Now that Michael Cullen has ruled out a tax-free bracket but promised that everyone will benefit from Labour’s tax-cut package, what cuts will he give?
The simplest option would be to cut the bottom tax rate, which would deliver a tax cut for everyone. As a percentage of income the tax cut would be largest for those on the lowest incomes, while the actual monetary value of the cuts would rise until the end of the first tax bracket, and then remain constant. That would satisfy Cullen’s desire to deliver more money to those on middle incomes without giving massive cuts to those on high incomes.
In the graph below the current effective tax rate at different incomes is compared to what would happen if the 19.5% rate was cut to 16.5% or 14.5%.
The 16.5% option would cost roughly $2.3 billion and give a $23 a week tax cut for people earning $38,000+. The 14.5% option would cost $3.7 billion and deliver $38 a week. On an income of $35,000 your tax would drop by 16% in the first option and 26% in the second. My money is on a cut somewhere between these two, perhaps in several steps: say a cut to 16.5% on October 1 and another two percent off by 2010. Cullen will probably include an increase in the tax bracket thresholds as well: an initial substantial rise and inflation indexing to deliver on the promise of multi-year cuts.
Some hopefully not altogether baseless speculation to ponder.
[Vernon Small raised the idea of an additional top tax rate of 45% at $150,000 like Australia has, to fund more cuts at lower incomes. This is unlikely to happen: any increase at that level would deliver relatively little revenue ($100 to $200 million) and encourage more tax dodging, so it wouldn't allow much more cuts at a lower level. Hardly worth the effort and the political cost of not making a clean cut.]