This budget’s tax tinkering isn’t the same as meaningful tax reform. Here’s why

Labor’s tax changes this week do not tackle tax reform, or why we desperately need it. They only address the amount collected from personal income tax, which is the largest source of tax revenue.

Real tax reform would review taxes such as the GST, taxes on savings (including housing and super), and personal and corporate income tax – and ensure they are sustainable over the long term.

Tax cuts and tax revenue relate to the amount of tax the government collects. Reform needs to tackle both the amount of tax and how we collect it.

It involves redesigning how we collect tax revenue in a way that is efficient, equitable, simple and resilient, to improve the well-being of all Australians.

And the quantum – how much we collect as part of tax reform – depends on the demand for government services, which is growing, with structural budget deficits forecast for the next 10 years.

So how does the income tax system work?

When you earn a salary from your job, every dollar earned above A$18,200 is taxed. Income earned between $18,201 to $45,000 is taxed at 16 cents per dollar. Three higher tax brackets follow, as the table below shows. This is known as a progressive tax system, where the tax rate increases as your income rises.

Mathematically, this means that if a worker named Jane has a $130,000 salary, the first $18,200 of her income is tax free, the next $26,800 of her salary is taxed at 16 cents for each dollar and so on. Her total income tax bill is $29,788.

In the budget, the Labor government announced from July 1 2026, it would cut the 16 cents marginal income tax rate to 15 cents and from July 1 2027 to 14 cents. As the example above shows, the proposed reductions will affect all Australian income taxpayers, not just low income earners.

The legislation passed parliament late on Wednesday night, but the Coalition has said it will repeal the cuts if it wins the election.

What is bracket creep?

Workers generally receive an increase in their wage each financial year. But in recent years, the increase in wages received by some workers hasn’t been enough to keep up with inflation (changes in prices).

This is the case for our imaginary worker, Jane. Where she lives, prices have increased by 10%. Her employer has offered her a wage increase of 5%, so now she earns $136,500. However, everything where Jane lives is now 10% more expensive, so while her salary has increased, the purchasing power of her wage has declined.

Unfortunately for Jane, the income tax system completely disregards her decline in living standards. Since her salary has increased she owes more income tax.

This is what’s referred to as bracket creep. It’s also known as fiscal drag. It arises when our income tax bill goes up, our take-home pay (our disposable income) goes down as a result, and our standard of living declines.

Sometimes inflation can push a person into a higher income tax bracket. This is the case for Jane, who now pays 37 cents per dollar on $555 of her income. However it also applies if a taxpayer remains in the same income tax bracket (since their salary still goes up and they owe more income tax).

Is bracket creep a good or a bad thing?

For workers, bracket creep is bad news because it reduces their after-tax income while their standard of living declines.

However, for governments it can be a useful tool.

First, bracket creep allows governments to collect more revenue than they would in the absence of inflation. Higher inflation means more revenue. This approach enables governments to increase expenditure and/or offer tax cuts to offset bracket creep. The government is doing the latter even in a period of budget deficit.

Second, bracket creep can be useful for governments during periods of high inflation. Governments need to rein in spending to reduce high inflation and bracket creep is one way of achieving this goal.

Given these benefits, Australia is not alone among developed countries that opt to change their income tax thresholds on a discretionary basis. Just over half (55%) of OECD countries took this approach in 2022 for their personal income tax systems.

The remaining OECD countries (45%) applied automatic indexation in 2022. Indexation ensures that taxpayers’ income tax bills only increase (in real terms) when their wages increase by more than inflation.

But ensuring tax brackets keep pace with inflation is only one part of the tax picture. Neither side of politics is addressing the sort of major tax reforms needed to make the tax system more sustainable and match fit for the 21st century. But the Tax and Transfer Policy Institute is prepared with ideas when they are.