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Modernising and Improving the Personal Tax System

Cutting income tax and freeing more than a million people from filing a tax return

The Government will make structural improvements to the tax system by introducing a higher tax free threshold. The changes the Government is proposing will modernise and improve the personal tax system, making it more transparent and simpler for users to understand, consistent with the recommendations of the Australia's Future Tax System review.

Raising the tax free threshold to $18,200 will free up to a million people from having to lodge a tax return from 2012-13. This will make life easier for many low-income earners who currently have to interact with both the tax system through the Australian Taxation Office and the transfer system through Centrelink. In future, many of these people will only have to interact with the transfer system.

In 2015-16, the Government will increase the tax free threshold again to $19,400 which will free a further 100,000 people from having to file a tax return.

This reform will contribute substantially to the Government's wider economic reform agenda aimed at strengthening the Australian economy for future generations.

Complexity and lack of transparency in the current tax system

Currently the Low Income Tax Offset (LITO) is used to deliver tax relief to low- and middle-income earners. While the LITO has been effective in delivering targeted relief to these groups, it has also created a gap between the published tax rates and thresholds that people see, and the effective tax rates and thresholds that people ultimately face.

It is a little known fact that most people who are nominally within the 30 per cent marginal tax rate bracket actually face an effective marginal tax rate of 34 per cent. Taxpayers between $30,000 and $67,500 currently pay their statutory marginal tax rate of 15 or 30 per cent, plus the 4 per cent tax rate created by the reduction of the LITO at four cents per dollar. The Government will cut this from 4 per cent to 1.5 per cent on 1 July 2012, and increase the threshold so that it only applies to income over $37,000. From 1 July 2015, the Government will cut it further, to 1 per cent. Although there are higher headline statutory tax rates, the combination of a higher tax free threshold and lower rate of reduction for the LITO, mean tax cuts for all taxpayers up to $80,000; and no-one pays more tax.

For example, currently, a person earning $60,000 faces a headline statutory tax rate of 30 per cent, but also loses 4 cents of LITO for every dollar they earn. This means their combined marginal tax rate is actually 34 per cent (excluding the Medicare levy). Under the new scales from 1 July 2012, they will face a statutory tax rate of 32.5 per cent, but only lose 1.5 cents of LITO for every dollar they earn. So their combined marginal tax rate is still 34 per cent, but it is now more transparent. The tax reforms the Government is introducing will more closely align published marginal tax rates with effective marginal tax rates, which is more transparent and fairer for everybody.

In addition, the fact that the LITO is not explicitly reflected in the published tax schedule means that many low-income earners need to lodge an income tax return, even when their tax liability after the LITO is accounted for is nil. By incorporating more of the LITO into the tax free threshold and increasing transparency, it is easier for people to judge whether or not they need to lodge a tax return.

Key facts

• The tax free threshold will be increased more than threefold, from $6,000 to $18,200, freeing up to one million low-income earners from needing to lodge a tax return from 2012-13.
• A higher statutory tax free threshold means better interactions with the transfer system and builds on the reforms the Government introduced in the Budget, which mean more cash in people's take home pay from week to week and more immediate and direct returns to work.
• The LITO will be reduced from $1,500 to $445, with the benefit being reflected in the new tax free threshold.
• The combined effect of the higher statutory tax free threshold and the LITO is that the effective tax free threshold will rise to $20,542. This means that individuals can earn up to $20,542 from 2012‑13 without paying any net income tax.
  • All taxpayers below $80,000 receive a tax cut from 1 July 2012, with most getting a cut of at least $300. This means around 60 per cent of all taxpayers will receive a tax cut of at least $300 and no one will be required to pay more income tax.
• In 2015-16, the tax free threshold will increase by a further $1,200 to $19,400 so that those earning up to $68,000 will receive a tax cut of around $385 per year from 2015-16 compared to 2011-12. The effective tax free threshold applying to individuals will rise to $20,979 and an additional 100,000 people will be freed from having to lodge a tax return.
• The pensioner tax offset will be rolled into the more generous senior Australians tax offset to create a single seniors and pensioners tax offset, further reducing complexity in the tax system.

The new tax scales

* Includes the effect of the tax free threshold and the low income tax offset (LITO).

* Personal Income tax cuts compared to 2011-12.  Does not include the Medicare Levy or the impact of the temporary flood and cyclone reconstruction levy ending in 2011-12.

** Tax cuts since 2007 are larger for people on incomes over $80,000