Tax cuts + inflation = 80% of Aussies worse off by end of decade

Annual inflation to the end of May was 4 per cent, higher than the previous month's figure of 3.6 per cent. Worryingly, inflation may have stabilised in the 3.5 per cent to 4 per cent range: after 12 months of falls to late 2023 it has trended slightly up from December to May.

There is increasing pressure on the RBA to raise interest rates again. Certainly, any relief for mortgage holders seems further away than at any point in the past six months.

Mortgage holders will benefit from the commencement of the stage three tax cuts next week. However, with inflation running at 4 per cent, the benefit of those cuts will be eaten away surprisingly quickly.

This runs contrary to the prevailing narrative that the stage three tax cuts were overly generous.

Indeed, previous CIS research demonstrated that even under the original stage three tax cuts, the compensation provided to the main beneficiaries would be less than the cumulative bracket creep since 2010-11 (the last time there was a comprehensive tax package). A tax package that doesn't even get you back to where you started cannot be considered generous - much less overly so.

Nevertheless, if you consider how many years of 4 per cent inflation it will take for someone to be paying the same amount of tax they are currently, it becomes even clearer that taxes are continuing their steady trend upwards despite the scheduled cuts.

In fact, for somebody earning $50,000 a year, the tax cut they receive on Monday would be gone by 2026-27. The story is slightly better for someone on $85,000 a year: they at least won't be dragged down to square one until 2029-30.

The high-income earners - who supposedly should be grateful to have received a tax cut at all, if you listen to some of the commentary online - will be paying the same tax they are this year from 2027-28.

Those between $87,000 and $118,000 will be fortunate enough to hold on to their tax cuts until after 2030. This represents about two million tax payers. The remaining 10 million taxpayers - more than 80 per cent - will see inflation eat away their gains before the turn of the decade.

Another way to look at this is to consider what would happen if the government announced a tax cut identical to the size and implementation schedule of the current iteration of the stage three tax cuts today. Remember from announcement to implementation of the stage three tax cuts took six years. By the time those new tax cuts came into effect, more than 80 per cent of taxpayers would be worse off than they are today.

There are two key takeaways from these sobering projections.

First, the level of inflation really matters. It is easy to allow yourself to be convinced that a per cent or two of extra inflation is less harmful than the alternatives. After all, a number of commentators argue that other indicators, like wages or unemployment, are sufficiently weak that the RBA shouldn't raise interest rates further.

And the inflation level particularly matters if you are a mortgage holder who has been absolutely smashed by the huge increase in your mortgage payments since the last election.

Far less defensible, though, has been the cavalier disregard the government has shown for the issue since taking office.

Despite the massive influx of revenue in recent budgets being clearly a temporary phenomenon, the government has ladled out benefits with barely a hint of restraint. As my colleague Gene Tunny noted, payments in 2024-25 are $33 billion higher than the projection for 2024-25 in Chalmers' first budget.

The real growth in payments in 2023-24 and 2024-25, expected in October 2022 to be basically flat, will instead average more than 4 per cent a year.

The government has also baked huge spending increases into future years; with significant deficits likely to accumulate out to 2030.

READ MORE:

Not only that, the government has put pressure on the Fair Work Commission to increase minimum wages at least as fast as inflation - and substantially above for select industries. It is also being very clear it would prefer if the RBA stopped increasing interest rates. Its main contribution to fighting inflation has been accounting tricks, manipulating the statistics with policies that will purport to reduce measured inflation in the short term while clearly increasing inflationary pressure over the medium term.

If the government was serious about protecting voters from the impacts of inflation, it could take the very simple step of indexing the tax brackets. The need for this indexation is the second key takeaway from the analysis above.

Indexing tax brackets would mean workers are not punished if their real wages aren't increasing. It would also neatly puncture the overblown rhetoric about the supposed generosity of tax cuts that don't even keep pace with inflation.

Put simply, it would bring the tax system in line with the transfer system it funds.

It would force government to justify to taxpayers why it needs more money, and stop it making political mileage from the occasional "tax relief" crumbs that are nothing more than restoring the status quo.

However, this imposition of fiscal discipline would be challenging. As we have seen with the inflation battle, Australians are not used to the hardship caused by economic mismanagement.

Few politicians have the skills necessary to educate and convince the public of the need to change course. Such skill and wisdom is long overdue.

Until then, when government boasts about the generous support it is providing, we would be best to keep an eye out for the hand surreptitiously reaching behind our backs to take it all away again.