You might hardly notice it, but every time your income goes up and tax brackets don’t, you’ll be paying not just more tax but a slightly higher proportion of your income as tax.
Why? Because of a phenomenon called bracket creep, whereby higher wages take taxpayers into higher marginal rates, so any increase is taxed at the highest rate, lifting the average tax.
We can’t know the precise effect on government revenue because a Freedom of Information request to find out was blocked by the High Court in 2006, after former Treasurer Peter Costello declared it against the public interest to know.
But I’ve done a little number crunching, and I think the answer helps explain why the government is keeping the figure quiet.
Wayne Swan left income tax thresholds unchanged in the 2011 budget, which means any future rises will be taxed at a higher rate. An interesting way to illustrate this is to look at the history of the tax-free threshold – the amount of money that can be earned without paying any tax.
In 1980 it was $4041 (click here). Since then it has risen to $6000 (click here).
As measured by average weekly ordinary time earnings (AWOTE), the average income in 1980 was $12,740 a year; today it is $66,300. This means that today only 9% of the average income is tax-free compared with those early, freewheeling days of the 1980s when 32% of the average wage was tax-free.
The reason? The tax-free threshold has risen more slowly than the rate of inflation, which has meant that bigger and bigger portions of taxpayer wages have drifted into higher tax brackets.
Although many might interpret the federal government’s decision not to change tax brackets for the 2011 budget as neutral, in actual fact the sneaky hand of bracket creep has dug into your wallets and delivered the government a nice little fillip.
Let’s spell out just what that means to you.
We now have to consider how much average incomes will increase in 2012.
Using the AWOTE figures over the past 10 years, average wage growth has been 4.6% a year. To be on the safe side, it might be more appropriate to use a wage growth figure of 4%, taking the average Australian's income from $56,493 to $58,752.
In the 2012 financial year the tax paid on this income will be $11,175 (excluding both the Medicare and flood levy).
This represents a 6.5% tax increase even though the average wage has only increased by 4%. Why? The answer is bracket creep: all of the 4% wage increase is taxed at the person's highest marginal rate (in this case the 30% tax bracket), meaning that the average rate of tax increases.
So, not only is a person paying tax on a bigger income, they are also paying a slightly higher average tax rate because the tax thresholds have not be adjusted to reflect everyone's higher incomes.
The next question is: what is bracket creep worth to the government? The short answer is, based on my calculations, is about $3 billion a year.
However, bracket creep pushes this average income tax bill up to $11,176 – $258 more than the 4% increase in wages growth. So if each of the 11.45 million working Australians are paying an extra $258 in tax from bracket creep, the windfall to the government is a neat $2.95 billion.
There is a simple answer to counter bracket creep: increase tax thresholds in line with either inflation or average wages. This has been suggested many times over the past 20 years but neither side of the political divide seems keen to tackle this issue and at some level it is understandable why: politicians can simply keep tax thresholds stagnant and quietly lift revenue by billions each year.
The other deliberate application of bracket creep in this budget is the use of $150,000 of income as a fixed limit for a number of welfare entitlements, such as family tax benefits and the baby bonus. Because this limit will not be indexed either, fewer and fewer families will be eligible for these benefits, delivering the government even bigger savings.
Bracket creep is an important concept for taxpayers to understand; it sees them facing increasingly higher tax rates unless tax brackets change as incomes increase. The resulting increase in government revenue means neither side of politics has ever tried to fix the problem, which could be done by the relatively simple step of indexing tax thresholds to inflation or wage rises.