Australia's Future Tax System

Final Report: Detailed Analysis

Chapter F: The transfer system

The primary purpose of government assistance payments to individuals is to provide them with a minimum adequate standard of living. In seeking to meet this goal, Australia has traditionally placed a higher weight on poverty alleviation than on income maintenance compared with many other countries. Most OECD countries have systems that provide both social insurance related to previous earnings and tightly targeted social assistance for poverty alleviation.

Australia's emphasis on poverty alleviation means that it has one of the most targeted and redistributive transfer systems in the OECD. This is largely because of the unique nature of the income support system. Australia has a 'flat' rate structure that does not take into account previous earnings and is financed from general government revenue. Assistance is not time-limited and is targeted to 'need' using means tests that are relatively generous compared to other social assistance schemes.

Principles

The primary purpose of government assistance payments is to ensure a minimum adequate standard of living, taking into account individual circumstances and prevailing community standards.

The design of the income support system, including amounts of payments and means test withdrawal rates, should take into account how the income support system and the personal income tax system together affect incentives to work and save. Design of the income support system should also take into account overall budget sustainability.

The main features of the Australian system should be retained. These are its targeted and category-based income support payments and family assistance, paid to income support recipients as well as working families.

Public spending on cash benefits in Australia is lower than in many other countries and is only 70 per cent of the OECD average. Australia has the most progressive benefit system in the OECD. Because of the design of assistance payments and taxes, Australia's system of redistribution is also very efficient in that there is minimal churning,1 and most money is transferred to low-income households (Whiteford 2009).

The combined redistributive effects of the personal tax and transfer system are substantial at the aggregate level compared to overseas systems. However, payment adequacy, structure and incentives could be improved.

Government assistance payments comprise cash payments to individuals for income support, payments to families to help with the costs of raising children, and subsidies for specific goods and services such as housing rent and child care. Access to these forms of assistance is means tested to target assistance to those with the greatest need. Government also provides assistance to individuals through subsidies to providers — public and private — for goods and services such as health care, education, training and housing.

There were around 40 Australian government assistance payments amounting to outlays of over $85 billion in 2008-09 and representing more than a quarter of Australian government spending. This Review has focused on the main income support payments for the aged, people with disability, the unemployed, parents and full-time students. It has also considered family assistance paid to income support recipients and working families, rent assistance and child care subsidies.

The income support system assists a large number of people — more than 4.8 million people, excluding children — and family assistance is paid to parents (receiving income support or working) in respect of more than 3.4 million children (see Chart F-1). The scope of the income support system is very broad and the Review Panel has not undertaken a detailed review of adequacy or reviewed individual payments. Instead this Report has focused on the broad architecture of the system — such as the relationships between payment categories — and its interactions with the personal tax system. In considering payment adequacy, the Review has taken the policy settings established by the Australian Government following the 2009 Pension Review as establishing the highest level of income support payment. The primary focus of this Report is the structure and relationship of working-age income support — for the unemployed, parents, people with a disability and students (see Section F1 Income support) — to the pension. The way in which assistance is targeted to individuals and families by means tests is examined in Section F2 Means testing.

Chart F-1: Income support recipients, and children for whom Family Tax Benefit Part A is paid

June 2009

June 2009

Source: Australian government administrative statistics.

While overlap between the tax system and the transfer system has increased in recent decades, full integration to achieve a single system would involve common treatment for income definitions, the unit of assessment (for example, individual or family) and the period of assessment. While full integration may be technically possible in the future, it is considered that assessment of need in the Australian transfer system and capacity to pay in the tax system are sufficiently different to warrant retention of a categorical means tested income support system based on joint assessment of need for couples. This differs from the tax system, where capacity to pay is assessed on an individual basis, on an annual rather than fortnightly basis.

An important reason to improve the income support system is to make it more work-focused for more people. Structural ageing of the Australian population makes it particularly important that people in the community who wish to and have some capacity to work should not be discouraged from doing so by the personal tax and transfer system. But structure of income support alone is not sufficient, as Whiteford (2009) has concluded:

Among the most disadvantaged and long-term jobless the problems appear to include very low levels of educational attainment (around 60 per cent having Year 10 qualifications or below), lack of access to reliable transport, relatively unsafe neighbourhoods for families with children, and complex personal problems including poor health and disabilities among adults and children. While it is possible that poorly designed tax and transfer systems might exacerbate these problems, it is difficult to see that transfer reform can resolve them. Instead, what seems more promising for these groups is a more effective mix of services that support participation generally (for example, better child care) plus targeted employment support programmes and activation policies (p. 30).

As stated earlier, the primary purpose of government assistance payments to individuals is to provide a minimum adequate standard of living. Poverty alleviation is a central feature of this purpose, but if poverty has dimensions beyond income then an income support system will not be sufficient to eliminate it. In the absence of measures that address these other dimensions there are limits to what the income support system can achieve. It may in fact entrench poverty if income support creates a barrier to employment.

In an influential work, Sen (1992) proposed that poverty is a function of capability — in effect, the choices people have in life. In this view, income is only one dimension of poverty — depending on the social surroundings, such things as poor health, poor education, poor family life or poor political voice can all be seen as valid measures of poverty because they limit individual capability and hence autonomy and happiness.

Significantly, these different dimensions can vary over time and across societies, which means that the importance and nature of instruments to address these dimensions — such as through the income support system — can also vary over time. It is difficult to predict the evolution of future social attitudes and arrangements, so policy choices will primarily reflect current Australian society.

Viewed in this way, alleviating poverty also involves reducing disincentives to work created by the tax and transfer system. This could include changes to payment rates, income withdrawal rates, activity tests, and access to child care, rental subsidies and other services.

Therefore the impact of all aspects of the tax and transfer system should be considered — including cash transfers, subsidies for housing, child care, concessions and other social services. While some of these areas are outside the Review's terms of reference, parallel reforms in aged care, disability and employment services will be crucial to managing the pressures of an ageing population. These pressures include the growing unmet need for aged care, and the need to ensure a high level of employment and a productive workforce.

The current disability service system is fragmented, insufficient to meet current needs, difficult for people to access, and has no incentives to promote increased efficiency or effectiveness. This system will face considerable challenges in the future in meeting the demand for accommodation, care and respite services for people with a severe disability. Despite increased spending, the rate of growth in demand is around 7.5 per cent. In this context the Productivity Commission will explore the merits of a national disability insurance scheme and review the efficiency, effectiveness; sustainability; case for increased investment (including the private sector); consistency of access; and planning for lifelong care in the provision of disability services.

There are two particular demographic groups — single parents and people with a disability — for whom increases in employment rates could substantially improve outcomes.

Income support

The income support system is a crucial social institution. As in the past, it will need to continue to be adapted to changing social and economic needs (see Section F1 Income support).

The primary focus of the income support system has been and should continue to be the provision of a minimum adequate level of income to people who are unable to support themselves through work or their savings. This focus on payment adequacy, however, has to be balanced with incentives to work. And payments need to be seen as affordable, sustainable and fair by the community at large.

There are large differences in rates and conditions of payment for people of working age. These differences produce very different outcomes for people with similar capacity to work. They can create disincentives to work or incentives to move to non-activity tested payments.

There should be three primary payment categories that reflect societal expectations about the level of work that can reasonably expected to be undertaken by an individual — a pension category where there is no expectation of work; a participation category for those who are expected to work now or in the near future; and a student category for those undertaking full-time study in an approved course. Rates of payment for those in the pension category should generally provide a higher level of adequacy than rates in either the participation or student categories.

To improve equity, the current differences in rates of payment should be reduced through increases in the single person's rates of payment in the participation and student categories. These single rates of payment would be lower than in the pension category; however, increases over time in the rates of payment should establish a consistent treatment of households of different size and composition based on the current relativities between the single and combined couple rates of payment in the pension system.

Under present indexation and benchmarking arrangements, the relative adequacy of allowances diminishes over time relative to pensions because different indexation methods apply. The last adjustment to the single rate of allowance — apart from normal price indexation and compensation for the goods and services tax — was in 1994. Similarly, youth rates of allowance have not been increased since 1987 when Austudy was introduced. Once established, relative levels of adequacy should be maintained over time. This could be achieved by a consistent approach to indexation across the three payment categories. But it should be noted that developing a consistent indexation regime that meets community expectations and is fiscally sustainable is challenging.

Means testing

Means testing is an important tool for targeting government payments to those with most need and for managing the sustainability of the transfer system (see Section F2 Means testing).

The transfer system should have a broader assessment of means than the tax system, which is focused on a person's ability to pay. The concept of means for income support payments should include not only income but also a person's ability to generate an income from their assets.

Means test arrangements should ensure that people on the same payment with similar means, including their income and their assets, receive an equivalent level of income support or other assistance.

As means testing has similar economic impacts as taxation, the settings for a means test should have regard to its impact on a person's decision to work and save as well as its primary objective of targeting government payments.

The current means test for income support payments is not as equitable as it could be because it results in people with similar need for support and the same level of means receiving different rates of income support. This reduces the fairness of the system and creates incentives to hold wealth in particular types of assets. In its strategic report on the retirement income system (AFTS 2009) the Review Panel foreshadowed that there should be a comprehensive means test that replaces the assets test by extending the income test by deeming returns on a greater range of assets.

Assistance for families and youth

Family assistance (including payments for dependent youth) is the part of the transfer system that has the greatest overlap with the tax system because it is paid to many households with children where parents are not receiving income support. Because family payments can be substantial and are means tested, they raise effective tax rates for both recipient and non-recipient households. Consequently, family assistance has considerable potential to affect incentives to work.

Because family assistance and income support for dependent young people are similar in nature, these forms of assistance are considered together in the report in Section F3 (Family and youth assistance). Rates of payment for income support recipients aged under 21 (22 for full-time students), including rates of Disability Support Pension and Carer Payment, need to be considered in the context of the principles underlying family assistance rates and in the context of the principles underlying income support rates for adults. These issues are also discussed in Section F3. Australian families are increasingly balancing work and family responsibilities. The workforce participation rate of secondary earners, who in most cases are women, has risen steadily over the past few decades. The design of the system needs to be responsive to that.

The tax and transfer system can impact on the benefits of working relative to the benefits of not working. This can include the choice to work or to take care of children at home. It is therefore a major influence on some parents' ability to participate in the workforce. The system is inherently biased against paid work because of the taxation of wage income (but not home production), the removal of benefits as earned income increases and the availability of government payments as a substitute for paid work.

The current system of family assistance can be rationalised and remodelled to create a family assistance program that is simpler, more transparent and provides greater support where needed. Support provided through family payments should be designed to assist with the direct cost of children, while support for adults (including parents) should be provided through income support payments.

The family assistance system includes a number of payments with overlapping objectives. This increases the compliance costs for parents and increases the challenge of designing a system that is fair to families in different circumstances. The existence of multiple payments also results in overlapping withdrawal rates, which increases effective rates of tax.

Family payments should be the main form of assistance for children up to the age of 18 or until the completion of secondary school. Beyond these points, youth payments alone should be available and should be focused on encouraging study, training or workforce engagement. There should be a seamless transition from family payments to youth payments. Youth payments should be the main form of income support from the age of 18 until the age of independence.

The rates of youth payment should reflect that youths generally have lower needs than adults, but should be sufficient to support investment in education, training and other capability-building activities. Youth rates should not favour unemployment over education and training. Youths in different living arrangements and personal circumstances have different needs, for example young people living away from home have higher costs than those living at home.

Access to high-quality and affordable child care is important to facilitate the workforce participation of parents, particularly secondary-earner parents and single parents with the primary care of children. For parents who use child care in order to participate in paid employment, child care is a cost of employment. The costs of child care may mean that in the short term parents receive minimal financial benefit from returning to work, even though the long-term gains from working are much greater for parents and their children, and for the broader community when this lowers reliance on income support. Helping parents to access good quality and affordable child care can help overcome these barriers to workforce participation.

The level of child care assistance currently provided to families is broadly adequate. However, the current payment structure could be simpler and more transparent (see Section F4 Child care assistance).

Rent assistance

The purpose of rent assistance should be to ensure that adults with limited means can afford to live in an adequate standard of rental housing (see Section F5 Housing assistance).

Rent Assistance payment rates should be increased so that assistance is sufficient to support access to an adequate level of housing. Maximum assistance should be indexed to move in line with market rents. Rent Assistance should be extended to public housing tenants, with recipients generally paying rents that reflect market rates, subject to transitional arrangements.

A new source of funding should be made available in respect of the tenants who have high housing needs, such as those with high costs due to disability or people likely to face discrimination in the private market. The payment would be based on the needs of recipients and where practical directed by them to providers of their choice.

The Australian government and the States should retain the option of providing capital for housing construction.

Transfers tied to goods and services

While transfers are usually thought of as cash payments, governments also provide transfers such as concessions and payments that are tied to the purchase, or supply, of a particular good or service. These transfers are often provided to encourage the consumption of goods and services that help people improve their capabilities (see Section F6 Transfers tied to goods and services).

All three levels of government are involved in the funding and provision of transfers tied to goods and services; however, the approach across the federation is not always coherent with other aspects of the tax and transfer system.

Transfers tied to goods and services can be tailored to people with high need. A person may have high health or support needs due to illness or disability, or their costs may vary depending on where they live. Determining a rate of payment based on what an average person requires can result in some people receiving less support than they need, and others receiving more. In cases where levels of need vary considerably across the population, a transfer provided as a concession may entail less risk than a cash payment of under-compensating those with high needs and over-compensating those with low needs. It can also allow people to manage their risks better by giving them access to goods and services at times when their needs are higher.


1 Tax–welfare churning occurs when governments tax individuals and then spend tax revenues on providing income and services 'back' to those same individuals.