Dispatches From the Moderate Left

Wednesday, May 11, 2005

Budget Part I - Taxes (Aust)

The Conservative Howard government handed down its 10th budget today. Considering this is a government which has enormous political power by historical standards (4 re-elections, control over both houses, broad popularity) it's welcome to see no sign of fundamental changes to our generally fair (esp with comparison to the US) taxation and welfare systems. Anyway, on to the substance.

Gee it's annoying when you have an idea and then find someone else has already put it to paper. Kenneth Davidson's piece in The Age today pretty much sums up my opinions on the budget - (1) big kudos to the government for maintaining the fundamental progressivity of the tax system, (2) moving the rate at which the highest marginal tax rate (MTR) cuts in will have little to no effect on the number of hours worked and (3) a real chance to increase workforce participation for those on welfare has been missed. I'll look at the first two now and the third in a later post.

There have been strong calls in recent months to use the huge budget surpluses to fund broad tax reform. The two proposals with, apparently, the most traction (a flat tax and eliminating the top MTR) would have destroyed or massively diminished the strongly progressive nature of our tax system. We don't see enough justification for progressivity in political discource nowdays. To my mind the strongest justification is that it achieves vertical equity. Thanks to the diminishing marginal utility of income ($1,000 is literally worth much more to someone on $20,000 than $200,000), which is a standard and empirically based economic assumption, to treat those on different incomes equally you must tax higher income earners at a higher proportional rate. While the movement of the threshold at which the top MTR cuts in today seems quite regressive it isn't too extreme (the old threshold kicked in at an insane 1.4 times average earnings, the new one is a more reasonable 3x) and the fundamental nature of the tax system is unchanged.

As for the argument that this is likely to make higher income earners work more, that's not really based on sound economics. As Davidson puts it:
For high earners, the income effects of lower marginal tax rates (I will have more income as a result of the tax cuts, therefore I can afford to play more golf and work less) is likely to be as important as the incentive effects ( I will work more overtime because I will take home more of the extra income).

This statement is backed up by almost every econometric study that has been done on the issue - cutting the tax rates of high income earners doesn't have any net effect on hours worked.


  • Budget surplus? No problemo. Just invade some oil rich Muslim country and watch it disappear.

    By Blogger Charles Watkins, at 2:00 PM  

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