Australia's Future Tax System

Final Report: Detailed Analysis

Chapter F: The transfer system

F3. Family and youth assistance

F3–1 What is the role of family and youth assistance?

Ensuring children have access to a basic acceptable standard of living

Parents have primary responsibility for the financial support of their children. However, some families do not have a level of private income sufficient to adequately support their children. As income support payments are designed to be adequate only for their recipients, these families need additional income to adequately support their dependent children.

The primary role of family payments, as distinct from income support payments, is to ensure all children have access to a basic acceptable standard of living. To achieve this goal, family payments must work hand in hand with income support payments so that parents have the means to provide themselves and their children with a basic acceptable standard of living. The provision of a basic acceptable standard of living encompasses both poverty alleviation and social inclusion objectives.

Access to services such as education and health is also fundamental to ensuring access to a basic acceptable standard of living for children and to facilitating their social inclusion. Children's access to these services is as relevant as the role that family payments play in addressing the objectives of poverty alleviation and social inclusion. From early childhood onwards full access to health services and participation in education should not be restricted by a family's financial circumstances.

Poverty alleviation and social inclusion should not be considered in a static sense. While it may be necessary to provide financial assistance to families when their available income is low, social inclusion is not likely to be sustainable if families continue to rely on transfer payments as a primary source of income. It can be difficult to find the right balance between providing an adequate level of support and not providing government transfers at a level where these payments become a substitute for employment.

A general principle is that the rate of family payments should reflect the direct costs of children in low-income families — that is, the out-of-pocket expenses parents must incur to provide a basic but adequate standard of food, clothing, housing and other items necessary for the development of children. Family payments should combine with income support payments to provide an adequate level of support for both parents and children.

Principle

Family payments should be sufficient to ensure that children have access to a basic acceptable standard of living. The rate of family payments should reflect the direct costs of children in low-income families.

Horizontal equity

The principle of horizontal equity is that individuals with a similar ability to pay taxes should pay the same amount. For family payments, this involves acknowledging that people with children have greater costs and greater needs than people without children at the same level of income, and recognising that children are a valued social resource on which future living standards and the wellbeing of society as a whole depend. This suggests that taxpayers supporting dependent children should have a lower net tax burden than those without dependent children. This lower net tax burden could be achieved through tax offsets or family payments.

Applying the horizontal equity principle in pure terms would mean a universal family payment; that is, families with similar characteristics (such as, age and number of children) would receive the same amount of assistance irrespective of income. However, because family payments in Australia are paid at relatively high rates to achieve adequate levels of support for low-income families, it would be extremely costly to provide universal payments. Phasing out payments using a low withdrawal rate can provide some level of assistance to most families without the full cost of a universal family payment.

Horizontal equity can also refer to providing similar tax treatment to couples that receive their income primarily through one earner, relative to couples where both members undertake significant work. Because of the progressivity in the tax and transfer system, the couple where both members work pay lower net tax. The current system provides assistance to dependent spouses through Family Tax Benefit (FTB) Part B for those with children and through the Dependent Spouse Tax Offset, where the primary earner pays sufficient tax, for those without children.

Historically, assistance for families has addressed vertical and horizontal equity for families with dependent children in different ways. Vertical equity — the concept that people with low means should receive greater assistance than those with higher means and that those with greater economic capacity should have a higher tax burden — has been addressed by the provision of additional assistance or higher rates of family assistance to low-income families.

Although family payments in Australia have generally provided a degree of horizontal equity, since the late 1980s governments have also tended to identify points on the income spectrum where assistance has no longer been considered necessary. In the current system, this occurs through the provision of a base rate of assistance for middle-income families (though not fully horizontal, as this is also means tested).

Principle

Family payments provide a degree of horizontal equity between taxpayers with dependent children and taxpayers without dependent children. For a given amount of funding, this horizontal equity role must be balanced with the need to ensure vertical equity.

Supporting parents with young children

Families may also experience indirect costs (such as loss of income) when parents need to care for their children and have limited capacity to work. The Paid Parental Leave (PPL) program scheduled to begin in 2011 will encourage time out from the workforce after the birth of a child and provide an alternative source of income for primary carers who satisfy the employment requirements before their child is born.

Supporting the role of parents is particularly important in the period immediately following the birth of a child. OECD studies and the Productivity Commission's report on PPL identify a period after the birth of a child when it is significantly advantageous for both the child and the mother to be at home (around 0 to 6 months), with a reasonable prospect that longer periods of parental care (9–12 months) are also beneficial (OECD 2007c; Productivity Commission 2009b).

The literature also identifies a period (beyond five months) over which absences from the workforce become more critical to parents' longer-term employment prospects (Jaumotte 2003; Ruhm 1998). Maternal participation is in turn important for longer-term outcomes for mothers and their children (OECD 2007c; Jaumotte 2003).

In Australia, most primary carers (who are usually mothers) who choose to return to work after the birth of a child do so between one and three years of the birth (see also Section F1 Income support).

Family payments have a role in ensuring that the choice to spend a reasonable length of time out of the workforce to care for young children is not constrained by financial need. PPL provides a strong signal that an absence from employment is appropriate and provides an alternative source of income for primary carers after the birth of a child.

Beyond the immediate post-birth period covered by PPL, many parents continue to stay out of the workforce or reduce their hours of participation to provide care to young children. Low- to middle-income families should continue to be supported in the interests of the welfare of children, while still fostering increasing workforce attachment. For some families, one parent remains out of the workforce or works reduced hours; for other families, both parents reduce their hours of employment or forgo employment opportunities. The family payments system should support families with young children through this period, while minimising disincentives to participate in paid work, and acknowledge that families balance their work and family responsibilities in different ways.

The income support system also provides a safety net of support for parents, to ensure that both parents and children have a basic acceptable standard of living if they are unable to earn sufficient income to support themselves. Paying an additional amount for parents with young children assists in improving the adequacy of payments for this group.

Supporting parents with children six years and older

For all parents with a youngest child aged six years and over, supplementary parental support should be provided to raise the level of adult income support payments above the rate of those without children, reflecting the need to ensure that the total support provided to families is adequate.

For couples, the supplement should be provided through the income support system and withdrawn with income support payments. This recognises that the combined withdrawal of two income support payments occurs well above the minimum wage and close to the average wage.

For single parents, the supplement should be provided through the family payment system and withdrawn with family payments. Applying the income support method (used for couples) to single parents would result in assistance cutting out at relatively low levels of income, which is not desirable.

Section F1 (Income support) provides detail on the payment rates for partnered parents with youngest children aged six years and older.

Principles

A degree of assistance with income replacement for a parent after the birth of a child (to recognise their reduced capacity to participate in the labour market) should be provided through paid parental leave, and through higher rates of family assistance in the pre-school years.

Income support for low-income parents with children should, in combination with family payments, provide a higher rate than standard income support payments.

Some additional assistance (over and above the direct cost of children) should continue to be provided to single-parent families with youngest children aged six years and older.

Supporting educational attainment

Family payments should also support older children to continue with education and training. Changes to technology and the labour market have increased the need for all workers to develop their skills. It is well established that higher levels of educational attainment are associated with higher levels of workforce participation. The participation rates of both men and women in Australia with no post-school qualifications are around 10 percentage points lower than those with post-school qualifications (Kennedy et al. 2009).

Decisions to undertake post-compulsory education will be determined by a number of influences throughout a young person's life, but important decisions are often made at the point when they reach school-leaving age. For many older children and their families, access to financial support plays an important role in decisions about Year 12 completion and post-secondary school training and study.

Beyond the age of compulsory education, older children have the option of participating in the workforce on either a part-time or full-time basis. Assistance for older children should recognise that there may be pressure on them to earn income from work, in addition to or instead of full-time study, because of the financial circumstances of their family. If adequate support is not available, some people (particularly from low-income families) may be forced to compromise their educational performance or discontinue their education.

Within Australia, Year 12 completion rates vary according to socioeconomic status, location and Indigenous status. For example, James et al. (2008) found that in 2006, while the Year 12 completion rate23 was 67 per cent across Australia, for low socioeconomic status students it was 59 per cent compared with 78 per cent for high socioeconomic status students. The corresponding figures were 52 per cent for remote students and 69 per cent for metropolitan students. The rate for Indigenous students was 40 per cent. As the completion of secondary education can have a significant impact on a person's ability to find and retain employment, and is usually a pre-requisite for further education, the failure to complete Year 12 can have a large impact on an individual's future workforce participation.

Recent Council of Australian Governments (COAG) reforms aim to guarantee that young people have access to education and training opportunities. The reforms also impose a requirement that they participate in education, training or employment.24 These reforms need to be complemented by ensuring that young people have access to appropriate financial support when they do participate in appropriate education or training.

Principle

Assistance for older children and youth should support young people to continue with education and training. This requires the provision of adequate support accompanied by appropriate conditions so that payments do not favour unemployment over education and training.

Recognising diverse youth transition paths

As children grow older and become more financially and socially independent, it becomes less appropriate for parents to receive payments for their direct costs. While family payments can generally be provided without conditions on what children do (other than the requirement that they attend school), beyond the age of compulsory education, older children make more choices independently. As older children transition into early adulthood, it is more appropriate that assistance should be contingent on the circumstances of the young person, and less on the circumstances of their parents.

The transition paths of older children into early adulthood are diverse and involve many dimensions, including:

  • living arrangements — some older children will need to move away from home in order to complete their secondary or post-secondary education;
  • participation in education and training — different career paths require different levels of education and training, which take varying amounts of time to complete; and
  • participation in the workforce — different career paths imply different ages at which young people move into full-time work. Young people will also have varying capacities to combine education and training with work.

It is therefore difficult to design assistance for young people in a 'one size fits all' model. Assistance needs to be flexible enough to accommodate diverse transition paths. This may require different types of payments to people in different circumstances.

Assistance to young people should also take into account the expected availability of financial support from their parents. Although this will require imposing somewhat arbitrary distinctions between dependent and independent older children, if independence tests are designed effectively they can be a useful way to ensure that appropriate levels of assistance are available for different circumstances.

While assistance for young people should be flexible, there should also be a seamless transition from family payments to youth payments. Youths and families should be able to understand the assistance available to them and what they are required to do to receive it. There should be a single clear mechanism for assistance based on circumstances, rather than a complex choice between a number of different forms of assistance.

Principles

There should be a seamless transition from family payments to income support for young people based on a young person's circumstances.

Youth payment rates should reflect the fact that young people generally have lower needs than adults, but should be sufficient to support investment in education, training and other capability-building activities. To accommodate diverse transition paths, assistance should be flexible and should recognise that the financial needs of young people vary depending on their age, living arrangements and availability of financial support from parents.

Trade-offs and interactions with other parts of the system

The design of family payments will be a function of how objectives are prioritised. Although the objectives may be complementary to some degree, for a given aggregate level of family payments they involve trade-offs with other parts of the tax and transfer system.

Adequacy of family payments and workforce participation

The objective of family payments in relation to participation should be the same as that of the broader tax and transfer system — that is, payments should not discourage participation beyond the level that is unavoidable when providing any safety net support. There are two aspects to this. The first is ensuring that the withdrawal of family payments does not significantly add to effective marginal tax rates (EMTRs) for a large number of people. The second is ensuring that government assistance does not become a substitute for income earned from working.

In the current system, the withdrawal of income support payments can result in relatively high EMTRs. FTB Part A has therefore been designed so that it is not withdrawn at the same time as income support payments. The FTB Part A income test begins to withdraw benefits beyond the cut-out points for allowance payments and the single pension, but operates over the same income range as the income test for a partnered pensioner. The degree to which these payments can be tightly targeted at low-income families is limited by the withdrawal of income support payments.

While means testing payments keeps assistance targeted and affordable, it also necessarily imposes higher EMTRs over the withdrawal range. While the payment may achieve a poverty alleviation goal in immediate financial terms, a poorly designed means test can have a detrimental impact on participation, leading to lower family income in the longer term. The more that means tested payments are provided to families, the more significant is the compounding effect of these withdrawal rates on EMTRs.

Child care assistance also plays a role in assisting parents (particularly secondary earners and single parents) to balance paid employment with parental caring responsibilities. Child care assistance is discussed in detail in Section F4.

Principle

Family payments should be designed so as to limit the participation disincentives inherent in all targeted transfer payments. In particular, where families are eligible for more than one means tested payment or concession, the means tests need to be designed to operate in a coordinated way to avoid means test stacking resulting in high EMTRs.

Relationship of horizontal equity to poverty alleviation and workforce participation

If family payments are designed to provide for poverty alleviation for families with low incomes and pure horizontal equity between all parents of dependent children and taxpayers without dependent children, then disincentives to workforce participation for a broader range of people will be introduced. This happens because an alternative to earned income is available to a larger number of people — as family payments would be extended to families with higher incomes currently affected by the means test, and because other taxpayers would incur a larger tax burden to fund a larger total amount of family payments.

On the other hand, fully universal payments (without means tests) would reduce the EMTRs for some families, which could increase workforce participation incentives.

The degree to which payments impact on participation depends on the rate of assistance (which reduces incentives through an income effect), the withdrawal of payments (which reduces the amount of each dollar of earned income that the family keeps after tax and transfer withdrawal), and the distribution of families affected by the withdrawal of payments.

Within a given budget constraint for family payments, 'pure' horizontal equity would necessitate a reduction in the adequacy of the payment available to low-income families. If a government's budget constraint is less binding, payments could be set high enough to meet the adequacy objective, but tax rates across the population would need to be higher to support the higher cost of universal family payments.

As the primary goal of family assistance is to ensure adequacy, this objective should not be traded off against horizontal equity. Similarly, parents have primary responsibility for the financial support of their children and should not be discouraged from working due to the provision of horizontal equity payments.

Horizontal equity payments for dependent spouses (either with or without children) are payments or tax allowances intended to provide support to couples where one partner does not participate in paid employment. To ensure that this assistance is restricted to spouses who are dependent, an income test on the secondary earner's income is necessary, and this can create a disincentive to participating in paid employment. The withdrawal rate and the interaction with other income support and family payments, as well as the number of people affected by the assistance, will determine how significant the participation impact is.

Providing payments simply

Like all areas of the tax and transfer system, family payments should be easy to understand, both in how the payments operate and in the way they interact with other parts of the system. Families should be able to understand their entitlements and navigate the system without difficulty and without incurring debts. This can also build greater community support for family payments.

Simpler payments can make it easier for assistance to respond to changes in family circumstances in a timely way. The birth of a child and other events — such as returning to work, separation, re-partnering and the birth of subsequent children — impact on the family and its finances. If payments are unnecessarily complex, it can be difficult for a family to understand what is required when circumstances change.

The interaction of family payments with other parts of the tax and transfer system can be a significant source of complexity. If family payments are withdrawn at an income level where other tax and transfer rates are also changing, this can complicate decisions related to workforce participation.

Principle

Family payments should be provided in a simple and transparent form that is coherent with other parts of the tax and transfer systems.


23 In this case, the Year 12 completion rate was measured as the number of Year 12 completions (Year 12 certificates issued by State/Territory education authorities) as a proportion of the estimated population that could attend Year 12 in that calendar year.

24 These reforms are detailed in the COAG communiqué of 2 July 2009 and the National Partnership Agreement on Youth Attainment and Transitions.