By Gareth Aird, head of Australian economics at CBA.
- Personal income tax cuts worth 0.8% of GDP will kick in from 1 July 2024.
- The Government will change the distribution of the previously legislated Stage 3 tax cuts, but the size of the expected tax cut in 2024/25 is little changed.
- Income tax paid as a share of household income will continue to rise and will push new record highs over the next few quarters before the tax relief arrives.
- The changes to the tax cuts are not material enough for us to modify our economic forecasts.
- Our base case remains that the RBA will commence an easing cycle in September.
A recap of the proposed tax changes:
Last week the Commonwealth Government announced changes to the already legislated Stage 3 tax cuts. The Government’s remodelled tax plan will need to be passed by the Senate before coming into effect. We see this largely as a done deal.
The new tax cuts are broadly similar in size over the next few years to the previously legislated tax cuts (a touch larger at the margin). But the key difference is around the distribution of tax relief.
The changes mean that more individuals will receive a tax cut from 1 July 2024.
Specifically, the Government estimates that 13.6 million taxpayers will receive a tax cut, compared with 10.7 million taxpayers under the previous arrangements.
The new tax cuts result in a smaller share of tax relief going to higher-income earners. Low and middle-income earners now receive a larger portion (see below chart).
Importantly, the overall size of the tax-cut pie is little changed over the next few years. This is of primary significance when assessing the impact of the changes on the outlook for the economy and the RBA.
Our economic forecasts and RBA call factored in the already legislated Stage 3 tax cuts. We used a working assumption that ~80% of the tax relief would be spent (~$A16bn). That may seem high given the majority of tax relief was due to flow to higher income earners who generally have a lower marginal propensity to consumer (MPC) than lower income earners.
But given the squeeze on real household incomes at present, we thought it prudent to opt for a larger number.
A case can be made that a greater share of the income tax cuts will now be spent than we previously assumed given the skew has shifted towards lower and middle income earners.
But the overall changes are not enough to shift the dial for economic growth, the labour market or inflation.
For example, if we now assume that all of the tax relief is spent due to the distributional changes of the tax cuts, the additional consumption relative to our forecasts is just ~$A4bn or 0.15% of GDP a year ; a rounding error in a $A2.6tn economy.
Importantly, changing the spending assumption has no discernible impact on our inflation forecasts.
We do not wish to trivialise the tax cuts as they are significant in size. But the above back of the envelope calculation highlights why we do not think the Government’s new tax plans warrant a change of economic forecasts.
In any event, the bigger picture matters. The tax cuts are only a partial offset to the massive lift in income tax paid as a share of household income over recent years.
As a result, we do not believe they are sufficient in size to fend off RBA rate cuts later in the year.
Tax paid as a share of income will continue to lift until 1 July 2024:
The impact of the RBA’s aggressive rate hiking cycle on household income and by extension consumption has been well covered. For context, interest paid on housing debt has surged by 70.6% over the year to Q3 23 and a massive 173.3% ($A18.8bn) from pandemic lows.
But the role that higher tax paid as a share of income has had on household purchasing power has not received as much air play. And yet the impact has been very significant.
The quarterly amount of income tax payable is up by a whopping 23.4%/yr to Q3 23 (latest available). Over the same period total household income has grown by a much lower 7.5% (see below chart).