Income Tax - Bracket Creep - 2006/2007

The New Tax System for Australia (2000) changed the income tax rates, but did not amend the inequitable aspect of Tax Bracket Creep. Taxes on beer, wine, vehicle fuel amongst others are adjusted to take account of inflation. The tax thresholds on which income tax is calculated are not similarly adjusted.

The table below shows the current Income Tax Brackets and Tax Rate Change Points. On income up to $6000 the income tax rate is 0% - tax free.

For a taxable income of $24,000 the tax would be

• $0 for the the $6000 in the $0 to $6000  bracket - plus

• $2,970 for the $18,000 in the 16.5% bracket.

Present Value

In financial calculations, the concept of "Present Value" (pv) is used to consider the effect of time and inflation of values. For example, with inflation of 4% per year, $100 today is worth about the same as $104 a year from now.

Based on inflation of 4% per year, a value of $6000 a year from now is the same as $5769.23 today. (6000 / 1.04 = 5769.23).

Consider the $6000 tax free threshold, with 4% inflation - the present value is

• $5769 one year from now,

• $5574 two years from now

• $5334 three years from now

• $5129 four years from now

Let's assume that inflation over the next five years will average 3.5% and examine the effects of Tax Bracket Creep.

With inflation of 3.5% per year and a taxable income of $68,000, - assume that our income keeps pace with inflation - compare the present value of tax paid this year and a year from now - an extra $160 - or an extra 0.96% more tax in the second year.

Bracket Creep Below the $75,000 Tax Rate Change Point

Assume that income keeps pace with inflation. The following table shows the increase in present value (pv) over the $11,640 tax payable a taxable income of $52,000 in the present year (referred as the "First year" in the table below).

The values shown in the "Increase in tax paid (pv)" column are the same for taxable incomes above $25,000 and below $65,358. Above $65,358 the income creeps into the $75,001 to $150,000 bracket in the 5th year . The values shown in the "Annual % increase in tax paid (pv)" column vary as the "First year tax" value changes.

Bracket Creep Within the $75,001 to $150,000 Tax Bracket

Assume that income keeps pace with inflation. The forecast movement of the bracket points in 2007-08 is not taken into account in the figures below. 

The values shown in the "Increase in tax paid (pv)" column are the same for taxable incomes above $75,000 and below $130,716. Above $130,716 the income creeps into the over $150,000 bracket in the 5th year. The values shown in the "Annual % increase in tax paid (pv)" column vary as the "First year tax" value changes.

Bracket Creep Above the $150,000 Tax Rate Change Point

Assume that income keeps pace with inflation.  The forecast movement of the bracket points $75,000 and $150,000 in 2007/08 is not taken into account in the figures below. 

The values shown in the "Increase in tax paid (pv)" column are the same for taxable incomes above $150,000.

Bracket Creep into the $75,001 to $150,000 Tax Bracket

To illustrate the effect of bracket creep, look at the calculations for a first year taxable income of $68,000. Assume that income keeps pace with inflation. The first year taxable income of $68,000 will result in income creeping into the $75,001 to $150,000 bracket in fourth and following years 

The values apply only to a first year taxable income of $68,000.

The Political Promises

The switch to GST (spending based tax) builds inflation into the amount of GST collected. Other taxes on beer, wine, vehicle fuel etc. can be expected to be adjusted to take account of inflation.

The tax thresholds on which income tax is calculated should be similarly adjusted. Otherwise, the real value of income tax collected increases each year. Any government which wants to increase spending in real terms should be required to justify the increase in taxes each year. 

A government that fails to index the Income Tax Rate Change points (thresholds) is promising to increase income tax in real (present value) terms of approximately 1.4% per year, assuming wages keep pace with inflation for annual earned income between $25,000 and $65,000.

The chart below shows the annual percent increase in tax paid (in present values) for taxable incomes between $38,000 and $74,000 - compared to the first / present year. Data series are shown for 2nd, 3rd 4th and 5th years.

The chart below shows the present value of the increase in annual tax paid for taxable incomes between $44,000 and $80,000. Series are shown for 2nd, 3rd 4th and 5th years compared to the first / present year.

Grant McEwing BSc (Science Applied)
 

Last Modified 14/02/2009