Cuts in income taxes are a hot political issue at the moment, with the government trying to get its seven-year plan for lower income taxes through the Senate.
Whether those tax cuts are affordable in the current era of budget deficits and rising government debt is an important issue. Many economists reckon the budget should be in healthy surplus before the government sprays tax cuts around the community.
This seems a sensible take, given the risks unfolding for the economy as house prices fall, wages growth hovers near record lows and the global economy starts to cool. If these issues bite the Australian economy, the return to budget surplus will be pushed back a further few years not least because of tax cuts that should not have been delivered.
There is also the vital issue of whether there are higher priorities for the $144 billion the government is planning to forgo to fund the lower tax scales.
This issue is where the political debate is also gaining heat with Labor reckoning the money would be better allocated to health, education and funding the ABC.
There is another issue, which unfortunately gets too little attention, and that is if we are to proceed with income tax cuts over the next few years, who should get them?
This is important given the current economic picture of dismally weak wages growth and rising inequality within the Australian community. It is also important given the growing income and wealth inequality which has seen the financial well-being of low and middle income earners fall relative to high and very high income earners.
Suffice to say, to the extent that there will be tax cuts, the discussion needs to ensure that the bulk of the benefit from a lower tax take be directed to low income earners.
There are several reasons for this, not least because it is fair.
Importantly, and in the context of trying to kick start the rate of economic growth, tax cuts to low income earners have a more powerful effect on consumer spending than if the tax cuts are skewed to high income earners. This is because those on lower incomes have a higher propensity to consume (spend) than those on very high incomes.
By way of illustration, this ‘propensity to consume’ means that someone on, say $50,000 a year who gets an extra $500 from lower income taxes is likely to spend almost all of that extra money.
The extra take home income will boost consumer spending and with that, the overall rate of growth in the economy will increase.
If, conversely, the $500 a year income tax cut is directed at someone on, say $200,000, there will be less of that extra $500 add to spending and there will be a less powerful impact on bottom line economic growth. This is because high income earners save a larger share of their income as their income rises.
If one of the aims of income tax cuts is to generate additional economic growth which will lift the business sector, lower unemployment and reflate a deflated economy, any income tax cuts should be skewed towards low income earners.
This is good economics and good social policy.
A simple increase in the tax free threshold, for example, and in the income level at which the 19 per cent threshold kicks in would have a more powerful effect on economic growth than tinkering with the tax scales for those earning $90,000 or $180,000 a year.
Alas, this is not the focus of the current tax plan of the government.
Which is why the tax cuts are not only risking the return to budget surplus, but they will do little to boost growth. Worst still, there will add to inequality at a time when more progressive policies are needed.