When it comes to tax, what is bracket creep – and is ‘fixing’ it really that important?


Photograph: djgunner/Getty Images

The term “bracket creep” is getting thrown around with wild abandon at the moment, so we might as well get a handle on what it means and work out if it is actually all that important.

So what is bracket creep?

Related: The stage-three tax cut changes could be a pivotal moment for Anthony Albanese – if he frames them right | Peter Lewis

Slow down, there; first we have to talk about marginal tax rates. In Australia, we tax income at different levels (or “brackets”) depending on how much you earn. The more you earn, the higher your marginal tax rate in that bracket. That’s “progressive taxation” and it is done in pretty much every country, because the more you earn, the more capacity you have to pay.

Alright, I’m with you.

Australia currently has five different tax brackets:

  • 0-$18,200 – 0% tax

  • $18,201-$45,000 – 19% tax

  • $45,001-$120,000 – 32.5% tax

  • $120,001-$180,000 – 37% tax

  • $180,000+ – 45% tax

It looks like this:

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What is that “average rate” line?

That’s there because the marginal tax rates only apply to money you earn in those brackets. Imagine you earn $80,000. You pay no tax on the first $18,200 you earn, 19% tax on the $26,800 you earn between $18,200 and $45,000, and then you pay 32.3% on the $35,000 you earn above $45,000

So your $80,000 is taxed like this:

  • On the first $18,200, you pay 0% tax.

  • On the next $26,800, you pay 19% tax.

  • On the remaining $35,000, you pay 32.5% tax.

  • In total, on your income of $80,000, you end up with a 20.6% average tax rate.

That leaves you with $63,533 after tax.

I assume we are going to get to bracket creep at some point?

Yep, we’re nearly there. Now assume you get a 5% pay rise, because inflation has also gone up 5%. Now your income is $84,000, and this is how it is taxed:

  • On the first $18,200, you pay 0% tax (no change).

  • On the next $26,800, you pay 19% tax (no change).

  • On the remaining $39,000, you pay 32.5% tax.

  • In total, on your income of $84,000, you end up with a 21.2% average tax rate.

That leaves you with $66,233 after tax.

And that is bracket creep. All that happened is you got a pay rise to keep pace with inflation, but the tax system doesn’t account for inflation so you were taxed at a higher average rate.

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So what’s the big deal?

Well, it means your “before tax” income went up 5% but your “after tax” income only went up 4.2%. So, your real wage after tax went down. And that is bracket creep.

And why is this complicated?

Politicians will often try to tell you bracket creep is something else.

For example, when he was trying to sell the stage-three tax cuts, the then treasurer, Josh Frydenberg, told parliament that stage three “will tackle bracket creep. If you get another job or a promotion, or you do some overtime, you won’t necessarily pay a higher marginal rate of tax.”

But if you get a promotion or another job that pays more, that’s not bracket creep – that is just you getting a better paying job, and under progressive taxation you are now able to pay a bit more in tax. You will still be better off.

Why would he or anyone else try to say that’s bracket creep?

Did you miss the part about how he was trying to sell the stage-three tax cuts?

Bracket creep actually affects lower-income people more because wage rises mean a bigger change in the amount of their income that is taxed at a higher rate.

By June, inflation will have risen around 17% since the tax rates were last changed, so the impact of bracket creep looks like this:

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But now let’s include the old stage-three tax cuts:

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The old stage three was all about giving the biggest tax cuts to those on the highest income, but they are not as affected by bracket creep, so all the talk about it curing bracket creep was a bit of a fib. It was about a high-income tax cut.

So if bracket creep is about inflation, why not just increase the thresholds by inflation?

That would do it, but the question is what year you choose to start increasing the thresholds from.

Why not from now?

So you think the tax system designed by Scott Morrison is the one we should stick to?

Errr … can I say no?

What about the 2006-07 scales? If we had increased the top tax threshold in line with inflation from then, $150,000 would now be $237,596.

Or should we go from the 2004-05 financial year when the top threshold was $70,000? If we had increased that in line with inflation it would now be just $117,724.

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This is getting complicated.

That’s the problem with “fixing” bracket creep. Indexing the thresholds means picking a moment and essentially suggesting that was the ideal level of tax rates.

If we look at the percentage of tax paid by the richest 10% and the bottom 50%, you can see that the old stage three essentially wanted things to be as they were at the end of the Howard years when the top decile paid around 47% of tax. The new stage three mostly changes them back to where they were at the end of the Gillard years, when the top 10% of income earners paid 49% of tax:

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So that’s it?

One last thing. Why is bracket creep bad?

Because I pay more tax just because of inflation?

And why is that bad? Doesn’t tax pay for services, such as health and education and roads, the cost of which has also gone up due to inflation?

Related: Guardian Essential poll: one in two voters back stage-three tax cuts changes

Yeah, but …

And shouldn’t the governments we vote for be the ones to decide tax rates rather than some arbitrary moment in time being the point we decided to make it automatic?

Well, sure, but …

And Australia already is a low taxing nation when it comes to income. Compared to other nations in the OECD, we don’t tax income much at all:

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And the average tax rates we pay are less than the UK and US.

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And will you actually want to work less?

Wait, what?

Economists like to say that bracket creep is a disincentive on work, because as your marginal tax rate rises, you are apparently less likely to want to earn more money because doing so could take you into a higher tax bracket.

Is that real?

Do you think about marginal and average tax rates when you are offered a higher-paying job? And would you turn down a promotion because your average tax rate might go from 20.6% to 21.2%?


Correct. Most people don’t, but it looks good in theory when we assume people act like a calculator.

The ones who really care about such things are those on low and middle incomes who get less childcare subsidy and other benefits once they earn over a certain amount. For people in those situations, and also those paying off Hecs, there can be times where earning more money makes you worse off.

So shouldn’t we be more focused on those people?

Now you’ve got it.