Since the May budget one area of dispute has been the raising of the Medicare levy to 2.5% to pay for the National Disability Insurance Scheme. While the ALP is arguing the new rate should only apply to those earning over $87,000, the progressive thinktank the Austrhighalia Institute has released a paper arguing it is time for the levy to become fully progressive.
Progressive taxation has a history of being mangled by treasurers. Joe Hockey did it when talking about the petrol excise and now Scott Morrison has joined the party.
When justifying the raising of the Medicare levy Scott Morrison argued that “If you’re on a higher income, you’ll pay more under our plan. If you’re on lower income, you’ll pay less”.
He is right of course only if you talk in terms of nominal figures.
Of course someone on $180,000 will pay more in nominal terms than someone on $50,000 – As the author of the Australian Institute’s report, “Time for a Progressive Medicare Levy”, David Richardson, notes: “Two per cent of a big number is always going to be bigger than 2% of a smaller number.”
Nominal figures tell us nothing about whether or not a tax is progressive.
Australia’s income tax – as with most others in the world – is a progressive system, which means people pay a higher average rate of tax the more they earn. This occurs by increasing marginal tax rates – which apply only to the income earned above each threshold (thus for example someone on $200,000 only pays the top tax rate of 45% on the money they earned over $180,000):
But the Medicare levy is not progressive. It is a flat tax – 2% no matter how much you earn (with a few exceptions based on family size and income) and it applies to all income. Thus someone on $200,000 pays the 2% Medicare levy on all $200,000, and someone on $70,000 similarly pays 2% on their entire income.
As the Australia Institute report notes, moving from a system where the Medicare levy is a flat 2% but with the highest marginal tax rate of 47% (due to the deficit levy) to one where the Medicare levy is 2.5% and the top tax rate is 45%, makes the income tax system less progressive:
The sweet spot is $240,000. At that point the 0.05% increase in the Medicare levy is cancelled out by the 2% cut in the top marginal tax rate. Everyone earning above that rate is better off.
The ALP has responded to the government’s 2.5% Medicare levy proposal by arguing for the increase to only apply to those earning over $87,000 and also keeping the 2% deficit levy.
While that would counter some of the lost progressivity, the Australia Institute has argued that it is time to resurrect an idea from the Henry tax review and make the Medicare levy itself progressive.
The Henry tax review noted a couple problems with the Medicare levy. One of these was that it incorrectly leads people to think the levy somehow covers our health expenditure, which it doesn’t.
David Richardson notes that while the suggestion of a Medicare levy is needed to pay for the NDIS is a nice enough proposition, “when there is a deficit, one could nominate anything and say it ‘needs funding’”.
The Henry tax review also noted that while the Medicare levy appears simple, because of exemptions and because it treats singles differently from couples in ways normal income tax does not, it actually complicates the entire system.
The Henry Tax review recommended either absorbing the levy in the income tax system – ie removing the exemptions and differing treatments for singles and families – or to make the more progressive by applying it as a proportion of the income tax payable.
This is the path chosen by the Australia Institute.
The institute estimates that a 8.5% rate on top of people’s average tax rate would make the changes revenue neutral, however for simplicity, it recommends a rate of 10%.
How it would work is if you paid an average rate of 20% income tax you would pay an extra 2% in Medicare levy. If you paid an average of 30% in income tax (the rate paid by someone earring around $176,000) you would pay a 3% Medicare levy.
The Australia Institute calculates this would mean those earning less than $67,624 would be better off – a figure they estimate would include 61% of taxpayers:
Such a policy would of course bring forward charges that the top income earners are being forced to pay too much tax – and that our top tax rate would be uncompetitive with other nations.
These accusations have already occurred because the ALP proposes keeping the deficit levy. The prime minister recently suggested such a policy with a 49.5% top tax rate “would send a very poor signal to all Australian workers: don’t bother trying to earn just over two times average full-time weekly earnings”.
And yet Australia is actually a low taxing nation for high-income earners.
The top tax rate alone is a dumb way to compare income tax systems – you need to take into account when it kicks in. And despite what you might have heard, on both measures, Australia is nowhere near the top:
But the OECD sensibly also looks at the average tax rate, and here Australia does seem to have a high rate. A person on average earnings paid 24.3% average tax in 2016 – well above the OECD average. But the problem is we don’t have social security contributions taken out in the manner done in other OECD nations. And that skews the average rate down for those nations.
The OECD also looks at “net personal average tax”, which takes into account not only tax paid, but also employee social security contributions and cash benefits they receive.
This measure was also used by a tax review done during the Howard government and cowritten by Peter Hendy who until recently was Malcolm Turnbull’s economic adviser. That review noted that the net personal average tax rate was “important” because it is “a measure of the employee’s incentive to increase the number of hours they work or to seek promotion”.
Using this measure Australia’s tax paid by Australians is well below the OECD average:
But the measure I like the most is the “tax wedge”. This measures the difference between what it costs your employer to employ you and what you actually receive. It means we can better compare different tax systems such as those in Europe which include employee and employs social security contributions.
The OECD also calculates the tax wedge across different income levels.
For those on average full-time earnings (which in 2016 was around $82,000) Australia has a lower average tax wedge than the UK and the US. For those on 220% of average earnings (which in 2016 was equal to $180,000 – the top tax threshold), Australia had the 9th lowest tax wedge in the OECD:
Clearly we need to work harder to send a signal to workers not to “bother trying to earn just over two times average full-time weekly earnings”.
Australia’s progressive tax system does not overly penalise high-income earners, but moves to make the tax system flatter by putting more emphasis on measures such as the Medicare levy will shift the burden on to lower-income earners.
