Weaning off welfare

The sustained high-powered campaign to lower the top tax rate of 47 per cent applying to our best-off Australians, contrasted starkly with the lip-service given to addressing much higher effective tax rates applying to our worst-off Australians.

So I posed a challenge to the federal treasurer - would he work to make sure no Australian would suffer an effective marginal tax rate greater than the new top tax rate of 45 per cent?

A challenge is easy, but what would it cost? Could it be done? These questions are very big ones that have no simple answers. They are also ones which have not received a great deal of attention.

Effective marginal tax rates up to 70 per cent apply to low-income Australians when income tax and the removal of welfare are combined when moving from welfare to work. High EMTRs affect the willingness to work.

Reducing EMTRs competes as a policy objective with other important objectives. Targeting of assistance to those most in need was the major objective of family assistance reform through the years of the last Labor government. Those reforms dramatically increased the adequacy of assistance to low-income families but also produced much of the EMTR problem facing us today.

The present government has both exacerbated and relieved the problem to some degree. Creating Part B of Family Tax Benefit stacked another income test onto those already faced by women re-entering the workforce. Reducing taper rates reduced EMTRs for some and extended assistance further up the income range. However it also increased EMTRs for middle-income families.

Very high EMTRs have been reduced as the objective of unemployment assistance has changed. They had to come down to encourage part-time and casual work among recipients. At the same time, if they came down too far unemployment assistance could become some sort of income supplement for low-income workers. That has not been the traditional role of unemployment assistance.

The problem to be addressed is how to produce lower EMTRs without compromising the other equally important objectives of family assistance and low-income support.

EMTRs are produced by the overlapping of income tests on government payments and subsidies and income tax rates. The more payments, subsidies and rebates a family attracts, the higher the EMTRs. There are also not only income tax rates, but a low-income rebate and a Medicare levy that both modify the tax rate and have phase-out ranges that can add to EMTRs.

Family assistance is broken into two parts which overlap and inevitably produce higher EMTRs when combined with tax rates, levies and rebates. Families with Youth Allowance dependants face further stacking when the family income test for YA is added. Other families may have further complications due to public housing subsidies.

Research on how many people are facing high EMTRs is thin on the ground. A NATSEM report by Gillian Beer in 2002 gave an idea of the considerable scale of the problem. She found that high proportions of families with children, and especially sole-parent families, faced high EMTRs.

In 2000 David Ingles from the ANU mapped out three approaches to EMTR reduction: harmonisation, integration and separation.

The harmonisation approach essentially tries to ameliorate the existing system by adjusting income tax and income tests to avoid the most serious conjunctions of withdrawal rates.

In terms of fundamental reform Ingles canvassed integration of tax and income tests. Separate means tests for welfare payments would be removed and replaced with special tax scales for those in receipt of payments. However he warns that the differing definitions of income used for income tax and for welfare may be too far apart for integration to be feasible except as a very long-term goal.

The opposite approach is to aim for full separation of the tax and welfare regimes. One model suggested involved adding family tax benefits, Youth Allowance and rent assistance to basic income-support payments in a family and subjecting them to a single withdrawal rate. A tax credit would be provided to ensure that no tax was paid until all income support and additional payments were exhausted under the income test. This would ensure the family was subject to only the taper on the income test for payments until they ceased and then taper on the tax credit plus the underlying tax rate.

All these approaches involve quite radical restructuring of tax and welfare systems, but government action to date has just modified EMTRs to some degree through reduced tapers and tax rates.

Without fairly fundamental recasting of tax and welfare interaction any further adjustments to the existing system may tend to shift the EMTRs to another income or benefit group, and like squeezing a balloon, it won’t get smaller but just bulge out in a different place.