Date created:27/8/04 Last modified:27/8/04 Maintained by: John Quiggin John Quiggin
29 may 2004.
One of the sillier claims in the debate over tax policy was pushed by the Treasurer at the time of the GST debate and resurfaced recently in the pages of The Australian, which is running hard in support of tax cuts. This is the claim that:
"The top tax bracket was worth 15 times average earnings in 1960; nine times average earnings in 1970; three times average earnings in 1980; but is just 1.3 times average earnings today."
A closer look at history produces a different story. In 1984, the threshold for the 48 per cent marginal rate of tax was $28 000, which corresponds to about $55 000 at 2004 prices, or about 1.6 times average weekly earnings. In 1974, the threshold was only $8000. This is a bit over $40 000 in today's prices, or about 1.2 times average weekly earnings at the time.
To find any real evidence of bracket creep, you have to go back to the 1960s. There was no change in the 48 cent threshold between 1964 and 1974, a period during which prices rose by 60 per cent, and average weekly earnings more than doubled. Even so, the point at which the 48 cent rate applied was only about three times average weekly earnings, not the 15 times cited by the Treasurer and others.
How, then, did Costello get his figures ? The answer is simple. Until about 1990, there were additional tax brackets, applying to those on high incomes, with marginal tax rates as high as 67 per cent. The removal of those brackets, a policy strongly supported by advocates of tax reform, meant that the 47 per cent bracket automatically became the top one.
Indeed, if the government wanted to restore a situation where hardly anyone pays the top marginal rate of tax, it could hardly do better than to return to the scale prevailing in the 1950s and 1960s, with 29 different brackets. As was observed in a Parliamentary Library Study recently, this system had the happy effect that only 0.05 per cent of taxpayers were in the top tax bracket.
The fact that top marginal tax rates were so much higher in the past, and particularly in the 1950s and 1960s, than today raises an obvious questions. Why are people so exercised about high marginal rates of taxation when the economy has performed very well in the past with much higher rates.
It might be thought that new evidence has shown that economic performance is much more sensitive to tax rates than was previously supposed. The Reagan tax cuts in the 1980s were based on this supposition. The 'supply-side' economists advising the Administration claimed that the cuts would pay for themselves. Instead, they produced gigantic deficits and little, if any evidence, of positive incentive effects.
More recently, the second Bush Administration introduced another round of big tax cuts. The cuts have certainly provided a Keynesian fiscal stimulus, but they have not had any obvious effect on incentives to work. Hours worked in the US economy have actually declined over the period since Bush came to office.
An even sharper illustration is provided by events closer to home. Until the 1980s, New Zealand, like Australia, had a top marginal tax rate of 66 per cent. And, despite a severe downturn following British entry to the EU, New Zealand began the 1980s with per capita income about 90 per cent of that in Australia.
New Zealand took the path of radical free-market reform cutting its top marginal rate of tax to 33 per cent in 1988. The following decade saw one of the most miserable economic performances experienced anywhere in the developed world , with virtually no growth in income per person. When the Clark Labour government was elected in 1999, New Zealand's income per person was less than 75 per cent of that in Australia.
The first action of the new government was to raise the top marginal rate to 39 per cent. Despite predictions of doom, and continuous sniping from architects of failure like the NZ Business Roundtable, the economy has performed strongly ever since. There are other factors at work, but if the increase in tax rates had any adverse effect, it has been imperceptibly small.'
If there is so little evidence for an adverse effect of existing marginal tax rates, why do we hear such a clamour on the subject. The most plausible answer is also the simplest and most obvious. Those who are making the clamour are, almost invariably, among the group who would benefit.
John Quiggin is an Australian Research Council Federation Fellow in Economics and Political Science at the University of Queensland.
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