In Parts 1 and 2, I used three desirable attributes (equity, efficiency and simplicity) of a coherent tax and transfer system to assess the 2020-21 personal income tax changes and the lack of a rate increase for JobSeeker recipients. In Part 3, I examine family assistance and child care.
Broadly, family assistance serves two equity goals: vertical equity to protect families from poverty and horizontal equity to acknowledge that at all incomes those with dependent children have more needs and lower capacity to pay tax than those without dependent children. The assistance is also designed to address two different costs families with children bear: the direct costs involved and the costs of caring for them when they are young.
Family assistance arrangements are even more complex with a variety of payments and tests, causing high effective marginal test rates
Family assistance arrangements have become even more complex than the personal income tax system and pension/benefit arrangements. This is related to the confusion over and tension between vertical and horizontal equity goals, and the failure to clarify the costs the assistance is intended to address. Apart from Family Tax Benefits A and B, there are parenting allowances, parental leave and child care subsidies. Most but not all are means tested, based on the joint incomes (and assets in some cases) of parents, and in some cases those tests are very tight.
The means test arrangements result in very high effective marginal tax rates as assistance is withdrawn above designated thresholds and income tax is also applied, typically leaving parents with 20 cents or less of each extra dollar earned until the relevant assistance reduces to zero (or to any universally paid amount). The behavioural impact is likely to be greater amongst mothers than fathers on average as it is mothers who are more often able to adjust their hours of paid work.
Of course, reducing effective marginal tax rates requires either reducing assistance at low incomes or increasing assistance at high incomes (or both). The challenge is to get the balance of vertical and horizontal equity right, avoiding too many people facing too high effective marginal tax rates.
The problem is not just child care, some other family allowances should also be made universal
Labor has rightly drawn attention to the disincentive effects of such high effective marginal tax rates, but focused only on child care, not the other components of family assistance (though they have promised to refer the broader system to a Productivity Commission inquiry).
A broader review might start with the family assistance that is aimed to compensate for the direct costs of dependent children. Originally, family allowances were universal, incorporating child tax rebates into the pre-existing universal child endowment. They recognised that, at all income levels, those with dependent children have lower capacity to pay tax than those without. They did so more fairly than the previous system by extending the value of the rebates to those below the tax threshold, and they transferred the assistance ‘from wallet to purse’ providing the assistance to mothers who more often bear more of the direct costs of children.
While not opposed to means-tested supplements to the basic allowances to provide additional support for very low income families, I believe the case for some universal family allowances is strong and would allow some relief to the effective marginal tax rates families now face. The work incentive benefits are likely to be greater than those from reducing marginal tax rates in the personal income tax scale, and the gains would be confined to higher income families with children, not everyone on higher incomes.
A similar argument may be mounted (as Labor has done) for extending universal support for child care to reduce high effective marginal tax rates. But child care is just one part of the assistance available for the costs of caring for children, and it is only available to those who choose to use formal child care, not those who forgo income to care for children themselves, or who choose to use informal care (such as grandparents). The fact is that very young children require the full-time care of an adult, a cost society should help to cover whoever the adult chosen to undertake the task.
A more equitable and less complex proposal
Society is rightly concerned to ensure the care that is supported is safe and of adequate quality. Also, as the Productivity Commission suggested in 2015, there is a strong case for separately funding the education and development needs of pre-school children and this is most effectively delivered via formal child care providers. But exclusive direction of care subsidies via child care is not the optimal solution. Moreover, it has led to extraordinarily complex rules around eligibility, beyond means testing to work activity testing etc. Surprisingly, the Productivity Commission’s last report in this area did not canvass the interaction between child care assistance and family payments aimed to assist with the costs of caring for young children.
I strongly suspect that a more equitable and less complex arrangement would replace some of the child care assistance, and some of the tightly means-tested parenting payments, with universal payments in respect of the care of young children. These might, for example, comprise the universal maternity leave now available for 18 weeks, then a lower but substantial payment while the child is under two and a lesser payment in respect of children aged between two and six. More modest child care support might then supplement these payments with more relaxed means-testing, perhaps as Labor suggests.
This would allow a significant reduction of high effective marginal tax rates, but also recognise that a high proportion of mothers (sometimes the fathers) do choose to withdraw from the paid workforce while their youngest is under two and to return to full-time work gradually. Probably those with the most ‘human capital’ in terms of education and experience will draw on others to care for the children, to the benefit of the economy, but such an arrangement would still allow them the choice not to do so without undue penalty.
It would also involve retaining some user charges for child care, not an unreasonable discipline on providers to promote efficiency and quality if appropriately complemented by regulation.
There is considerable scope to simplify the tax and transfers system and achieve greater coherence in addressing equity and efficiency.
The Government’s claim that Stage 3 of its tax reforms would greatly enhance incentives is exaggerated and ignores more important incentive concerns in the tax and transfers system that could be addressed without unduly redistributing away from those on low incomes. Similarly, its concern about retaining incentives for the unemployed to search for work could be achieved while having a much more adequate level of Jobseeker (using the work test).
Labor is on the right track in looking to reduce effective marginal tax rates to enhance incentives for women, but is focusing too much on child care subsidies and needs to broaden its consideration of family assistance to better balance vertical and horizontal equity and give families more choice over their child care arrangements.
This article was first published by the Tax and Transparency Policy Institute.