Wednesday, June 30, 2010

Tiny tax cut a blessing for battlers

Forgive me, but I'm tickled by the latest joke: the good thing about having a woman as prime minister is we don't have to pay her as much. Actually, the amount the prime minister gets paid is just one of the many things that won't be changed by Labor's leadership switch.

A new face, a new atmosphere, a new attitude towards the government for many people, but surprisingly little change in policy.

Take, for instance, the tax cut we get from tomorrow. Its arrival has been forgotten in all the excitement, but it's still coming. It's the third of the three annual tax cuts Kevin Rudd promised and, though our budgetary circumstances have changed markedly since then, there was never much doubt it would be delivered.

Even so, the government has waxed hot and cold on the promised cuts. This time last year it didn't want to draw attention to them, perhaps because it might have seemed profligate adding a tax cut to all the cash it had been splashing around.

This year it's happy to have us noticing the cut because people have begun complaining again about "cost of living pressures". So, we're told - conveniently - the cut is intended to help.

But that's not all.

It's remarkable the things politicians think our forgetfulness will allow them to get away with saying. Wayne Swan claimed recently, "the Rudd government designed these tax cuts to boost incentives for labour force participation..." blah, blah, blah.

In truth, the cuts were designed by Peter Costello. Rudd simply pinched them from John Howard during the election campaign. The cut we get from tomorrow, the first day of the new financial year, will be the eighth we've had in a row, surely a record.

And next year? Next year we'll get nothing. Indeed, unless a change of government brings a change of policy, we're unlikely to see another tax cut for four years, maybe longer. That's because Labor has vowed not to cut taxes again until the budget is back in surplus and the surplus is equivalent to at least 1 per cent of gross domestic product (by then, about $17 billion).

So it's good to take note of tomorrow's cut, even if for most people it isn't all that generous. People with part-time jobs, or full-timers close to the minimum wage, earning between $16,000 and $37,000 a year will save a princely $2.90 a week. Those earning between $37,000 and $67,000 will save $8.65 a week.

From there up to $80,000 a year, the saving drops to $5.80 a week. But from there on it starts rising, to reach a peak of $25 a week for those battlers on $180,000 a year or more.

The higher dollar savings going to people on very high incomes shouldn't surprise you and, since those people pay a much higher proportion of their income in tax, this doesn't prove the tax cuts are biased in favour of the well-off.

By the same token, however, the government's trick of showing us the percentage decline in the amount of tax paid at each level of income is another unreliable guide to who benefits most.

This will always show those on the lowest incomes - and thus paying the lowest amounts of tax - make the biggest proportional savings.

If, for instance, I was formerly paying just $1 a week in taxation and the tax cut relieved me of this, the government could claim it had given me a saving of 100 per cent. But that would hardly leave me much better off. No, the tax economists will tell you the right way to determine the fairness of a tax cut is to look at the change in the proportion of people's total income they lose in tax - that is, their "average tax rate".

Judged this way, it turns out the maximum saving of about 1¢ in every dollar of income goes to people earning between $37,000 and $50,000 a year - quite modest incomes, well below the average full-time earnings of about $67,000 a year.

The workers who do best from this tax cut are those earning up to $30,000 a year less than average earnings. But, surprisingly, those who do worst are those earning up to almost $30,000 a year more than average earnings.

People earning incomes a bit below or above $180,000 a year save only about 0.7¢ in every dollar of income. Someone on $300,000 a year saves just 0.4¢ in the dollar.

Tax cuts can be expensive from the taxman's point of view. Just how expensive they are turns not on how much you give the high-income-earners (there aren't enough of them to make a big difference) but on how much you give those on incomes around the middle.

That's because such a high proportion of incomes are clustered around the middle. But the middle (or median) income is actually lower than average (or mean) full-time earnings of $67,000 a year. And since there are a lot more people on incomes a bit below the mean than a bit above it, this seemingly modest tax cut is actually quite an expensive one, coming at a cost to revenue of $3.8 billion a year.

So, largely by chance, these tax cuts really will do a bit to help a lot of genuine battlers cope with the rising cost of living.

Will it satisfy them? I very much doubt it. Because wages - and age pensions - rise faster than the cost of living, complaints about the rising cost of living are actually a cover for worries about the success of our efforts to keep up with our peers' ever-rising standard of living.

Most of us are pounding away on this hedonic treadmill, as psychologists call it, and all our economists and politicians can think to do is help us run faster.