Oliver Wendell Holmes, of the US Supreme Court, once said that he paid his tax bills more readily than any other bills, knowing that they were the price of “civilised society”. Conservative British politician Edmund Burke took a contrary view: “To tax and to please, no more than to love and to be wise, is not given to men.” Announcing $22 billion of personal income tax cuts over the next four years, Treasurer Peter Costello was clearly happier to throw his lot in with Burke than Holmes.
But how will the tax cuts be distributed across families, and what will their impact be on inequality? Australia taxes individuals, but welfare measures are based on comparisons between households. So to really see how the tax cuts will affect the distribution of incomes, we need to go beyond a simple comparison of tax tables, and also take account of household composition. For example, a couple with a combined income of $100,000 received a bigger tax cut in the recent budget if they had one $100,000 earner than if husband and wife both earned $50,000.
To perform the analysis, I took a sample of individuals across 7,000 households interviewed for the Household, Income and Labour Dynamics in Australia survey, and compared their after-tax incomes under the current tax system with their after-tax incomes under the proposed tax schedules.
Affluent households will do extremely well out of the tax cuts. The richest 10 per cent of households, with an average pre-tax income of $179,000, will get 27 per cent of the 2005-06 tax cuts, and 33 per cent of the 2006-07 cuts. The top 5 per cent of households, with an average income of $230,000, do even better: garnering 15 per cent of the total tax cut pie in the next financial year, and 19 per cent the year after. And the richest 1 per cent of households - average income a cool $433,000 - get 3 per cent of the first year’s tax cuts, and 4 per cent of the second year’s tax cuts.
By contrast, poorer households, since they pay less tax, gain only a small share of the tax cuts. The share of the tax cuts going to the poorest 50 per cent of households is a mere 17 per cent in 2005-06. In 2006-07, the poorest half will get just 11 per cent of the total tax cuts, a smaller share than the richest 5 per cent. The middle 20 per cent of households also receive a less than even share: 13 per cent in the first year, and 9 per cent in the second year.
In proportionate terms, these tax cuts are more regressive than the personal income tax cuts that accompanied the introduction of the Goods and Services Tax in 2000. Indeed, it is difficult to think of a more regressive set of tax reforms in recent Australian history. Their effect on the income distribution will be small, but not insignificant. My estimate is that the ratio of the disposable incomes of households at the 90th percentile to those at the 10th percentile (the so-called 90:10 ratio) will be pushed up from 7.4 under the current tax system to 7.5 in 2005-06 and 7.6 in 2006-07.
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