If you can enact a tax reform that improves both equality and efficiency, you must be doing something right. And so it seems with the government’s mooted redesign of the former Coalition government’s stage 3 tax cuts, to be announced by Prime Minister Anthony Albanese on Thursday.

Arthur Okun, US president Lyndon B Johnson’s chief economic adviser, described the key challenge in tax policy as akin to a leaky bucket: seeking to reduce inequality by redistributing income is like carrying water from a well using a bucket with a big hole in it; the leakier the bucket, the more water we will waste in trying to share it around. Okun described equality and efficiency as “the big trade-off”.

If you can enact a tax reform that improves both equity and efficiency, you must be doing something right.Credit: SMH

But Albanese and Treasurer Jim Chalmers seem to have overcome it. This sounds like a free lunch, and indeed it is. Such was the misguidedness of one big part of the stage 3 tax cuts, as I’ve described in these pages for 18 months.

Cutting the 32.5 per cent marginal tax rate that applies to most workers to 30 per cent was justified on both efficiency and equality grounds. And raising the top 45 per cent threshold from $180,000 to $200,000 simply returned some of the bracket creep since it was last adjusted 16 years ago.

But eliminating entirely the 37 per cent tax bracket between $120,000 and $180,000 never made sense. That component would see us spend $8 billion a year to improve work incentives for a tiny fraction of the population. Combined with the other two components, stage 3 would have seen more than $9000 a year go to every person earning more than $200,000 a year without raising their incentive to work one iota.

What the mooted redesign recognises is that this money can be reallocated to those on lower incomes (improving equality) in a way that has a bigger impact on the work incentives for a group of people who tend to be more sensitive to them (improving efficiency). This simply delivers bigger bang for buck.

What are the mooted changes? It seems likely the government won’t raise the $180,000 threshold all the way to $200,000, but will stop short at $190,000. This will lower the tax relief going to those earning more than $200,000 by $1500 a year.

The other revenue saver appears to be the retention of the 37 per cent bracket, but with an increase in the threshold from $120,000 to $135,000. This will lower the tax relief going to those earning more than $190,000 by $3850 a year. With the proceeds, the government can instead lower the marginal tax rate that applies to the first tax bracket between $18,200 and $45,000 from 19 per cent to 16 per cent. This delivers tax relief of $804 per year to everyone earning more than $45,000 (proportionally less to those earning between $18,200 and $45,000).