For richer or poorer: the delicate art of messing with middle class welfare

Originally posted at The Conversation by Gerry Redmond and Peter Whiteford

(Disclosure:  Gerry Redmond and Peter whiteford receive funding from the Australian Research Council for a project on “Supporting Families: Horizontal and Vertical Equity in the Australian Tax and Transfer Systems”.)

One of the most hotly debated features of the 2011 Budget was the freezing of thresholds for some family payments. This has been described positively as a “war on middle class welfare” and negatively as punishing aspirational families.

The Treasurer argued that while the families affected are not wealthy, the government wanted to target families on “modest incomes”, and pausing indexation would make payments more sustainable.

The Opposition Leader signaled he may oppose these cuts, saying they are a form of “class war” that hammers everyday households.

In the Sydney Morning Herald, Gerard Henderson argued that family payments are not “welfare”, but are equivalent to tax relief supporting families in the important role of raising children.

Ross Gittins pointed out the next day that there are more important issues at stake than the immediate impact on families, since this debate goes to the heart of what sort of welfare system Australians want to have.

Taking it out of the tax system

The government has pointed out that Australia spends much more than the OECD average on cash payments for families with children, and is the third highest spender among rich countries.

Australia is a low spender, however, on child care and maternity and parental leave, despite the Baby Bonus and the new parental leave scheme.

Some countries also support families through tax allowances, and even though our payments are called Family Tax Benefits, nearly all spending in Australia is provided through benefits made by Centrelink.

One of the most striking features of changes since the 1970s is that governments moved assistance for families out of the tax system, first abolishing rebates for dependent children in the 1970s and then moving rebates for “dependent spouses” and sole parents into the benefit system in the 1990s.

This was done to target assistance to lower income families who could not benefit equally from tax relief. It also directed assistance to carers with responsibility for children, usually the mothers.

The Howard government partly reversed this, but only a small minority ever took the option of receiving help through the tax system. Because family payments are made by Centrelink they are labelled as “welfare”.

Family assistance

An important feature of our system is how much we target assistance to lower income families.

Families not in paid work  and receiving payments as lone parents or unemployed couples always received higher assistance per child than better-off families.

The Fraser government first introduced income-tested benefits for low-income working families, although the scheme actually didn’t come into effect until after the 1983 election.

These payments were greatly increased by the Hawke government as part of their initiatives to reduce child poverty – which they nearly halved in three years. Just before their child poverty package in 1987, the Labor government also income-tested the previously universal benefit for children, family allowances.

Family payments were increased by the Howard government to compensate for the introduction of the GST, and were extended further up the income scale in 2003 and 2004 to complement income tax cuts and to reduce effective marginal tax rates on working families.

Since 2007, the Rudd and Gillard governments have scaled these payments back, but not significantly. As Ross Gittins pointed out, the families most affected by recent changes may well be “middle class” but they can hardly be described as middle-income – less than 3% of Australian families have a single earner making $150,000 a year or more. This is not so much middle class welfare, as upper income welfare.

How much has “middle class welfare” grown?

These trends should be put in perspective. The much criticized expansion of “middle class welfare” under the Howard Government increased the average real welfare payments for the richest 20% of working age Australians by around $1.60 per week.

Over the same period, the real earnings of this group went up by more than $500 per week. While their real taxes also went up, this was not in proportion to their income.

If the income taxes paid by the richest 20% of working age Australians were the same proportion of income as in 1996 then they would be paying $60 a week more than they currently do.  And this is a conservative estimate, because if the tax sxale had been indexed the extra earnings would be taxed at their marginal rate, and not their average rate.

So the expansion of middle class welfare on average gave the richest 20% less than $2 per week, but changes in tax scales gave them more than 30 times as much.

“High income welfare”

A puzzling aspect of this debate is the fact that Australia actually has the lowest middle or upper class welfare in the OECD. Nearly all other OECD countries either provide tax relief or universal payments for all children.

Only 2.2% of Australian welfare spending goes to the richest 20% of the working age population. This has increased from 1.6% since 1996, but even this higher level is but a small fraction of the extent of upper income welfare that is common in most other rich countries.

In the USA, for example, about 16% of their lower welfare spending goes to the richest 20% of the working age population.

While our current system is expensive, it has important strengths. For families in paid work we have one of the lowest rates of child poverty in the OECD: the family benefit system is an essential way in which we help “make work pay”.

Incentives to work

The main reason why family payments go to middle income and some higher income families is that we have generous base rates of payment for lower income families and we try to not withdraw them at too high a rate in order to avoid disincentives to work.

Correspondingly, if governments wanted to substantially cut “middle class welfare” they would need to either cut benefits for lower income families or increase effective tax rates on middle income families through a tighter income test (or both).

In restraining spending to reduce the deficit, it seems reasonable that the richest 20% of Australians who have enjoyed the largest real income increases should contribute, although this should include those without children as well as those with children.

At the same time, we should be conscious of the fundamental objectives of the system and make sure that we maintain the strengths of our approach.

31 thoughts on “For richer or poorer: the delicate art of messing with middle class welfare

  1. Correspondingly, if governments wanted to substantially cut “middle class welfare” they would need to either cut benefits for lower income families or increase effective tax rates on middle income families through a tighter income test (or both).

    This makes no sense. Why would you need to cut benefits for lower income families, they’re lower class (than middle) families and therefore is not required to cut benefits to them just the middle income (class) families.

  2. Senexx, if you cut benefits to middle income families while maintaining them for lower income families, by definition you have raised effective tax rates on those middle income families. These effective rates are currently of the order of 50-60 cents in the dollar; to seriously cut this “middle class welfare” without touching lower class welfare you may have to raise them above 100 cents in the dollar.

    It’s a tradeoff imposed by the laws of arithmetic. People who talk in one breath of “cutting middle class welfare”, in the next of “supporting the truly needy”, and in the next of “giving people incentives to work” are just showing that they’ve never actually had to design a payment. If they had they’d know that you can do any two of these but only at the expense of the third.

  3. If that’s the effective tax rate by doing that then fair enough. I often see economists talk of these things but there’s never any algebra that the every person can understand so it can be verified.

    I’ve never seen the need for any welfare for the middle or upper class. The upper can afford whatever they like and the middle just need to make the rational choices & the lower only need it to get them towards a middle class standard.
    Illness being the major exception to all that, of course they should be supported. There are various other minor exceptions too, as most things depend on circumstances.

    And the incentives to work thing is a myth for most, involuntary unemployment is caused by a lack of jobs which means either the private or govt are not spending/investing enough.

    There are those that are bludgers, yes, they’re the minority and there are those that just give up after years of trying because the middle & upper income classes don’t have a clue & nor do the legislative bodies.

  4. “It’s a tradeoff imposed by the laws of arithmetic. People who talk in one breath of “cutting middle class welfare”, in the next of “supporting the truly needy”, and in the next of “giving people incentives to work” are just showing that they’ve never actually had to design a payment. If they had they’d know that you can do any two of these but only at the expense of the third.” DD wrote.
    .
    I don’t feel we need to incentivise people to work.So cut in the middle and target for the needy!
    As I think you also agree support payments unallied to any obligation are fine with me- avoid disobeying the law is the basic requirement for citizenship and I feel it is too dry and unimaginative to always have this current obsession with the “dignity” of paid labour.
    If the middle band incoemearners pay more well that is ahealthy contribution to the greater good.

  5. Murph and Senexx

    What do you mean by the middle – where would you start to income test payments and where would you want them to stop?

  6. I’ve been trying to work out what we mean by the middle for the last few years.
    I did ask around on twitter and forums at the time but the better of the messages have vanished into the ethernet (not really but finding a small tweet convo from years ago is difficult)

    I’m going off the top of my head so I could be a little out, the median or average wage for a household is around $66k if I remember rightly, so that’d be about my cut off point. If pushed I could go up to 80k but would prefer not too.
    Those beyond that point should be able to do without any welfare assistance at all.

    Never really had to employ it since I don’t have children (yet) but I figure 26k is quite comfortable for an individual to live on, add about 10k for each dependent.

    I could’ve done a little better with the numbers if I had the data on hand but the short version is I’m closer to Matt Cowgill on the topic.

  7. Senexx

    One question is whether you think that any payments for children are “welfare” or would it be OK if they were tax reductions. also would you say the middle is the same for a family with one child, with two children or with three or more children

    For example, Family Tax Benefit is paid at different levels – between $4,900 and $6,200 per child for families earning below $45,000. Above this level it is income-tested and reduced by 20 cents in the dollar until it reaches just over $2,000 per year per child. This “base rate” is not income-tested until the combined family income is around $94,000.

    Now let’s say that you want to have benefits cut out by $80,000 but you don’t want to reduce the level of payment for people below $45,000. Now if you have only one teenager you could do what we currently do and reduce the payment of $6200 by 20 cents in the dollar and it would all be gone by about $75,000. but what if you have two teenagers, – if you keep the 20% withdrawal rate then they will still be receiving payments up until $105,000. Now if you want families over $80,000 not to receive payments, you would need to make the withdrawal rate about 40%. If you have three or more children, you have to either have a higher cut out point or a higher withdrawal rate.

    Now before 2000 we used to have a 50% withdrawal rate, so we could go back there. But if you have a 50% withdrawal rate overlapping with the 30% taxx band you have a combined effective marginal tax rate of 80%.

    I think people do respond to 80% tax rates.

  8. Why the lack of desire for radical overhaul Peter ?
    Is Australia about to enter an unrivalled period of prosperity or is this a mirage that only certain educations allow some to see ?
    If we are confident that economic conditions are going to steadily improve in the next 30 years then I’d go for a more drastic overhaul and start with a base payment to everyone – adult or child.
    Income would then be taxed in the usual manner and all manner of extra benefits rebates and allowances could be removed.
    The introduction of many of the allowances etc have been done for political and not efficiency outcomes and this looks to me to have overly complicated the system of support payments.
    On this point I am much happier to rely to trained technocrats than politicians.
    The aim of maintaining good support for children is admirable as you have mentioned.Everyone could have comfort that for their basic needs the state will assist them and the tax scales will remove slightly more funds from those who earn more then the median.
    Sure this system may have families with large numbers of children being well supported but they can use the help usually and such fmailies are a rare thing anyway.
    Apart from tinkering with the staus quo what plans would you advance?

  9. Good post Peter – unfortunately participation tax rates and marginal effective tax rates aren’t well understood by either the public at large, or even by a lot of political junkies that consider themselves fairly informed about policy issues. When you dig more deeply into the middle class welfare jibe, you often find that it isn’t middle class welfare per se that is being objected to, but something else. For example, when it comes to family payments you get the view that the state should not be trying to equivalize means for households that have made the private choice to have children. Or in the case of the private health care rebate, opposition to subsidies to the private health sector is at least as important as not wanting to provide subsidies to the middle or upper class.

    Another problem in these discussions is that too many people associate a transfer with welfare. They are not the same thing!!

  10. LO the whole point of the term MCW is that it is a jibe.

    Those in the middle class want to call their handouts ‘transfers’ whereas those poor people get ‘welfare’ or ‘charity’.

    Now I understand why these payments make sense in terms of someone who is making a decision whether to get into the workforce or not, because if the settings are not right, obviously someone may end up losing more than they gain. However, the problem is when that is then extended past the point where such transfers are meaningful.

    You are also right when you say that the question of whether the state should equivalise means for the private choice of having children is really behind the jibe. Yes, of course it is. That is the whole point of a jibe is it not? Again, should there not be a question about where that equivalisation should end (if at all) and why?

    I think that my objections might be summarised in that if one is in the middle class and paying the main burden of taxes, the situation of tax plus admin in collecting tax minus payment back for middle class welfare/transfers plus admin cost in distributing payment makes no sense when one could easily have paid it out of one’s own pocket in the first place (not to mention filling out all the ffing forms). Seen in this light, those transfers to/from the middle class are actually a form of loan where those in the child rearing years get an amount to cover extra costs at that time, and then pay that money back before (when single) and after (when in middle age and retirement). Such things are normally more expensive because of the admin. than pay as you go, and did I mention interest? Even from that POV it is probably better to make such schemes limited to those on lower middling incomes.

  11. Peter,

    “the families most affected by recent changes may well be “middle class” but they can hardly be described as middle-income – less than 3% of Australian families have a single earner making $150,000 a year or more.”

    So, by extension, changes to benefits for these families are only going to affect – at most – 3% of the welfare budget. In practice it is going to be much less than this: eg if benefits for these families are going to be cut by 10%, the budget impact can be no higher than 0.3%.

    So, really, what is the point? One can only assume that the government is trying to make a political point, because from a fiscal point of view it is irrelevant. To be fiscally relevant, the cutoff would need to be much closer to median income levels.

  12. IU has raised a separate point – trying to exclude upper-income people from payments, or just trying to tax their income heavily, raises bugger-all revenue. If done badly it can, in fact, cost more than it saves.

    If you want to do that then don’t kid yourself. You’re doing it from spite, not to actually get more money to the poor. Mind you, looking at some of our rich – how they got their money, and their chronic tendency to assume their wealth imbues them with moral superiority – spite is maybe understandable. It just doesn’t do a lot to balance the books.

    If you want to raise serious money you have to tax the middle classes – that’s where the numbers are.

  13. As for Mark @11′s point about “churning” (ie paying tax and getting it back in a payment at the same time), he’s right up to a point – but only up to a point.

    There can sometimes be good reasons to churn, especially where the payment is acting as a form of insurance (do you considering paying car insurance premiums and making a claim during the year inefficient churn?) or where we want to enforce a transfer of money to a different member of the household (eg to make sure it’s spent on the kids). And minimising churn can often make the whole system more, not less, complicated – especially in Oz where income tax is based on individual income but payments are based on the household’s income.

    See this thread or this one or this or this one - all on Club Troppo.

  14. Incurious and Unread

    As someone once said “save a billion here and a billion there, and pretty soon you are talking about real money”. In the context of aiming towards a small surplus, I imagine that the Government thinks the savings are important, particularly given that they are also spending a lot of money on increasing assistance to lower income families with teenage children.

    I certainly don’t object to governments making savings as they see fit – that’s what we elect them to do. What I am not comfortable with is claims about what is going on that are misleading or hyperbolic – not that the Government is doing that.

    What the original post raised is the issue that we should aim for more informed discussion of what we are trying to achieve, and what the negatives and positives of different approaches are.

    As the original post pointed out some of the discussion about “middle class welfare” in Australia is based on the idea that it suddenly got out of control in the Howard year, but when you crunch the numbers what you find is that increased welfare payments amounted to $1.60 per week for the richest 20% of the population. Now if you wanted to fund higher welfare benefits for the poor you are not going to get very much for this. Alternatively if you wanted to give people tax cuts, you are also not going to get very far.

    In reality, when you crunch the numbers what you find is that the people who benefited most from increases in family assistance in the Howard years were families with total incomes between about $40,000 a year and about $75,000 a year. Some money spilled over to higher income grousp, but as derrida derider pointed out, this reflects the arithmetic of targeting – increase benefits and reduce withdrawal rates and that is what must happen. Now families with incomes between $40,000 and $75,000 are probably not poor, but they are certainly not what I would describe as rich.

    This doesn’t mean that changes in the distribution of expenditure shouldn’t be debated and contested, just that we should get things into perspective.

  15. The comments at 12, 13 and 15 all explain why the opposition’s claims are exaggerated but these claims are surely being made for political and not economic reasons?
    Stir up the indignation of your supporters and that sort of thing….
    As such do these commentors see the currenet system as being the best of possible outcomes in Australia’s current position?
    As an outsider to the world of government beaurocracy I do feel that any challenge to the systems put in place are often batted away with explanations couched in a jargon designed to confuse the questioner.
    What reforms to Dave, Peter and DD want to see or do they think none are necessary?

  16. Murph,

    I don’t really have a problem with universal benefits where these are relatively small and targeted to a particular need. So a millionaire gets a baby bonus of a few hundred dollars. Who cares? I don’t, because there are so few millionaires. The millionaire doesn’t because it is a pittance(for them). The government shouldn’t because it is probably more expensive practically and politically to stop that benefit than just to pay it.

    I am more concerned where middle-class welfare creates moral hazard, general damage to the social fabric, or acts to entrench rather than mitigate inequality. Subsidies for private health and private education would fall into that category, for example.

    Those things are true “middle class welfare” because the benefits only flow to the middle classes.

  17. Mozzie@15, the reason Australia isn’t doing that well when it comes to child poverty is due to the number of children living in workless households. It’s the combination of wages, family payments and, in the case of sole parents, retained (part) pension (at least prior to the 2006 reforms) that lifted children out of poverty.

  18. Well, subsidies to private education would be as you describe, if it weren’t public education that is subsidised by the private school parents…particularly the majority who are sending their children to Catholic, rural or outer-suburban private schools and doing so at personal cost not because they have more money than they know what to do with.

    It is churn, if you like, but a fairly efficient form overall imho. It is just unfortunate that so many people mistake it for a subsidy to the rich.

  19. So this is why the thread about the ladder left on the church window ledge resonated with some but not so much with me – and your explanation is precise in away that explains a feature of the way things work I didn’t know.
    However why has the impetus for more reform to address inequality faeded ? Is this the lack of control of the current government?
    A lot of bluster and if they pull of a big one, the carbon tax, the CPRS , water reform , well that’s great?
    These address more all encompassing issues as I psee them than say school fee rebates or private health insurance(?)modifications and their reform will rebalance inequality as well.
    Will a time come when the isseus you mention won’t be worth the bother to try and change?

  20. Perhaps it doesn’t quite qualify as fiddling with middle class welfare, but the following illustrates the perils of changing bits of the system, willy nilly.

    Yesterday the new minimum wage was announced – an increase of $19.40 a week. It was accompanied by the usual bleatings about affordability, and the usual platitudes about the need to maintain the living standards of those on the lowest incomes. And yet…

    A single income couple on the minimum wage currently would have an after-tax, etc, income of around $655.25 a week. That includes some Newstart allowance paid to the partner without a job. On 1 July that much anticipated increase in pay of $19.40 kicks in but the result is in OMG territory. The household’s income actually falls to $642.05. They go backwards by around $13 a week.

    It’s often the case that those on minimum wages don’t get to keep all their increase – the Government tends to claw significant lumps of it back one way or the other. But in this case it’s worse because 1 July coincides with the date of effect of a budget measure to scrap the dependent spouse tax offset, that favourite target of middle class welfare haters.

    I’m sure the Government didn’t have low income households in mind when it gave in to calls for this “reform”, but the example shows how a bit of tinkering over here has nicely shafted someone else over there.

  21. Spog, the loss of the dependent spouse offset will only affect single income couples without kids and where the dependent spouse is under 40. Further, your comparator income includes the dependent spouse drawing Newstart, which isn’t an automatic entitlement for couple households but depends on the spouse looking for work and submitting themselves to all the activity requirements associated with Newstart. So, the scenario you refer to would be limited to a) single income couples; b) where the dependent spouse is under 40; c) where there are no kids; AND d) the dependent spouse is actively seeking and willing to undertake suitable work. I’m not sure how many households would actually be caught by this definition

  22. That’s all quite true, Anthony, but I wasn’t trying to imply it was a widespread phenomenon. I was mainly making the point that a change in one part of the system can have unfortunate consequences elsewhere.

    Nonetheless, I probably should have included more detail about the circumstances.

  23. I know I’ve been a long time coming back but I really hate the automatic subscriptions thing so I end up suspending them all. I would much prefer if the box to the right was unchecked by default than checked.

    Peter, I’ll skip the maths today but my short version is if you have a household income of around 60k, say 66k using my figures from earlier, I don’t care how many children you have – you should be able to live comfortably.

    I also consider all payments from the government (unless a rebate) to be welfare.

    I also don’t consider the word welfare to be a pejorative term as many in political circles do. I use the term in its broadest context – the well-being of all.

  24. Senexx, you’re kidding right? Do you live in Canberra?

    A household on $66k in Melbourne or Sydney would be doing it pretty tough without any welfare – the cost of living in these two cities at least has risen quite strongly over the last ten years (particularly petrol but also food), even before taking into account the stupendous increase in house prices.

  25. I’d made this point before, but surely from a political/social point of view the ultimate aim should be that everybody (barring those that are mentally/physically incapable) puts something in and everybody gets something out. Ideally for the majority the middle classes – they get out something roughly equivalent to what they put in over the span of their lives. If the only way of achieving this is what seems on the surface to be excessive middle class welfare, or churn, then so be it. I don’t really understand why churn should be at all expensive anyway given computers should be able to automatically handle the vast majority of it.

  26. Patrick, no I do not. Nor could I afford to move there. That said the pay rates in Melbourne, Sydney & Canberra are also considerably higher than other areas of the country hence the cost of living.

    For those that live in Sydney, I encourage them to move West (and I don’t mean to another Sydney suburb), Melbourne – North (& I don’t mean North Melbourne) & Canberra I’ve never given much consideration too. If I extend this line of thought I’ll be straying too far from topic.

    WizofAus – that is my impression of what Nick Gruen has said on this blog for years – we mightn’t have liked the Howard Welfare churn system but it is/was efficient. I used to agree with him (yet at this very instant I can not pinpoint want changed my mind).

    On a personal historical note: I was raised in a family of 6 – 2 parents & 4 kids & we lived on a nominal income of around $30k for around 30 years.

  27. Senexx, even moving North in Melbourne (and I mean Lalor or Thomastown) won’t help that much (it will help, but more on house prices than anything else). Beyond that you are in Mernda and there is no train…

    The historical example is just not that pertinent, My parents brought a house in Canberra (Narrahbundah) in 1981 for about $10,000. Even 20 years ago a comfortable Melbournian house in somewhere like Camberwell was about $2-300,000. Now that is the entry-level in Thomastown!

    That’s without taking into account the basic cost of living.

  28. That’s exactly the point, Patrick. There may be no train, people move, there becomes a demand for the train. You get the train. Jobs are created, etc.

    The historical example demonstrates that in real terms, the family was living on less and less money and had only a few issues.

    This was also in a time of economic deregulation in a rural area hence driving up expense for those in the community.

  29. The costs benefits of Living in the country depends a lot on your individual circumstances. If you are able to ‘export product’ and so earn income in the cities , the situation can be pretty good. House land prices are much lower than Canberra or sydney. However if you are dependent on the local economy, or on a pension, it can be not so good.
    The Average income in Braidwood is less than 30thou, council rates are about 2,500 per household, electricity is dearer than in the cities and the costs of most goods (that are not grown/made locally) reflect the transport costs of being 270 ks from Sydney excetera.

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