With legislated stage 3 tax cuts on the horizon (commencing 1 July 2024) you may have encountered the term "bracket creep" or "tax bracket creep."

Understanding what bracket creep is can help you make more informed financial decisions when it comes to salary considerations, optimising your tax and planning your retirement. It can also help you confidently engage in discussions about changes in tax policies.

To understand bracket creep you need to understand Australia's progressive tax system and average tax rates. In this article, we will discuss these factors and provide an overview of the stage 3 tax cuts and its impact.

What is a progressive tax system?

The Australian income tax system is "progressive," meaning that the more an individual earns, the more they pay in income tax. In this system, higher-income individuals are subject to higher tax rates, while lower-income individuals are subject to lower tax rates according to the tax thresholds.

The Australian residents tax rates for 2023-24 looks like the below. The table shows the thresholds in which tax rates increase with taxable income.

Taxable income Tax rate
0 — $18,200 Tax free
$18,201 — $45,000 19%
$45,001 — $120,000 32.5%
$120,001 — $180,000 37%
$180,001 and over 45%

The above rates do not include the Medicare levy of 2%.

Using the 2023-24 tax rates as an example, a lower earning individual making $18,200 would not have to pay tax on this income as it is within the 'tax-free threshold'. A higher-income individual would be subject to a higher tax rate — their next $26,800 is taxed at 19%, the following $75,000 at 32.5% etc.

What is the difference between marginal vs average tax rate?

Another important concept to understanding bracket creep is marginal vs average tax rates.

The marginal tax rate is the amount of tax an individual pays on additional income they earn according to the tax brackets. In the above example, it's the 19% (from $18,201 to $45,000).

An average tax rate on the other hand, is the total tax as a proportion of an individual's total taxable income.

As an example, consider an individual with an income of $150,000.

  • They would pay no tax on their first $18,200
  • 19% on their next $26,800
  • 5% on their next $75,000
  • 37% on their last $30,000

This results in a total tax of just over $40,000. $40,000 as a proportion of total income is around 27% - this percentage is the average tax rate.

See below as a visual representation from the Australian Parliamentary Budget Office.

What is bracket creep and its impact?

Bracket creep occurs when rising incomes cause individuals to pay a higher average tax rate, even though there may not have been changes to marginal tax rates and thresholds.

The impact of this is felt during periods of high inflation, wherein salary growth means more paid in tax but an individual's purchasing power is lower. This means that the value of this growth and a person's standard of living is not felt positively.

What is the government's role in bracket creep?

Bracket creep inevitably occurs as pay increases, and can impact the standard of living of individual taxpayers. As Australia's tax rates and thresholds do not automatically adjust for inflation, changes have to be legislated to manage average tax rates.

The government has proposed a redesign of the stage 3 tax cuts that were introduced several years ago. These new tax cuts are designed to provide bigger tax cuts for middle Australia to help with cost-of-living.

Let's compare the current 2023-24 tax rates against the proposed stage 3 tax cuts coming in 1 July 2024.

Current tax rates (2023-24) Proposed new tax rates (2024-25)
Taxable income Tax rate Taxable income Tax rate
0 — $18,200 Tax free 0 — $18,200 Tax free
$18,201 — $45,000 19% $18,201 — $45,000 16%
$45,001 — $120,000 32.5% $45,001 — $135,000 30%
$120,001 — $180,000 37% $135,001 — $190,000 37%
$180,001 and over 45% Over $190,001 45%

These changes will:

  • reduce the 19% tax rate to 16%
  • reduce the 32.5% tax rate to 30%
  • increase the threshold above which the 37% tax rate applies from $120,000 to $135,000
  • increase the threshold above which the 45% tax rate applies from $180,000 to $190,000

Having a clear understanding of bracket creep will enable you to assess the potential impacts of these proposed changes on your financial situation, empowering you to make more informed decisions with confidence.

How Gallagher can help

While we still have time in the current financial year, it is an opportunity to review your tax-effective strategies on what could be done prior to 30 June. So, wherever you are on your financial journey, we can help you plan for the future. Our advisers can help you achieve your financial goals by bridging the gap of where you are today and where you want to be tomorrow. Get in touch today.

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