Australia's Future Tax System

Final Report: Detailed Analysis

Chapter F: The transfer system

F1. Income support payments

F1–3 A restructured income support system

Recommendation 82:

There should be three categories of income support payments:

  1. A pension category for people who are not expected to support themselves through paid work, whether because of their age, disability or because they are providing full-time care for a person with disability (or frail aged). This pension would be paid at a rate that provides a basic acceptable standard of living, having regard to prevailing community standards.
  2. A participation category for people of working age who are expected to support themselves through paid work now or in the near future. This would cover the unemployed including youth (both under and over 18), those who are temporarily incapacitated, people with a partial capacity to work and primary carers of dependent children. The rate of payment, for those who are expected to work, should provide a basic level of adequacy while maintaining incentives to work. This would be less than the pension rate. Parents on income support would receive a higher total level of payment. Unemployed youth aged less than 21 would be paid no more than full-time students to avoid creating incentives to leave full-time study for unemployment.12
  3. A student assistance category for people engaged in full-time study. Students aged 21 and over would continue to be paid at a lower rate than the unemployed and at the same rate as younger students in similar circumstances. Some students have the capacity to work part-time to supplement their income support. Other students could be given the ability to borrow against future income to supplement their student assistance.13

Recommendation 83:

There should be a more consistent approach to payment relativities within each of the three categories of payment based on the single to couple pension relativity. A more consistent approach would mean an increase to base rates for single income support recipients in the participation and student assistance categories. However, a lower relativity for singles in these categories without children may be warranted given their greater capacity to share accommodation.

Recommendation 84:

Payments and income test parameters should be indexed in a consistent way to maintain relativities across the three payment categories and to reflect changes in community standards. Governments should regularly review indexation as community standards are likely to be affected by significant changes in the composition of the workforce and household incomes in coming decades. The current community standard for pensions is set by reference to Male Total Average Weekly Earnings. Indexing all payments to this standard has been projected to involve a significant increase in budgetary outlays over the coming decades so it will be necessary for governments to regularly review the appropriateness of this measure and the level of the benchmark.

Recommendation 85:

Income support arrangements for parents should support and encourage participation in work while maintaining adequate levels of assistance to families. As a condition of payment parents should be required to look for part-time work once their youngest child turns four. Parents would receive supplements as follows:

  1. For couples and single parents with a youngest child under six years, the amount of the supplement should be set such that the total support for single parents on income support will be equivalent to the maximum rate of pension. The supplement would be paid through the family payment system.
  2. For single parents with a youngest child aged six or older, the supplement should be paid at a substantially lower rate through the family payment system.
  3. For couples with a youngest child aged six years or older, the lower rate supplement should be paid through the income support system.

Recommendation 86:

People with disability who have a partial capacity to work, excluding people receiving Disability Support Pension (DSP), should have a part-time work requirement. They should be subject to a means test or payment arrangements that provide an incentive to work part-time and that recognise that they face higher average costs of work. This could also be achieved by an in-work supplement and/or an earnings disregard in the means test.

Recommendation 87:

Students should have access to an income test that facilitates significant part-time work at a level that does not compromise educational outcomes. Adults requiring additional income should be able to borrow to top up their student rate of income support to the level of the participation payment rate. The feasibility of using the existing income-contingent loans scheme and the potential impact of it on access to higher education of students from a low socioeconomic background should be examined.

The system should do more to encourage employment

The ageing of the population and a policy focus on individual wellbeing imply that the structure of income support should do more to encourage employment. This goal applies to all income support recipients. Two groups — single parents and people with disability with the capacity for substantial part-time work — have particularly low workforce employment rates. Improving employment rates for these groups should be a policy priority.

There are now considerable differences between pensions and allowances in terms of payment rates and conditions. This significantly affects the simplicity, equity and efficiency of the tax and transfer system. Again, two groups are particularly affected — the differences are most stark at payment boundaries for single parents and people with disabilities. Building a system that supports people's efforts to work entails a three-way trade off. While higher transfer payment rates provide recipients with a better standard of living, they can compromise incentives to work and are more expensive for the general community of taxpayers to support. This is why participation requirements are necessary. On the other hand, low rates that do not facilitate looking for work or participating in society can compromise employment outcomes (reducing tax revenues and increasing income support outlays) and social cohesion (crime levels, a more unequal distribution of income), which is also more expensive for the community to support.

The policy challenge is to ensure that those on income support have an adequate standard of living, and at the same time to give those with the capacity to work incentives that make work attractive. Maintaining category-based differences as proposed in Recommendation 82 will continue to be a way to meet this challenge. However, the boundaries between categories can be adjusted to ensure that an individual's capabilities are increased through employment. This is particularly needed for single parents and people with disability with significant capacity to work. Differences in payment relativities across the three categories and between payments within the categories should also be reduced to create a more coherent and simpler income support system (see Recommendation 83).

There are limits to the extent to which effective marginal tax rates can be reduced to improve incentives to work. This is particularly the case for parents, because at some point the total level of assistance — comprising income support, family and rent assistance — has to be withdrawn.

Within a categorical approach to income support it is possible to target incentives to work through participation requirements: continued eligibility for payment is conditional on job search. Further extension of activity testing is warranted in the case of parents — single and partnered — as a clear signal not to stay out of the workforce for too long and as a reflection of community norms and expectations.

Paying the same basic rate of income support to all people in the participation category —Newstart Allowance — with supplements for parents, children and rent costs, would reinforce the participation focus of income support for people of working age. Disability Support Pension and Carer Payment would continue to be separate categories of payment in the pension category.

The level of assistance for those who are expected to work is a trade-off between adequacy, work incentives and other priorities and is ultimately a matter for governments to decide. There is a case, however, for increasing the level of assistance for single unemployed and students, particularly for singles not sharing with another adult. This is based on a range of analysis, including appropriate single and couple payment relativities and the disincentives to work caused by large differences in rates of payment for people in similar circumstances. There is also a case for indexing payments on a common basis, and/or for conducting regular reviews of adequacy against community standards, so that differences between rates of payment do not increase too much.

Restructuring the income support system will be costly. It will have to deal with the difference in payment rates at the same time as providing strong incentives to work and adequate support services to ensure that new entrants to the labour market or people increasing their work effort succeed in getting jobs. The cost of indexing allowances to male total average weekly earnings is projected to increase from 0.08 per cent of GDP in 2019–20 to 0.35 per cent of GDP in 2049–50. Reforms will therefore have to be prioritised and phased in over the longer term.

Some differences between rates of assistance for people neither expected nor likely to work again and for those expected to look for work are justified to preserve incentives to work. However, the differences in the current system are growing and too large. They should be addressed.

A new structure for income support is outlined in Chart F1-12.

Chart F1-12: Indicative structure of adult working-age income support

Single person

    Single person

  1. Family assistance for the direct costs of children.
  2. Parent supplement for families with a youngest child aged under six would be paid through family assistance and be available to working families.
  3. Parent supplement for single parents with a youngest child six and older would be paid through family assistance. For partnered parents it would be paid as part of income support.
  4. Participation supplement could be delivered through the means test.
  5. Age, Disability and Carer pensioners would be eligible for the parent supplements.

The broad architecture of the system is based on three payment categories: a pension category, participation category and student assistance (see Chart F1-12). In addition there would be supplements in respect of the direct costs of children (see Section F3 Family and youth assistance), significant rent costs (see Section F5 Housing assistance), and a parenting supplement. There would also be a per family participation supplement in respect of the costs of work for people whose disability means they only have a partial work capacity.

Carers providing constant care and people assessed as having disability that precludes any level of workforce participation would receive the highest rate of payment, as they are more likely to be reliant on income support for a long and indeterminate time. The rate of payment for those aged 21 and over or aged under 21 with dependent children would be as established by the Australian government following the Pension Review.14

The participation category

In the longer run, the direction of policy should be to simplify working-age income support by reducing the number of payment categories and reducing differences between current categories. The UK government has committed to consult on such reform through a single income-replacement benefit for people of working age (UK Department of Work and Pensions 2008, p. 32).

For most people unemployment lasts for only a short time, which is one reason why rates of payment for Newstart Allowance can be less than pension rates. However, the unemployed population is becoming much more diverse as a result of changes to eligibility for Parenting Payment and Disability Support Pension access. Also, a sizeable proportion of unemployed people, even under favourable labour market conditions, spend more than two years on payment.

Australian unemployment assistance is based on the notion of 'reciprocal obligation' — that the taxpayer will support a person in return for the person actively pursuing ways to avoid the need for further support. Most jobseekers are expected to seek full-time work. Government policy since the mid-1980s has typically aimed at improving the rewards for part-time work to avoid poverty traps and to improve financial outcomes for those in work, while at the same time continuing to ensure that jobseekers seek further work or improve their employment prospects via the application of full-time activity tests.

In recent years this policy has been made more flexible. There are now substantial groups, such as people with partial work capacity and single parents with school-age children, who are expected to look only for part-time work. Activities other than job search are sometimes taken as satisfying recipients' obligations.

Under the Review's proposals (see Recommendation 82), the participation category would consist of those who are looking for work — the unemployed — and those who are working to their 'required level' but who are not income-tested off payment (such as those with part-time requirements). It would also include people expected to look for work in the future, such as primary carer parents whose youngest child is below age six and people with a temporary sickness or impairment that precludes work.

Single people and couples expected to look for work would face a full-time work requirement. Parents and people with disability with the capacity to work significant part-time hours who are expected to look for work would face a part-time work requirement.

Participation payments should focus on capability not disability, as many people with disability or another barrier to work still have a substantial capacity to work. A focus on capability would increase individual wellbeing. While this Review focuses primarily on the architecture of the tax and transfer system, it recognises that many people require tailored services to ensure a successful entry into work. These services are provided through the employment services system. Further development of this system may be required.

Unemployed people with full-time job search requirement

Jobseekers with a full-time work requirement would receive a minimally adequate base rate of payment and have access to employment services according to their individual needs. Assistance for singles would increase relative to the couple rate, to be more consistent with the relativity for the pension.

Increasing payments for the unemployed to a higher proportion of the pension, or indexing them to the same wages index as pensions, may mean that more people will be able to combine substantial part-time work with income support. However, this effect will be countered by participation requirements to continue to pursue full-time employment.

If participation requirements are considered insufficient and it is considered undesirable to assist those in low-paid work through the income support system, it may be necessary to consider other approaches. For example, the income test on payments could be tightened (through a low free area and a high withdrawal rate). If this were not considered sufficient, a 100 per cent withdrawal rate could be applied and earned income tax credits could be used to achieve a desired pattern of effective marginal tax rates. For example, single parents could be given a different set of work incentives compared to single people without children. Alternatively, the conditions for receipt of income support could be progressively modified — by reducing income withdrawal rates — to allow people to more easily combine work and benefits simultaneously.

Parents

Recommendation 85 focuses on workforce participation and income support for parents.

In moving to a participation-focused income support system, there should be a more coherent structure of assistance for parents who are primary carers and for other people who are expected to work in the future.

One possible approach for reform is a system like those of Scandinavian countries, where parents (including single parents) have high rates of workforce participation. Both parents, even of quite young children, are expected to work, just as any other capable adult is, but very extensive support is provided in the form of high-quality child care and early education. Further, there are extensive provisions in labour law to ensure 'family-friendly' workplaces.

While there is some movement in Australia in this direction — such as through child care subsidies, extension of early childhood education, and parental leave — fully implementing the Scandinavian approach would be very expensive in the short run.

Instead of enforcing an expectation that both parents work full-time when their children are young, current policy is explicitly aimed at keeping primary carers in touch with the labour market. That usually means some form of part-time work. The future direction of policy should involve requiring parents on income support to look for work when their children are younger. A first step would be to align the age of the youngest child at which single parents are expected to look for work with the reduction in income support. This should be the same age for partnered primary carer parents. In the short term, this should be at age six. In the longer term, this should be reduced in line with significant changes in the availability of early childhood education and affordable child care (including after school care). Such a shift should also be contingent on an adequate and affordable supply of child care and 'family-friendly' conditions of work.

Policy should be directed at increasing the workforce participation of single parents, as single-parent households constitute a significant proportion of all jobless households. A priority for income support policy should be to introduce a means test structure that provides a more seamless transition to work when the youngest child turns six.

Parents in the income support system would receive a supplement where there is a youngest child aged less than six to provide a higher level of adequacy for those likely to be outside the workforce. Single parents with a young child would receive the same rate of income support as a single pensioner (including the pension supplement). This would be achieved through the combination of the participation payment and the parent supplement. In addition there would be family assistance to reflect the direct costs of children (see Section F3 Family and youth assistance).

The additional assistance for single and partnered parents of children aged less than six would be paid as a separate per-family supplement — whether or not they receive income support — through the family assistance system. A single parent would receive the same amount as a couple.

Where the youngest child of a single parent is six or older a lower rate supplement would also be paid through family assistance and single parents receiving income support would be subject to a part-time work requirement.

Partnered income support recipients with a youngest child six or older would receive the lower parent supplement as part of their basic rate of income support and be income tested as part of the basic rate of income support to avoid stacking of income tests.

The parenting supplement would continue to be paid until the youngest child turns 18 or while there are children in the household receiving at home rates of payment.

Workers with partial capacity for work

Recommendation 86 proposes that people with a disability who have a partial capacity to work, excluding those receiving DSP, should have a part-time work requirement.

Many people with disability already work, and others would like to work. A system that supports work for people with a disability would enable them to increase their lifetime income and contribute to society in a wider range of ways.

Some OECD countries are applying activity test requirements to their disability payments, but these countries generally have much higher proportions of their working-age population on payment than Australia has.

If it is accepted that the current DSP qualification settings are appropriate — that is, that people who cannot work 15 or more hours a week due to a permanent disability require long-term income support because they are unable to support themselves through significant employment — there is little point in introducing requirements for people with such limited capacity to work. However, there should be better satisfaction that this is actually the case before a person gains entry to DSP.

It is inherently difficult to forecast the long-term employment prospects of many people with a disability, and errors in both directions will inevitably be made in the assessment. On the one hand, not paying DSP to someone who genuinely can never support themselves through work may seriously reduce their wellbeing. On the other, paying DSP to someone who may be able to find some work could also reduce their long-term wellbeing as well as incurring higher public outlays.

The risks and costs of these errors can be managed by reducing the differences in treatment (such as payment rates) between those assessed as being able to undertake significant part-time work, those deemed marginally able to work and those deemed unable to work, and by changes to the work test that determines eligibility for DSP.

The introduction of an expectation that people applying for DSP (except those who are manifestly eligible) should first test their ability to be assisted back to work would establish a greater level of objectivity and should lead to greater levels of workforce participation.

Previous attempts to tighten access to DSP have had limited success. Not only is it a matter of the disabled person's incentives, but also assessors are likely to be aware that refusing entry of marginal cases to DSP can have a high cost for individuals. Addressing the prospective nature of the current work test may be a way of ensuring that those who have a substantial capacity to work are assisted to find employment. Those who demonstrate capacity to work reasonable part-time hours without ongoing support in the workplace would not gain entry to DSP. In this way the focus of the payment would shift toward capability and away from disability.

Limited availability of employment services program places has in the past hampered the requirement for DSP claimants without a manifest entitlement to participate. However, recent increases in the availability of places will make it feasible to assess a person's capacity for work in this way. Strict safeguards would need to be in place to ensure exemptions form assessment for people who will clearly never be able to work.

People with disability who are limited to part-time work have similar workforce participation costs to those of full-time workers (such as the costs of transport to and from work for a person with the capacity to work five short days in a week), yet because part-time workers earn less, these costs can account for a greater proportion of their take-home earnings.

People with an assessed partial capacity to work more than 15 hours a week should be subject to an income test that provides a reasonable return to part-time work. This could be achieved through a higher income test free area, a lower withdrawal rate, or something similar to the work bonus for age pensioners. Alternatively a supplement could be paid, although this would be more complex to administer. This would also assist with the ongoing cost of workforce participation, reduce the incentives to seek DSP and recognise that this group is likely to have a longer duration on payment than other income support recipients.

The student assistance category

Recommendation 87 focuses on students' ability to work part-time while studying.

The decision whether to study beyond school leaving age is discretionary. For that reason, adult student income support differs from most other forms of income support, which are required because of circumstances over which the claimant has little control — they are unable to find paid work, they are aged or have a disability that limits their capacity for work (see Box F1-2).

Box F1-2: Rationale for student income support

The rationale for adult student income support is different from that for people who are not expected to work, are unable to work or are temporarily unemployed. There are two distinct arguments for student support:

  1. Efficiency: It is in society's interest to subsidise education because it benefits society as well as the individual.
  2. Equity: Because there are limits to the ability of students to borrow against their likely future income, those without the means to support themselves while studying can get an education only if the government provides support. This argument also has a substantial efficiency aspect — if talented people of lesser means are unable to get a tertiary education then this represents a cost to society.

Policy in Australia has dealt with the efficiency and equity arguments for student support by treating the direct costs of higher education (tuition fees, textbooks, etc) quite differently from the larger but more indirect costs, predominantly in income forgone by not working. The Higher Education Loan Program (HELP), which replaced the former Higher Education Contribution Scheme (HECS), is explicitly aimed at sharing the direct costs with the student through income-contingent loans. Around 92 per cent of domestic university students are in places supported by the Australian government and are therefore eligible for HELP.

For direct costs the efficiency argument has held sway — through HELP the student covers part of these costs, while other costs are covered by a system of grants to the States and to tertiary institutions.

However, student income support — which can be seen as either support to mitigate the indirect costs of education or income support to a person undertaking an approved course of study to improve their long-term employment prospects and self-reliance — has always focused on and been justified by the second argument; without this support, access and equity in higher education would be compromised.

Income support for students is spread across several programs with varying conditions and rates — Youth Allowance, Austudy and ABSTUDY. In addition, the parents of many full-time students receive the base rate of Family Tax Benefit Part A — an arrangement that can continue until the student is aged 25 (see Section F3 Family and youth assistance).

The Government announced that the age of independence for students (the age to which the parental income test is applied) will be lowered to 22 by 2012. Young people become eligible for Newstart Allowance at 21. Aligning the age of independence with the age at which young people become eligible for adult rates of unemployment payments would create a simpler system and avoid favouring unemployment over studies.

The single without child rate of Austudy and Youth Allowance are lower than both the single and partnered rates of Newstart Allowance. Student income support has been the focus of recent major reforms, following the Bradley Review of Higher Education, which found that higher education is becoming less affordable. It concluded that 'the contributions made by students themselves through the income-contingent loans scheme are currently appropriate and should not be increased any further' (DEEWR 2008, p. 58). It went on to recommend some changes to income support for students relating to the extent and the circumstances in which students should be considered dependants of their parents, such that the parents, rather than the taxpayer, should be called on where they are able to partly or fully support them. It also recommended a relaxation of the income test free area for student assistance to allow students to keep a higher proportion of what they earn. The Australian Government has accepted this last recommendation. In addition, the Bradley Review made two findings of relevance to this Review:

  • The level of income support paid to eligible students should be considered in the context of the findings of the Pension Review.
  • Further work should be undertaken on the feasibility, and impact on students, of introducing a loans supplement scheme or using FEE-HELP as an instrument for income support (p. xxvii).

The Review Panel is in favour of further analysis of an optional income support top-up through the existing income-contingent loans scheme.

The basic structure of student income support is Youth Allowance for those under 25, Austudy for those 25 and over, and ABSTUDY for full-time Indigenous students (for whom there is additional support). These payments differ from other income support payments in several ways.

  • Payment rates are the lowest in the income support system for those without children, although, subject to the passage of enabling legislation, relatively generous lump-sum scholarships will now be paid by the Australian government yearly to university students, especially if the student has to move away from home.
  • Personal income tests are more generous than for most other income support payments. An income bank effectively allows work over long holidays to be averaged over a longer period.
  • The notion of 'dependency' on parents will be reorganised, subject to the passage of enabling legislation. On the one hand, more students are considered dependent for income support purposes. On the other hand, the taxpayer's contribution to middle-income families with dependent students has been greatly increased through changes to the parental income test.

This structure is based on the idea that full-time students can supplement their income with paid work, either part-time or in holidays, or both. As a consequence, Australia now has the highest rate in the OECD of tertiary students who are also doing paid work. There are good arguments that people's study years and labour supply years should be separated, particularly where there is a risk that the need to work compromises study choices and achievement. But there are also good arguments that combining work and study can improve both. Even if it is considered generally desirable for post-school students to work part-time, some of them may risk hardship under the current system, such as those unable to supplement their student income support with paid work because of where they live, their choice of course or study load, the unavailability of suitable employment, caring obligations or disability.

The rates of Newstart Allowance for single adults are sometimes compared with the rate of Austudy and student Youth Allowance for those over 21. That Newstart Allowance is paid at a higher rate may present adults with an incentive to abandon full-time study for unemployment. However, the loss of future income in abandoning full-time study is so large relative to any short-run differences in income support rates, and the number of students affected so relatively small, that this may not be a significant practical problem.


12 Rates of payment for participation category customers aged less than 21 are discussed in Section F3 Family and youth assistance.

13 Rates of payment for student assistance category customers aged less than 21 are discussed in Section F3 Family and youth assistance.

14 Rates of payment for pensioners aged less than 21 without dependent children are discussed in Section F3 Family and youth assistance.