July 03, 2015

Horse 1929 - I Love Bracket Creep

I start this tale with the famous law from the world of supermarket shopping:

Woolworth's Law: The other checkout line always moves faster.

Woolworth's Law¹ is of course a specific form of confirmation bias or specifically a cognitive bias where people remember information selectively. There is no real reason to believe that the other line always moves faster without any empirical data, it's just that when the line that you happen to be in moves faster than the other lines, you have no reason to complain about it.

There is another famous law from the world of supermarket shopping which is far more practical:

Coles' Law: Finely-shredded cabbage and vinaigrette dressing.

What Woolworth's Law does show though is that everyone loves to complain. Not only does everyone love to complain but they love to complain if they think that they have been slighted. The converse is that people tend to forget when they have been given some sort of benefit because that benefit becomes part of a new normal.

What does any of this have to do with bracket creep? In order to explain that, I first need to illustrate what bracket creep is.

These are the taxation rates for the year 2014/15²:
$00,000 – $18,200 : Nil
$18,201 – $37,000 : 19c for each $1 over $18,200
$37,001 – $80,000 : $3,572 plus 32.5c for each $1 over $37,000
$80,001 – $180,000: $17,547 plus 37c for each $1 over $80,000
$180,001 and over : $54,547 plus 45c for each $1 over $180,000

Let's assume that you were on a wage of $79,000 per annum. That's slightly above Average Weekly Ordinary Time Earnings figures (and well above the median wage because of the distribution skew).
The amount of tax payable, based on an assessment of $79,000 is $18,802 or an effective rate of 23.8%.

If you were to get a modest pay increase of 4% (which is keeping in line with the historical long term average since 1 ab urbe condita - from the founding of the City of Rome on 21st April 753 BC), then your wage would increase to $82,160.00

Something interesting happens. For ever $1 over $80,000, instead of paying 32.5c on that next dollar, you're now paying 37c on that next dollar. Even though your real wage might not have increased because of inflation, the taxation taken has been increased in real terms because you've jumped into that next bracket.
The amount of tax payable, based on an assessment of $82,160 is $19,989.40 or an effective rate of 24.3%.

The difference in the increase of taxation taken is only 0.5% but it is enough to send people who hate paying tax and those who want the government sector to be as small as possible, into spirals of great outrage.

Consider this:

Gen Y to be slugged $100,000 in extra taxes for Canberra's budget failures
However, as shown in the Grattan research report – Fiscal Challenges for Australia – Treasurer Joe Hockey has shifted the lion's share of his anticipated budget repair over the next four years onto the burden of fiscal drag, or the process by which wage hikes push workers into higher tax brackets.
Also known as bracket creep, the process means the Federal government will extract an extra $25 billion from payrolls by 2018-19, equivalent to more than half of total budget repair job.
- Jacob Greber, Financial Review, 1st July 2015

Oh Calamity! Howl, howl, howl!

Bracket Creep is almost always written about as though it was some hideous abomination; the harbringer of all kinds of evil upon the world but is it really?

One of the important functions of taxation, is that it is one of the controls of fiscal policy and can be used to stabilise economic growth and hopefully level out the booms and busts of an economic cycle. In a growing economy, people will automatically pay more in taxation and this means that the mechanism of taxation itself acts as an automatic fiscal stabiliser.

That probably should have happened in the early 00's but before the global financial crisis, instead of collecting more in taxation, the Howard Government chose to cut income taxes. From 2007-2013, the Rudd-Gillard-Rudd Governments also chose to cut income taxes as a method of pursuing expansionary fiscal policy to hopefully stimulate aggregate demand and boost the level of economic activity.

From 1994/95 to 1999/2000 income tax rates remained static and from 2000/01 to 2012/13, we had 10 sets of tax cuts in 12 years, in the face of a mining boom which made no sense at all and the global financial crisis which might have made some sense, if it wasn't for the previous tax cuts.

In essence, Joe Hockey as Treasurer has a horrible task ahead of him. The most effective method of paying down he debt would be to increase taxation rates and collect more in income tax but people would start complaining. He can't sell off very many government assets because the government has very little left to sell and so cutting transfer programs like welfare, health care or defence spending, is also like to set people off complaining.

This is why I love bracket creep. Most voters are too politically ignorant to realise that their pay packets are being shaken just that little bit harder and won't complain. From the government's perspective, bracket creep is great because it requires no legislation at all and when they finally do announce a tax cut, it looks as if they are heroes, even though they might not actually be in real terms.

Also, Consider this:
"As soon as you move to $37,001 of income you're moving from [paying] 19 to 33 cents in the dollar... and you may well find that you're losing family tax benefits."
- Chris Richardson, Deloitte Access Economics, as quoted by Eliza Borrello, ABC News, 12th May 2015

Bracket Creep is blamed for all sort of things by people who have a barrow to push. Those things are not grounded in fact.

The whole point of progressive taxation rates is that they employ marginal tax rates. A marginal tax rate is the percentage of tax taken from that next dollar. Yes, someone might very well move from $37,000 to $37,001 but it is only every dollar over $37,000 which is taxed at 32.5%; not every dollar from dollar one. The actual difference between those two amounts is only 35c (including the Medicare levy).

Also, the first Income test which reduces the maximum rate of Family Tax Benefit Part A³, only kicks in at $51,027; the second test begins at $94,316. The Income test³ which reduces the maximum rate of Family Tax Benefit Part B doesn't apply until the primary earner earns more than $100,000 per year.
Those things aren't bracket creep issues. Besides which, if you are on an income of $94,316 which is 122% of AWOTE, you're kind of doing pretty well anyway.

Literally no-one in Australia complained when the Howard, Rudd, Gillard and Rudd Governments cut taxes during the 00's and early 10's. Attempt to raise taxes to implement an actual budget repair and you'll trigger Woolworth's Law. People love to complain if they think they've been slighted; they tend not to care or notice if the government announces no changes to taxation and bracket creep occurs silently.
Bracket creep is like nature reclaiming civilisation. Bracket creep is part of a new normal.

¹Woolworth's Law isn't a real law.  Coles' Law is delicious.

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