How increased self reliance will result in a lower burden

Tax and welfare reform are on the agenda. Given the government’s newly-won control of the Senate, most attention is focusing on the next 18 months, but it is also important to think longer term about the kind of tax and welfare systems we shall need over the next few decades.

The welfare state was a 20th century invention designed to ensure that everyone enjoys a minimum living standard. This remains an important objective, but with economic growth doubling living standards every 30 years, we no longer require a mass welfare system to achieve it.

Unlike earlier generations, many Australians today earn enough over a lifetime to enable them to save, borrow or insure to cover their basic needs without government help. What stops this from happening is the big chunk taken out of their earnings in taxes.

The main reason taxation is so high is that government spends so much on the welfare state. Cash transfers like the age pension, Family Tax Benefit, and disability and parenting payments cost $80 billion last year, and $90 billion more went on government health services and education. Two-thirds of the $260 billion raised in federal and state taxes was spent feeding the welfare state.

Clearly, if we want to cut taxes on earnings we shall have to cut government social spending. But this is where voters start getting edgy and politicians take fright. The welfare state, we are told, is a necessary safeguard for the poor and a badge of our fair go society. It cannot and should not be rolled back, for millions of Australians depend upon it.

Yet many of the people who depend on cash benefits or government services like hospitals and schools pay for what they receive through their taxes. If they didn’t pay so much tax, they could afford to buy education, health and income insurance out of their own pockets. Seen in this way, the welfare state is creating their neediness rather than solving it.

It is commonly believed that the primary role of the welfare state is to redistribute resources from rich to poor. This was its original intended purpose, and there is still some redistribution going on today, but much of the $175 billion spent on the welfare state now goes back to the same people who contributed the money in the first place. We pay high taxes to fund government services (often of poor quality) which we could have purchased better for ourselves if only the government hadn’t taken our money.

The National Centre for Social and Economic Modelling (NATSEM) estimates that in 2001-02, an average couple with pre-school children paid $374 each week into the welfare state through direct and indirect taxes, but received $320 of this back in welfare benefits and services. Couples with older children paid $474 into the welfare state budget and got $564 back. For these families, the welfare state is not redistributing money, it is churning it.

Of course, people with low or no incomes at any one time generally get more back from the tax-welfare system than they put in - but over time, they too often end up financing their own benefits. Income mobility is common (only one-quarter of households under the poverty line in 2001 were still there two years later). This means even those who are heavily dependent on the welfare state at one point in their lives often become net contributors at another, so over a lifetime they pay for much or all of what they receive.

Ann Harding at NATSEM shows that even the lowest lifetime earners end up paying for half of all the income support they receive through their lives and for more than one-third of the value of government-provided health care they consume.

At least half of the $175 billion of tax revenue spent on the welfare state last year will probably find its way back to the people who paid the money in. If we could eliminate this churning, it would release $85 billion which could fund spectacular tax cuts without making anyone worse off. We could, for example, raise the tax-free income threshold to $20,000 and combine it with a flat 10 per cent income tax.

Finance Minister Nick Minchin recently challenged the Liberal back-benchers calling for radical tax and welfare reform to show where savings could be made. One answer is that the government could try to reduce tax-welfare churning. This would increase efficiency, and it would renew the spirit of self-reliance.

Increased self-reliance should be the long-term reform objective. But it will not happen until politicians allow us to keep more of our own money and trust us to make our own decisions about how we want it spent. A small but crucial first step down this path would be to raise the tax-free threshold at the next budget.