Don’t let tax creep up on you

The Weekly Advertiser Horsham - - Tax Time -

Aus­tralia has a pro­gres­sive in­come tax sys­tem. This sim­ply means that higher in­come earn­ers pay a greater pro­por­tion of their in­come in tax than low-in­come earn­ers.

It is achieved by ap­ply­ing a dif­fer­ent rate of tax to each in­come band or ‘bracket’.

For ex­am­ple, if you earn $25,000 a year you will pay $1292 in tax, or 5.2 per­cent of your to­tal tax­able in­come.

Earn $87,000, how­ever, and your tax bill jumps to $19,822, or 22.8 per­cent of your tax­able in­come.

Where it be­comes creepy

So what hap­pens if you are earn­ing $87,000 a year and then re­ceive a pay rise of three per­cent?

That ex­tra $2610 will be taxed at 37 per­cent, so your to­tal tax now rises to $20,788, or 23.2 per­cent of your tax­able in­come.

This is what ‘bracket creep’ is all about.

As your tax­able in­come rises and you move into higher tax brack­ets, the pro­gres­sively higher tax rates mean that a greater pro­por­tion of your in­come is paid in tax.

De­spite that, your take-home pay has still gone up by $1644, so what’s to com­plain about?

In a word: in­fla­tion. Bracket creep means your three per­cent pay rise has re­sulted in only a 1.9 per­cent in­crease in af­ter-tax in­come.

Bracket creep is a big­ger prob­lem dur­ing pe­ri­ods when in­fla­tion and wages growth are higher than when wages are grow­ing slowly.

How­ever over time, and with­out ac­tion, it will still be felt.

It af­fects ev­ery­one with tax­able in­come above the tax-free thresh­old, though in both dol­lar terms and as a pro­por­tion of tax­able in­come, bracket creep has a greater im­pact on higher in­come earn­ers.

What is the so­lu­tion?

From a pol­icy per­spec­tive, the ob­vi­ous so­lu­tion to bracket creep is tax in­dex­a­tion.

This would see tax thresh­olds au­to­mat­i­cally in­crease each year, in line with the con­sumer price in­dex or a wages in­dex.

If your tax­able in­come rises at the same rate as the in­dex, your av­er­age tax rate would re­main the same.

Tax in­dex­a­tion has been talked about for decades, but it is a so­lu­tion that no gov­ern­ment has yet im­ple­mented.

One rea­son could be that bracket creep de­liv­ers an al­most in­vis­i­ble tax wind­fall to gov­ern­ments.

With­out chang­ing any num­bers or mak­ing any head­lines, as wages rise the ex­tra tax qui­etly rolls in.

What can you do?

A num­ber of strate­gies can help re­duce bracket creep.

Gen­er­ally they re­volve around the dif­fer­ent tax rates that ap­ply to per­sonal in­come, su­per­an­nu­a­tion con­tri­bu­tions and earn­ings, or even com­pany prof­its.

Salary sac­ri­fice to su­per­an­nu­a­tion is one op­tion, pro­vided the tax rate on su­per con­tri­bu­tions is less than your mar­ginal tax rate. Take care, how­ever. Tax plan­ning is a com­plex area, so make sure you seek the help of an ap­pro­pri­ately qual­i­fied pro­fes­sional to de­velop your so­lu­tion to the bracket creep. – Robert Goudie, au­tho­rised rep­re­sen­ta­tive of Mer­i­tum Fi­nan­cial Group. the im­pact of

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