Australia's top marginal tax rate is 47% (45% plus Medicare levy), but some of us face a so-called effective marginal tax rate that's much higher.
Author
Ben Phillips
Associate Professor, POLIS@ANU Centre for Social Policy Research, Australian National University
Effective rates include everything that is lost as a result of earning more, including personal income tax, government benefits and sometimes childcare costs and student loan repayments.
These rates can be high, resulting in so-called poverty traps in which people are reluctant to earn more because they will lose most of it.
The government's Women's Economic Equality Taskforce reported last year that for second earners in a two-child couple moving from three days' employment per week to four or five, the rates were as high as 65% and 110% of the extra dollars they earned.
But it's important to know how common these situations are.
I set out to find out. I used the Australian National University's microsimulation model of taxes and welfare payments, PolicyMod and data about earnings, benefits and work arrangements as at December 2023.
Poverty traps are rare
The findings, just published in the Australian Journal of Social Issues, suggest very few of us face high effective marginal rates. Only 9% of Australians of traditional working age face rates exceeding 60%. Less than 1% face rates exceeding 80%.
The question I set out to answer was how much of an extra day's pay would be kept (and how much would be lost) from an extra day's work, taking into account tax, lost benefits, extra childcare costs and higher education contribution repayments.
In certain situations, the effective marginal tax rates can be high. For a privately renting single parent with one child in long day care, they approach 60%.
But these situations aren't common.
The bulk of working-age Australians (more than half) face effective marginal tax rates of 20% to 40%. This means they keep 60% to 80% of what they earn from an extra day's work.
About 15% of working-age Australians face effective marginal tax rates of less than 80%, meaning they would keep at least 80% of everything extra they earned from an extra day's work. Many of them face an effective rate of zero.
Only 0.9% of the working-age population faces effective marginal rates of 80% or more. These people are more likely to be women than men facing the loss of various welfare payments and potentially child care costs as they increase their working hours.
I also calculated effective marginal tax rates using a different definition: the loss from earning one extra dollar rather than working one extra day. Even fewer working-age Australians turned out to face high effective marginal rates.
What matters most for most people (those in all but the lowest-earning 20% of households) is their income tax rate.
For those in the lowest-earning 20% of households what matters most is lost government allowances such as JobSeeker.
Lost family payments and pensions, childcare costs and student loan payments turn out to matter little for most households.
Even for families with children who are considering an extra day for paid employment, lost family payments and childcare costs turn out to be dwarfed by tax.
Across all Australians of working age, the average effective marginal rate comes in at 36%. This means the average working-age Australian keeps 64% of his or her earnings from an extra day's work.
About 29% of the 36% comes from personal income tax. The rest comes from lost JobSeeker and other allowances (2.5%), family payments (1.9%), higher education repayments (1.2%), childcare 0.9% and pensions (0.7%).
Total effective rates low
Why are effective marginal tax rates so low? And why do things other than tax turn out to be of only minor importance?
Partly it is because of Australia's tightly targeted welfare system. While it is true that targeting adds to the marginal tax rate for people facing the withdrawal of payments, withdrawals generally operate across a small income range, meaning not many people are affected at any one time.
The childcare result might seem surprising (and is at odds with the report of the Women's Economic Equality Taskforce) but the July 2023 increase in the childcare subsidy cut the contribution of childcare to the effective marginal rate quite a bit.
While it might also seem surprising that men and women face similar average effective marginal rates, the result for men is driven by them typically earning more than women and facing higher tax rates. The result for women is driven by them being more likely to be a second earner returning to work.
Women with children in formal childcare who increase their working days tend to face moderately high effective marginal tax rates but these are typically below 60% and more likely to be 40% to 60%.
Another reason the modelling finds poverty traps are rare is that relatively few working-age Australians are on welfare payments. (Age pensioners get the pension but they are not of working age.) Even fewer Australians of working age are in the income range in which payments are withdrawn.
These findings don't mean everything is rosy with Australia's tax and welfare system. Parts of it are overly complex and some people miss out on payments who should not. And some of the payments - particularly JobSeeker and Youth Allowance - are too low and the loss of some payments is arguably too steep as private earnings increase.
But the good news is worth noting. Most of us keep most of the extra money we earn.
Ben Phillips does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.
