Australia's Future Tax System

Consultation Paper

Section 4: Personal tax and transfers

Overview

The personal income tax and transfer systems have far-reaching implications for the wellbeing of Australians and their choices to work, save and acquire skills.

Tax and transfer policies involve trade-offs between the adequacy of payment rates, incentives to work, and the complexity individuals and families face. Higher payment rates can lessen individuals' incentives to work and to invest in skills. The application of means tests for transfers leads to a more targeted but more complex system. Most critically, incremental reforms generally involve a trade-off between equity objectives on the one hand and efficiency and simplicity on the other.

With the ageing of the population and increasing global competitiveness, the structure and settings of the tax-transfer system and resulting incentives are key components in meeting these challenges.

Reforms which reduce complexity and deliver adequate incentives will improve resource allocation, productivity and participation. However, there are significant tensions between such objectives, and with targeting, equity and fiscal sustainability.

Consultation questions

Q4.1 How might the personal tax system be changed to better achieve the goals of greater simplicity, transparency, equity and efficiency?

Q4.2 What is the appropriate distribution of income tax across income levels and how should it differ from the current distribution? Should governments seek to maintain a similar distribution over time, or should they fix the value of current tax thresholds through indexation?

Q4.3 Is the personal income tax base appropriately defined? Should reforms such as changes to the scope of deductions or other measures be considered?

Q4.4 Should the tax treatment of transfer payments be reconsidered? Should transfer payments be taxed at the same rate or a lower rate than earned income?

Q4.5 Should people in different circumstances be taxed differently (for example, by age, occupation, location), and what might be the implications of such arrangements? Are tax offsets the best way to achieve differential taxation?

Q4.6 How can fringe benefits tax be simplified while maintaining tax integrity? Would it be better to adopt the general OECD practice of taxing fringe benefits in the hands of employees, rather than employers?

Q4.7 Are the current categorical distinctions for income support, including rates of payment and income tests, still relevant? If not, would other categories be better? What goals or principles should guide categorical distinctions and associated payment rates?

Q4.8 What priority should be given to the different objectives associated with family assistance, such as poverty alleviation, recognising the social value of child rearing, facilitating workforce participation of parents, and early childhood education? Would it be better to provide less family assistance to higher income earners?

Q4.9 What are the key factors that should affect rates of transfer payments? What should be the relative importance of duration on income support, costs of work and job search, costs of children, value of home production and the level of the federal minimum wage?

Q4.10 Should transfer payments have a common benchmark? If so, should it be a proportion of a wage measure, and if so, which one? Or is there a better benchmark? Should there be a common indexation arrangement?

Q4.11 Should payments for retired people remain linked to payments for people of working age?

Q4.12 In a targeted system there is a trade-off between the level of income support and workforce incentives. Given this, what priority should be given to reducing the disincentives to work?

Q4.13 What structure of income tests and taxes would best support the increasing diversity of work and the need to increase workforce participation, and where should improved incentives be targeted?

Q4.14 Does the tax-transfer system create disincentives for individuals seeking to acquire new skills or upgrade existing skills? If so, what sort of tax or transfer changes would provide better incentives?

Q4.15 Given the competing demands of targeting assistance to people when they need it and minimising unnecessary transactions, what changes could be made to existing tax and transfer policies?

Q4.16 Should the different bases of assessment for tax and transfers be reconsidered (including the unit of assessment, income definitions, period of assessment and assets treatment)?

The personal tax and transfer systems have, in part, evolved separately. While in the past individuals were more likely to be either in one system or the other, today they are more likely to be in both. This has not only resulted in overlapping administration, but also potentially adverse interactions between the two systems. The interaction of the two systems determines not only the disposable income of an individual or family and its distribution, but also incentives to work and invest in education and training.

This section considers the personal income tax system, including the tax base, rates, thresholds and indexation, and the taxation of fringe benefits. It also outlines the key structural features of the transfer system and examines the issue of payment adequacy. It examines the way the combined tax-transfer system affects incentives to work and invest in education and skills and implications arising from the choice of unit and mechanism for delivering assistance.

4.1 Personal income tax

Personal income tax is the single largest source of tax revenue, accounting for around 44 per cent of total Australian Government revenue collections and around 36 per cent of revenue from all levels of government. Its structure and interactions with the transfer system are central to how government collects and seeks to redistribute revenue.

The personal income tax system has evolved over time, with a wide range of provisions beyond the basic framework of marginal rates and thresholds. This section examines issues arising from the structure of the personal income tax system — the income tax base, personal tax rates and progressivity, offsets and levies, and the overall impact on different groups.

Summary of key messages from submissions

A number of submissions call for greater progressivity in the personal tax system (for example, higher marginal rates for high income earners). Others argue that high personal tax rates reduce incentives for skills acquisition and for high skilled workers to stay in Australia.

Submissions also suggest that the top personal tax rate should align with the company tax rate to create incentives to attract and retain high skilled labour and reduce incentives for tax minimisation.

A number of submissions note that private company and trust structures are used as a tax minimisation arrangement for high-income earners.

A number of submissions suggest limiting or removing deductions, while others suggest capping deductions for high-income earners. Some submissions suggest allowing additional types of deductions.

Several submissions raise concerns about tax offsets for complexity or equity reasons, and related to this, a number raise concerns that some transfer payments are taxable while others are not.

On the grounds of reducing complexity, some submissions suggest removing the Medicare levy and incorporating it into the personal income tax rate scale.

Most submissions that mention the senior Australians tax offset implicitly accept the idea that people aged 65 years or over should be taxed differently and propose specific changes that could be made to benefit this group. Other submissions that raise the issue of age mention the inequity of providing tax benefits to retirees and not to people of working age.

A number of submissions call for indexation of the personal tax thresholds, either to the consumer price index or to an index of wages growth.

The personal income tax base

Australia's personal income tax is applied against most receipts that have the character of income. The income tax system does not generally distinguish between income from capital and income from labour. There are a few notable exceptions from the income tax base:

  • unlike in most other countries, fringe benefits are taxed in the hands of the employer rather than in the hands of the employee (see Section 4.2);
  • the range of deductions that can be claimed against income for tax purposes is broad by international standards;
  • owner-occupied housing is a significant exemption from the tax base (see Sections 6.7 and 10.1); and
  • income from some forms of savings, such as superannuation and capital gains, is treated differently to other income (see Sections 5 and 6).

Many countries specify a limited number of non-business items that are deductible by individuals. Australia allows deductions for non-private and non-capital expenses incurred in gaining or producing assessable income. As such, Australia's personal income tax system provides for a wide variety of non-business deductions. These amounted to $27 billion in 2005-06, equivalent to around 5.5 per cent of the $483 billion in declared income. Submissions indicate a range of views on deductions, from further broadening to tightening or capping allowable deductions.

Under Australia's approach, individuals are able to claim a broad range of work-related and other expenses against their assessable income. However, this adds complexity and provides greater scope for personal expenses to be claimed as work-related expenses. Approaches in other countries tend to be more prescriptive and, in some cases, cap the deductions that can be claimed or allow a standard deduction in lieu of individual deductions. These approaches are advocated in some submissions.

A number of submissions call for changes to the tax treatment of transfers to achieve greater consistency and equity between recipients of transfer payments. The tax treatment of transfer payments differs depending on the payment. This reflects both program-specific considerations and the historical development of payments. The majority of income support payments, including Newstart and the Age Pension, are taxable. The majority of supplementary payments and family payments are non-taxable. The tax treatment of some payments depends on the recipient's age (for example, the Disability Support Pension), and in the case of the Carer Payment, on the age of both the recipient and the person being cared for.

Tax offsets are available for transfer payments that are taxable. This means no tax is payable by recipients of taxable transfer payments unless they earn sufficient additional private income to generate a tax liability that exceeds the value of the offset. For example, the beneficiary tax offset2 (which applies to Newstart and Youth Allowances) and the pensioner tax offset3 (which applies to some pensioners who receive a taxable pension payment) ensure that full-rate pension and allowance recipients pay no tax.

Additional income is treated differently depending on the type of income support payment. The type of payment also determines the rate of withdrawal of the payment, where there is additional income. Where the transfer is taxable, additional income is generally taxed as the top slice of the individual's income.

Personal tax rates and progressivity

Submissions present a mix of perspectives on the appropriate degree of progressivity within the tax-transfer system. These reflect concerns with equity and incentives.

Australia has a progressive personal income tax system. The personal rate scale has four personal income tax rates, as well as a zero rate of tax below the tax-free threshold. In addition, other elements such as the low income tax offset (LITO) alter the effective rate of taxation. A progressive income tax could also be achieved with a tax-free threshold and a single rate of tax above this point. While this would be less progressive than the current system, it would be simpler and could potentially provide better participation incentives.

A progressive tax system is characterised by average tax rates that rise with income, in line with the idea that reductions in income (caused by taxation) reduce the wellbeing of low income earners more than high income earners. It allows revenue to be collected with lower tax rates for those on lower incomes. In 2005-06, a revenue-neutral flat rate of tax would have required a 24 per cent tax rate. This would have resulted in almost 80 per cent of taxfilers paying more tax (those with a taxable income less than $55,200 in that year).

The design features of the personal income tax system, including progressive tax rates, may contribute to system complexity, particularly once the interactions with transfers are taken into account. They can also lead to inefficiencies and inequity where taxpayers experience volatile incomes, or can share home production and paid work within their family. Some studies suggest that progressive taxation can dampen entrepreneurial activity, and some submissions suggest that it is a driver of international labour mobility (or that the current top personal tax rate has this effect). The OECD (2008a) has noted that reforms to enhance labour competitiveness and encourage entrepreneurialism also need to consider the desirability of their equity outcomes.

Interactions between personal tax rates and offsets

Offsets reduce the tax burden on individuals in particular circumstances, but can add to complexity and affect participation incentives. They can be used to selectively reverse the tax levied by the personal tax rate schedule.

The most widely available offset is the LITO. It was used by over five million individuals in respect of the 2006-07 income year, when it was half its present size. The Commissioner of Taxation takes into account half of the LITO when determining the pay as you go (PAYG) withholding schedules, reducing the amount of salary and wages withheld.

The explicit tax-free threshold has remained at $6,000 since 2000-01. However, the effective tax-free threshold has risen with the increase in the LITO from $150 in 2002-03 to $1,200 in 2008-09. At its current level, the LITO results in an effective tax-free threshold of $14,000.

A larger explicit tax-free threshold could reduce or remove the need for LITO and various other offsets — in 1983-84 the tax-free threshold exceeded the maximum level of pensions and allowances. Some submissions argue that this is desirable as it would increase transparency, enhance progressivity and reduce complexity.

Increasing the LITO costs less in forgone revenue than increasing the tax-free threshold. This is because increases to LITO do not flow to higher income taxpayers, as LITO is currently withdrawn over the $30,000 to $60,000 income range. However, the withdrawal of LITO creates higher effective personal tax rates in this range (see Chart 4.1). For more detail on effective tax rates, see Box 4.1 (Section 4.5). The same effect could be achieved through changes in the explicit thresholds and rates. This would result in less complexity and greater transparency.

Chart 4.1: Marginal rates including the low income tax offset

By taxable income (2008-09)

Chart 4.1: Marginal rates including the low income tax offset - By taxable income (2008-09)

Note: Does not include Medicare levy.

Source: Australian Treasury estimates.

Delivering changes to the tax-free threshold through LITO can obscure the returns from work. Unlike an increased tax-free threshold, which can be fully incorporated into PAYG withholding schedules and directly affect a person's regular pay, only half of LITO is currently available through PAYG withholding. The other half of LITO is payable on assessment, which reduces the possibility of tax debts (the final amount of LITO available to a taxpayer depends on their annual income). A consequence of withholding greater amounts than necessary until assessment may be to dampen the participation incentives compared to what might otherwise be achieved with a higher tax-free threshold. It also has a negative impact on personal finances throughout the year.

Levies

In addition to the general rates and thresholds, tax revenue can be collected through specific levies.

The Medicare levy is a structural element of the personal income tax system. For most people, it is levied at a rate of 1.5 per cent of a taxpayer's income (in addition to the personal tax rates). It is not a hypothecated tax, as it is paid into Consolidated Revenue and represents only a portion of total Australian Government health spending.

By operating separately, the Medicare levy adds complexity to the system. Some taxpayers do not pay the Medicare levy, such as certain Defence personnel and Disability Support pensioners who are permanently blind. For others, there are a series of low income thresholds where the levy begins to shade in, based on family rather than individual income. There are different thresholds for single people, people in families, pensioners below Age Pension age, and senior Australians tax offset (SATO) recipients. Some of these are designed to ensure that certain groups, such as pensioners, do not pay the levy where they do not have a tax liability. Also, unlike other tax, the Medicare levy generally cannot be reduced by offsets. Some submissions advocate removing the Medicare levy and incorporating it into the personal income tax rates.

Specific levies can gain more community support than general tax increases, particularly in cases where the purported use of the revenue is for a cause that is supported by taxpayers. The downside of levies is that they: limit budget flexibility; are less able to deal with equity concerns than a progressive rate schedule (flat rate levies); are a relatively inefficient way of raising revenue; and generally add a layer of complexity to the system.

Taxing people differently

While people face the same personal income tax schedule, they are taxed differently through mechanisms such as offsets, the exemption of certain forms of income and different fringe benefits tax arrangements. Differences arise in terms of age, occupations, marital status and location. These differences can assist certain policy outcomes, such as enhancing the participation incentives of older workers, levying lower taxes on older people, or assisting particular family types. However, the policy intent must be weighed against the equity, transparency and complexity outcomes that result from different tax treatments.

Age

One outcome of the current tax arrangements is that people of different ages have different average tax rates for the same level of income, due primarily to the senior Australians tax offset (SATO). Table 4.1 illustrates this point.

A number of submissions propose lighter tax treatment of those aged 65 years or over. Allowing personal tax rates to vary with age may enhance economic efficiency if there are substantial differences in the labour supply elasticities of different age groups. If this were to be the goal, it would be necessary to differentiate between labour income and passive income. SATO does not do this but the mature age worker tax offset does. (Section 3 discusses arguments for taxing labour income differently to passive income.)

Table 4.1: Various effective tax-free thresholds (2007-08)(a)

Taxpayer type Threshold (per annum)
Person not receiving income support $11,000
Allowee under Age Pension age $14,511
Pensioner under Age Pension age $22,922
SATO recipient $25,867
  1. An effective tax-free threshold is the maximum level of taxable income (including government payments but excluding superannuation) that is allowed before incurring a tax liability.

Income types

Certain forms of taxable income can have their tax treatment altered through specific offsets. For example, as previously noted, offsets mean that people who receive maximum rate pensions or allowances from government do not pay tax on this income. As noted above, it is arguable that this could be achieved more simply and equitably by raising the explicit tax-free threshold.

Income received as certain types of fringe benefits (for example, cars) are taxed more concessionally than cash income. This is discussed in Section 4.2. Salary sacrificed income (for example, salary sacrificed to superannuation) is also treated more concessionally than income from salary and wages. Several submissions note that salary sacrifice arrangements create an uneven playing field by allowing some people to reduce their tax liability. One submission notes that they are regressive as the largest benefit accrues to those on higher incomes.

Some lump sum payments from employers are concessionally taxed through eligible termination payment offsets.

Occupations

Personal income tax can also vary for people in different occupations, such as defence force personnel and farmers. Some submissions argue this is inequitable, being based on government decisions about the value of particular work. Generally, submissions argue for a broadening of the available concessions (for example, fringe benefit concessions for employees of not-for-profit organisations) to include their occupation, either because they consider their work to be sufficiently 'valuable', or because, as employers, they have to compete for employees with industries receiving the concessions.

In some cases, such as tax offsets for Defence personnel, the effect is simply to shift costs within the government budget. In other cases it represents a transfer to particular groups. Examples include the FBT concessions for some not-for-profit organisations (see Section 7) or the income smoothing provisions for primary producers.

Family types

While the individual is the primary unit for the personal income tax system, there are elements which depend on family circumstances. For example, in the tax system there are dependant rebates which reduce the tax paid by certain people with low income dependants, such as a spouse.4 The Medicare levy has thresholds which depend on family income, while SATO can be shared between spouses. (See Section 4.7 for discussion on the unit of assessment.)

Several submissions note concerns that income splitting across families, through the use of private company and trust structures, is exploited to reduce taxes and increase family payments.

The tax-transfer system results in different levels of net taxation (taxes less transfer payments) for different family types. Outcomes vary with the number and age of children, and the presence of a partner and their earnings.

While some elements of the system, such as FTB Part A, depend only on total family income, for other elements, such as FTB Part B, the distribution of income within the household is important (Chart 4.2).

Chart 4.2: Family disposable incomes by lower income earner's share

Couple with two children aged 11 and 13, at selected levels of family private income

Chart 4.2: Family disposable incomes by lower income earner's share - Couple with two children aged 11 and 13, at selected levels of family private income

Note: Income support (where payable) is Newstart Allowance.

Source: DEEWR estimates.

Passive income of minors in excess of $416 per year is taxed at the highest personal tax rate to limit parents' ability to claim their income as that of children who are minors. However, the availability of LITO allows minors to receive $2,667 in passive income for 2008-09 before tax is incurred.

Locations

The zone rebate means that people in different areas in Australia face different levels of tax. The current zoning arrangements were introduced in 1945 and have not been updated since 1958-59 (for example, Darwin and Cairns are included as concessional locations). Submissions note that fly-in-fly-out arrangements weaken the targeting of residents in some locations and highlight concerns over where boundaries are drawn and how qualification for such rebates is determined.

In certain circumstances, the employment income of Australians working overseas is exempt from Australian income tax.

Maintaining the system over time

The coherence of the tax system involves more than point-in-time considerations. Interactions between elements that only change due to particular government decisions, such as the income tax thresholds and LITO, and elements that are indexed, such as the pensioner tax offset (PTO), can result in unintended consequences. As an example, the current impact of SATO is that both Age pensioners and self-funded retirees have the same effective tax-free threshold. However, the wage-driven growth in the PTO will mean that it will soon become more generous than SATO. Similarly, while the amount of LITO is expected to continue to increase over the next few years, its maximum rate phase-out point is set to remain pegged at $30,000. This means that its relationship with other offsets will change. At present, SATO is viewed as an additional offset for seniors, and begins to phase out before LITO does. However, by 2010-11, LITO will begin to phase out before SATO.

Indexation

Regular adjustment of the tax thresholds maintains the progressivity of the system by ensuring people only move into higher tax brackets when their real income increases.

Automatic indexation ensures that governments cannot use implicit tax increases to collect revenue. Some countries index their income tax thresholds each year to price rises to achieve this outcome. Another option is to index thresholds to wages growth. This would ensure that real income increases would not attract an increased tax liability as long as they are in line with average changes in wages. Linking thresholds to wages would significantly limit the growth in tax revenue over time. Both price and wage indexations of thresholds are proposed in submissions.

Australia relies on discretionary adjustments to personal tax thresholds. Implicit tax increases are revealed in published tax to GDP ratios, which make transparent the degree to which fiscal drag is returned. Australians at all income levels have lower tax liabilities now than they would have if the 1985-86 or 2000-01 personal income tax schedules had been indexed to growth in either prices or wages.

Not locking in a particular income tax schedule provides flexibility to government to determine the distribution of taxation and respond to economic circumstances. For example, automatic indexation could result in fiscal policy working in conflict with monetary policy in times of high inflation. The discretionary approach allows government to not only accommodate growth in prices or wages, but also allows for more nuanced goals, such as limiting the proportion of taxpayers facing high personal tax rates, which may not occur under automatic indexation.

It might be expected that indexation of the tax thresholds would enable the tax and transfer systems to move with greater synchronicity. However, there are currently a number of different approaches to indexation within both systems. Keeping relativities constant would be difficult and would involve significantly greater reform than simply indexing personal tax rates, including consideration of the indexation arrangements for offsets, levies, and rates and thresholds of transfer payments.

Consultation questions

Q4.1 How might the personal tax system be changed to better achieve the goals of greater simplicity, transparency, equity and efficiency?

Q4.2 What is the appropriate distribution of income tax across income levels and how should it differ from the current distribution? Should governments seek to maintain a similar distribution over time, or should they fix the value of current tax thresholds through indexation?

Q4.3 Is the personal income tax base appropriately defined? Should reforms such as changes to the scope of deductions or other measures be considered?

Q4.4 Should the tax treatment of transfer payments be reconsidered? Should transfer payments be taxed at the same rate or a lower rate than earned income?

Q4.5 Should people in different circumstances be taxed differently (for example, by age, occupation, location), and what might be the implications of such arrangements? Are tax offsets the best way to achieve differential taxation?

4.2 Fringe benefits tax

Fringe benefits tax (FBT) is intended to ensure that remuneration is treated consistently, irrespective of the form in which income is received (cash or in-kind). In this way, FBT acts as an integrity measure, by ensuring a potentially significant loophole in the income tax law is not created.

This section considers Australia's approach to taxing and valuing fringe benefits and explores some implications of the existing FBT exemptions and concessions. The FBT arrangements for not-for-profit organisations are explored in Section 7.

Summary of key messages from submissions

Submissions highlight concerns over the inequity of the current FBT system, particularly in relation to the application of the top personal tax rate.

Submissions focus on the ongoing appropriateness of the FBT arrangements, particularly their legal incidence. A number of submissions suggest fringe benefits should be taxed in the hands of employees rather than employers.

The current FBT arrangements are seen by business as complex and administratively burdensome. The reporting requirements are a particular concern, with a number of submissions arguing that the reportable benefit threshold is too low to remove the need for detailed record keeping on minor benefits (that is, businesses must keep comprehensive records simply to ascertain whether a reporting or payment obligation exists). Submissions suggest several options to minimise FBT compliance costs, ranging from a comprehensive rewrite of the current FBT legislation to the application of broad and streamlined formulas for compliance.

A number of submissions, particularly from business, call for the adoption of the general OECD practice of taxing fringe benefits at the marginal tax rate of the employee, as suggested in A Tax System Redesigned (Review of Business Taxation 1999). However, several submissions explicitly reject this approach.

Several submissions call for rationalisation of the existing FBT exemptions and concessions.

The majority of submissions by individuals raise the environmental impact of the statutory formula for valuing car benefits (see Section 13.2).

Australia's approach to taxing fringe benefits

FBT applies where non-cash benefits are provided by an employer to an employee — for example, through the provision of free or discounted property. It is paid by employers (including government employers) at the top personal income tax rate plus the Medicare levy (currently 46.5 per cent) irrespective of the income of the employee receiving the fringe benefit. Where the employer is entitled to credits for GST paid on the goods and services acquired to provide the benefits, these credits are taken into account in the calculation of the FBT liability.

The cost of providing a fringe benefit (and thus its taxable value) may be reduced by employee contributions. For example, rent paid by an employee receiving a housing fringe benefit is deducted from the market or statutory value of the benefit, which is then used to calculate its taxable value.

The value of a reportable fringe benefit is included on an employee's payment summary on a 'grossed-up' basis — that is, the value of the fringe benefit is increased to reflect the value of income tax (at the top personal rate) that would be paid if the fringe benefit were purchased out of after-tax income by the employee.

Several submissions suggest the application of the top personal income tax rate promotes vertical inequity in the FBT system by discouraging employees with lower personal tax rates from accepting non-cash benefits, even where this may be beneficial to them. Submissions also express concern that the FBT system gives rise to horizontal inequity, as fringe benefits are not equally accessible to all employees.

While taxing fringe benefits in the hands of the employee might address the equity concerns described above, it would not necessarily result in simplification of the system. To ensure tax system integrity, employers would still be required to value benefits provided to employees for reporting purposes. It would therefore be likely to have a minimal effect on compliance costs.

Treatment of fringe benefits for transfer payments

While means-tested tax programs take into account the 'grossed-up' value of fringe benefits, transfer programs generally only include the net or 'cash' value (the income test to assess child support liability is an exception).

While a measure from the 2006-07 Budget was due to apply the grossed-up value to family assistance payments from 1 July 2008, the Australian Government reversed this measure on 20 June 2008, citing concerns over the implications for charitable sector employees. These employees were concerned that the grossed-up amount overstated the pre-tax value of the benefits provided to those on a lower personal tax rate. A small number of submissions express strong support for the reversal.

The Government has asked the Panel to examine the complexity of the existing fringe benefit arrangements for the not-for-profit sector and make recommendations to improve equity and simplicity in the longer term (see Section 7).

Valuation

The current approach to valuation is to use 'market value' in some cases (for example, for the purpose of calculating stamp duty on motor vehicles), complemented by a large number of statutory valuations. Some submissions raise the complexity of the current arrangements and express concern over the practical difficulties in determining the value of the benefits to the employee.

An alternative approach might involve the valuation of all benefits at their market value, as currently occurs for non-cash business benefits. Broadening the base of FBT in this way might involve removing the concessional treatment of some benefits (for example, cars). A submission also proposes the valuation of all benefits at cost. As the accounting value of fringe benefits is likely to be lower than their market value, valuation at cost would promote horizontal and vertical inequity by favouring individuals receiving fringe benefits rather than cash income.

FBT exemptions and concessions

In 2008-09, estimated tax concessions for fringe benefits were $3.3 billion.5 In comparison, FBT revenue collections were $3.8 billion.

Some submissions call for the removal of specific FBT exemptions and concessions (particularly in relation to cars, as discussed in Section 13.2), while others support extending the exemptions and concessions to other benefits, such as off-site child care.

Fringe benefits exempt from FBT include:

  • infrequent minor benefits (currently subject to a threshold of $300);
  • recreational or child care facilities on employer premises;
  • small business employee car parking;
  • housing benefits provided to employees in remote areas;
  • certain eligible work-related items; and
  • taxi travel to or from the workplace in certain circumstances.

In addition, FBT concessions apply, among other items, to: cars; certain types of meal entertainment; and holiday travel by employees posted overseas.

The current FBT exemptions and concessions exist for several reasons, including practical difficulties in respect of valuation (for example, where multiple employees share the fringe benefit). The compliance costs of valuing certain benefits could outweigh the equity benefits of valuation.

Historically, exemptions and concessions were also extended to organisations that were exempt from paying income tax. Several submissions suggest the ongoing justification for this treatment is not readily apparent, particularly given the economic incidence of FBT is generally considered to fall on the employee.

These exemptions and concessions are likely to distort demand for goods and services. For example, as noted in A Tax System Redesigned (Review of Business Taxation 1999), the concessional treatment of car fringe benefits provides a strong incentive for some employees to take a car as part of their remuneration package and to skew their consumption toward motor vehicle services.

Consultation question

Q4.6 How can fringe benefits tax be simplified while maintaining tax integrity? Would it be better to adopt the general OECD practice of taxing fringe benefits in the hands of employees, rather than employers?

4.3 The transfer system

The transfer system is the means by which the Australian Government redistributes around $70 billion of income each year. While much of this redistribution is targeted to those on low incomes, some transfers assist middle and higher income individuals and families. The transfer system has evolved over time, with a range of provisions that are complex for recipients.

Summary of key messages from submissions

A number of submissions identify problems with the categorical structure of income support, including its division into pensions and allowances. A key concern is that the difference between the two kinds of payment creates workforce disincentives, both because of the different rates of payment and also because of payment conditions such as activity testing.

Other concerns raised about the categorical nature of income support are that the system is unfair for people on allowances. Some submissions argue that all income support recipients should be paid at the same basic rate, possibly with tailored add-ons. Others contend that rates should be differentiated but on a basis other than the current pension/allowance distinction.

Family assistance is primarily a focus of submissions in relation to its impact on incentives for parents to work. Some submissions indicate a preference for a system that encourages families to move from one to two incomes.

Submissions raise concerns about the level of Rent Assistance relative to the costs of renting, particularly given that people in different parts of the country face a wide diversity of rents. Concern is also raised about the sharers' rate of Rent Assistance, which could be seen as penalising those who share housing.

A number of submissions comment on the relative support available to private renters through Rent Assistance, and to homeowners through the generous treatment of a person's home for the purpose of the assets test. Several submissions propose changes to the treatment of a person's home, such as including more valuable homes in the assets test.

Some submissions note that much of the assistance provided through supplementary payments and concessions advantages retired people, including relatively wealthy retirees, with much less benefit to people of working age. Some submissions indicate that cash payments give people greater control over resources, while others indicate a high level of support for concession cards.

Some submissions identify the complexity of the transfer system as a problem, including the observation that those facing this complexity include members of society who are least equipped to do so.

The Australian Government transfer system has several elements. Income support provides assistance for the basic living costs. Family assistance, Rent Assistance, other payments and concession cards provide additional assistance to income support recipients. Some are also paid to those who have other basic means of support. State transfers are primarily provided through concessions and subsidies, often based on entitlement to a Commonwealth concession card.

Categorical income support

Categorical eligibility and means testing requirements are imposed on income support recipients — that is, pensioners and allowees. Categorical eligibility requirements are the conditions that entitle people to certain kinds of support. Pensions are paid to people meeting age requirements (for Age Pension and some service pensions), with caring commitments (Carer Payment and Parenting Payment Single), or with a significant disability (Disability Support Pension). Allowances are generally paid to people with work and study obligations (such as Newstart, Austudy and Youth Allowance). While categorical systems are the norm internationally, several submissions proposed various forms of negative income tax, which might not be categorically based.

Pensions have traditionally been paid to people who were not expected to work, such as widows, sole parents, people with disability, certain veterans and the aged. The more generous pension conditions applying to such groups relate not only to rates of payment, but also to the amount of money a person can earn or receive without affecting their payment rate, the withdrawal rate for the payment, and the way in which the payment is indexed over time.

By contrast, allowances have historically been paid to unemployed people, who were not expected to need support for an extended period, reflecting that high unemployment was not typical when unemployment benefits were first introduced in 1945.

Since 1984, when allowance rates were temporarily frozen, there has been a difference in the rates of payment made to pensioners and allowees. The gap between the two sets of rates has been widening since 1997, when pension rates were benchmarked to 25 per cent of male total average weekly earnings (MTAWE). This gap is illustrated in Chart 4.3.

Chart 4.3: Real rates of the single pension and allowance (1988 to 2008)(a)

Chart 4.3: Real rates of the single pension and allowance (1988 to 2008)(a)

  1. Rates for all years are expressed in 2008 dollar values.

Source: FaHCSIA estimates.

The higher rates for pensioners have several implications. The first is that if a person is paid an allowance for an extended period of time, the rate of payment may not be considered adequate. Some submissions suggest that this may be the case for people who spend long periods on Newstart because they cannot find or take up a job. It may also apply when a person has a disability but can still work more than 15 hours per week. These people may only have capacity for part-time work and so may be reliant on Newstart for many years. Similar conditions are created for sole parents with children aged eight years or older.

A second implication is that people have a strong incentive to receive pensions in preference to allowances. A person with some level of disability or caring responsibility experiences a material financial advantage if that disability or caring responsibility is significant enough for them to meet pension requirements. Once a person is paid a pension, there is a strong incentive not to jeopardise their more secure and financially generous arrangements by taking on significant amounts of work.

Several submissions discussed the significant drop in income support that results when a person moves from a pension to an allowance. For example, moving to the lower single rate of Newstart Allowance produces a drop of over $100 per fortnight. The drop is even higher if the person has private income. A sole parent working 15 hours a week (to meet their activity test obligations) at the minimum wage could experience a drop of over $200 per fortnight in their transfer income. Chart 4.4 illustrates the net impact on disposable income of moving from pension to allowance rates, depending on the amount of private income received. Significant reductions resulting from the move from pension to allowance rates are the experience of many sole parents when their youngest child turns eight years of age, or if they form a new relationship with a person on income support or in low-paid work. Significant reductions in disposable income can also occur for carers when their caring role ends or diminishes.

Chart 4.4: Loss of disposable income experienced on switching from Parenting Payment Single to Newstart Allowance

By annual private income (2008-09)

Chart 4.4: Loss of disposable income experienced on switching from Parenting Payment Single to Newstart Allowance - By annual private income (2008-09)

Source: DEEWR estimates.

A common payment for people of workforce age, as called for by some submissions, is one approach to lessening the distinctions between payments, and would diminish the incentives for people to receive pensions over allowances.

The preferred approach will depend on the income support goals for each of the categories or circumstances of various recipients. At this time, it is not clear to the Panel what the goals are, or should be. In general, all that can be said is that the assistance goals for each category are implicit in the payment rates.

Family assistance

Key ongoing forms of family assistance include Family Tax Benefit (FTB) Parts A and B, Child Care Benefit and the Child Care Tax Rebate. In addition, the Australian Government has asked the Productivity Commission to consider possible ways to introduce paid parental leave and to report by February 2009.

FTB Part A is paid on a per-child basis. FTB Part B is paid to single income families on a per-family basis. If the primary purpose of the payments is considered to be part compensation for the direct and indirect costs of having children, it could be argued that they should not be income-tested. While this would lower effective marginal tax rates (EMTRs) (see Box 4.1, in Section 4.5) and possibly improve workforce incentives, it would be more costly. On the other hand, if the payments are directed at reducing child poverty, arguably they could be more tightly targeted. This could worsen workforce incentives for some groups and improve them for others. According to submissions, the way the system seeks to address disparate goals is considered by many parents to be very complex.

Chart 4.5 illustrates the responsiveness of the tax and transfer systems to variations in earnings. This contrasts with overseas systems that distinguish assistance, such as family assistance, according to whether or not the recipient is in paid employment. A relatively seamless transition between no earnings, moderate and higher levels of income reflects the contemporary labour market, with its substantial levels of part-time and casual work.

Chart 4.5: Effective marginal tax rates and disposable incomes(a)

By yearly private income, single earner couple with two children

Chart 4.5: Effective marginal tax rates and disposable incomes - By yearly private income, single earner couple with two children

  1. Effective marginal tax rates (EMTRs) are calculated using a $1000 income increment. Spikes in EMTRs at $140,000 and $150,000 reflect the imposition of the Medicare levy surcharge and the loss of FTB Part B respectively.

Source: DEEWR estimates.

While FTB provides integrated assistance to families with children, it is seen by many parents as very complex. Eligibility for FTB is assessed on an adjusted form of taxable income, requiring parents to estimate their combined taxable income for a year. In other words, they are, in effect, pre-paid their entitlement during the year. The difficulty of estimating income is seen in the significant number of overpayments made since the system was introduced. Particular complexity can arise for parents who separate during an income year. Some submissions also raise the difficulty that families receiving FTB Part A experience when a child turns 16 years of age in determining whether their overall package of assistance would be more favourable if they accept the lower rate of FTB Part A or if their child claims Youth Allowance.

Rent Assistance

Rent Assistance may be paid as a supplement to a person's income support payment or with FTB Part A where a family receives above the base rate. People receiving Rent Assistance can have very different levels of income (Table 4.2). Rent Assistance is generally paid at lower rates to single people who share accommodation. Submissions raise concerns about the equity of these arrangements.

Table 4.2: Level of private income at which Rent Assistance cuts out

Primary payment recipient Amount
Newstart allowance, single $26,762
Pension, single $47,655
One child family receiving FTB Part A $72,854

Several submissions raise the issue that the level of Rent Assistance does not reflect the changes over the past decade in house prices and rents, or the diversity of prices across different locations. Rent Assistance is indexed by the CPI; relativities are only maintained where rental prices increase in line with the whole basket of goods and services comprising the CPI.

While Rent Assistance is paid to private renters, public renters also receive subsidies for housing. Home owners who are income support recipients have an assets test treatment that tends to favour saving through a home over other forms of savings. This is provided by way of an assets test threshold that assigns the low notional value of $124,500 to a person's home, regardless of the actual value of the home.

Housing issues are considered further in Section 10.

Delivering assistance through other supplementary payments and concessions

Certain costs are recognised via supplements, primarily for pensioners and for self-funded retirees. These include Telephone, Utilities, Pharmaceutical and Seniors' Concession Allowances. The transfer system also provides concession cards, with the most generous being the Pensioner Concession Card. A more limited set of concessions is available to self-funded retirees through the Commonwealth Seniors Health Card, and to allowees and low-income individuals and families through the Health Care Card.

The system provides higher levels of support through payments and concessions to retirees (including self-funded retirees) than to working-age people. This disparity is a point of concern in a number of submissions.

Many State government and private concessions are available to individuals with concession cards. This form of delivery can be less targeted than other mechanisms because concession cards cannot be provided on a partial basis. Some submissions propose changes to the eligibility rules for concession cards.

Supplementary payments would be likely to feature in proposals for a single payment for people of working age, as proposed in some submissions. These might recognise costs such as the costs of working, including for people with disability, and the indirect costs of sole parenthood, particularly for those whose children are young.

See Box 4.2 at the end of Section 4 for a further discussion of alternative means of delivering support.

Consultation questions

Q4.7 Are the current categorical distinctions for income support, including rates of payment and income tests, still relevant? If not, would other categories be better? What goals or principles should guide categorical distinctions and associated payment rates?

Q4.8 What priority should be given to the different objectives associated with family assistance, such as poverty alleviation, recognising the social value of child rearing, facilitating workforce participation of parents, and early childhood education? Would it be better to provide less family assistance to higher income earners?

4.4 The adequacy of support for people of working age

The adequacy of payments and other support underpins the living standards of people in receipt of support, as well as influencing their incentives to work and to develop and improve their skills. The generosity of transfers affects both those who are out of the workforce and also the decisions of many people who are in work.

Adequacy has been a focus of the Pension Review, with an emphasis on the Age Pension, Disability Support Pension and Carer Payment. There is no consensus as to how to measure adequacy. Any judgment needs to take into account the standard of adequacy being sought and the value of non-cash as well as cash benefits. It also needs to recognise that the same level of income can lead to different outcomes for different people, depending on their circumstances, preferences, skills and any other resources they can call upon.

Summary of key messages from submissions

A number of submissions express concern about the adequacy of income support and transfer payments more generally. Some organisations note that payment rates are below a number of indicators such as the Henderson poverty line.

Working-age allowance recipients are identified as a group for whom payment rates are particularly low. Another group associated with adequacy concerns is low-income people renting in the private housing market. Many submissions to the Pension Review argue that payment rates and overall support packages are not adequate.

Several submissions propose a change to indexation or benchmarking arrangements, with several organisations supporting the development of a new single benchmark based on a range of research and data.

The gap between pension and allowance rates, and its continuing growth, is a concern expressed in many submissions. Some people believe payment rates should be the same for pensioners and allowees, while others argue payment rates should be differentiated but on some basis other than the current pension/allowance distinction.

In terms of the design and level of payment rates, submissions point to the need to 'make work pay', including through a smooth transition into work from income support.

Some submissions compare arrangements for retired people and those of working age, expressing a range of views as to whether existing links should be maintained or the retirement income system separated.

The need for compensation for the effects of the Carbon Pollution Reduction Scheme is identified as an issue in some submissions.

Defining adequacy

Government uses several mechanisms for adjusting or setting rates that affect a significant proportion of the population. As discussed above, both price and wage indices are used to adjust pension rates and the consumer price index is used to adjust allowance rates. A separate independent process is used for setting minimum wages.

The adequacy of payments could be assessed by means of a range of indicators. These include distributional measures (such as half median household equivalised disposable income6), replacement rates, budget standards, the Henderson poverty line and financial hardship measures. These indicators are described in the Architecture paper. Each measure yields different results, and often markedly so.

Choosing one or a combination of these indicators embodies a set of implicit judgments, as does any other method of payment rate-setting. Submissions that cite such indicators do so to support their views and judgments about issues such as how to balance the adequacy of support against incentives to work, and how to balance income available to young adults against expectations of parental support.

Factors affecting payment rates

Payment rates arguably reflect a range of judgments made over time about the relative needs, incentives and expectations applying to particular groups of income support recipients. This section outlines some relevant considerations potentially underlying the rates of payment.

The first consideration may be expected duration on income support. As discussed in Section 4.3, pensions were historically paid to people who were not expected to work again, while allowances were paid to unemployed people, who were not expected to need support for an extended period. Although most working-age people once tended to have short periods of income support receipt, Table 4.3 shows that a substantial proportion of working-age people have long periods of receipt. This may not be continuous or on the same payment.

Table 4.3: Average time on working-age income support over the period July 1999 to July 2008

For new recipients in 1998-99 or existing recipients at the beginning of 1998-99(a)

Recipient type Average number of years in receipt of income support Average years as a percentage of the whole period
New recipient in 1998-99 3.1 34.2%
All recipients on 1 July 1998 4.8 53.0%
  1. Excludes time spent on the Age Pension. New recipients are individuals who had previously had at least a six week period without income support, or 13 weeks where a previous period of income support was greater than 46 weeks.

Source: Australian Government administrative data.

While groups that have traditionally been paid pensions continue to have long durations on income support (on average and not necessarily on the same payment), there has been some compositional shift not only in the groups themselves, but also in the labour market and in societal expectations about employment. For example, while in the past a sole parent was not expected to seek and find employment, the Welfare to Work changes introduced from 2006 require sole parents to start looking for work once their youngest child turns six. When their youngest child turns eight they may lose entitlement to Parenting Payment Single and may shift to allowance payment rates and conditions, underlining the expectation that they are now regarded as being available for part-time work.

A second consideration in setting payment rates may be the costs of work and of looking for a job. There is little evidence on these costs, although they could be expected to vary considerably according to such factors as the cost of travel and people's need for child care.

The direct and indirect costs of having children may be a third consideration in setting payment rates. Research indicates that direct costs increase as children get older. By contrast, the indirect costs, such as the cost of taking time out of the workforce, are likely to be highest when children are very young. Indirect costs are particularly relevant for sole parents, because they are less able to share the responsibility of child-raising which can affect their availability for work. Indirect costs are also important for partnered parents, particularly when children are very young. These costs are reflected in the part-time activity testing requirements for partnered parents.

A fourth consideration may be the value of home production, other than child rearing activities. The amount of time available to individuals to undertake home production can make a material difference to the standard of living they are able to achieve.

A fifth factor affecting payment rates may be the level of the federal minimum wage (FMW). The levels of both the FMW and transfer payment packages have varied over time. Under current arrangements, an allowee undertaking substantial part-time work can earn 80 per cent of the FMW and still receive income support, while a pensioner can earn substantially over the FMW while still retaining some residual income support. People's incentive to work for low wages, whether part-time or full-time, can be influenced by income available to them through the transfer system. Chart 4.6 shows the stability of the relationship between allowance rates and the FMW over the past 20 years.

Chart 4.6: Allowances as a percentage of the minimum wage (1988 to 2008)

Chart 4.6: Allowances as a percentage of the minimum wage (1988 to 2008)

Source: DEEWR estimates.

A related consideration may be the relativity between single and partnered rates. Under current arrangements, a single pensioner receives 60 per cent of a couple's entitlement, while a single allowee receives 55 per cent of a couple's entitlement7. There are a range of views on the appropriate relativity.

Benchmarks of adequacy

Submissions note that rates of pensions and allowances can be defined with regard to a range of benchmarks of adequacy, including by reference to general community standards as measured by wages or an externally determined minimum standard of living. The various benchmarks of adequacy reflect different judgments about the actual standard of living that a person reliant upon transfers should be able to achieve. In making this judgment, governments consider a range of factors such as incentives to work, costs of work, equity with low paid workers, and the capacity and willingness of taxpayers to support transfers.

An issue for consideration is whether there should be a common basis of benchmarking across pensions, allowances and other transfer payments. Currently pensions are benchmarked to MTAWE, whereas allowances reflect historical judgments about adequacy, as indicated by movements in prices. At the same time, there is an independent process for establishing minimum wages.

The relationship between transfers for retirees and working-age people

The key financial supports for most retired people are income support payments and private superannuation. The Age Pension is currently available to men from age 65 years and women aged from 63 and a half years. Superannuation is currently preserved until age 55 and superannuation benefits paid to a person of age 60 years or older are tax-free when paid from a taxed superannuation fund.

Other entitlements also become available to older people at varying ages between 55 years and Age Pension age, and many people move to the Age Pension from another payment. The issue of age-based taxation is discussed in Section 4.1. There is no distinct age of retirement. In part, this reflects changes in the relationship between people of working age and retired people.

With increasing life expectancy, a growing number of people are reaching Age Pension age and receiving payments for a longer period than has previously been the case. In response to this trend, and as part of a broader scaling back of the generosity of pension schemes, a number of countries, including the United Kingdom and the United States, are increasing their Age Pension age, typically to 67 or 68 years.

There is also a greater dispersion in the wealth of Age pensioners. With the maturity of the superannuation guarantee (SG) system in 2037, the proportion of Age pensioners with significant levels of private income is expected to grow. However, there will still be some pensioners with little private income or assets, as they may have spent time out of the paid workforce or worked mostly in a pre-SG environment.

With the proportion of working-age people projected to decline as Australia's population ages, there is increased community acceptance that older Australians will increase their traditionally low level of workforce participation. Many older Australians have increased retirement income expectations, which have increased their willingness to work. Australians are also now living longer. Coupled with greater workplace flexibility, this now allows older people to be more active in the workforce.

Consultation questions

Q4.9 What are the key factors that should affect rates of transfer payments? What should be the relative importance of duration on income support, costs of work and job search, costs of children, value of home production and the level of the federal minimum wage?

Q4.10 Should transfer payments have a common benchmark? If so, should it be a proportion of a wage measure, and if so, which one? Or is there a better benchmark? Should there be a common indexation arrangement?

Q4.11 Should payments for retired people remain linked to payments for people of working age?

4.5 Participation incentives and the tax-transfer system

Increased workforce participation can reduce the potential impact of an ageing population on future workers through higher economic growth and also have substantial social benefits by reducing exclusion and improving the distribution of income.

This section examines the impact on the incentive to work arising from the interaction of taxes and income tests on working-age income support payments, such as Newstart, Disability Support Pension, Parenting Payment and family assistance.

Summary of key messages from submissions

Several submissions argue that our ageing population will create budgetary pressures, which can be met by increasing workforce participation.

Some submissions argue that the tax-transfer system can be a disincentive to part-time work, such as through high effective marginal tax rates. Submissions also recognise there are significant trade-offs between incentives, adequacy and affordability.

A number of submissions suggest that reductions in EMTRs could increase participation. They propose several ways this could be achieved, including through: reductions in income test taper rates for Newstart; the introduction of a single income test on cash transfers to reduce the overlap of income tests; the introduction of an earned income tax credit; and a change to income testing for FTB to reduce effective tax rates on second earners.

Other submissions focus on the disincentives in the tax-transfer system for women's workforce participation, such as the structure of the allowance income test, the income test on Family Tax Benefit, and interactions with child support.

Ageing and participation

Recently, Australia has achieved historically high labour force participation rates (76.2 per cent for people of working age) that are above the average of OECD countries (70.7 per cent) (OECD 2008a). The primary reasons for people aged 25 to 54 years being outside the labour force are health (disability, sickness or caring), home duties or care of children (Chart 4.7).

Chart 4.7: Labour force status of 25 to 54 year olds (2007)

Chart 4.7: Labour force status of 25 to 54 year olds (2007)

Source: DEEWR estimates.

The Productivity Commission (2007) considers further increases in participation are possible, particularly amongst these groups and older workers. However, they note that the full costs and benefits to the individual and society of reducing impediments to participation by these groups need to be identified. These could include child care, training, costs of work, and changes to income tests and taxes.

Part-time work

A number of submissions highlight that existing tax-transfer arrangements are not sufficiently supportive of people who prefer to work part-time. This is a major issue for policy design.

The number of people in part-time work has increased from around 15 per cent of the workforce in 1978 to 28.4 per cent in 2008 (Chart 4.8). This shift reflects a significant increase in female participation, especially mothers, for whom part-time work may provide balance with caring for their children. It also reflects increased participation by people with disabilities. More students also work part-time than in the past.

Chart 4.8: Part-time workers as a percentage of all workers (1978 to 2008)

Chart 4.8: Part-time workers as a percentage of all workers (1978 to 2008)

Source: ABS (2007e).

Research shows that some groups, such as mothers, are more responsive to financial incentives than working-age men (see for example, Dandie and Mercante 2007). It also shows that the net financial return from work has more effect on the decision to work than on the decision to change hours of work. This is consistent with the view that taking a job involves large fixed costs and benefits. Fixed costs of working include the time spent commuting, while fixed benefits include the psychological benefit of working.

These developments call for a careful consideration of the goals of participation policies. There are trade-offs between the level of benefits, the cost of the program and the financial incentives to participate (Box 4.1).

Policies encouraging part-time participation through low EMTRs at the bottom of the income scale target those most responsive to financial disincentives, but can result in increased EMTRs further up the income scale. These higher EMTRs may affect more people and will tend to discourage them from taking on more work, possibly resulting in a 'low income trap'.

On the other hand, policies leading to high EMTRs at the bottom of the income scale can keep people out of work, resulting in an 'unemployment trap'.

The final effect on labour supply will be determined both by how many taxpayers face the various effective tax rates and how responsive they are to them.

Box 4.1. Effective tax rates

The tax-transfer system drives a wedge between the gross pay that people earn and the take-home pay they actually receive. Part of this wedge is from taxes on personal income. Australia's targeted transfer system, withdrawing payments as incomes rise, can also reduce the financial gains from extra private income.

Effective tax rates attempt to measure all of these effects to provide a measure of the total wedge people experience. However, effective tax rates do not typically account for other changes such as increases in the costs of public housing, child support payments, Higher Education Loan Program (HELP) repayments, the value of lost concession cards, and the costs of child care necessary to facilitate work.

There are also issues with including elements that have a delayed impact on take-home incomes, for example those where the effects only become apparent after filing a tax return.

Effective marginal tax rates (EMTRs) measure the percentage of an additional amount of income that is lost through mechanisms such as tax and benefit withdrawal. Different sized income increments can be used for different purposes: small (one dollar) increments can provide a finely detailed picture of the effects of interactions in the tax-transfer system, while larger increases are useful for examining the effects on more realistic changes in income that people experience.

One key area of interest is looking at the effective tax rate when moving from outside the workforce into work. In this case, the increment is a person's entire gross pay, and the result is often referred to as a participation tax rate (PTR).

High effective tax rates can act as a disincentive to taking up work, increasing hours or moving into a higher paid job. However, effective tax rates need to be considered in light of the numbers of people actually or potentially experiencing them (the distribution) and the responsiveness of these people to them (their labour supply elasticities). Distributional analysis can highlight that some measures which reduce effective tax rates for a target group (for example, reducing tapers) can actually raise rates for more people outside the target group. Financial incentives have different effects on different groups, as there are other factors such as social expectations which affect labour supply decisions.

There are some constraints on the ability to reduce effective tax rates. For example, a single person with no private income can receive $11,680 of Newstart Allowance, while the same single person earning $100,000 will pay $27,500 in tax. Thus the tax-transfer system must collect $39,180 (claw back the Newstart Allowance and raise the tax) over the intervening income range. This would imply an average effective tax rate of almost 40 per cent, and for any income ranges where the effective tax rate is below this average there would need to be income ranges where it is above this average. To reduce effective tax rates for the entire income range in the above example would either require the Newstart Allowance to be reduced or tax reduced. Without changing payment levels or revenue requirements, the disincentive effects can only be minimised by targeting effective tax rates over the income range in accordance with the responsiveness of people in the income range — that is, lower effective tax rates for those groups who are more responsive and vice versa.

In recent decades, the progressive easing of income tests for income support payments has allowed recipients to work part-time and still receive some payment. This has encouraged more people to work part-time.

The loosening of the income tests on both family payments and income support means that couples, particularly those with children, can receive substantial cash support even while working full-time (Chart 4.9).

Chart 4.9: Proportion of disposable income from cash transfers

Single income couple with two children under age five, not renting (1970 to 2008)

Earning the minimum wage

Chart 4.9: Proportion of disposable income from cash transfers - Single income couple with two children under age five, not renting (1970 to 2008) - Earning average weekly earnings

Earning average weekly earnings

Chart 4.9: Proportion of disposable income from cash transfers - Single income couple with two children under age five, not renting (1970 to 2008) - Earning average weekly earnings

Source: DEEWR estimates.

The changes to benefit withdrawal have been partly motivated by the increase in available part-time work and recognition that part-time work helps balance work and family responsibilities. The OECD notes that participation policies can adversely affect women's choices between paid work and having children (OECD 2002). These choices also have implications for economic security and retirement incomes.

Another consideration has been the effect of part-time and intermittent work in maintaining work skills. There is evidence that part-time work can act as a 'stepping stone' to fuller engagement in the labour market. However, further research is needed on the extent to which encouraging part-time work through tax-transfer design acts as a low pay or part-time work trap.

The United Kingdom (UK) has a different approach to these issues in its tax-transfer system. It uses in-work benefits to supplement its unemployment and other direct welfare payments. To receive income support in the UK — equivalent to Australia's Newstart Allowance — a person must, among other things, have 'usual working hours' of less than 16 hours a week. This is in contrast to Australia, where it is sometimes possible to receive Newstart while working full-time.

However, the UK also has several in-work cash benefits, of which the largest and most significant is working family tax credit (WFTC). WFTC plays a role similar to FTB in Australia in supporting the incomes of families with children. It also serves a similar purpose to the earned income tax credit (EITC) in the United States (US) in that it is specifically attached to work. To get the WFTC a person or couple must have 'usual working hours' of 16 hours a week or more, so it is not possible to simultaneously get income support and the tax credit. Unlike the US tax credit, it is common for the WFTC to be paid fortnightly in cash.

High effective marginal tax rates and workforce participation

There have been policy changes in the past decade which have reduced EMTRs for different people at different parts of the income distribution. For example: marginal rates in the tax system have fallen; the income test taper for pensions has been reduced from 50 per cent to 40 per cent (2000); one of the tapers in the Newstart income test has been reduced from 70 to 60 per cent (2006); and the first taper on FTB Part A was reduced from 30 to 20 per cent (2004). These and other changes over the past decade have reduced the number of working age Australians facing EMTRs above 80 per cent. However, there has been an increase in the proportion of people facing EMTRs above 50 per cent (AMP.NATSEM 2006). Almost two thirds of these are members of couples with dependent children, reflecting the widening eligibility for family assistance over the period. This widening eligibility for family assistance has focused attention on second earner incentives.

Generally, issues with the incentives for second earners arise from the use of a joint assessment of income for items like FTB Part A and the Medicare levy low income thresholds. Joint assessment means that income test thresholds may be fully utilised by the first earner, thereby increasing the EMTR for the second earner relative to if they were single. Second earner EMTRs may also be increased through the withdrawal of entitlements that have a separate second earner income test, such as FTB Part B or the dependent spouse tax offset. The separate test can operate in tandem with other withdrawals or liabilities. A consequence of these features of the tax-transfer system is that for couples there are some combinations of first and second earner incomes where the second earner faces a higher EMTR than the first earner.

Participation tax rates (PTRs) give a better indication of the financial disincentives for those moving into work than EMTRs. Chart 4.10 shows the estimated distribution of PTRs for non-workers in families with dependent children. The largest group, women with a working partner, tend to face PTRs below 50 per cent. Relatively few sole parents face PTRs over 50 per cent. Males in jobless households tend to face higher PTRs, but there are fewer of them.

Chart 4.10: Estimated distribution of participation tax rates

For non-workers with dependent children (2008-09)

Chart 4.10: Estimated distribution of participation tax rates - For non-workers with dependent children (2008-09)

Note: Wage rates and potential hours are imputed.

Source: Australian Treasury estimates using Melbourne Institute Tax Transfer Simulator.

There are trade-offs involved in such a distribution and the benefits of reform options need to be carefully considered. For example, research suggests working-age men are less responsive to financial disincentives than mothers — that is, prime-aged men have a relatively inelastic labour supply.

A number of submissions note that the benefits of easing social security income tests are not clear cut. This is because it is necessary to balance the impacts on the labour supply of individuals with lower incomes (for example, part-time versus full-time work) with the decisions of individuals with higher incomes, who might reduce their work effort.

Submissions recognise that a gain for one group is often at the expense of others and therefore the overall costs and benefits of policy changes must be carefully considered. Poorly designed changes to income tests could reduce overall work and output, while leading to higher average tax rates.

As discussed in Section 4.3, submissions note that the different payment rates, activity requirements, and income tests associated with pensions and allowances can affect participation incentives. For example, there could be an incentive to obtain and maintain eligibility for Disability Support Pension rather than Newstart, given the differences in rates of payment and income tests (Chart 4.11).

Chart 4.11: Newstart (NSA) and Disability Support Pension (DSP) compared(a)

EMTRs by yearly private income(b)

Chart 4.11: Newstart (NSA) and Disability Support Pension (DSP) compared - EMTRs by yearly private income

Disposable incomes by yearly private income

Chart 4.11: Newstart (NSA) and Disability Support Pension (DSP) compared - Disposable incomes by yearly private income

  1. For single people.
  2. The spike in the Disability Support Pension effective marginal tax rate (EMTR) at around $40,000 reflects the loss of Utilities and Pharmaceutical Allowances.
  3. DEEWR estimates.

The UK is considering similar issues in its working-age income support, with a view to implementing policies that assist people to prepare for and return to work, rather than provide incentives to stay on benefits (Department for Work and Pensions 2008). Options include a reduction in both the number of payment types and the differences between them.

Consultation questions

Q4.12 In a targeted system there is a trade-off between the level of income support and workforce incentives. Given this, what priority should be given to reducing the disincentives to work?

Q4.13 What structure of income tests and taxes would best support the increasing diversity of work and the need to increase workforce participation, and where should improved incentives be targeted?

4.6 The tax-transfer system and skills acquisition

As well as affecting workforce participation incentives, the tax-transfer system can also affect decisions to undertake education and training.

Summary of key messages from submissions

Submissions note the importance of encouraging appropriate investment in education and training to respond to Australia's demographic and economic challenges.

Some submissions argue there is a need to ensure there are incentives for people to invest in education and training to lift productivity. A number of submissions also argue that the current tax-transfer system has adverse impacts on lower income students and affects the type of degrees they undertake.

Other submissions also note the need for a comprehensive examination of the implications of different tax reform proposals for skill formation.

Submissions note that deductibility of education expenses is only available to individuals undertaking study related to their current job, rather than to those seeking to acquire new and different skills.

Some submissions argue that people's lives are now more diverse and complex and that access to tax-favoured savings accounts for education and skills could help people to manage their changing needs. There are differing views on the respective roles of tax and transfers in supporting investment in education. Some prefer tax-based policies while others prefer direct government grants.

The amount of investment in skills

Australia has a system of compulsory schooling which, in most states, currently extends to age 16 years. After this age, individuals make choices about whether to pursue further education or enter the workforce. Factors influencing these choices include: the formal costs of education courses; income forgone while studying; the benefits of higher wages; and any other non-monetary benefits of education. Individuals are likely to compare these trade-offs with other options, such as working and/or investing money in financial or physical assets rather than human capital.

There has been little analysis in Australia of the impact of the tax-transfer system on incentives to invest in human capital. The Panel is commissioning a background paper to further examine how effective tax rates affect human capital investment decisions. Identifying how these tax rates compare with the tax on other investments is required to determine whether the tax-transfer system encourages individuals to over-invest or under-invest in human capital.

Table 4.4 outlines the tax-transfer treatment of the various private benefits and costs of education.

Table 4.4: Tax and transfer treatment of the private benefits and costs of education

Benefits Tax-transfer treatment
Monetary benefits to the individual, such as higher wages and ability to respond to involuntary unemployment Taxed at progressive rates
Non-monetary benefits to the individual, such as improved leisure opportunities and more satisfying jobs Exempt from tax
Costs Tax-transfer treatment
Costs of tuition No deduction is provided for costs of tuition, except where the tuition is related to the individual's current earning activities.Costs of tuition are generally subsidised. Subsidies vary, and the value to the individual may be higher or lower than immediate (or amortised) tax deductibility.
Costs of time spent in tuition (forgone earnings and/or leisure) Costs related to forgone earnings are effectively immediately tax deductible (see Box 4.2).No deduction is provided for costs related to forgone leisure.
Costs of course materials and other ancillary expenses No deduction is provided for the cost of course materials, except where the course is related to the individual's current earning activities.

The overall effective tax rate depends on the proportion of costs covered by tax deductions and subsidies, compared to the proportion of benefits that are taxed. If the deductions and subsidies are provided at the same rate as the tax applied to the benefits, the effective tax rate may be zero (this is similar to the cash-flow treatment discussed in Section 6.2). This treatment would be broadly similar to the current treatment of investment in an individual's own home and more generous than the current treatment of some other investments in real estate and most financial assets.

In practice, the deductions and subsidies are likely to be at different rates to the tax applied to benefits. This can arise due to the different effective tax rates created by the tax-transfer system, different rates of subsidy for different courses and the exemption of the non-monetary benefits from tax. If the deductions and subsidies are at a lower rate than the tax applied to benefits, the overall effective tax rate is likely to be positive, and vice versa if the deductions and subsidies are higher.

Table 4.4 only covers private costs and benefits, and does not include potential social and economic spill-over effects. Other considerations that may justify concessional treatment of education relative to alternative investments include: agency and equity problems (not all parents are in a position to maximise their children's future incomes); spill-over effects (high productivity people may raise others' productivity); capital market imperfections (it can be difficult to borrow against future earnings); and non-monetary benefits of education (such as a more tolerant and cohesive society).

Box 4.2 The tax treatment of forgone earnings in education

The tax treatment of investments made by forgoing earnings is equivalent to providing an immediate deduction for investment in a physical asset.

Consider the example of a taxpayer investing in a physical asset from which they expect to generate returns in the future. If a taxpayer with a 30 per cent tax rate invests $20,000 in an immediately deductible physical asset, the deduction reduces their taxable income by $20,000, which reduces their net tax liability by $6,000. Thus, the net impact on their disposable income of making the $20,000 investment is $14,000.

Suppose that instead of investing $20,000 in a physical asset, the taxpayer reduces their working hours to study part-time. Assume they make an equivalent investment in their human capital. That is, their time off work reduces their pre-tax income by $20,000. The reduction in their pre-tax income is the opportunity cost, in terms of lost income, of them studying rather than working. Their taxable income falls by $20,000 and their net tax liability falls by $6,000. Assuming their investment in human capital is valued at $20,000, the net impact on their disposable income of that investment is $14,000.

The size of the effective deduction depends on both the reduction in the individual's tax liability and any additional transfer payments they are entitled to receive. For example, someone on a low income who does not earn enough to generate a tax liability will not reduce their tax by working fewer hours. However, they may be eligible for additional transfer payments, such as Youth Allowance.

Lifelong learning

The OECD recommends that governments adopt a whole of lifecycle approach to learning, from early childhood through adulthood (OECD 1996).

There is a considerable body of labour economics literature examining the relationship between formal education and labour market outcomes. While this literature has found a strong relationship between formal education and outcomes, the evidence is much less clear on whether participation of adults in training beyond the initial education experience improves their outcomes sufficiently to justify the costs. The literature is even less clear in respect of lower-skilled workers.

One finding from labour market research is that skills and the likelihood of gaining employment decline if people are out of work for long periods. The high proportion of people aged 55 to 64 years who are outside the workforce, some of whom may be involuntarily retired, suggests that there may be large potential benefits from establishing an appropriate balance between the individual, the employer and government in adult education and training.

Some countries allow individuals to draw temporarily on retirement savings accounts to fund training. This gives individuals a greater incentive and responsibility in determining the type of training that is of greater value to them.

Consultation question

Q4.14 Does the tax-transfer system create disincentives for individuals seeking to acquire new skills or upgrade existing skills? If so, what sort of tax or transfer changes would provide better incentives?

4.7 Combined impacts of the tax and transfer systems

The tax and transfer systems have in part evolved separately. As a result of this and an active decision to target policies in the two systems in fundamentally different ways, they have remained relatively separate in their operation. While the systems are separate the interaction of both taxes and transfers determines an individual's or family's final income.

Summary of key messages from submissions

Many submissions raise concerns about the complexity of the interactions between the tax and transfer systems. Several submissions also support increased harmonisation of the tax and transfer systems, or even integration. A number of submissions propose alternative models, such as a negative income tax, as a potentially simpler approach.

Of those submissions that raise churn as an issue, some view it negatively on the grounds that it is inefficient, citing administrative duplication and compliance costs. Others view it more positively, valuing the ability of the tax and transfer systems to pursue their separate goals of revenue raising, poverty alleviation and supporting socially valued activities such as child rearing.

Some submissions, particularly from individuals, argue that family unit taxation would be fairer than the individual basis of the existing system. These arguments are based on a view of couples or families as the primary economic unit. Other submissions argue that individual taxation is fairer and has more efficient outcomes in terms of incentives to work, particularly for mothers.

Many people deal with both systems at any given time as well as over their lifetime. Chart 4.12 shows that, viewed over an individual's lifetime, there are periods when people are typically net recipients and other periods when they tend to be net payers. The targeted tax and transfer systems smooth income between periods of higher need, such as when a person has young children or in old age, and times of higher capacity, such as during the period before children or during the prime working years.

Chart 4.12: Incidence of taxes and government assistance(a)

Selected lifecycle groups (2003-04)

Chart 4.12: Incidence of taxes and government assistance - Selected lifecycle groups (2003-04)

  1. Figures are equivalised to take into account different household sizes and structures by identifying the amount needed to provide an equivalent standard of living to that of a single person.
  2. Reference person aged less than 35 years.
  3. Reference person aged 65 years or over.
  4. Final income includes government-provided health and education services.

Source: ABS (2007b).

Churn

Churn refers to situations where an individual or family pays tax and also receives transfer payments. It generally refers to events occurring within a short time period, such as a fortnight or a year, although it can also be viewed in terms of a person's lifetime.

Individuals and families experience churn in a range of ways. A typical situation is when a person is eligible to receive fortnightly support through the transfer system, but is assessable for tax over the course of the year. This includes situations where people are unemployed for part of a year, or work part-time and receive some income support in a form that responds to changes in their earnings or other circumstances. Another key area where churn occurs is when parents receive family payments and are also working and paying tax. With the level of family payments being high by historical standards and available to relatively high-income families, many families with children are subject to churn.

Targeting is one key cause of churn. The redistributive system directs income in ways that focus on timeliness and assessment periods, the needs of families as opposed to those of individuals, and the kind of income and assets available to the individual or family.

Another perspective on the cause of churn is a lack of information. In principle, if government had perfect information about the circumstances of people it could always pay or receive net amounts, effectively eliminating churn.

Australia's system has been judged as having the lowest level of churn of a group of OECD countries, as illustrated in Chart 4.13. It is among the most progressive, targeted and redistributive of the OECD. Nevertheless, there may be scope for more efficiency in the design of the tax and transfer systems.

Chart 4.13: Churn in OECD countries(a)

As a percentage of disposable income and direct taxes (around 2000)(b)

Chart 4.13: Churn in OECD countries(a) - As a percentage of disposable income and direct taxes (around 2000)(b)

  1. Churn is calculated by comparing the annual level of transfers received by each decile with the level of direct taxes paid by each decile. Where transfers exceed taxes, churn is the level of taxes and where taxes exceed transfers, churn is the level of transfers. The level of churn is the average of these amounts across all decile groups, weighted by the decile shares of disposable income. Some OECD countries have been omitted where taxation data are not available.
  2. The data are from around 2000, varying slightly by country.

Source: Whiteford (2007).

Churn could be reduced through greater integration of the tax and transfer systems. This would entail greater alignment of the two systems across the key structural elements — the unit and period of assessment, the treatment of income and assets, and the categorical aspects of the two systems (discussed in Section 2.2). There are a number of ways in which this could be done. For example, a single delivery system could provide all entitlements and determine all liabilities on a single unit and period of assessment with a single income definition. Several variants of this most extensive version of integration, known as a negative income tax, are called for in a few submissions.

A more moderate form of integration could entail a unified policy basis and delivery of entitlements and liabilities for target groups, such as retired people. It could also entail delivery of family assistance entirely through the tax system or, alternatively, through the transfer system with a closer mirroring of the income and assets tests and assessment periods applying to income support.

An alternative approach to reducing churn would be to seek greater separation of the tax and transfer systems. There are a number of ways in which this might be done. One approach would be to align policy settings so that people only deal with one or other system in a given period. Another approach would be to redesign elements such as family assistance and means-tested tax offsets, which currently incorporate elements associated with both the tax and transfer systems.

Questions about churn ultimately go to how precisely the system is designed to target its incentives, and how it trades off precision of targeting with simplicity or other goals.

Consultation question

Q4.15 Given the competing demands of targeting assistance to people when they need it and minimising unnecessary transactions, what changes could be made to existing tax and transfer policies?

The unit of assessment

As noted in Section 2.2, the personal income tax system is primarily based on individual assessment. Earnings in the form of salary and wages are clearly taxed on an individual basis. Unearned income from sources such as investment may, however, relate to an individual or to a couple or family. Individual assessment also applies to some offsets and other policy settings, including the LITO, mature age worker tax offset (MAWTO) and government co-contribution for superannuation. However, certain other offsets have couple or family aspects to them, such as the SATO, the dependency offsets and spouse superannuation offsets. By contrast, all elements of the Australian Government's transfer payment system use a couple or family based income test.

A number of submissions raise issues relating to the unit of taxation. Some support some form of family unit taxation, for example, joint filing or income splitting. Others support maintaining an individual unit for tax purposes, although in many cases people see a continuing role for couple or family assessment of income for transfer purposes.

Submissions identify several reasons for supporting family unit taxation. The key argument is that couples or families form a single economic unit and should be taxed as such. Family unit taxation arrangements exist in several OECD countries, notably the United States and France. The United Kingdom moved from family to individual unit taxation in 1990. Another argument raised in favour of family unit taxation is that many couples and families achieve an equivalent arrangement through the use of trusts or companies, and it would improve equity to make such an arrangement available to all.

A key argument in submissions supporting an individual unit of taxation is that people engage with the labour market and to some extent with other taxable activities as individuals, and accordingly it is inequitable for those in couple or family relationships to have their tax schedule determined by the income of their partner. A second argument is that unpaid domestic work is currently untaxed, which makes it relatively attractive in comparison with paid employment. Individual unit taxation avoids strengthening this existing tax advantage.

An important efficiency implication of these arguments is that those most affected by the choice of tax unit are women in couple families, particularly mothers, who tend to be responsive to financial incentives. They face fewer disincentives to paid employment in an individually based tax system. Family unit taxation would also change the distribution of tax within couples — with higher tax being paid by the lower income earner, though lower tax would be paid by the couple. Practical considerations associated with a family tax unit include defining families in a way that is accepted by the community and developing ways of assessing people whose family circumstances change during a tax period.

Consultation question

Q4. 16 Should the different bases of assessment for tax and transfers be reconsidered (including the unit of assessment, income definitions, period of assessment and assets treatment)?

Box 4.3: Forms of taxes and transfers

Governments provide assistance and impose liabilities in various ways. Assistance in the form of transfers could potentially be provided as a tax concession or refundable tax offset. The reverse is also true.

Whilst the final outcome of a cash transfer or reduction in tax liability may be the same in terms of income, the way in which assistance is provided is important. Delivery mechanisms determine the level of complexity that people face, particularly where compliance requirements vary. The delivery mechanism is also important because it affects the timeliness of a payment or collection of a tax liability and timeliness affects incentives to work. The mechanism can also be important where there is a question of coherence. For example, payments may interact in ways that are unintended, anomalous or create disincentives to work.

In addition (or as an alternative) to providing cash transfer payments or a reduction in tax, government can provide 'in kind' assistance which is either linked to income (means tested) or universally available.

Cash and in kind transfers in Australia

In Australia, cash transfers are the principal means of providing income support to individuals and families. Some means tested assistance is also provided through the tax system.

Most cash transfers are untied. Untied cash benefits allow recipients to spend the money as best they see fit. A recent change has been the introduction of a tied element to income support and family payments through income management, which limits what can be purchased by recipients in certain circumstances.

Some cash transfers, while being untied, are earmarked for meeting the costs of particular circumstances or needs. Examples include the Baby Bonus and Utilities Allowance.

Other payments are tied in some way. Providing some support in the form of tied cash benefits can allow increased support to be provided to individuals who face specific costs. For instance, Telephone Allowance is paid to those income support recipients and holders of a Commonwealth Seniors' Health Card who are telephone subscribers, with a higher rate being paid to home internet subscribers. The medical expenses tax offset and Private Health Insurance Rebate are subsidies that are provided in reimbursement of certain costs. Child Care Benefit is paid in proportion to the amount of eligible child care used by a family, while the Child Care Tax Rebate provides a benefit proportional to out- of- pocket child care costs, up to a cap.

A number of payments and entitlements are paid on the basis of a person being entitled to some other benefit. Families who receive FTB Part A can also claim the Teen Dental Plan subsidy and the Education Tax Refund, in respect of eligible expenditure. Bonuses for seniors and carers in recent years have been paid on the basis of entitlement to Age and other pensions. Residential aged care has a fee structure that imposes lower fees on maximum rate pensioners than on others.

Providing assistance in this way can create a discontinuity at the edge of payment thresholds if there is no taper applying to the supplement or bonus. Where a taper does apply to a supplement or bonus, this leads to higher effective tax rates across some ranges of income.

Where the payment is made as a lump sum, it may be difficult to target effectively. For example, people who became eligible for a payment after the lump sum entitlement date may miss out on the lump sum. However, lump sum payments have the advantage that they can assist with 'lumpy' costs in the absence of effective credit markets.

Both Australian and state governments, as well as private providers, provide lower cost goods and services to holders of Australian government concession cards. These cards are available not only to income support recipients but also to self funded retirees and low income families. The benefit they provide can vary greatly from one person to another.

The Australian and state governments also provide support to individuals and families through the direct provision of goods and services. In some cases they are linked to income, such as public housing. In other cases they are made available irrespective of income — for example, education and health services.

In kind benefits provide a mechanism to target assistance. For example, in the case of disability support recipients, some individuals will face greater costs of disability than others. Offering in kind benefits that are generally only of value to those who need such assistance allows a degree of self selection in a way that would otherwise be difficult to achieve.

In kind benefits may also be provided with the intention of constraining the behaviour of the recipient where society, through government, determines that the recipient should be directed in the goods and services they receive. The provision of public education (and the requirement that children attend school or an approved substitute), is an example.

Incidence

With each of the transfers described above, the recipient may not be the sole beneficiary. The ultimate impact, or the incidence, may lie partly or wholly elsewhere.

Untied cash transfers are unlikely to influence overall price levels. This means the recipients of these transfers are likely to receive most of the benefit. An exception to this may occur where the recipient is unlikely to spend the transfer themselves. For example, it may be that the Age Pension benefits not only the pensioner, but also, through allowing them to maintain the value of their estate, their heirs.

Payments that are tied to particular consumption items and in kind benefits are more likely to have flow on impacts on prices. This can result in some of the benefit flowing to the provider of the good or service. For example, some of the benefit of government child care assistance is likely to flow to child care providers.

Subsidisation of specific goods and services and payments that reduce the cost of a good or service are likely to increase their utilisation. This may be an objective of policies such as subsidies for child care and private health insurance. However, reducing the cost of particular goods and services can encourage people to over use those goods and services, and possibly under use alternative goods and services. For example, subsidised provision of energy may encourage people to spend more on heating, and less on insulation than they otherwise might.

The method of providing assistance also has equity implications. Linking assistance to particular consumption items can be a way of targeting assistance at particular groups. For example, subsidising health services is a way of providing additional support to people who are sick compared to those who are well.


2 In the vast majority of cases, the low income tax offset (LITO) could render the beneficiary tax offset (BTO) superfluous.

3 The pensioner tax offset (PTO) is larger than the BTO in that it covers not only pension income, but also private income up to and a little over the level where it starts reducing the pension. Pensioners of Age Pension age receive instead the senior Australians tax offset (SATO), which is even larger.

4 Rebates are also available for other dependants, such as child housekeepers and invalid relatives.

5 As reported in the 2007 Tax Expenditures Statement (Australian Treasury 2007). Since the publication of the TES, several FBT integrity measures for eligible work-related items, meal cards and jointly-held assets have been announced which reduce the concessionality of these items.

6 Equivalised incomes take into account different household sizes and structures by identifying the amount needed to provide an equivalent standard of living to that of a single person.

7 If the single allowee has a child or is aged over 60 and has been on allowance for over nine months, they receive 60 per cent of a couple's entitlement.