Tax Bracket Creep
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Tax Bracket Creep
You have no doubt heard a lot of talk in the media about the upcoming Stage 3 Tax Cuts and their impact on tax bracket creep. We thought this might be a good time to take a look at the current income tax system in Australia and how you might be able to mitigate its effect on your take home income.
A Progressive Income Tax System
Australia operates on a progressive income tax system. This means that higher income earners pay a greater proportion of their income in tax than low-income earners. It is achieved by applying a different rate of tax to each income ‘bracket’.
What Is Tax Bracket Creep?
“The process by which inflation pushes wages and salaries into higher tax brackets, leading to fiscal drag.”
As you move towards the higher end of a tax bracket, or from one tax bracket to the next, a larger proportion of your income is taxed at a higher rate. This means the percentage of your income paid in tax increases. It is a particular problem during periods of high inflation and wage growth, as the dollar amounts of the tax brackets remain the same, while wages and salaries increase. Therefore, the wages of people doing the same job ‘creep’ towards the top of their bracket, or ‘creep’ from one tax bracket to the next, without a change of job or promotion.
Bracket creep has a twofold effect, particularly if you move from one tax bracket to the next. Firstly, the take-home impact of any wage increases is lessened by higher tax rate. Secondly, your overall tax exposure increases. For instance:
You are earning $115,000 a year you will be paying $27,842 tax, which is the equivalent of 24.2% of your total income.
If you receive a raise of $15,000, which takes you into the next tax bracket, you will pay $33,167 tax, or 25.5% of your total income. Your raise will therefore be reduced to $9,675 take home.[i]
Current Tax Brackets
Currently, there are five tax brackets:
Income Tax Bracket Tax Rate
$ 0 – $18,200 0%
$18,201 – $45,000 19%
$ 45,001 – $120,000 32.5%
$120,001 – $180,000 37%
$180,001 and over 45%
So, for the first $18,200 of your income, you pay no tax, The next $26,800 you pay 19% and so on.
Stage 3 Tax Cuts
From July 2024 Stage 3 Tax Cuts will come into effect. This will reduce the number of tax brackets from five to four, as well as reducing the marginal tax rate in the upper middle bracket.
Income Tax Bracket (July 2024) Tax Rate
$ 0 – $18,200 0%
$18,201 – $45,000 19%
$45,001 – $200,000 30%
$200,001 and over 45%
There is an argument that this change in the progressive tax system will help alleviate bracket creep. However, The Australia Institute, based on research and information from the Parliamentary Budget Office, have identified that since tax bracket creep mainly affects those earning under $120k. Since the budget cuts primarily benefit those earning over $120k, this will do little to ameliorate the problem for the majority of tax payers.[ii]
Is There A Solution?
From a policy perspective, one way to handle this is tax indexation. By automatically indexing the tax thresholds each year, based on the CPI or wages growth, the government could limit bracket creep. However, governments from neither side of the political divide have shown an inclination to make this change, possibly because bracket creep provides them with a silent tax windfall as taxpayers pay a greater percentage of their income as it increases.
What Can You Do?
There are a number of strategies you can employ to avoid tax bracket creep, or at least lessen the impact.
- Salary Sacrifice – by investing in your superannuation via salary sacrificing, you are effectively reducing your taxable income. If you can afford to sacrifice enough to keep you in the lower tax bracket you improve your overall tax position.
- Negative Gearing – whilst negative gearing is actually the bearing of a loss, if it is sufficient to take you down to the lower tax bracket it can be worth doing
- Deductibles – we’ve talk a lot in the past about bringing deductible spending forward to the current financial year. If you know you will be experiencing tax bracket creep in the coming financial year, this is one instance where pushing deductible expenditure till after June 30 can be a good idea.
Tax planning is an extremely complex area. The best thing to do if you are concerned about tax bracket creep, or any other aspect of your tax burden, is to seek professional financial advice. How you are able to avoid bracket creep may involve one or more of the above suggestions, but will depend entirely upon your individual circumstances.
If you are concerned about bracket creep and would like to ensure you minimise your tax exposure, Manly Financial Services have the knowledge and expertise to give you effective advice. Give us a call on (02) 9976 3388 or contact us via the below link.
