Australia's Future Tax System

Architecture of Australia's tax and transfer system

7.3 Important impacts of the personal tax‑transfer system

Adequacy of support

The personal tax—transfer system plays a key role in the social support of individuals. The primary source of income for the majority of Australians is earnings from work. The tax system provides concessions to reduce the tax paid by lower income earners, particularly those receiving transfers. The transfer system plays the societal function of providing support for people who are transitioning into the workforce or are unable to work, or not expected to work (due to age, disability, study or carer responsibilities).

A central issue for the personal tax‑transfer system is the level of support that it should provide to people with lower resources. This is usually expressed in terms of the 'adequacy' of the rate of assistance.

There are many views on what constitutes adequacy, and how it should be measured. Common adequacy measures include the use of fixed and relative benchmarks, such as replacement rates, budget standards, wellbeing outcomes and poverty lines (see Box 7.2). Measuring the adequacy of income support against these benchmarks can give different results.

Adequacy measurements that look solely at the base level of income support can misrepresent the total level of support provided to individuals and families. Supplementary payments, other sources of income and in‑kind benefits are also important determinants of the overall level of support.

The issue of adequacy of income support payments is dealt with in more detail in the companion document to be issued by FaHCSIA.

Box 7.2: Types of adequacy benchmarks

Common measurements of adequacy of income support payments include: replacement rates; budget standards; wellbeing outcomes and poverty lines.

Replacement rates

There are two main types of replacement rates. The first compares an individual's post‑retirement spending power with their spending power before retirement. The other compares the income of an individual with that of a particular group (for example, a comparison of the income of an Age Pensioner to a person who earns the average wage). An increase in the proportion of income support to wage income suggests an income support recipient has become relatively better off.

Budget standards

Budget standards are used to estimate the budget to fund the goods and services a person or family needs to achieve a particular standard of living. The Social Policy Research Centre at the University of New South Wales has developed budget standards for two levels, a 'median living standard', for households somewhere around the median standard of living in Australia, and a 'low‑cost' budget which requires frugal management but still allows social and economic participation consistent with community standards.

Financial stress indicators

These are determined by survey responses to questions on financial wellbeing. The responses enable comparisons of income support recipients to the community as a whole. A series of financial stress indicators has been included in the ABS's Household Expenditure Survey.

Poverty lines

Poverty lines set a benchmark income below which a person or household is considered to be living in poverty. A commonly used line is 50 per cent of average or median household income. An equivalence scale is often used to adjust the income of different household types to that of a standard household type used for the poverty line.

Adequacy benchmarks are dealt with in more detail in the companion document to be issued by FaHCSIA.

Measuring the level of support

Many transfer recipients receive an amount which is greater than the base rate of payment. The total income support package received depends on both the type of payment and the supplementary amounts available with that payment. The recent introduction of Utilities Allowance and 'one‑off' lump sums, in addition to Telephone and Pharmaceutical Allowance and support for carers, has increased the total cash benefits well above the base rate of payment for carers and pensioners. These supplements have also significantly altered the relationship between various income support packages. Chart 7.6 illustrates the different levels of support given to recipients, which for a single person can range from $11,364 per annum for a Newstart allowee to $19,715 for a Carer pensioner of Age Pension age. Further support of up to $2,782 a year is available for private renters through Rent Assistance.

Chart 7.6: Income support packages for selected single recipients — March 2008

Chart 7.6: Income support packages for selected single recipients — March 2008

Excludes non‑cash benefits and tax expenditures.

Source: FaHCSIA estimates, rates as at 20 March 2008.

Beyond cash payments

The support provided by governments to individuals and families also includes government services, concessions and in—kind benefits. ABS estimates show that, for welfare dependent households receiving the Age Pension, the average equivalised1 value of these benefits is $203 per week. This is almost equal to the average value of income support cash payment ($247 in 2003‑04 dollars). These in‑kind benefits therefore are an important part of the total support provided to households and individuals (Chart 7.7).

Chart 7.7: Components of final income of income support dependent households

Classified by main type of payment in 2003‑04(a)

Chart 7.7: Components of final income of income support dependent households - Classified by main type of payment in 2003-04(a)

  1. Households reliant upon income support for 90 per cent or more of disposable income classified by main income support payment, equivalised components of final income.

Source: FaHCSIA estimates derived from ABS (2006a).

Many households that receive income support have private sources of income and wealth. This is particularly the case for Age pensioners where a growing number of recipients are retiring with increasing levels of wealth, including superannuation savings. This trend is expected to continue as more people retire with higher levels of superannuation. However, the proportion of people receiving the Age Pension is not expected to decrease significantly. Projections prepared for the second Intergenerational Report (Australian Government 2007b) indicate that even with the maturation of the superannuation guarantee (SG), there will only be a modest increase in the proportion of older Australians who will not receive at least a partial Age Pension. However, the proportion of retirees on full‑rate pensions will fall from over two thirds to less than half.

Replacement rates

One approach to measuring adequacy is to consider the value of income support as a replacement for earnings — defined as the level of income that payments provide relative to the take‑home pay of an employed person. Using this approach, the replacement rate for a single allowee, such as a person on Newstart Allowance, is currently 46 per cent of the net earnings of a minimum wage earner, while a single Age pensioner receives 60 per cent. In comparison with a male on average wages, a single allowee receives 25 per cent, while an Age pensioner receives 33 per cent.2

Further discussion of benchmarks of adequacy can be found in the companion document prepared by FaHCSIA.

Changes to the real value of basic income support over time

Both pensions and allowances are indexed by the CPI to maintain their purchasing power in the face of price increases. In addition, pensions are benchmarked to earnings as measured by MTAWE. This means that pension recipients benefit from productivity growth in the economy.

The rate and indexation of pensions and allowances has changed over time (Chart 7.8). In the past 10 years, the real value of the pension has increased. Over the same period, allowances have remained flat in real terms, being linked to the CPI. The difference in real value partly reflects the different rationale for allowances which have historically been designed to provide temporary assistance and pensions which are for longer‑term assistance. Chart 7.8 illustrates this divergence for the case of couples. Allowances such as Newstart are estimated to be 50 per cent of the pension by 2035 under current indexation arrangements if real wages continue to grow at their long term average rate.

Chart 7.8: Real rates of selected pensions and allowances 1970‑2008(a)(b)

Chart 7.8: Real rates of selected pensions and allowances 1970-2008(a)(b)

  1. Annualised rates of assistance applying as at 1 January, adjusted by the All Groups Consumer Price Index.
  2. Rates include Telephone, Pharmaceutical and Utilities allowances, but exclude bonuses.

Source: FaHCSIA estimates.

The value of assistance provided to families has increased substantially, as has its role in complementing the earnings of low income working families. Over the last 21 years, transfers have increased the disposable income of a single income family earning the minimum wage by 67 per cent (Chart 7.9). In contrast, there has been little change in the real value of the minimum wage over that period.

Chart 7.9: Real income components — minimum wage single income family(a)

Chart 7.9: Real income components — minimum wage single income family(a)

  1. Couple family with a single income earner on the minimum wage with two children aged 3 and 8 and receiving full Rent Assistance.

Source: FaHCSIA estimates.

Maintaining value over time

The effect of the SG on future retirees' income will be significant. The SG commenced in 1992 and did not reach the maximum rate of 9 per cent until 2002. The influence of the SG on an individual's retirement income will depend on when they retire, whether the individual has made voluntary contributions and how long they are in paid employment.

Under a fully mature SG system, an individual who earns 75 per cent of Average Weekly Ordinary Time Earnings (AWOTE) (approximately $43,000) is estimated to have a replacement rate3 of 78.4 per cent. The same individual earning AWOTE (approximately $58,000) will have a replacement rate of 68.5 per cent. Although the replacement rate is lower for the individual earning AWOTE, their actual retirement income will be higher. If there was no SG and these individuals retired only on a full‑rate Age Pension, the replacement rates would be 48.5 per cent and 38.1 per cent respectively.

Affordability

In 2007‑08, transfers constituted approximately $70 billion or over a quarter of total Australian Government expenditure.

The affordability and sustainability of the personal tax‑transfer system is influenced by a range of factors, including: workforce patterns, such as shifting patterns of part‑time, full‑time and unpaid household employment; the levels of different payments; and other non‑financial policy settings. In addition, the size of the budget (now and in the future) and competing priorities for government expenditure will affect overall policy settings.

Demographic trends will play a significant role through their impact on the aggregate level of income support payments and the number of people in the workforce who will support these payments through the tax system.

The second Intergenerational Report (Australian Government 2007b) estimates that the ageing of Australia's population, coupled with higher life expectancies, will drive a net increase in payments to individuals from 6.7 per cent to 7.1 per cent of GDP over the next 40 years. Notwithstanding the maturation of the SG arrangements and the expected reduction in the proportion of individuals receiving a full‑rate Age Pension, Age Pension outlays are expected to increase from 2.5 to 4.4 per cent of GDP.

Non‑working age people as a proportion of working age people will increase as the population ages. This is reflected in the dependency ratios illustrated in Chart 7.10.

Chart 7.10: Past and projected total dependency ratios in Australia

Chart 7.10: Past and projected total dependency ratios in Australia

Note: The dependency ratio is the ratio of the dependent population (those aged less than 15 or 65 or more) to the working age population.

Source: Australian Treasury projections for Australian Government (2007b).


1 Equivalised incomes seek to identify the equivalent level of income households need to achieve a comparable level or pattern of consumption to a single person.

2'Net earnings' are after-tax earnings of a single adult who receives this rate over the entire tax year. The average wage comparison is based on net MTAWE. Pension rates include Telephone, Pharmaceutical and Utilities allowances, but exclude bonuses. Pension and allowances rates both exclude Rent Assistance.

3 This includes income from the Age Pension and superannuation and assumes a male who works for 35 years and retires at age 65, income indexed at 4 per cent per annum, net earnings of 7 per cent per annum and inflation of 2.5 per cent per annum.