The Gruen tax

Blogger Nicholas Gruen has written a report for CEDA on tax cuts.* The executive summary:

The Australians facing the strongest disincentives to work are mostly on middle and lower incomes. These people are also the ones most likely to respond to the incentive provided by tax cuts. By contrast, tax cuts for Australia’s high-income earners will probably do far less to increase the amount of work done in Australia. To encourage more work, tax cutting should focus on lowering the bottom (15 per cent) income tax rate, raising the tax-free threshold, and/or introducing a tax device called an “Earned Income Tax Credit” (EITC) for low-income households. Where tax cuts are focused on those on higher incomes, very large savings can be made by lifting thresholds rather than cutting rates. For instance, based on 2002–03 tax statistics and the old tax scales, approximately three quarters of the cost of eliminating the top marginal tax rate would have been able to have been saved by lifting the top threshold from $125,000 to $200,000.

Another option – which I don’t think anyone has mentioned so far – is to tweak the $600 low-income tax offset (presently available to Australian residents with incomes below $25,000). For people with salary earnings over $6000, we could make it  a “refundable” tax credit. In other words, if your income is below $25,000, and your tax bill is less than $600, you still get the full $600. A negative income tax, if you like.

* Nicholas has clearly been making good use of the blogosphere – I notice that Mark Bahnisch did some research assistance, and I gave comments on an earlier draft.

Update, 26/5: Nicholas has taken the paper off his website, so I have removed the link above. The paper is available for purchase ($16.50) on the CEDA website.

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9 Responses to The Gruen tax

  1. Yep, the blogosphere is a marvellous place for finding collaborators. Anyone interested in research assistance – email me on ngruen AT lateraleconomics DOT com DOT au. And Andrew, I’m working on that gig on default super. Watch this space!

  2. cba says:

    a few thoughts on this:

    is the failure of people to work a problem in Australia? I thought participation was at a historic high and unemployment historically low…

    is the objective of tax policy to raise hours worked or raise social welfare? I don’t think the two are the same thing

    Marginal tax rates also affect saving and investment decisions (since income taxes hit both wages and returns to capital). so while it might be true that the rich don’t work harder in response to tax cuts, they do have more incentive to put their capital to work in low tax regimes.

  3. Matt Cowgill says:

    I like the idea of EITC and the idea of using the low-income tax offset as a negative income tax, but who would that affect? The only people with a total tax liability less than $600/year are earning a gross income of less than $10000/year. The dole pays more than that.

  4. cba, You’re right, policy shouldn’t try to get people to work for it’s own sake – for instance it might be best to let parents who prefer spending time with their kids to do so. But the idea should surely be to try to minimise the extent to which tax discourages work effort – which is really what the paper is about.

  5. Patrick says:

    Unless you want to encourage people to stay home with their children – apparently, judging from these comments, that is a popular idea on the left.

    Ironic, given that I thought it was 1950’s misogyny last time someone actually changed the tax code to that effect.

  6. David Walker says:

    “Is the objective of tax policy to raise hours worked or raise social welfare? I don’t think the two are the same thing.” – cba

    CEDA has tried to be careful NOT to have a paper say: a) we must cut taxes; b) more people working more hours is always a good thing; or c) boosting the economy is the only reason to cut taxes.

    Rather, we have published a paper that addresses one specific question: If we’re going to cut income taxes, where should we cut them in order to do the most to raise economic activity.

    There’s plenty of room left for debate after you’ve answered this question. But it seemed to us that you could take a reasonable stab at answering this question, and inject some facts or at least rigorous analysis into the debate.

  7. Corin says:

    Nicholas,

    For political reasons – an obvious ability to cut EMTR’s is being overlooked – perhaps we should raise he GST (as much as another 5% to 15% and include food) and reduce the tax rates (may be to say 10, 20, 30, and 40) – and push up thrsholds at which they cut in, raise the T-F threshold itself (perhaps to 15K), give family tax credits (near the thresholds of each threshold), as well as raising the super contribution to 12% to promote long term retirement savings.

    If people really want to get keen on reducing wage costs at the low end on business perhaps we could reduce the payroll tax – which is high by international standards I believe. This would take a lot of pressure of the Fair Pay Commission to minimise rises in minimum wages over the cycle – if payroll tax cuts effectively did the job of reducing cost on business anyway.

    I’d suggest this is also a better method of ensuring minimisation of tax evasion – than lowering the top rate into the 3’s.

    The key would be finding a way to compensate those on fixed incomes – that I can’t crack – to make it a truly worthwhile idea. A compensation package may create even more churn I suppose.

    It will never get elected but hey! I hear you say Hewson all over ……..

    But I’d suggest that if that set of policies was implemented by Labor, it could potentially operate more fairly than the current system over the long term.

    I started reading your piece and will finish it over the weekend. I’ve gotten up to page 17 – compelling reading so far.

    Cheers,
    Corin

  8. Patrick says:

    I like that idea Corin – I suggested over at clubtroppo my pet idea – increase the GST to 20% and add in household income-determined rebates so as to effectively create a progressive consumption tax.

    It has a lot of advantages – notably it taxes the rich better than anything else, and can be quite cheaply reimbursed for poor households. Even if a millionaire gets away with pretending his income is and index the brackets.

    Of course, introducing a progressive (ly rebated) consumption tax is hardly tackling EMTRs.

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