Ph: 0422 311 350

Ph: 0422 311 350

Tax Tips

Bracket creep and you

bracketcreep-1800x600-min_432e0.jpg

With all the discussion of increasing the GST that is taking place one of the hot issues in taxation has almost slipped under the radar. And that's bracket creep.

So what is bracket creep?

Bracket creep is when your income has risen with inflation and at some point tipped you into a higher taxable income bracket.

So what's the problem?

In the ideal situation we are earning more money ahead of inflation and the move from a lower tax bracket to a higher tax bracket represents the improvement in our income and purchasing power. However for most of us, our income increases to keep up with inflation. When this is happening our salary represents no increase in real terms in our purchasing power at all. The extra money in our salary is simply helping pay for the increase in prices. At some point that pay rise will push you into a higher tax bracket. Now your spending power has stayed the same but the government is taking more money out of your pocket through taxation - you are financially worse off.

Have I been hit by bracket creep?

The upper range of the middle income tax bracket has not changed since 2008 so we've listed below the inflation rate since that time to demonstrate the issue and looked at the case of someone earning $75,000 in 2007 and their salary increasing with inflation each year. 

                Total
Year  2008  2009  2010  2011 2012 2013 2014  
                 
 Inflation Rate  4.4% 1.7%  2.9%  3.3% 1.7% 2.5% 2.5%  
                 
 Starting income
of $75,000		  $78,300  $79,631  $81,940 $84,644 $86,083 $88,235 $90,441  
                 
Tax Bracket the
income falls under		 $34,001
–
$80,000		 $35,001
–
$80,000 		 $80,001
–
$180,000 		  $80,001
–
$180,000		 $80,001
–
$180,000		  $80,001
–
$180,000		 $80,001
–
$180,000 		  
                 
Tax Paid $17,490 $17,889 $18,587 $19,268 $19,801 $20,594 $21,410  $135,039
                 
Now imagine if the government had adjusted the tax scales each year according to inflation.
                 
If the tax scales
shifted with inflation		  $35,497
–
$83,520		 $36,100
–
$84,939		 $37,147
–
$87,403		 $38,373
–
$90,287		 $39,025
–
$91,822		 $40,001
–
$94,117		  $41,001
–
$96,470		  
                 
Tax Paid  $17,490 $17,889  $18,432 $18,943 $19,375 $20,223 $20,940 $133,292
                 
Difference $0 $0 $155 $325 $426 $371 $470 $1,747
                 

This example shows how for the first two years (even with the salary increasing to match inflation) the tax payer's income remained in the same tax bracket and so there was no difference in the taxable amount paid. But from 2010 bracket creep starts taking effect. Each year they start paying more tax than they would have if the tax brackets were adjusted for inflation and in this example the difference ends in paying $1,747 extra in tax.

Our example highlighted a middle income earner's salary but bracket creep can also affect low income workers.

What should be done?

The government should adjust the taxation scales according to the CPI. Right now the last adjustment to the middle income upper tax bracket of $80,001 was back in 2008 and this has allowed bracket creep to really increase government revenue over the last few years. It would seem that the solution is to calculate the tax scales yearly, so that the tax scales more truly reflect our actual purchasing power in the economy.