My plan to cut tax is feasible

A system with three brackets: 15 per cent, 29 per cent and 40 per cent would cost, at most, about $3.8 billion in 2006-07. It would deliver almost all taxpayers a cut. The top 20 per cent of income earners would get a 4.5 per cent cut, the next 20 per cent a 3 per cent cut. Even the bottom 60 per cent (who on our figures will pay about 15 per cent of the total tax take in 2006-07) would get a tax cut. Because most taxpayers are in the 30 per cent bracket, the 1 per cent cut in that bracket would cost about the same as the 7 per cent cut in the top brackets.

As we discuss in our paper, means-testing of benefits has the consequence that welfare is withdrawn as income is earned. The combination of a withdrawal of benefits and the imposition of income tax can result in high effective marginal tax rates for low-income earners moving from welfare to work. There is no silver bullet for this problem; it is inherent in any means-tested welfare system. But some relief can be given by lowering tax rates in the bottom bracket (as was done in the previous budget with the reduction in the 17 per cent rate to 15 per cent) or by lifting the tax-free threshold.

Lifting the tax-free threshold is very expensive because it benefits every taxpayer, not just those on low incomes. But one reform package that delivers broad tax cuts would involve raising the tax-free threshold to $10,000, and then dropping the top rate to 40 per cent. That would cost (at most) $7.5 billion. The top 20 per cent would get a 5 per cent tax cut, as would the next 20 per cent. The last 60 per cent would get a 26 per cent tax cut. And of course EMTRs would be reduced.

If the top rate reduction was increased to bring it down to 35 per cent, the cost would increase to $11 billion and the top 20 per cent would get an 11 per cent tax cut, the next 20 per cent a 5 per cent tax cut and the last 60 per cent would get 26 per cent tax cut.

But because of the big impact a change to thresholds has on those on lower incomes, the share of total personal income tax paid by the top 40 per cent of taxpayers would increase.