Cutting the top marginal rate

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As Mark Bahnisch said to me having read a draft of this week’s Courier Mail column, “Getting pissed off is often good for one’s writing”. Well, I’m not sure, but it certainly works for this genre. I’m thoroughly pissed off with the latest turn of events and so am grateful that I get the chance to put my case in the paper.

Most of the efficiency arguments for cutting top marginal tax rates are not too hot, and downright poor when one considers that almost all taxes distort – so if you want to argue against some tax, you have to show how its unusually bad. Anyway I’ve argued these things in various columns before. For instance here and here.

As I argue in the column this issue is a critical one for the ALP because so many of those policies for which the labour movement had high hopes either make life worse for most working people (eg. tariffs) or are ambiguous in their effects helping ‘insiders’ and hurting ‘outsiders’ (as I argue below is the case with most IR regulation including the basic wage).

As I suggest at the end of the piece, it’s also (yet another) loss of contact with the recent sucesses of the ALP, which was – uniquely amongst English speaking countries in the 1980s and 90s, economic liberalisation with a strongly redistributive flavour. The bargain between Paul Keating and Brian Howe.

Helen Clarke was able to sell this message in NZ, and indeed argued for higher taxes at the top end and got into government with that message. Whether one wants to embrace that (and top rates were much lower when she argued that) going the other way seems to me to be politically silly. A kind of rerun of the budget debacle when the ALP found a way of letting the Government off the hook for cutting taxes (for the second time) exclusively for those on higher incomes.

Anyway, the column is over the fold.

Is Peter Costello all that’s left?

We should get top marginal tax rates closer to our Pacific neighbours and align them with company tax to reduce avoidance.

Welcome to the new conventional wisdom.

I’ve explained previously how economically dubious these assertions are however plausible they seem. But they’re rolling off politicians’ tongues of both major parties with increasing ease.

The Liberals’ fundamental creed but not usually their practice is small government. So while most Liberals believe in progressive tax rates, many think tax rates above some figure are unfair and oppressive. Since fairness is in the eye of the beholder, that’s a perfectly reasonable position.

I wish Malcolm Turnbull had left it at that. I’ve been reading his long awaited paper arguing the case for further lowering marginal rates for those on over $125,000 per annum where top rates will cut in from next year. And, compared with the thoroughness of the modelling of various options, the arguments are surprisingly slight.

High rates encourage avoidance. Too true! But so do low tax rates maybe by nearly as much. Tax avoidance is a favourite hobby of the rich everywhere including for instance Hong Kong. If you could save 15 cents in the dollar, why wouldn’t you?

His simulations of umpteen policy options are built on credible models, so you’d expect the basic arguments would be founded on credible research. But Turnbull’s case that high taxes foster a brain drain amounts to this. “Many contend” that it is so. Despite lower taxes there, New Zealand brains drain to Australia. Australian brains drain to Europe and America. Overwhelmingly brains drain towards larger markets, not lower tax.

Turnbull also quotes right-wing think tanks. But, like left-wing think tanks, their numbers’ are often carefully chosen to mislead. We’re told that the rich paid a higher proportion of total tax paid after Reagan’s tax cuts than they did before. But during that time low incomes stagnated (or worse) while high incomes soared. Credible advocacy would concede these complications.

There should be a stronger burden of proof on proposals to further aggravate inequality.

Instead, in the mysterious way these things occur, the new enthusiasm is taking increasing hold on the ‘light on the hill’ crowd. They’re the people who, a couple of months ago, voted against the Budget’s tax cuts because they favoured the rich.

Powerful union boss Bill Shorten and Victorian ALP Premier Steve Bracks want lower top rates. And eminences grise Lindsay Tanner and Craig Emerson agree, but emphasise that cutting top rates is a low priority.

There’s much more at stake here for Labor than for the Liberals. Because traditional Labor policies have been falling like nine-pins lately. Indeed, Labor’s often bowled the balls. Why? Because so many traditional policies to help working people and the poor actually harm them.

Did tariffs help them? They created few jobs. But they probably destroyed more jobs at the same time as imposing regressive price increases on necessities like clothing and footwear. Some help.

You won’t hear a peep out of the ALP on the subject now, but something similar can be said about industrial relations regulation. The power it gave unions destroyed hundreds of thousands of jobs in the recessions of the seventies and eighties. The Accord worked miraculously to prevent further disasters until it was gradually unpicked and morphed into IR deregulation, first under the ALP and now the Coalition.

Even the basic wage is a double edged sword. It’s main effect is probably to increase low wages. As a side effect it wrecks the lives of that (probably smaller) number of people whom it prices out of a job.

At least for those keeping their job we’ve assumed it promotes equality. But recent research shows that a huge number of those with low paid jobs live in high income households. Why? Think doctors’ wives doing reception. Students waitressing.

So there’s not a lot left in the policy kitty when it comes to redressing economic disadvantage. Tax and welfare systems were always our first port of call. Turns out they’re pretty much our last port of call too.

And we’ve used them to great effect. In the 1980s other countries’ economic reform increased inequality. New Zealand cut tax for the rich and welfare for the poor. We pioneered economic reform with a human face. We deregulated, and we cut top tax rates. But they’re still higher than others’. And we massively increased payments to low and middle income families. And guess what? Despite its greater egalitarianism or was it because of it? we were the most successful reformers of all. Behold the miracle economy. Australia!

For its first ten years in opposition the ALP tried to forget its proud history as an economic reformer only to discover the electorate thought its economic credibility a pale imitation of its opponent’s. It will be the pale imitation again if it ditches Peter Costello’s idea that those pulling in $125,000 should pay a little more, so others can live a little better.

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Ken Parish
Ken Parish
2021 years ago

Great post and column, Nicholas. There doesn’t seem to be any hope for the ALP, what with this sort of cross-factional moronic reaction to Turnbull’s kite-flying. Where was the talk about alleviating poverty traps at the bottom end of the tax scales, or even about the desirability of using more of the surplus to replace ageing infrastructure or build new infrastruture for the 21st century (like creating a truly national broad broadband network, rather than the snail’s pace last generation ADSL we’ve got at the moment)? Well, the Nats were talking about infrastructure, and Costello at least mentioned poverty traps in passing. Labor? Not a sausage.

Geoff R
2021 years ago

Once unions were so weakened they could not coerce a Labor government by the threat of a wage breakout there was no constraint on Labor’s drift to the right. The ‘deregulate and redistribute’ argument of the 1980s was not politically feasible in the long run.

Homer Paxton
Homer Paxton
2021 years ago

I would have thought the second top rate was the one that was worth it in terms of votes.

The highest MTRs are in the welfare to work which we need to get gong before the labor force declines in growth because of age pressures

2021 years ago

It always amuses me when business ‘leaders’ claim that high tax rates lead to a brain drain.

Cutting the highest tax rates to 30% would result in a net (take home) wage increase of, what, 20% over current rates?

But overseas your salary is (generally, for the skilled) far more than 20% higher than it is in Australia. The benefits of a tax cut in Australia are dwarfed by the increase in salary when overseas.

I was part of that ‘drain’ (not to sure about the brain bit). But, as an example, I was living in HK and my pre tax salary (thus we can ignore tax effects) was 3 times my Australian pre tax salary. I didn’t go to HK because it had a lower tax rate, I went (amongst other reasons) because the salary was so much higher. No amount of tax cuts in Australia will change that. And that is why so many Australians go to the UK (similar tax rate, higher salaries – plus lifestyle choice, of course).

My point is that if they want to keep people in Australia is well within the ability of business leaders to do so. Pay your staff more (and not just the few at the top). Don’t demand that the government/lower income earners subsidise your attempts to retain your most highly skilled employees.

As a postscipt – Nick is right, tax ‘minimisation’ in HK is rife despite the 15% tax rate. The easiest way was to base your company in the British and Virgin Islands (nil tax) and carry out some nifty transfer pricing. HK didn’t tax foreign income brought back into the country, so you just repatriated your earnings back into HK as if they were earnt overseas.

Nicholas Gruen
2021 years ago


Craig Emerson recently suggested just what you refer to as a higher priority than cutting the top rate.

derrida derider
derrida derider
2021 years ago

Yep, can’t believe the ALP was just so *dumb*. As you point out, it’s not even particularly good economics. It’s truly hopeless politics.

The only explanation I can think of is that all of the shadow cabinet is on the top rate itself. In which case it’s not only dumb, it’s a betrayal of their constituents.

Wayne Swan’s line hinting that he’d pay for it by means testing Family Tax Benefit Part B (the payment for stay-at-home mums) is especially dumb. The consequence would be a redistribution from high income couples with one earner and kids to otherwise identical couples without kids.

In fact, unless you were game to tackle the Dependent Spouse Rebate (in which case listen to the retirees scream) the couple with kids would be paying more in net tax than the couple without kids. Really great family policy – not.

Homer Paxton
Homer Paxton
2021 years ago

I am surprised there isn’t a bigger grumble about welfare payments FTB in particular, given how strong the economy is.

I saw Emerson on lateline and was impressed. I still think he should be shadow Treasurer.

One can never fully agree with pollies reforming the tax system as we want the ideal and they want the possible.

Stephen Bounds
Stephen Bounds
2021 years ago

Homer: Unfortunately, Emerson is currently so far out of favour with his faction that he is about as likely to become shadow treasurer as Alan Cadman is to become PM.

On Labor policy: The only unquestionably good policy decision Labor has made recently is to support voluntary student unionism while retaining a compulsory amenities fee — essentially maintaining the status quo without the political baggage. Everything else makes me despair of the ALP *ever* getting back into office.

Homer Paxton
Homer Paxton
2021 years ago

I know that Stephen but sometimes ability wins out.

Andrew Bartlett
2021 years ago

I think Craig Emerson’s recent paper on this topic is fairly reasonable (as is this post I should add).

Craig didn’t totally rule out cuts in the top rate, but said (1) it is way down the priority list, (2) must not occur at all unless it is matched by cuts in welfare for the rich (which probably should happen anyway), and (3) the arguments spouting the wider economic benefits of cutting the top tax rate were at best rather thin.

My view would be fairly similar.

This contrasts to reported comments from Labor figures like Bill Shorten, which say we should cut the top rate to 30% – wacky stuff!

I find it hard to see much evidence at all for the suggestion that higher income earners will work harder or smarter if they get a cut in their rate. Firstly, even for the 3% who will benefit, it will only help for the income they earn above $125 000 – one would assume many of that 3% don’t earn much above the figure, so it would be of marginal overall benefit to them. Secondly, most people who earn more than that through investments, etc would already have structured their affairs through trusts and companies to pay lower rates. Thirdly, almost everyone else would be on a fixed salary package, so they will still earn the same whether they worked more hours or not (and most of them are probably already working more hours than is healthy for them or for the quality of their work).

Lifting the bottom threshold has to be the top priority, along with lower effective marginal tax rates for the middle income earners.

As an aside, lifting the bottom threshold goes a fair way in avoiding the problem which Nicholas suggests occurs with the minium wage. It would immediately give minimum wage earners the same effect as a wage rise (i.e. more money in their pocket), without that money having to come directly from employers.

Finally, I think the ‘brain drain’ argument is also very thin. A lot of recent research suggests that overall there is as much ‘gain’ as ‘drain’ happening for Australia, and the ‘drain’ that does happen can still benefit us anyway, mainly because many of those people eventually return with extra skills and experience to contribute, and in some cases even when they are remain overseas. (as an aside, doing more to ensure expats keep benefitting Australia even while they stay overseas is an area that needs more attention. There was a recent Senate Committee report on this that is worth looking at).

In as much as we do lose people because purely because of the finanical factor, I would say that would be more to do with total earning potential than tax rates – most of the very big buck earners here would already be paying less than 48% (unfortunately).

R. Patterson
R. Patterson
2021 years ago

Looking after the rich and very rich will increase the liberal coffers. But howard wouldn’t do that – oh yes and pigs fly. numbat