couple with a combined income of $100,000 received a bigger tax cut in the recent budget if they had one $100,000 earner than if husband and wife both earned $50,000.
To perform the analysis, I took a sample of individuals across 7,000 households interviewed for the Household, Income and Labour Dynamics in Australia survey, and compared their after-tax incomes under the current tax system with their after-tax incomes under the proposed tax schedules.
Affluent households will do extremely well out of the tax cuts. The richest 10% of households, with an average pre-tax income of $179,000, will get 27% of the 2005-06 tax cuts, and 33% of the 2006-07 cuts. The top 5% of households, with an average income of $230,000, do even better: garnering 15% of the total tax cut pie in the next financial year, and 19% the year after. And the richest 1% of households â€“ average income a cool $433,000 â€“ get 3% of the first yearâ€™s tax cuts, and 4% of the second yearâ€™s tax cuts.
By contrast, poorer households, since they pay less tax, gain only a small share of the tax cuts. The share of the tax cuts going to the poorest 50% of households is a mere 17% in 2005-06. In 2006-07, the poorest half will get just 11% of the total tax cuts, a smaller share than the richest 5%. The middle 20% of households also receive a less than even share: 13% in the first year, and 9% in the second year.
In proportionate terms, these tax cuts are more regressive than the personal income tax cuts that accompanied the introduction of the Goods and Services Tax in 2000. Indeed, it is difficult to think of a more regressive set of tax reforms in recent Australian history. Their effect on the income distribution will be small, but not insignificant. My estimate is that the ratio of the disposable incomes of households at the 90th percentile to those at the 10th percentile (the so-called 90:10 ratio) will be pushed up from 7.4 under the current tax system to 7.5 in 2005-06 and 7.6 in 2006-07.
Dr Andrew Leigh is an economist in the Research School of Social Sciences at the Australian National University. The full analysis is available at www.andrewleigh.com.