The revised changes distribute tax relief across all income segments instead of concentrating them among the wealthiest households
The revised Stage 3 tax cuts will provide marginal benefit to consumer spending over the medium term. Households will save about AUD 20 billion in taxes in FY 2024–2025, and over AUD 240 billion over the next 10 years. However, this amount only makes up a small amount (approximately 2%) of annual spending in Australia. Moreover, not all households will use their tax savings to finance spending. The marginal propensity to consume, i.e., the proportion of additional income that households spend on goods and services, generally falls as household incomes rise.
Lower-income households, or those with steep mortgages, will likely use most of the additional cash to finance essential spending and existing obligations. Those higher on the income spectrum, with robust savings, will likely spend a smaller amount of their tax savings, but are more likely to use the money they do spend on discretionary items. The biggest winners here will be middle- to upper-middle-income households (those that fall between the 5th and 8th income deciles); they are expected to increase their demand for travel, entertainment, electronics, and personal goods. However, while those in the highest-income brackets (those in the 9th and 10th income deciles) are expected to use their tax breaks in a similar fashion, the value of the benefit they will receive is smaller than previously expected. As a result, firms forecasting a boost in demand for products in the premium or luxury segments, targeted toward high-income earners, should temper these expectations.
Overview
The Labor government has completed a revision of the Stage 3 tax cuts that will come into force in FY 2024–2025. The Stage 3 tax cuts were the last series of changes in tax policy that were originally drafted by the Morrison government in 2019. Under Stages 1 and 2, low- and middle-income earners benefited from temporary tax relief, and certain tax brackets were adjusted upward to account for inflation. Stage 3 was, by far, the most consequential and controversial portion of the plan― granting major tax cuts for high-income earners.
In January, the Albanese administration revised the original Stage 3 plan such that lower-income earners will get greater tax relief, while high earners will get less than previously expected:
- Those with incomes between AUD 18,200 and AUD 45,000 a year will face a tax rate of 16%, instead of the 19% tax rate specified under the previous version of the plan. This will give a tax cut of up to AUD 804 a year to all taxpayers.
- Taxpayers who earn between AUD 45,000 and AUD 135,000 will face a marginal tax rate of 30%. Under the previous plan, this rate was to be applied to all earners with incomes between AUD 45,000 and AUD 200,000.
- The 37% marginal tax rate that was set to be abolished under the previous plan but will now be retained for those earning between AUD 135,000 and AUD 190,000.
- The top tax rate of 45% will be applied for those earning more than AUD 190,000, instead of the AUD 200,000 threshold envisaged under the original Stage 3 plan.
Under the new plan, those earning less than AUD 147,000 will either pay less or the same amount in taxes. This represents almost 90% of all taxpayers. Those earning more than AUD 147,000 a year will still get a tax cut, but the size of their tax cuts will fall.
The new tax plan is expected to cost the government AUD 20 billion in FY 2024–2025, and AUD 240 billion over the coming decade. This is largely similar to the cost of the original Stage 3 plan.
The revised Stage 3 plan passed both houses of Parliament in February.
Our View
The revision of the Stage 3 tax cuts has created a more equitable distribution of tax relief across the income spectrum in Australia. The government drafted the changes due to the rapid increase in the cost of living over the past three years, which has disproportionately affected lower-income households. The Stage 3 tax cuts, as originally drafted, were no longer politically palatable or as economically efficient. As a result, the tax changes have been revised to give almost all households some tax relief, but few households will see huge tax breaks. Therefore, instead of a spending surge that might have come from households in the top-income brackets, we will only see moderate spending increases across all segments.
The value of the tax cuts that each household receives will also dilute over time. As wages increase over the years, more households enter higher tax brackets. This concept of “bracket creep” will be most apparent for the 37% tax bracket, as it will remain in place under the new plan, instead of being discarded. Households exposed to this tax rate, those earning between AUD 135,000 to AUD 190,000, will increase from 7% of all taxpayers in 2024–2025 to 13% in 2033–2034. On average, Australian households will still be better off under the new system over the next decade, as they will accumulate savings in their current tax brackets and through a decrease in the base rate. However, the real impact of those savings will weaken over time.
The revised Stage 3 tax cuts, as they stand, will give a marginal boost to consumption over the medium term. It will increase both essential and discretionary spending across the country. However, its impact will be negligible, and we are likely going to see further tax reform in the coming years. The Liberal-National coalition, which drafted the original three stage tax reforms, was against the revised plan put forth by Labor. While the coalition passed the revised plan in parliament, it has stated intent to change it if it returns to power. Even if the coalition does not return to power, tax reform will be a key election talking point in next year’s general election. Moreover, the issue of bracket creep remains open and will only become more salient over the next few years. Thus, the recent revision to Stage 3 is another step in an ongoing conversation about the structure of tax policy in Australia.
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