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A pat on the back is better than a kick in the behind

By Andrew Leigh - posted Wednesday, 20 July 2005

With the Federal Government gearing up to reform its welfare system, the jobs debate seems to be splitting into two simplistic camps. Some argue welfare dependency is a problem that can be solved only with punitive policies, while others reject the view that welfare dependency is anything to worry about. This false dichotomy is leading Australian welfare policies astray.

Welfare dependency is a problem. In the late 1960s, 87 per cent of working-age men had full-time jobs. Today, only 66 per cent do, with many now reliant on income support. Not only has women's employment not risen enough to make up for the fall in participation by men, but employed women are increasingly choosing employed men as their partners. At a family level, this means that rich households are working more, but poor households are working a lot less. One in six children live in a household without an adult in the labour force. Mark Twain once said: "If work were so pleasant, the rich would keep it for themselves." Now they have.

The Federal Government has opted to deal with welfare dependency mainly through punitive policies. Under the new regime, people with school-aged children who receive parenting payments must search for at least part-time work. Unemployed workers aged 50-64 face more stringent requirements in their search for work. And qualifying for disability benefits has become harder.


In contrast, welfare reforms implemented in the US during the 1990s used a combination of penalties and incentives to increase workforce participation. While strict time limits were applied to welfare benefits, those entering the labour force also received a large wage subsidy, in the form of a tax credit. For poor families with two children, the subsidy can be worth more than $US4,000 ($5,400) a year.

An important question from the US reforms of the 1990s is which had more effect on moving people off welfare - penalties or incentives? Separate studies by Jeffrey Grogger, and by Bruce Meyer and Dan Rosenbaum, give more kudos to the big carrot (the earned income tax credit) than to the various sticks (such as time limits on receiving welfare). This provides a clear policy lesson for other countries seeking to move more people into work: if you want to be successful, wage subsidies should be part of the solution.

The US is not the only country to have this kind of wage subsidy program. Britain's earned income tax credit program provides a wage subsidy of up to £3,000 ($7,000) to induce parents into the workforce. Many other developed countries, including Belgium, Finland, France and the Netherlands, also have income tax credits to boost workforce participation.

Yet Australia has largely eschewed wage subsidies. While the so-called "five economists" proposal in 1998 received broad support among academics, the Howard Government took little notice. For its part, the Labor Party proposed an income tax subsidy in the 1998 and 2001 election, but dropped the idea for the 2004 election. Current wage subsidy programs tend to be targeted at particular groups (such as apprentices, older workers, disabled and indigenous people), or operate for only a very short time. Australia provides generous benefits to families with children, but because they are not linked to workforce participation and have high income thresholds, they end up operating more like middle-class welfare than as incentives to help low-income parents into the labour force.

Can the Federal Government be persuaded to amend its welfare reform proposals to take what Opposition Leader Kim Beazley recently called a more "carroty" approach? At this stage, the odds are not good.

But there is an alternative. As Treasurer Peter Costello has pointed out, land taxes and higher-than-expected GST revenue have left state Labor governments flush with cash. Rather than heeding Costello's call to cut business stamp duties, state and territory governments should hold true to their Labor values by putting in place wage subsidies for the low-income earners. In conjunction with the government's more punitive welfare reforms, this could lead to a worthy rise in the employment rate, for which the states would rightly deserve most of the credit.


The Howard-Costello welfare reforms are poor policies - in both senses of the phrase. It's time for the state and territory leaders to help them work.

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First published in the Sydney Morning Herald, July 11, 2005.

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About the Author

Andrew Leigh is the member for Fraser (ACT). Prior to his election in 2010, he was a professor in the Research School of Economics at the Australian National University, and has previously worked as associate to Justice Michael Kirby of the High Court of Australia, a lawyer for Clifford Chance (London), and a researcher for the Progressive Policy Institute (Washington DC). He holds a PhD from Harvard University and has published three books and over 50 journal articles. His books include Disconnected (2010), Battlers and Billionaires (2013) and The Economics of Just About Everything (2014).

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