16 February 2013

Tax thresholds - so tasty you can't stop at one

How exciting can a tax threshold get!  Over the last few weeks I've come across a few "discussions" on the subject, largely driven by speculation about what will happen to the tax scales if the Coalition wins September's federal election. 

Last year the Government increased the tax threshold from $6,000 to $18,200 as part of a package of measures associated with putting a price on carbon pollution.  The Coalition is intent on abolishing the "carbon tax" and, apparently, the household compensation measures that went with it, including the tax changes.  This obviously provides much scope for polite discourse on how people would be affected by winding back the changes.  I've even read some entertaining stuff questioning whether the Government's changes really did much at all, or in fact made people worse off.

None of this is made easier by the fact that tax-threshold apparently means different things to different people and is also rather dependent on the context in which it's used.  So, let's have a look at tax thresholds and how they've changed over the last 4 Parliaments.  A chart first, and if that makes no sense to you an explanation follows.





The best place to start is probably the tax threshold, or tax free threshold, shown in blue.  This has been $6,000 for most of the period covered, but was increased to $18,200 during the current Parliament (from 1 July 2012).  Now, inflation being what it is, $6,000 back in November 2001 was worth rather more than it is today.  I've adjusted for this, which is why the threshold is showing as more like $8,000 at the start of the period and declines in value at each subsequent point, until rocketing up in the current term.

That final change is the most marked on the chart, so it's scarcely a surprise it's the one the Government refers to.  However, while the tax threshold is an important number in terms of calculating tax liability, the actual tax bill is reduced by any Low Income Tax Offset (LITO) a person attracts.  Effectively, this means the amount of taxable income a person can have before becoming liable to pay tax is more than the tax threshold.  The effect of the LITO in combination with the tax threshold is shown in red on the chart.

While the LITO had been around since Keating it seemed to be an unloved blemish on the system until the latter years of the Howard era.  During the 41st Parliament (2004-2007) it really took off, almost doubling the income at which tax became payable relative to the actual threshold.  This trend continued under the Rudd-Gillard Parliament that followed. Immediately before the carbon related threshold change the effect of the LITO was such that the taxable income at which tax actually became payable was $16,001.

Against a background of a LITO tax threshold of some $16,000 the introduction of the new $18,200 threshold does not appear as grand as the more-than-tripling the old $6000 seems to be.  However, this is not the whole story as some LITO has been retained under the new arrangement (albeit no longer the main player when it comes to the final threshold).  When the (reduced) LITO is taken into account the tax threshold becomes $20,542.  This is apparent in the chart, as is the much greater role played by the basic tax threshold under current arrangements.

The two thresholds looked at so far reflect the tax system in lonely isolation.  But, realistically, it doesn't work that way - we need to factor in the receipt of transfer payments as well.  This brings us to the last two thresholds, starting with the green trace on the chart.

A single person with little or no income will almost always be eligible for some kind of income support and, importantly, that income support is typically taxable income.  Depending on the level of income support they get, some or even all of the tax threshold will be "used up" by their payment before they have any private income of their own.  This is why the green line is saying that the private income at which tax becomes payable is, with one exception, the lowest of the four values shown.  At the moment the private income tax threshold is about $15,700, which means in effect that the combination of that income and the taxable Newstart allowance is producing a total taxable income of $20,542 (the LITO-enhanced tax threshold shown by the red trace).

The increase in the private income threshold is quite marked over the period shown here and points to a considerable reduction in churning in the system (at least for single NSA shown here).  In this context churning refers to the situation where a person simultaneously receives transfer payments and pays tax.

The final (purple) line is a figure that Treasury often includes in their budget material - the point at which a person's liability for tax equals/exceeds their transfer payments.  It's where they become a net tax-payer instead of a net recipient (but note that this measure doesn't include indirect taxes paid [eg, GST] or non-cash benefits received [eg, the value of concessions]).  Interestingly, while it has increased over the 4 Parliamentary periods shown here it's to nowhere near the same extent as the other 3 measures. 

The final 2 lines covered above are very much dependent on what kind of payment(s) the person receives.  As the chart says, the picture shown above is only for single Newstart allowance under 55 years old.  If you are interested in the values for some other household types you might like to look at an earlier post of mine here.  The charts there are different to the one above, but represent similar data.

I'm not sure there are any profound conclusions to be drawn from these 4 lines.  Nonetheless, they do show that while the most recent changes to the tax scales and LITO did involve a degree of shuffling the deckchairs, they have resulted in a real increase in the tax threshold, however measured.

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