A new study by the IMF
examining the impacts of tax cuts has found that while lowering tax
rates for the rich will stimulate the economy, it does so at the great
cost of increased inequality.
Most damningly, it finds the benefits of tax cuts targeted at the wealthiest 25% – such as the one the Turnbull government brought in last year – are far too weak to raise the welfare of the majority of the population and also never pay for themselves.
Last year, the government made great talk of the need for a tax cut for those earning more than $80,000.
The threshold for the 37% rate was raised to $87,000 to ensure – as the prime minister argued at the time that “middle-income Australians, those that are on average full-time earnings, which as you know is nudging $80,000, don’t move into the second top tax bracket”.
But as I noted at the time, those on $80,000 earned roughly 1.5 times the current median taxable income of $55,000, putting them above what would be considered “middle class”. Such income earners were also around the top 25% of those with a taxable income and in the top 14% of all adults.
This year, the only income-tax cut delivered was similarly targeted at high-income earners – in this case the very high.
The end of the deficit levy, which delivered a 2% tax cut to those earning more than $180,000, combined with the 0.5% increase in the Medicare levy, meant everyone who earned less than $240,000 had a tax rise, while those earning above that amount received a tax cut.
And this is important because of the new IMF study – tax cuts aimed at the top 25% improve growth but reduce the welfare of most of the population, and tax cuts targeted at middle-income earners reduce inequality and can actually raise the size of the middle class.
The study also rather sharply slaps down the biggest furphy put forward by many who advocate tax cuts to stimulate growth – that they will pay for themselves through stronger growth and, thus, more tax revenue.
The idea of self-funding tax cuts got a big run in the 1980s under Ronald Reagan. He argued that his policies, which slashed the top tax rate in the US from 70% to 26%, would pay for themselves through increased growth. They didn’t.
In 2006, a US treasury study found that the tax cuts caused revenue to fall in real terms and was only partially made up by other tax increases that Reagan introduced.
But the myth of tax cuts paying for themselves remains.
The current US treasury secretary, Steven Mnuchin, said in April that economic growth would pay for Donald Trump’s tax cuts; in the same month Liberal senator James Paterson told the Senate that “the revenue collected from individuals after the tax rates were cut [by Reagan] in fact increased rather than decreased”.
The IMF study, which modelled the impacts of tax cuts on a US-style economy, found that any income-tax cut – whether targeted at middle or high-income households – reduced tax revenue.
The study’s authors noted that personal income-tax cuts stimulated growth but the supply-side effects, such as increased employment and wages, “are never large enough to offset the revenue loss from lower marginal tax rates”.
Or as they succinctly conclude: “tax cuts do not pay for themselves”.
The study, however, finds that tax cuts do generate growth. This is not uncontroversial – giving people money either through direct or indirect payments or a tax cut will generally lead to them spending more money and thus increase economic growth.
The issue is how to pay for the tax cuts and what impact they will have on the economy.
The study looked at two types of tax cuts – one for middle-income earners and the other for those in the top 25% income bracket. It found that both improved economic growth, but more growth resulted from the high-income tax cuts.
If you stopped reading there, you would miss the crucial aspect.
While a high-income tax cut generates more growth than one directed at middle-income earners, that growth delivers very skewed benefits.
The study found that in an economy such as the US or Australia, the high-income tax cut would lead to increased spending on goods and services, which in turn could improve wages for those lower-income earners who provided those goods, but it would also cause prices to rise and would need to be paid for by either other tax increases or cuts to government spending.
The total impact, even when you accounted for policies that tried to “protect the poor” to reduce the impact of other tax increases and spending cuts, was “a significant decline in consumption of low and middle- income households, and a significant reduction of the middle class”.
So you get strong economic growth, but you reduce the size of the middle class and increase inequality.
Damningly, the study’s authors conclude of the high-income tax cut that “the ‘trickle-down’ effects” are “insufficient to raise the welfare of the bulk of the population”.
On the other hand, they find that a tax cut targeted at middle-income earners, while generating less overall growth, “reduces income inequality and polarisation by moving people from lower income households back into the middle class”.
The study estimates that a tax cut targeted at middle-income earners can increase the size of the middle class by about 4% and reduce inequality, even if itis paid for by raising consumption taxes such as the GST.
In the past, the belief has been that you need to sacrifice equality for economic growth. Numerous recent studies, however, have found that reducing inequality improves economic growth in the long term.
The IMF study gives the issue an even more precise examination. Rather than talking in general economic terms, it looks at the specific impact of taxation policy.
And it shows that governments that choose high-income tax cuts are choosing economic growth for the few and reduced welfare for the many.
Most damningly, it finds the benefits of tax cuts targeted at the wealthiest 25% – such as the one the Turnbull government brought in last year – are far too weak to raise the welfare of the majority of the population and also never pay for themselves.
Last year, the government made great talk of the need for a tax cut for those earning more than $80,000.
The threshold for the 37% rate was raised to $87,000 to ensure – as the prime minister argued at the time that “middle-income Australians, those that are on average full-time earnings, which as you know is nudging $80,000, don’t move into the second top tax bracket”.
But as I noted at the time, those on $80,000 earned roughly 1.5 times the current median taxable income of $55,000, putting them above what would be considered “middle class”. Such income earners were also around the top 25% of those with a taxable income and in the top 14% of all adults.
This year, the only income-tax cut delivered was similarly targeted at high-income earners – in this case the very high.
The end of the deficit levy, which delivered a 2% tax cut to those earning more than $180,000, combined with the 0.5% increase in the Medicare levy, meant everyone who earned less than $240,000 had a tax rise, while those earning above that amount received a tax cut.
And this is important because of the new IMF study – tax cuts aimed at the top 25% improve growth but reduce the welfare of most of the population, and tax cuts targeted at middle-income earners reduce inequality and can actually raise the size of the middle class.
The study also rather sharply slaps down the biggest furphy put forward by many who advocate tax cuts to stimulate growth – that they will pay for themselves through stronger growth and, thus, more tax revenue.
The idea of self-funding tax cuts got a big run in the 1980s under Ronald Reagan. He argued that his policies, which slashed the top tax rate in the US from 70% to 26%, would pay for themselves through increased growth. They didn’t.
In 2006, a US treasury study found that the tax cuts caused revenue to fall in real terms and was only partially made up by other tax increases that Reagan introduced.
But the myth of tax cuts paying for themselves remains.
The current US treasury secretary, Steven Mnuchin, said in April that economic growth would pay for Donald Trump’s tax cuts; in the same month Liberal senator James Paterson told the Senate that “the revenue collected from individuals after the tax rates were cut [by Reagan] in fact increased rather than decreased”.
The IMF study, which modelled the impacts of tax cuts on a US-style economy, found that any income-tax cut – whether targeted at middle or high-income households – reduced tax revenue.
The study’s authors noted that personal income-tax cuts stimulated growth but the supply-side effects, such as increased employment and wages, “are never large enough to offset the revenue loss from lower marginal tax rates”.
Or as they succinctly conclude: “tax cuts do not pay for themselves”.
The study, however, finds that tax cuts do generate growth. This is not uncontroversial – giving people money either through direct or indirect payments or a tax cut will generally lead to them spending more money and thus increase economic growth.
The issue is how to pay for the tax cuts and what impact they will have on the economy.
The study looked at two types of tax cuts – one for middle-income earners and the other for those in the top 25% income bracket. It found that both improved economic growth, but more growth resulted from the high-income tax cuts.
If you stopped reading there, you would miss the crucial aspect.
While a high-income tax cut generates more growth than one directed at middle-income earners, that growth delivers very skewed benefits.
The study found that in an economy such as the US or Australia, the high-income tax cut would lead to increased spending on goods and services, which in turn could improve wages for those lower-income earners who provided those goods, but it would also cause prices to rise and would need to be paid for by either other tax increases or cuts to government spending.
The total impact, even when you accounted for policies that tried to “protect the poor” to reduce the impact of other tax increases and spending cuts, was “a significant decline in consumption of low and middle- income households, and a significant reduction of the middle class”.
So you get strong economic growth, but you reduce the size of the middle class and increase inequality.
Damningly, the study’s authors conclude of the high-income tax cut that “the ‘trickle-down’ effects” are “insufficient to raise the welfare of the bulk of the population”.
On the other hand, they find that a tax cut targeted at middle-income earners, while generating less overall growth, “reduces income inequality and polarisation by moving people from lower income households back into the middle class”.
The study estimates that a tax cut targeted at middle-income earners can increase the size of the middle class by about 4% and reduce inequality, even if itis paid for by raising consumption taxes such as the GST.
In the past, the belief has been that you need to sacrifice equality for economic growth. Numerous recent studies, however, have found that reducing inequality improves economic growth in the long term.
The IMF study gives the issue an even more precise examination. Rather than talking in general economic terms, it looks at the specific impact of taxation policy.
And it shows that governments that choose high-income tax cuts are choosing economic growth for the few and reduced welfare for the many.
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