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Tax Policy Design and the Role of a Tax-Free Threshold

PFM, Vol. 11 No. 4, (2011)

This paper examines the role of the tax-free threshold in a tax and transfer system consisting of a range of taxes and income support payments. The simultaneous payment of tax and receipt of income support, seen by some commentators as a problem, is examined. The analysis shows that with an income support system, a tax-free range is not required to achieve redistribution. With the aim of improving labor supply incentives while maintaining approximate revenue and distribution neutrality, a policy change involving the elimination of the tax-free threshold in Australia is examined using a behavioral microsimulation model which ac-counts to a large extent for population heterogeneity. The results demonstrate that the tax-free threshold can be eliminated under these conditions, but labor supply incentives cannot simultaneously be improved. This means that the status quo could be more or less maintained while eliminating the tax-free threshold.

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