Inflation has eased in Australia from 7.3% in September 2022 to 2.4% in March 2025 and it’s now within the Reserve Bank’s inflation target of 2–3%. The easing of inflation is welcome. However, even low inflation has a significant impact on the tax system.

Currently, it is inflation – and not tax reform – which is being relied upon to increase tax revenue. The Parliamentary Budget Office (PBO) expects the average personal income tax rate to increase to a record high of 28.2% in 2034–2035, due to inflation resulting in bracket creep.

The recent budget announcement of a series of reductions to the lowest marginal tax rate does not make a significant difference to this outcome.

A barrier to workforce participation

Why should Australia be concerned about inflation resulting in greater taxation?

Bracket creep has the greatest impact on lower income earners as they progress into higher tax rates and pay higher average taxes. This makes the tax system less progressive and discourages people from trying to earn that extra amount.

With Australia facing an ageing population, there needs to be a high participation rate to support economic growth. Any structural feature that discourages people from working needs to be removed.

Good tax policy is often compromised by the combination of the passage of time and an unindexed threshold, and indexation would solve this problem. It is a sensible idea and it’s easy to implement. So why hasn’t it been adopted?

In part: it relies on political will. Indexation reduces the ability of politicians to announce a tax reduction and no politician wants to give up such an opportunity.

A raft of indexation

It is not just the individual tax rate thresholds that need indexing. There are many other provisions in the tax act taxpayers rely on that are not indexed. The lack of indexation of these provisions makes it harder for taxpayers to access concessions or reduced substantiation requirements, undermining the purpose for the existence of these thresholds over time.

For example:

• The reportable fringe benefits threshold was set in 2000 at A$1000 to reduce compliance costs. This increased to A$2000 in 2006 and it has remained at that level, despite CPI increasing over 60% since then.

• Small business capital gains tax concessions only apply if a small business has net assets worth less than A$6 million. This amount was set in 2007 and would be over A$10 million now, if it had been indexed.

How to index

Once we accept that indexation is desirable, a decision must be made as to what index is appropriate and how frequently the amount should be indexed. The answers to these questions are influenced by both the policy intent and the characteristics of the recipients.

These decisions are important. For example, as the PBO wrote in its May 2023 budget explainer: “The difference between the single rate of age pension and the single rate of JobSeeker payment has grown from a A$16 per week (10%) gap in 1998 to a A$174 (51%) gap per week in 2023, largely due to differing methods of indexation.”

While CPI is widely known, when consideration is given to indexing personal income tax rates it may be more appropriate to use a wage index because wages generally grow faster than prices. Alternatively, a combination of benchmarks can be used in a manner similar to the approach used for the age pension.

In the meantime

If there is no political appetite to implement indexation, there should at least be recognition of its impact.

Hidden in the budget papers is a table which contains a line about the impact of budget creep. There is an opportunity for the impact of indexation on the tax system to be explicitly discussed by including it in the tax expenditure statement, so that the distributional and equity impacts can be highlighted.