Reducing taxes for low-wage earners is more effective than increasing welfare

Tony Abbott wants to reform tax and welfare so that it pays to work.

His recent speech did not go into detail, but he wants to replace the existing system of pensions and allowances for working-age adults with a single payment, and to change income tax to avoid penalising people who move from welfare into employment.

The case for reforming the welfare system is overwhelming. In 1965, only 3 per cent of working-age adults relied wholly on welfare; today it is about 14 per cent. In the mid-60s there were 22 workers for every working-age person dependent on welfare benefits; today there are just five. This system is unfair and unsustainable.

Tony Abbott and Senator Vanstone think part of the answer lies in abolishing the distinction between pensions and allowances. The present system, they say, is too rigid and claimants in similar circumstances get treated very differently according to how they are classified. Workers classified as 'unemployed', for example, are subject to mutual obligation requirements while those classified as 'disabled' are not.

But the solution to this is not to abolish the distinction; it is to improve the way people are classified.

Blending pensions and allowances into a single payment would massively increase welfare spending, for allowances are currently less generous than pensions and the commitment is to increase them.

Removing the distinction between people deemed capable of supporting themselves and those who are not also sends out the wrong signals, for we need to emphasise that support for the former group is strictly temporary. When the Americans reformed their welfare system in 1996 they named their new, time-limited, benefit "Temporary Assistance for Needy Families" precisely for this reason.

Some working-age people cannot earn an income, and they should receive generous, and unconditional, pensions. They include people with severe disabilities and those with full-time caring responsibilities. This group must be distinguished from claimants who are capable of supporting themselves and whose situation is therefore transitional.

The problem with the present system is that we define incapacity too broadly. Twenty years ago, there were 230,000 disability pensioners; today there are more than 600,000. This number should be halved. Similarly, single parents with very young children should not be expected to work (surveys find that most Australians are willing to support them until their children start school), but under current arrangements, they can stay on a pension until their children reach 15. Again, we need to tighten up rather than abolish the pension altogether.

Unlike those who cannot work, people who are capable of working but who do not have a job should receive temporary and conditional assistance. Half of all jobseekers find work within eight weeks but attention needs to be paid to those (about a third of the total) who have been out of work for a year or more. The Americans have shown that time limits coupled with a rigorous work requirement can dramatically cut the numbers on welfare.

What about tax reform?

In his speech, Tony Abbott was rightly sceptical about Earned Income Tax Credits. Overseas experience is that they are expensive and susceptible to fraud. Furthermore, they have disturbing disincentive effects.

Tax credits for low-income workers taper off as household incomes rise. While encouraging unemployed people into work, this means they discourage people from working longer hours or getting a higher-paid job, and they penalise second earners in low-to-middle income households.

Despite their name, tax credits are really one more welfare hand-out, and they discourage personal initiative just as other welfare benefits do. If we go down this road, we will end up spending even more than we do currently on income support.

To make work pay, it might make more sense to increase personal tax thresholds to take low-paid workers out of tax altogether. Governments are taking a higher proportion of GDP in tax than ever before, and it is absurd that tax liability starts at an income well below subsistence level. The current tax threshold of $6,000 is less than half what a single unemployed person gets in income support and rent assistance ($12,370), and it is just over a quarter of the federal award minimum wage ($22,400).

In his speech, Mr. Abbott referred to Centre for Independent Studies findings that a worker supporting a family on Average Weekly Earnings paid no income tax at all in 1960. What was possible then is possible now. Tax reform should aim to relieve those on the lowest incomes from paying income tax rather than locking them into dependency on another welfare transfer payment. There is no better work incentive than keeping hold of every cent you earn.