Two-pronged attack to give families a break

As far as interventions go, this one nailed it. In the week leading up to last night's federal budget, Labor's former prime minister and treasurer Paul Keating bemoaned Labor's aversion to hard-headed reform. Labor was, as Keating called it, returning to the anvil. And since 1996, you can see the old anvil just about everywhere, especially when it comes to tax.

Witness the opposition to the 2005 budget tax cuts, the failed working tax credits of past campaigns, the opposition to the GST and the lifting of the top tax thresholds in 2000. And now the one-dimensional policy of means-testing family tax benefit Part B. There was a time when Labor could do tax.

Labor's starting point should be that families with the same household income - irrespective of how it is drawn - should be assisted in the same way, the classic goal of horizontal equity. John Howard has designed a system where you can have two families with exactly the same family composition and household income but who end up with different after-tax earnings. How? Because the first family elects to draw all the income from the primary income earner with a stay-at-home parent, while their neighbour draws their household income by splitting it 50-50 or 60-40.

This structure does not make for good policy, whether economic or social. Regardless of what Howard may think, his family tax system reduces flexibility, disrupting the family-work balance. His Sex Discrimination Commissioner, Pru Goward, has consistently raised the spectre of the overworked father and the stay-at-home mother, and how the family tax benefit system militates against a more flexible work pattern, with perhaps the father working less and the mother a little more.

But although Goward has drawn attention to the work-family effects of the family tax system, dry economists at the Melbourne Institute and now the Organisation for Economic Co-operation and Development have highlighted how the same system discourages participation in the work force precisely at a time when greater participation is needed.

But where Howard is on solid ground is when he dismisses the critique of churning: taking tax with one hand and redistributing it through transfer payments with the other. If nothing else, the family tax benefit is designed for exactly that reason. Tax is accumulated from all taxpayers, regardless of whether they have children or not, and distributed to those with children. There can be no more transparent policy.

And though this may not be welcomed by taxpayers without children, the fact is that Australian taxpayers have consistently supported government transfers to dependent children. Howard is no different from his predecessors in supporting assistance to families with children.

He is also astute enough to know that providing targeted assistance to families with dependent children is a lot cheaper than providing the equivalent assistance through the general tax system.

Which brings us to Labor's expressed goal: reducing so-called effective marginal tax rates. Let's not forget it was Labor that, correctly, introduced means testing of welfare and ipso facto introduced effective marginal tax rates (EMTRs).

What choice does Labor have now? Nothing short of universal payments will eliminate EMTRs. Conveniently, Labor seems to have overlooked that introducing a new means test for FTB PartB will just give people another EMTR. Sure, it will be up the income scale, but an EMTR is an EMTR and if you oppose high EMTRs you oppose them. You shouldn't leave much room for relativism.

For Labor, it would be better to tackle reform of the tax system and family payments simultaneously. Start by doing a Keating and collapse the top rates to something with a three in front of it. Then, on the targeted side, merge the FTB parts A and B into a single payment with a single means test, providing relief to low and middle-income families.

This would lead to the best of all worlds. Lower marginal rates would be good for incentive, encourage participation in the work force, discourage income arbitrage and reduce EMTRs. It would also have the pragmatic advantage of compensating households for any loss of their FTB PartB payment.

Similarly, a new merged family payment would better target assistance to low and middle-income families with children, result in a more seamless and efficient system, and be a cost-effective solution for government.