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What’s wrong with churning?

By Nicholas Gruen - posted Friday, 17 February 2006


You’d think that cutting top marginal rates would have stronger political opponents than John Howard and Peter Costello. But the “cut top rates” bandwagon just keeps rolling - even though each dollar spent cutting taxes for the 3 per cent earning over $125,000 a year can’t be used to raise thresholds and so lower tax for the rest.

Now a bandwagon is starting up against “fiscal churn” - that’s when you pay tax only to get it back as “government transfers” - like family payments. Consider the Joneses. They’re a couple with one breadwinner earning around $48,000 with two children. They pay around $11,000 in tax and then receive about the same amount back in family payments and childcare subsidies.

The right-leaning Centre for Independent Studies (CIS) is on a crusade against churn. ALP Senator Chris Evans has joined in, claiming that churn creates “enormous” costs “for absolutely no economic gain”.

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It sure sounds silly. But there’s method in the madness. Our tax system raises revenue according to individuals’ capacity to pay. Our family payments system focuses on need and assists people according to their household income and the number of dependents.

Tax churning is the logical result of each system doing its job tolerably well. We could reduce churn by cancelling the Joneses’ family payments and distributing the proceeds as general tax cuts. But we’d lose the targeting, making the Joneses much worse off. In funding general tax cuts, their family payments would in effect be shared with single and wealthy people.

What’s not being shouted from the megaphones of the anti-churn bandwagon is that our family payments system has been incredibly well targeted to relieve poverty and help families.

Remember Bob Hawke’s infamous claim that “no child will live in poverty”?

What a pity he didn’t read from the supporting documentation which said, correctly, that “no child need live in poverty”. As pre-tax incomes became more unequal in the following years, family payments saved thousands of families and their children from poverty and hardship. They still do.

As in other countries, a lot of our family payments go to the middle class. But that’s overwhelmingly when they’re raising children - a good time for a helping hand. Why are we helping much wealthier families than the Joneses? Think about it: withdraw family payments too sharply as family incomes rise undermines families’ incentive to earn more.

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On the other hand we should exclude rich people. We don’t do it perfectly. But as an Australian at the OECD, Peter Whiteford demonstrated recently, we’re way ahead of our peers.

Using 1998-99 data Whiteford showed Australia had the least churn of any OECD country. In most OECD countries the richest fifth of households got their hands on more than half the benefits the poorest fifth did. In the second best performer, New Zealand, the rich got a fifth as much. In Australia the figure was less than a twelfth.

Though we spent less than the OECD average on welfare benefits (which keeps our taxes below OECD averages), our own targeting was so tight that we redistributed more to poor people than any other OECD country. And disposable income for Australian families with children on social assistance was among the highest in the OECD.

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First published in The Courier-Mail on February 1, 2006.



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About the Author

Dr Nicholas Gruen is CEO of Lateral Economics and Chairman of Peach Refund Mortgage Broker. He is working on a book entitled Reimagining Economic Reform.

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