OECD endorsement

Nice to see the OECD citing and supporting Lateral Economics’ paper on income tax priorities – published as Tax Cuts for Growth by CEDA. The OECD has in the past lined up with the chorus of people calling for cuts to higher marginal taxes on the (unsubstantiated) grounds that its necessary for Australia to be competitive in holding and attracting skilled labour.

I say ‘unsubstantiated’ not because the argument doesn’t have some merit (after all most arguments have some merit). It’s because the recommendation to cut marginal tax rates on skilled labour is not much of a recommendation if it isn’t implicitly saying that this should be given a relatively higher priority than others. In the words of one of Club Troppo’s patron saints of economics quoted in our masthead, Ken Arrow, ‘the economist’s job is to say ‘this or that – you can’t have both’.

Anyway, now it’s all different. This is what their summary ‘policy brief’ document (pdf) of their larger report on Ozsays:

Recent cuts in higher rates of personal income tax and the widening of thresholds address concerns about the tax burden on skilled workers raised in the previous Survey and are to be welcomed. Indeed,as discussed further below,the extent of these changes are such that the priority for any future tax cuts should now be at the lower end to address the problem of “low wage traps “. This would build upon measures in recent years to reduce benefit withdrawal taper rates in the Family Tax Benefit system and the targeted tax relief recently provided to low income earners.

The extent to which the tax cuts might stimulate the supply of skilled labour is not addressed, but now it’s a lower priority and tax cuts lower down make more sense. Oh well, I’m not sure of the logic, but the new priorities are better than the old ones. They always were.

Another tip. It’s true that the high effective marginal tax rates produced by the withdrawl of benefits are the source of some important problems but (paradoxically) the ‘Tax cuts for growth’ paper makes it clear that simply reducing taper rates (rates at which benefits are withdrawn) might not be such a good use of funds.

That’s because cutting withdrawl rates is always a double edged sword. It lowers effective marginal tax rates (EMTRs) where the (hgher) taper used to be, but raises them above that level. Why? Because by the time people get to the income level where their benefits used to have fully tapered out (restoring them to their simple tax rate as their EMTR) under a lower taper rate there’s still more tapering to go at this point. So this raises EMTRs by the full amount of the (new, lower) taper rate – up to the point at which the benefit is fully withdrawn under the new taper rate.

The one tax cutting policy experiment modelled with the Melbourne Institute Tax and Transfer Simulator (MITTS) which actually reduced labour supply involved lowering taper rates. As Dilnot and McCrae put it: “The apparently common-sense assumption that lowering tapers must be good is far from obviously true; it may be better to have higher taper rates affecting a smaller group”.

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4 Responses to OECD endorsement

  1. spog says:

    One thing that maybe the Melbourne Institute doesn’t take into account when comparing taper rate reduction with other EMTR-reducing methods (Earned Income Tax Credits or Low Income Tax Offsets) is that the former is available in “real-time”, whereas the latter two don’t turn up until the tax return is lodged and processed. Tapers change the amount in your pocket as you earn, EITC and LITO change the size of your tax refund.

    If people are ignorant of the mechanisms by which EMTR reductions are achieved, how do they know to respond to them other than by what their hip pocket is telling them? How does the Melbourne Institute take this into account?

    An EITC, at least the versions I’ve seen discussed in Australia, suffers from two problems. First is the end of year delivery combined with ignorance issue mentioned above. The second is that they seem to adversely affect second earner incentives in couples. If you could champion an EITC that was individually based (so no second earner issues) and was capable of being delivered in the PAYG system rather than via tax refunds, I’d be all ears. Drooling even.

  2. Well you can. No problem. Drool away, just depends on how you design it. And the LITO is already withdrawn according to individual rather than household income.

  3. spog says:

    That is a good feature of the LITO. My concern with EITC is that the only versions I’ve seen touted around (Labor’s for example) all involve a family (or at least a couple) income test. That effectively rules out PAYG delivery unless we want to get into FTB style end of year debts.

    The EITC that Australia currently has (the Mature Aged Workers Tax Offset) is individually based, however, and is deliverable via PAYG. I guess there’s hope.

  4. Pingback: A 50 per cent top rate makes sense | Club Troppo

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