Fix bracket creep to help families, economist says

Source: The New Daily

Australians are being squeezed more by rising taxes than higher mortgage bills, a leading economist says, and she argues that big changes are needed to address bracket creep.

Former RBA assistant governor and now Westpac chief economist Luci Ellis said on Friday that “more coherent design” of government and RBA policy is needed to better shield families from inflation.

That’s particularly the case as the climate crisis threatens to make price shocks much more frequent, threatening household budgets.

Ellis, who says consumers are reining in spending to cope with rising bills, singled out bracket creep and the indexation of prices like education and subsidised medicine as areas that need reform.

“Higher tax payments have done more to weigh on real household incomes than higher net interest payments have done,” Ellis said, of the effects bracket creep has had on workers.

“This additional fiscal squeeze distinguishes Australia from some peer economies, including the United States and Canada where tax brackets are CPI [Consumer Price Indexed].”

Ellis wants the government to index brackets to the midpoint of the RBA’s inflation target (2.5 per cent), which would address the issue of rising incomes pushing people towards higher tax bills.

The call comes after Treasurer Jim Chalmers booked a multi-billion dollar windfall in the federal budget as a result of far higher than expected income tax revenues from workers.

Oxford Australia head of macroeconomic forecasting Sean Langcake says that even the huge tax cuts touted by Chalmers on budget night won’t make up for bracket creep in recent years.

“We’re not going to come even close to unwinding what’s gone on with bracket creep,” he said.

“A system that indexes those brackets, whether it’s to CPI or the midpoint of the central banks target, seems fairer.”

Ellis argued that indexing tax brackets to 2.5 per cent a year would have other benefits too, including the government being able to preference that figure in taxpayer contract bids.

“Capital gains could be taxed at the full marginal rate on a ‘real’ return using a 2.5 per cent annual inflation rate,” Ellis said.

“This would remove the tax preference for capital gains over rental income – a significant distortion in the housing market – without the complexity of the pre-1999 system and without having to touch negative gearing.”

Need to guard against inflation shocks

The context of Ellis’ policy proposals is that inflation shocks are tipped to become more common in the coming decades as the effects of the climate crisis increasingly weigh on global markets.

“If Australia and the world are indeed facing a more inflationary environment – or as the RBA Governor put it, ‘shock after shock after shock’ – surely it would make sense to refine the economic policy architecture to be more resistant to inflationary surges,” Ellis said.

“And again, it would make sense for fiscal policy and monetary policy to operate hand in hand.”

Another set of changes would be to reform inflation indexation on key prices such as education costs and subsidised medicines under the Pharmaceutical Benefits Scheme (PBS), Ellis said.

The problem here is that when inflation is too high, indexation worsens the problem and extends more price growth into the following year – something that happened between 2021 and 2023.

“Indexing by 2.5 per cent, the midpoint of the RBA’s inflation target, would avoid this issue,” Ellis said.

Langcake warned that changing indexation to a fixed rate could create fluctuations in the share of those goods the government is subsidising when actual inflation deviates from the target band.

“Some of what she’s proposing requires other people to pick up the bill if inflation deviates,” Langcake said.

“Other people here are mostly the government.”

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