Application Exercise 10y: Calculating income tax
- Explain why the personal tax system is considered
The personal income tax system is considered progressive because those on higher incomes pay a larger percentage of their income in tax compared to those on lower incomes. This is evident in the fact that the rates of tax on income above a certain level are higher in the personal income tax scales (the marginal tax rates increases as income increases.)
- How much income (before income tax) will Adam earn in his first year of work?
Adam will earn $65,000 from his job, plus $52,000 from interest (52 weeks x $1000 per week), meaning his gross annual income (yearly income before tax) is $117,000.
- Calculate the amount of tax Adam and Emma will pay excluding the Medicare
Using the table, Adam will $5092 on the first $45,000 of this income and $0.325 on each dollar he earns above $45,000. This amounts to $117,000-45,000= $72,000 x 0.325 = $23,400. This brings his total tax bill to $28,492 ($5092 plus $23,400).
Emma will pay $5092 on the first $45,000 of this income and $0.325 on each dollar she earns above $45,000. This amounts to $65,000-$45,000 = $20,000 x $0.325 = $6500. This brings her total tax bill to $11,592 ($5092 plus $6500).
- Calculate the amount of tax Adam and Emma will pay including the Medicare
The Medicare levy of 2% is applied to the total taxable income earned, which means that Adam’s tax payable increases by $2340 ($117,000 x 0.02), bringing his total tax liability to $30,892. Emma’s tax payable increases by $1300 ($65,000 x 0.02) increasing her total tax liability to $12,892.
- Calculate how much tax Tim will pay over the course of the
Tim’s annual income is determined by multiplying $350 per week by 52 weeks, which equates to $18,200. This income falls just below the tax free threshold which means that Tim pays no income tax at all.
- Calculate the average rate of tax for Adam, Emma and
The average rate of tax is simply determined by dividing each person’s total income by their tax payable (how much tax they have to pay). Their respective average rates of tax are shown in the table below.
| Adam | Emma | Tim |
Income (A) | $117,000 | $65,000 | $18,200 |
Tax payable (B) | $30,892 | $12,892 | 0 |
Average rate of tax (B/A *100) | 26% | 20% | 0% |
- Discuss whether it is fair that Adam pays more tax than both Emma and
Everyone’s idea of fairness is likely to be different. However, it is arguable that most people would believe that fairness is achieved by Adam paying a much higher average rate of tax compared to both Emma and Tim. This is because he has a much greater capacity to bear a larger tax burden compared to both Emma and Tim who will be forced (other things being equal) to spend the bulk of their income, particularly in Tim’s case, to purchase the necessities for survival (e.g. food, clothing, and shelter.)
- Describe how the government could use the money raised from these income earners to further improve equity in the distribution of income.
The government can, and does, further improve equity by providing a considerable amount of both financial and non-financial support to low-income earners. This includes welfare payments as a form of direct cash support (e.g. pensions, unemployment benefits, and single-parent allowances) as well as non-cash support such as public housing and transport concessions. There are also certain other provisions in the tax system that penalise higher income earners (e.g. luxury car tax) and favour lower income earners (e.g. the low income tax offset.)