Australia’s Government is hitching its re-election campaign pitch on tax cuts to boost jobs and growth, but their claims aren’t borne out by the research, writes Maria Racionero.
In the 2016 Budget Treasurer Scott Morrison announced what equates to modest personal income tax cuts by increasing the income threshold for the 37 per cent tax bracket from $80,000 to $87,000. This would effectively reduce the taxes paid by all of those earning above $80,000, which is about 30 per cent of income earners.
Can we expect these changes to have a significant effect on “jobs and growth”? According to both theory and available empirical evidence, most probably not. If the Government is genuinely concerned with “jobs and growth” the focus should be put on low and middle income individuals, and notably on second earners.
Research from the USA on the impact of marginal income tax changes holds some important lessons for Australia. The evidence suggests that past reductions in top marginal individual income tax rates have had an insignificant impact on growth but may have contributed to bigger budget deficits and greater income inequality.
Most of the early research focused on the impact of marginal tax changes on labour supply responses, typically measured by hours worked. Support for lower tax rates on top incomes is often argued on efficiency gains from reduced disincentive effects. This argument, though, seems unfounded, since labour supply elasticities estimates tend to be relatively small. In particular there is no evidence that high-income taxpayers have substantially large labour supply elasticities.
Modern research has switched the focus to the elasticity of taxable income, which captures all possible behavioural responses through which revenue can respond to rate changes, including income shifting, tax avoidance and tax evasion.
Indeed, recent research has shown that a decrease in the taxable income of top income earners in response to a higher tax rate often reflects an increase in tax avoidance, not a change in hours worked.
According to the research on taxable income elasticities, a tax code that minimises tax avoidance strategies (e.g., a broader tax base with fewer deductions or exclusions) provides, in fact, scope for increasing marginal income tax rates. Hence, if tax avoidance is the reason why taxable income of top earners appears elastic it should be dealt with directly, not through the tax scale.
Reliable estimates for the elasticities of taxable income are unfortunately not yet available for Australia. Taxable income is precisely measured in tax return data. The tax return records required for this kind of analysis have only recently been made available to Australian researchers, who are now working intensively to produce such estimates. In the future, these will prove crucial for tax policy.
There are however other aspects of the Australian tax system that have been carefully studied. Professor Patricia Apps from the University of Sydney has consistently drawn attention to the negative impacts on families of the income tax and family payment reforms over the last three decades.
Her research illustrates how this suite of reforms – in particular, the reduction in top marginal tax rates and the switch to family payments withdrawn on family income – have transformed a relatively progressive individual tax system into a de facto joint family tax system where most of the burden falls on middle income earners, and disproportionately so on partnered mothers. The resulting high effective marginal tax rates on second earners have strong negative effects on female labour supply, particularly on hours worked. Even worse, these negative effects seem to persist, even when children grow up, and crucially affect household income and savings.
All this suggests that if the Government is genuinely concerned with “jobs and growth” it is not pulling the right levers. Excessive focus is put on tax cuts on high-income earners when there is no compelling evidence this will generate positive and significant labour supply responses. Indeed research suggests that a more effective avenue to raise revenue from top earners is to close tax loopholes – an arguably politically challenging option that requires some courage. The Government should instead put the focus on the real bottleneck for increased participation and productivity growth, second income earners.
Maria Racionero is one of the panelists in the The Vote: Policy Forum.net and ANU 2016 Election Series event on ‘Tax and the economy’ on 31 May 2016. Find out more and register here.