The Federal Budget has been and gone and, like always, tax was a big issue. You have probably heard the term ‘progressive tax.’ Australia’s personal income tax system is a progressive one. But what does that mean, exactly?
Put very simply, the rate of tax paid under a progressive income tax system increases as the taxpayer’s income rises. The idea is that people who earn more income pay a higher proportion of their income as tax than people who earn less income. So, the amount of tax you pay progresses upwards with your income.
The following table shows the income tax rates payable for individuals in the 2018-2019 financial year:
|Taxable Income||Tax on this income|
|0 to $18,200||Nil|
|$18,201-$37,000||19 cents per dollar over $18,200|
|$37,001-$90,000||$3,572 plus 32.5 cents per dollar over $37,000|
|$90,001 -$180,000||$20,797 plus 37 cents per dollar over $90,000|
|Over $180,000||$54,097 plus 45 cents per dollar over $180,000|
NB: this table does not show the Medicare levy.
To see how this works, imagine you receive a bonus of $5000 from your employer. That bonus forms part of your assessable income. If your only other income for the year totals $10,000, then your total assessable income for the year becomes $15,000. This means that the bonus will not be taxed. This is because you don’t pay any tax when your total assessable income is below $18,200.
If your other income for the year totals $30,000, then your total income will be $35,000. This means that the $5000 bonus will be taxed at 19%, because that is the marginal tax rate that applies for income between $18,201 and $37,000. So, the $5000 will incur tax of $950.
If your other income for the year is $100,000, then your total taxable income becomes $105,000. This means that the $5000 bonus will be taxed at 37%, which is the marginal tax rate that applies to income between $90,001 and $180,000. So, the $5000 will incur tax of $1850.
If your other income for the year is $200,000, then the $5000 bonus will be taxed at 45%. 45% is the marginal tax rate that applies to all income above $180,000. The $5000 would incur tax of $2250.
So, a $5000 bonus will be subject to a different amount of income tax depending on what other income the taxpayer has received in the relevant financial year. The higher that other income the more tax payable on the bonus – a progressive system at work.
The main alternative to progressive taxation is ‘flat rate taxation.’ This is where the same rate of tax is paid regardless of factors such as income. Two common examples of flat rate taxation are the Goods and Services Tax, which is applied at a rate of 10% on all relevant goods and services, and the tax payable on superannuation contributions and earnings. These are typically subject to a flat rate of tax at 15%.
In many ways, these flat taxes are actually regressive, which is the opposite of progressive. This is because people on lower incomes pay a relatively higher proportion of their income when a flat rate of tax is applied. For example, if two people need to make an identical purchase for $1000 plus GST, they will each pay $100 in tax. If Person A has a total income of $10,000, $100 represents 1% of their total income. If Person B has a total income of $100,000, $100 represents 0.1% of their total income. The same amount of tax represents a greater proportion of a lower income.
When tax rates are flat, a person on a lower income is arguably paying more of their income in tax than a person on a higher income. This is why many people argue that flat rates of taxation are unfair. It is also why our income tax system is a progressive one.