Only rich people want to lower the top tax rate

With Treasurer Peter Costello last Sunday announcing a review of how Australia's tax system compares with those of other countries, the door to further tax cuts has been cracked open. As Costello pores over reform options, it is easy to forget that just last year, the Government announced tax cuts amounting to $22 billion over four years, with a larger share going to the richest 5 per cent of households than to the poorest 50 per cent. With the ink on the 2005 Budget barely dry, the tax-cutting brigade began asking for more.

Yet survey evidence shows that those who want the top tax rate lowered still further are out of touch with popular opinion. For many years, Australian surveys have been asking the question: "If the government had a choice between reducing taxes or spending more on social services, which do you think it should do?" In the late 1980s, Australians clearly supported the tax-cutters, with those who wanted lower tax rates outnumbering those who wanted more social spending by four to one. But in the 2004 survey, social spending was more popular than tax cuts. Although I have been unable to find a recent survey of the attitudes of the Australian economics profession towards tax cuts, I would surmise that most academic economists would also oppose further reductions in top tax rates.

Why are those who want to cut top tax rates so out of step with public opinion? One possible reason is that the rates applying to most politicians, journalists, executives and think-tank staffers (and indeed, to academic economists) are not those that apply to the average voter. Only 4 per cent of Australian adults have a six-figure salary, and even fewer will be in the top tax bracket once the threshold rises to $125,000 in 2006-07. According to data from the Household, Income and Labour Dynamics in Australia survey (HILDA), the income of the median Australian adult is just $26,000 per year, placing them near the bottom of the 30 per cent tax bracket.

Erroneous views about what the typical person earns can only lead to bad policymaking. The first error is to use the mean income instead of the median income.

Mean income is the total income in society divided by the number of adults. If the incomes of highly paid corporate lawyers rise, mean incomes go up too. But median income is the income of the person at the 50th percentile - a measure of what the typical person has in their pocket. To find out what the average person earns, we should look at median income. Just as the median house price represents what the typical house costs (and is not sensitive to the sale of a waterfront mansion), so median incomes tell us what the typical voter has in their pocket.

The second error is to omit those not working. For policymaking purposes, those out of employment should matter as much (if not more) than those in employment. Yet commentators frequently ignore the unemployed when making statements about what a typical person earns. Average wages are not the same thing as average incomes.

The third error is to exclude those who work part-time. Since Australia has a high rate of part-time employment, this again inflates the estimate. Combining all three errors produces a fallacious estimate of $56,000, more than twice the typical person's income. Such errors can have serious consequences for the policy debate. In November 2004, when mean annual earnings of full-time workers rose above $50,000 for the first time, one newspaper headlined a story "The $50,000-a-year worker - but that's just average". Yet the typical voter has an income of just $26,000.

Even if we combine incomes within a family, the typical household income is just $66,000, meaning that half of all Australian households get by with less than that. Policy debates must acknowledge that most households are still well out of the top tax brackets.

Politicians should not make policy simply by following opinion polls. In some instances, long-term reforms are the right option for the country, despite being initially unpopular. But when only one in three voters support cutting top tax rates, the tax-cutting brigade should pause to consider whether they have it right.

And when reporting on tax cuts, journalists should make sure that they keep in mind what the typical Australian actually earns.

Instead of further cutting tax rates on the rich, Costello's next budget should focus on making the tax system simpler for ordinary Australians. Like New Zealand, Australia could dramatically simplify the tax filing system, saving many of us the hassle of poring over the Tax Pack for a weekend, and reducing the $3 billion dead-weight cost of the personal income tax system that comes from compliance costs alone.

Real tax reform would involve offering tax credits to encourage the transition from welfare into work. Effective marginal tax rates are higher on the poor than on the rich, and making work more attractive may be a way of breaking the inter-generational cycle of poverty and joblessness.