Australia’s most popular tax cut is being chucked in the bin and it’s going to make the cost of living even harder to handle.

The Albanese government has confirmed it is junking the Low and Middle Income Tax Offset (LMITO), which delivered up to $1,500 in tax rebates per person last year and helped anyone making less than $126,000. It could cost households up to $3,000 if two adults were collecting the tax cut.

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The LMITO was a clever tax cut – it gave to middle-income earners without rewarding the top end of the earning spectrum. This means it cost less. Let’s explain how.

Bracket magic

Now, you still sometimes encounter people who don’t understand how our tax system works. They worry about going up into the next tax bracket, as though that could make them worse off. It can’t*.

Imagine your earnings like a stack. The bottom $18,000 is the foundation, the government won’t touch that, it’s tax free.

• The next $27,000 you make, the government takes 19 per cent of it

• The next $75,000, it takes 32.5 per cent

• And so on, up to the top rate of 45 per cent

The next graphic illustrates it (excluding the effect of tax offsets, the Medicare levy surcharge, HECS, etc).

If you move up into the next tax bracket, it doesn’t change the lower blocks in the stack. You pay the higher tax rate only on the new block on the stack.

For example, If you make $18,200 you pay zero tax, if you make 18,300, you pay $19 tax and take home $18,281. You’ve gone up a tax bracket but you’re still better off.

Your take-home pay is still higher than if you didn’t make that extra money. The same is true at every level. But it also means that a tax cut for low-income earners goes to high-income earners as well.

This is why the LMITO was so clever. Imagine you’d like to cut taxes for low-income earners. You could change the rate on that bottom part of the stack, reduce it to 15 per cent. But high-income earners pay that rate on their earnings between $18,200 and $45,000 too. You can’t give low-income earners a tax cut that doesn’t also give high-income earners a tax cut. So, cutting taxes for low-income earners is expensive.

The LMITO worked differently. It was an offset. It paid low-income earners back the tax they’d already paid. It came as a refund after June 30. So, it delivered the tax cut to low- and middle-income earners without the expense of also giving a tax cut to high-income earners.