Yahoo Finance Farewell to our favourite $1,500 tax cut
The LMITO was a clever way of giving to middle-income earners without rewarding the top end of the earning spectrum.
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.
That was a clever design that let the families doing it tough enjoy some tax relief without costing the budget too much. It’s a shame the government is chucking this design in the bin.
We should note here that while they are getting rid of the LMITO, they are keeping the LITO – the low-income tax offset – that pays out $700 to anyone earning $37,000, and slides down from there. You might get a few dollars in LITO if you make up to $66,000.
Why hike taxes at all?
The government needs money to make up for what was spent during COVID. After spending more than it took in as tax for the past three years, the national debt is higher than it has ever been: estimated at $970 billion in the most recent budget. The outlook is for debt to grow even more, as forecast revenues continue to be lower than forecast expenses.
“Australia is on track for 25 years of deficits,” the Grattan Institute said in a recent report. “The structural deficit is expected to be about 2 per cent of GDP, or nearly $50 billion every year, by the end of the decade.”
But should paying down debt be a priority? After all, the government can borrow at 3.6 per cent, well below the rate of inflation, meaning the real interest rate on government debt is negative. The better argument for cutting the deficit is not to get on top of the debt pile, rather squash spending. Spending is contributing to inflation, and reducing household spending by hiking taxes will help encourage businesses to cut prices.
If we defeat inflation, interest rates can relax and the value of savings holds steady. That is an outcome everyone can cheer.
*The exception is when the government takes away some sort of benefit or entitlement when income rises. Losing childcare subsidy and paying more tax combined can make you worse off, for example. But the tax system alone will never make you worse off for earning more money.
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