Making tax fair and equitable

Last year, not long after their first budget in government, the Rudd Government called for a “root and branch” review of the Australian tax and transfer system. The review, which is due to report to the government at the end of 2009, provides a great opportunity to examine some of the major inequities and inefficiencies of our tax and transfer system.

In this article, three priority areas for reform are identified, which the review panel, and government policy following it, must consider if the equity and efficiency principles of good tax reform are taken seriously. These three areas are:

1. the adequacy of income support;
2. making work pay; and
3. taking a progressive lifelong savings approach to asset building.

Adequacy of income support

An essential feature of an equitable tax and transfer system is an adequate safety net to protect people from entering poverty. So what kind of safety net does the Australian income support system provide? Well let’s just say that if you’re unemployed, don’t have children and are in the private rental market, you’re stuffed.

Government support to age pensioners increased in the May budget, because of concerns about its adequacy. What the government has completely overlooked is that there is a group of Australians on income support that has to get by on even less than the pension; the unemployed. Prior to the recent increase in the Age Pension rates, there was a $56 a week difference in the payment rates for the Age Pension and Newstart Allowance, Australia’s unemployment benefit, for a single person. Now if the government acknowledged that pensions were inadequate to support basic living standards, increasing the basic single pension rate by $32 a week in the May budget, then what does that say about allowance rates?

If people were on income support for short periods of time this might not be such a problem. However, many current recipients of allowances are long term recipients. Also, rising unemployment rates mean that this is affecting more and more people.

Particular attention needs to be made to private renters on income support, as Rent Assistance has not kept pace with rising rents.

Make work pay

Another major problem of our income support system is that for many income support recipients, entering the workforce simply doesn’t pay. As people’s income support payments are withdrawn when they enter paid employment, effective marginal tax rates (EMTRs) for many income support recipients can be more than 50 per cent.

A particular problem occurs for those of working age eligible for the higher pension payments, as they risk losing their eligibility for a pension and having to claim the lower allowance if things do not work out in their job and they need to re-claim income support.

Individuals and families moving from income support into employment not only have their benefits withdrawn but also face the prospect of no longer being eligible for their Pensioner Concession Card or Health Care Card, which entitles them to cheaper medicines and a range of concessions (varying across states) relating to utilities, health, transport and education.

In addition individuals and families in public housing face an increase in their rent when their income increases until their rent reaches market rates.

The current Working Credit was introduced in recognition of these problems and allows working age income support recipients with little or no earnings to accumulate credits over time, up to a maximum of 1,000. For every credit accumulated, income support recipients can earn an extra dollar of income before their payment is withdrawn. For someone with 1,000 credits for example, they can earn up to $1,000 before their payment is reduced. Leigh and Wilkins (in Working Credits: A Low-Cost Alternative to Earned Income Tax Credits? 2009) find that the Working Credit has had a small positive impact on workforce participation. However, the maximum value of the credit is relatively small and it has not been indexed over time, so its real value is declining.

One obvious, and fairly straightforward, fix would be to increase the maximum amount of the Working Credit so that people can keep their benefits for a longer period when they start work. Another straightforward change would be to allow income support recipients entering employment to retain their Health Care Card for 12 months after job entry.

For public housing residents, links between rents and incomes should be removed, or at least not increased while income support is being withdrawn. Public housing waiting list assessment criteria and processes also need to be reviewed, as Dockery et al (Housing Assistance and Economic Participation National Research Venture 1 Final Report, Australian Housing and Urban Research Institute, 2008) show that current state policies in this area are leading to people getting locked on welfare.

Finally, there is a need to remove the discrepancy between allowances and pensions for those of working age. Unless all allowance payments are brought up to associated pension rates, an expensive and unlikely outcome, this requires structural reform.

A progressive lifelong savings approach to asset building

The third key priority for reform is in relation to asset building policies. The Australian government currently invests significant amounts of revenue to encourage people to save and invest and build their asset base. Major investments occur through the tax perks provided to superannuation investments, tax exemptions on owner-occupied housing and concessionary treatment to other longer term investments.

However, as the majority of asset building initiatives are provided through tax concessions, rather than through direct spending initiatives, they are of most benefit to high income individuals and families.

This is most apparent in relation to income invested in superannuation, which in most cases attracts a flat rate of tax of 15 per cent on funds at entry and 15 per cent on the annual income earned. As the Henry tax review has found, this is grossly inequitable with 37 per cent of the $25 billion worth of concessions going to the top 5 per cent of income earners. This inequity is unlikely to have an efficiency trade-off either as the concessions are largely going to people who would have saved anyway and who would be unlikely to be eligible for the age pension in their absence.

The government is aware of this problem and introduced some minor changes in the recent budget to begin reigning in these grossly inequitable concessions. But it has by no means gone far enough.

A more progressive lifelong savings approach is needed. Support needs to be targeted to those who most need it and are most likely to respond to it. And the focus needs to expand from one which only focuses on saving for retirement incomes to one that also considers a broader range of assets and savings needs throughout the life course. A lifelong savings approach would distinguish between three forms of saving:

1. saving for long term goals (i.e. retirement incomes);
2. saving for mid life needs such as housing and lifelong learning; and
3. saving for short term needs.

Saving for long term goals can be thought of in terms of our superannuation system. However, in order for it to be more equitable and more efficient there is a need to replace the current tax concessions for superannuation with a more fully developed government co-contribution scheme, which better targets those on low to middle incomes. This requires that all income going in to super and fund earnings be taxed at the individual’s marginal tax rate and the existing superannuation co-contribution scheme be abolished.

Government support for superannuation would however continue, not through tax concessions, but rather via a direct co-contribution matching both compulsory and voluntary contributions up to an annual ceiling. This ensures that everyone receives some form of government support, but that those on low incomes receive a much larger contribution as a proportion of their income. This approach to superannuation concessions has been long advocated by ACOSS on behalf of the community sector.

Saving for mid life needs such as housing and lifelong learning could be achieved by enabling individuals to access their superannuation funds for other important mid life needs such as home ownership or for education, as is the case in the Canadian Registered Retirement Savings Plans.

However, people on low incomes are reluctant to lock away their voluntary savings into accounts that they can’t access for long periods of time, as they tend to have more short-term needs such as their children’s education expenses, the purchase of major household durables etc.

Thus in addition to the above reforms to superannuation support for saving for short term needs can be achieved by a government funded Matched Savings Account to allow people to save for more immediate needs. The government would then encourage and assist people to save by paying a direct tax free co-contribution into their account, up to a cap, once people have reached their savings goal. Current initiatives such as the First Home Saver Account and the Education Tax Refund would then be rolled into this more coherent and flexible system.

There are already small-scale schemes around that show how this can be done. Saver Plus, a matched savings scheme for families on low incomes developed by the Brotherhood of St Laurence in partnership with ANZ, shows that well structured and targeted savings programs can help people on low incomes build assets for their future wellbeing.

Not only are these measures fair, but they also have the potential to increase aggregate savings, because people on lower and middle incomes are more likely to respond to incentives to save, whereas those on higher incomes are more likely to substitute from other forms of savings and investment into tax preferred options rather than increase their overall savings and investment levels.