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Cuts to individual tax rates a likely Federal Budget centerpiece. But at what cost?

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Personal tax cuts are shaping up as a likely Federal Budget centrepiece, but the question of how exactly they’ll be funded is still anyone’s guess.

“Logic dictates they’ve got to make savings somewhere, but where that’s going to be nobody knows,” said Tax Consultant to Thomson Reuters, Terry Hayes.

“Everyone’s going to be looking for that on budget night because there’s not a huge amount of wriggle room in terms of hitting surplus by 2020-21.”

It’s this tight budgetary environment, combined with a looming Federal Election, that has got economists, political pundits and armchair observers alike weighing in.

What kind of personal tax cuts?

With Treasurer Scott Morrison indicating middle-income families would benefit from personal tax cuts, there are two likely forms they could take.

“The $37,000 to $87,000 threshold is where there may be some movement,” said Hayes.

“The rate of tax on that could go down a couple of points. It’s currently 32.5%. Or the government could increase the $87,000 threshold to $90,000 or maybe $95,000.”

Any changes within this bracket would, of course, flow through to all taxpayers earning more. “A lot of people would benefit,” Hayes said.

At what cost?

The 32.5% personal tax threshold was last increased in 2016 from $80,000 to $87,000. That was during an election year and it cost the government $4 billion.

This time, it remains uncertain whether this will be the Coalition’s last budget before it goes to the polls.

“It could be close to that, which might have some influence on what’s actually announced,” Hayes said.  “It could be a very interesting budget.”

Any personal tax cut is likely to be framed as both sound economic policy and a vote winner.

“The train of argument is likely to be that putting more money in people’s pockets suggests they tend to spend it. And spending is good for the economy overall,” Hayes said.

Funding budget measures

Additional big-ticket items this budget include billions of dollars in infrastructure spending, and the increasingly-likely extension of the $20,000 instant asset write-off for businesses.

These costs come amid an improving economic outlook.

The Mid-Year Economic and Fiscal Outlook (MYEFO) released late last year showed the budget deficit sitting at $23.6 billion — a $5.8 billion improvement since the last budget.

But with the Coalition’s self-imposed return-to-surplus deadline of 2020-21, and commodity prices notoriously difficult to forecast, it’s hard to see how this spending can be funded through existing revenue sources.

“They’re going to have to look to make some savings somewhere,” said Hayes.

“They got burnt a couple of years ago under then-Prime Minister Tony Abbott by trying to make some significant social services changes. They probably won’t try that again.”

Cuts unaffordable, observers say

A who’s who of former treasury officials has been speaking out against personal income tax cuts in recent weeks.

Former Treasury secretary Ken Henry has described promises made by both sides of politics as “theatrically absurd”.

“It seems to me absurd, theatrically absurd, that we know we’re going to have to raise taxes but we’re having an argument about which taxes to cut,” Henry, now the chairman of National Australia Bank, reportedly told The Australian.

Former Treasury official Robert Carling, meanwhile, released a Centre for Independent Studies policy paper last week arguing that,

“After the anticipation, a ‘hamburger and milkshake’ cut would be a disappointment, but adding the bacon would cost a lot so the government must show it has revenue to spare to go that far,” he said.“The picture portrayed in MYEFO is that there is little scope for personal income tax cuts without the revenue losses breaching the government’s strong commitment to return the budget to balance or a small surplus by 2020-21.”

Similarly, Deloitte Access Economics’ Chris Richardson reportedly warned:

“The risk is that the government, losing in the polls and facing a pretty populist opposition, again reaches for five minutes of economic and budgetary sunshine [to fund personal income tax cuts] and that could again prove to be a mistake.”

Reality: not so black and white

The argument that the country cannot “afford” tax cuts may well be a moot point.

“That could probably have been said for the last umpteen years worth of tax cuts because of the state of the budget,” Hayes said.

“This year is no exception but I don’t think it will stop the government giving the tax cuts anyway.”

That’s because tax cuts are about more than a simple revenue loss equation.

“Yes, on its own, a tax cut in theory adds to the deficit. But that totally depends on what other measures are announced in the budget,” Hayes said.

“It’s not quite as black and white as a lot of people try to make it out.”

The funding details, and all the shades of grey, will no doubt come to light by the evening of May 8.

“There are surprises in every budget. No doubt that will happen again,” Hayes said.

By the time the Treasurer delivers his budget speech that night, Thomson Reuters will be hitting publish on its 2018 Weekly Tax Bulletin Federal Budget Report.

In the meantime, subscribe to our Weekly Tax Bulletin to receive all the latest ongoing tax, GST and superannuation developments – and visit our Federal Budget Count Down site for the latest developments in the budget lead up.