Churning the other cheek

There’s quite a lot that went into this column and then had to be taken out for lack of space. The first draft began “The memes are out in force again I see”, because it seems to me that the tax debate, like so many public debates develop more like an infection than a decent conversation.

You don’t worry too much about the quality of the arguments (Malcolm Turnbull’s initial paper was surprisingly thin). You just keep serving up the lines and then, instead of helping people assess the quality of the arguments, the media start race-calling. It all becomes obvious ‘must do’ stuff to the commentariat. Voila, lifting thresholds is not ‘real tax reform’ and cuting rates is – independently of the respective merits of the two positions that is.

(If you tread on some well entrenched institutional toes – and the institution has any stuffing as for instance the Treasury does, sometimes you get some quality pushback as Michael Chaney did today from Ken Henry. But that’s the exception rather than the rule.)

I also wanted to talk more explicitly about the dual role of the welfare state as ‘Robin Hood’ and ‘piggy bank‘. But I only had room to hint at these things.

Thanks to various people for helping me with their suggestions for the column including Peter Whiteford, Naomi Parry and the indefatigable James Farrell as well as some others.

Remaining errors are (probably!) mine.

Pun warning. There’s a rather dumb joke at the end – not really even a pun. I wrote it very quickly so it had the shape of a finished draft to hand to someone before I went out to an appointment. Then when I said I was going to get rid of it various people said they liked it. So while I take responsibility for the piece, I’m writing this to wriggle out of responsibility for the last line!

Anyway, enough of the navel gazing – the column is over the fold.

What’s so wrong with churning?

You’d think that cutting top marginal rates would have stronger political opponents than John Howard and Peter Costello. But the “cut top rates” bandwagon just keeps rolling even though each dollar spent cutting taxes for the three percent earning over $125,000 a year can’t be used to raise thresholds and so lower tax for the rest.

Now a bandwagon is starting up against ‘fiscal churn’ that’s when you pay tax only to get it back as ‘government transfers’ like family payments. Consider the Joneses. They’re a couple with one breadwinner earning around $48,000 with two kids. They pay around $11,000 in tax and then receive about the same amount back in family payments and childcare subsidies.

The right leaning Centre for Independent Studies (CIS) is on a crusade against churn. ALP Senator Chris Evans has joined in, claiming that churn creates “enormous” costs “for absolutely no economic gain.”

It sure sounds silly taking with one hand and giving with another. But there’s method in the madness. Our tax system raises revenue according to individuals’ capacity to pay. Our family payments system focuses on need and assists people according to their household income and the number of dependents.

Tax churning is the logical result of each system doing its job tolerably well. We could reduce churn by canceling the Joneses’ family payments and distributing the proceeds as general tax cuts. But we’d lose the targeting, making the Joneses much worse off. In funding general tax cuts, their family payments would in effect be shared with singles and the wealthy.

What’s not being shouted from the megaphones of the anti-churn bandwagon is that our family payments system has been incredibly well targeted on relieving poverty and helping families.

Remember Bob Hawke’s infamous claim that “no child will live in poverty”?

What a pity he didn’t read from the supporting documentation which said (essentially correctly) that “no child need live in poverty”. As pre-tax incomes became more unequal in the following years, family payments saved thousands of families and their kids from poverty and hardship. They still do.

As in other countries, a lot of our family payments go to the middle class. But that’s overwhelmingly when they’re raising children a good time for a helping hand. Why are we helping much wealthier families than the Joneses? Think about it: withdraw family payments too sharply as family incomes rise undermines families’ incentive to earn more.

On the other hand we should exclude the rich. We don’t do it perfectly. But as an Australian at the OECD, Peter Whiteford demonstrated recently, we’re way ahead of our peers.

Using 1998-99 data Whiteford showed that Australia had the least churn of any OECD country. In most OECD countries the richest fifth of households got their hands on more than a half the benefits the poorest fifth did. In the second best performer, New Zealand, the rich got a fifth as much. In Australia the figure was less than a twelfth.

Though we spent less than the OECD average on welfare benefits (which keeps our taxes below OECD averages), our own targeting was so tight that we redistributed more to the poor than any other OECD country. And disposable income for Australian families with children on social assistance was amongst the highest in the OECD.

Still the concern about churning does raise legitimate issues.

The right leaning CIS wants to reduce churn by extending self-provision for education, health, and unemployment and other hardship. We’ve begun doing so by forcing people to make superannuation contributions. That will lower churn by reducing people’s future dependence on pensions. We should do more, but the CIS underestimates the difficulties in replicating the targeting of our existing system and the bureaucracy that would be necessary for specific self provision accounts. Just look at the bureaucracy engulfing super.

From the left of centre, ALP politicians Chris Evans and Craig Emerson proclaim the iniquity of higher taxes for those without children. Now call me old fashioned but if you want to get extra cash to families with children I reckon you’ve got to get it from people without children.

Still as Evans and Emerson point out, amongst people without kids, those earning over $52,000 per year have received much larger tax cuts than those below.

These contributions from the left and right help highlight the need for vigilance in keeping family payments away from the wealthy.

We’ve increased churn and loosened targetting since 1988-89, not least in the 2000 tax package. (Back then churn was called ‘compensation for the GST’). In 2005 we extended childcare subsidies to the rich. By then we were already paying Family Tax Benefit B to 76 families earning over a million dollars a year and to nearly 40,000 families earning more than $100,000.

So, when they spot real problems, with workable solutions let’s pay attention to the critics of churning.

But let’s not churn the baby out with the bath-water.

This entry was posted in Economics and public policy. Bookmark the permalink.

8 Responses to Churning the other cheek

  1. Red Peter says:

    Well the idea of a “churned baby” has certainly left me with some strange imagery.

    …but anyway, interesting in light of the discussion around fringe benefits tax on childcare, and childcare rebates in general.

  2. Anna Winter says:

    I remember reading a few years back that there is a pretty strong link between the targetting of family payments and the amount of money paid. Many of the Scandanavian countries, for example, have the most generous family payments, and they are universal.

    I’m not sure what their reasoning was/is, but I remember thinking that it made sense – less money spent on assessments and recovering overpayments, and no disincentive to earning.

    I also think that Chris Evans’ attempts to distinguish the childless from those receiving family payments is misguided and a bit dangerous. Partly because I think there’s already a pretty serious sense of resentment on both sides that doesn’t need to be encouraged, partly because as someone who has no plans to have children of my own I can see the benefits of effectively paying others to raise the next generation :) and lastly because, as you point out, this is about rich/ middle class/ poor – it shouldn’t be about whether you have children.

  3. c8to says:

    indexing thresholds would remove stealthy tax increases.

    tax simplification would be a good thing to shout from the megaphones.

    the main thing with the top tax brackets is that only a few people without company structures pay them, and its probably worth removing this distortion. i think it would be relatively cheap to abolish the top rates and bring them into line with 30% company tax, given that there are so few taxpayers on these rates anyway. nearly 50% is a quite extraordinary rate of taxation. increasing the tax free threshold would be a good move as well, although obviously the most expensive since all taxpayers receive the benefit.

  4. Increasing the tax free threshold is all the rage amongst some for reasons that escape me. I’d rather lower it I think – and lower the bottom rate to refund the money, though I guess some tax free rate makes sense for administrative reasons.

    As for alignment with the company rate, there isn’t a problem if you charge an undistributed profits tax – which we did until Paul Keating (briefly) aligned the rates (I think in 1985).

  5. c8to says:

    yes, at some point you dont want to bother someone with a tax return if they earn a few hundred (or even a few thousand dollars)

    a friend of mine likes the idea of a flat tax starting at zero…including taxing welfare payments (theres some churn for you)…i think this is some perverse theoretical simplicity…

    why not move more people out of the income tax system.

    the reason for raising the tax free threshold is it reduces the amount of people that have to do a return (or at least a non trivial return, but the ATO should abolish the nil return totally, as they do in some circumstances)

    these people still pay tax in the form of the GST. i hope eventually income tax goes away and the government raises money through sales taxes and rents on road, utilities and lands generally.

  6. c8to says:

    i intended to put another reason in the above comment, raising the threshold reduces Marginal tax rates for people that are admittedly not earning very much, but its equitable in the sense that everyone gets a tax cut…

  7. Pingback: The Bartlett Diaries

  8. “Agitatio” – that’s an unfortunate elision. I clicked through to The Bartlett Diaries, expecting a lot of smutty taxual innuendo, only to be sorely disappointed.

Leave a Reply

Your email address will not be published. Required fields are marked *

Notify me of followup comments via e-mail. You can also subscribe without commenting.