WHY THE HENRY REVIEW FAMILY TAX REFORMS ARE UNSUSTAINABLE

Women and Tax Seminar, 30 July 2010

Patricia AppsFaculty of Law, University of Sydney, ANU, UTS and IZA

The University of Sydney

HENRY REVIEW FAMILY TAX REFORMS

Focus on HR recommendations for:

• Personal Income tax: a simplified rate scale with a “high tax free threshold with a constant marginal rate for most people” to replace Personal Income Tax scale, Low Income Tax Offset (LITO) and Medicare Levy (ML)

• Family Tax Benefits: replace Family Tax Benefit A and B by “a single family per-child payment … withdrawn with a single means test defined on family income … at a single taper rate of 15-20 per cent ”.

ORDER OF PRESENTATION

1 HR reforms are “more of the same”:Joint family income tax system with high MTRs and ATRs on married mothers as second earners

2 “Targeting fallacy” – the idea that universal child payments are more costly than targeted payments

3 HR reforms: negative effects on labour supply contract the tax base. System is unsustainable in an ageing population.

4 Joint taxation is unfair: shifts tax burden to low and average wage two-earner families, and increases the gender wage gap.

5 Negative effects on household saving and GDP growth.

1 HR REFORMS: “MORE OF THE SAME”

Australia’s family tax system in 1980s: Highly progressive rate scale on individual incomes and universal child payments

2009-10: joint taxation with an inverted U-shaped scale for most working families due to changes in rate scale on individual incomes and withdrawal of child payments on family income.

 

HR proposals - a consolidation and perpetuation of reforms since the mid 1980s

2009-10 and HR rate scale on individual incomes

Personal Income Tax (PIT) – progressive and simple – 5 MTRs

PIT + LITO – complicated and not strictly progressive.

Medicare Levy (ML) – a partial joint tax policy instrument - omitted

2009-10 PIT scale

HR scale

Taxable Income $pa PIT + LITO ($1,350)

$0-15,000 $15,001 - $30,000 $30,001 - $35,000 $35,001 - $63,750 $63,751 - $80,000

$80,001 - $180,000 $180,000 +

0.00 0.15 0.19 0.34 0.30 0.38 0.45

Taxable Income $pa Review

$0 - $25,000 $25,001 - $180,000

$180,000 +

0.00 0.35 0.45

2009-10 and HR rate scale on individual incomes

MTRs – Income tax rates + LITO ATRs Income tax rates + LITO

-.1

0.1

.2.3

.4.5

A

TR

0 50000 100000 150000Taxable income, dollars pa

ATR 2009-10 ATR HTR

-.1

0.1

.2.3

.4.5

M

TR

0 50000 100000 150000Taxable income, dollars pa

MTR 2009-10 MTR HTR

Lower income earners above $15,000 gain. Small loss from $72,700 - $85,100 (includes ML) Gains from $85,100.

Consistent with incremental changes in PIT scale and expansion of the LITO over successive budgets.

When considered in isolation, each rate scale change appears so small as to be unimportant, and to benefit low income earners.

As part of a cumulative process, the overall shift in the tax burden towards the middle income earners has been substantial.

ATRs: 2007-08, 2008-09, 2010-11 and proposed 2013-14 rate scales.

Downward shifts in the ATR profiles indicate a disproportionate shift in the tax burden towards “middle”. Income earners from around $60,000-$80.000 have been denied an equi-proportional rate of compensation for the failure to index tax bands.

-.1

0.1

.2.3

.4.5

A

TR

0 50000 100000 150000 200000 250000Taxable income, dollars pa

ATR 2007-08 ATR 2008-09

ATR 2010-11 ATR 2013-14

Income tax + Family Tax Benefits

Example: 3-child family: children aged13 to 15 years.

Maximum rate per child 13-15 years: $6,033.45 pa, withdrawn at 20 cents on family income over $44,165 up to the base rate.

Base rate per child: $2,018 pa, withdrawn at 30 cents in the dollar at a family income thresholds $101,908.

HR reports estimates of costs for 13-15 yrs equal to FTB A

Supplements are larger than FTB B for child aged under 6.

HR recommend cutting child care payments for the second earner

These reforms need to be modeled together: rate structures omits FTB B and supplements.

ATRs and MTRs of single and two-earner families

Joint taxation - tax rates of partners are interdependent. MTRs and ATRs depend on partner’s earnings as well as own income.

We show how tax rates change when a family switches “type” by changing the labour supply of the female partner as second earner.

Two types:

• TYPE SE Single-earner family: male, as primary earner, works full time in market and female works full time in untaxed work at home

• TYPE FT Two-earner family: both partners work full time in taxed market work and earn the same incomes.

Non-labour incomes are zero and no intra-household wage gap.

3-child family

2009-10: PIT+ML+LITO+FTB A9 HR PIT + family payments excl. supp.

-.2

0.2

.4.6

.8

M

TR

0 50000 100000 150000Primary income, dollars pa

MTR SE MTR2-.

20

.2.4

.6.8

M

TR

0 50000 100000 150000Primary income, dollars pa

MTR SE MTR2

FT MTRs strongly to the left of SE MTRs – joint taxationIndividual taxation: FT family pays twice as much tax as SE familyJoint taxation: FT family pays more than twice as much tax as SE family

3-child family 2009-10: PIT+ML+LITO+FTB A HR PIT + family payments excl. supp.

-.4

-.2

0.2

.4.6

A

TR

0 50000 100000 150000Primary income, dollars pa

ATR SE ATR2ATR FT

-.2

0.2

.4.6

.8

M

TR

0 50000 100000 150000Primary income, dollars pa

MTR SE MTR2

-.2

0.2

.4.6

.8

M

TR

0 50000 100000 150000Primary income, dollars pa

MTR SE MTR2

-.4

-.2

0.2

.4.6

A

TR

0 50000 100000 150000Primary income, dollars pa

ATR SE ATR2ATR FT

3-child family

-.4

-.2

0.2

.4.6

A

TR

0 50000 100000 150000Primary income, dollars pa

ATR SE 2009-10 ATR FT 2009-10ATR SE HTR ATR FT HTR

HR PIT + family payments excl. supp.

2009-10 system: Impact on “in-work” families

“Lost revenue” - tax on increment in h’hold income due to second earnings. Average of $7110 represents 40 per cent of total income tax revenue collected from working families.

Quintiles of primary income 30386 49122 64534 82842 172722 All SE Taxes if zero 2nd earnings Net tax $pa -9149 -1092 5969 13248 45135 10822 Lost revenue $pa 3577 5894 6806 9588 9685 7110 ATR % -30.1 -2.2 9.2 16.0 26.1 13.3 PT Second earnings $pa 12808 18385 19466 22110 26046 19763 Tax on second earnings $a 4576 6106 5885 7095 9588 6650 ATR2 % 35.7 33.2 30.2 32.1 36.8 33.6 FT Second earnings $pa 17055 27744 36761 49224 50486 36985 Tax on second earnings $pa 6106 9006 11652 16649 15809 11844 ATR2 % 35.8 32.5 31.7 33.8 31.3 32.0

2 TARGETING FALLACYSingle person household

• Hypothetical economy: average earnings rise from $20,000 in quintile 1 to $200,000 in quintile 5. Fixed labour supplies.

•  Progressive rate scale funds a universal cash transfer of $20,000.• Reform: government withdraws transfer at 25 cents in dollar above

$20,000 to reduce “cost” to tax revenue.

Reform replaces progressive MTRs with an inverted U-shaped scale

Income $pa 20,000 40,000 60,000 80,000 200,000 1. Pre-reform MTR % 0.0 25.0 25.0 25.0 50.0

Cash transfer 20,000 20,000 20,000 20,000 20,000 2. Reported Reform

MTR % 0 12.5 12.5 12.5 25.0 Cash transfer 20,000 15,000 10,000 5,000 0

3. True reform MTR % 0.0 37.5 37.5 37.5 25.0 Cash transfer 20,000 20,000 20,000 20,000 20,000

TARGETING FALLACYCouple households: single and two-earner

Household can switch type from single to two-earner.

 

Assume equal split between types:

Single-earner household. Male partner as primary earner works full time in the market and the female works full time at home providing child care and related services.

Two-earner household: Both partners work full time in the market and buy in substitute services for child care and home production.

Primary income rises from $20,000 in quintile 1 to $200,000 in quintile 5.

Second income rises from $20,000 in quintile 1 to $100,000 in quintile 5.

Pre-reform: progressive individual income tax funds $20,000/household

Note increase in tax base with second earner. Universal $20,000 can now be financed by lower MTRs.

TARGETING FALLACYCouple households: single and two-earner

Reform: government withdraws transfer of $20,000 at a rate of 25 cents in the dollar above a threshold joint income of $20,000.

Assuming no behavioural effects, government can claim a “cost” saving of 65 per cent.

Single-earner household: MTRs and cash transfers Primary income $pa 20,000 40,000 60,000 80,000 200,000 1. Pre-reform MTR % 0.0 20.0 20.0 20.0 40.0

Cash transfer 20,000 20,000 20,000 20,000 20,000 2. Reported Reform

MTR % 0 7.0 7.0 7.0 14.0 Cash transfer 20,000 15,000 10,000 5,000 0.0

3. True reform MTR % 0 32.0 32.0 32.0 14.0 Cash transfer 20,000 20,000 20,000 20,000 20,000

TARGETING FALLACYCouple households: single and two-earner

Cash transfer is fully withdrawn at a primary income of $100,000 for the single-earner household, but at only $50,000 for the two-earner household. The much greater loss for the low and average wage two-earner family can be concealed by reporting the reform by household income.

Two-earner household: MTRs on 2nd income and cash transfers Second income $pa 20,000 40,000 60,000 80,000 100,000 1. Pre-reform MTR% 2nd inc 0.0 20.0 20.0 20.0 20.0

Cash transfer 20,000 20,000 20,000 20,000 20,000 2. Reported Reform

MTR% 2nd inc 0 7.0 7.0 7.0 7.0 Cash transfer 15,000 5,000 0 0 0

3. True reform MTR% 2nd inc 25.0 32.0 7.0 7.0 7.0 Cash transfer 20,000 20,000 20,000 20,000 20,000

WHY TARGETING MAKES NO ECONOMIC SENSE

Since 1980s: • Significant widening in underlying inequality• Rise in overall wage level due to productivity gains

Q1: Why switch to a less progressive individual income tax?

More equal incomes make it harder to redistribute income – need lower elasticities – put simply, most of the income is in the middle and taxing the top other doesn't raise much revenue.

This changes with increased inequality and a higher wage level. The top has more income and taxing it raises a lot more revenue.

Q2: Why raise taxes on second earners with high wage elasiticities?

Reduces female labour supply and household saving.

Makes no sense with declining fertility.

Declining fertility: Average cost of a child is greater than that of a retiree. Overall per capita cost of dependency falls.

1961 TDR=63.46%; 2050 TDR=66.20 – almost the same. Min. around 2010.

From 1961 to 2010 we should have seen large increases in resources for funding education, child care, health, and infrastructure, due to productivity gains and a larger tax base with rising female labour supply and saving.

Family tax, poor child care and other policies have undermined this mechanism for redistribution to future generations. Our “ageing crisis” is policy driven.

Child 0-14 Working age 15-64 Aged 65+

3 HR REFORMSLabour supply and saving disincentive effects

Time use data show:

1 Allocation of time to home child care, especially by the female partner, is a major form of time use when children are under school age.

Choice between home child care and market work + bought in child care drives female (or second earner) labour supply elasticities.

2 High degree of heterogeneity in female time use choices across households with similar demographics and wage rates.

3 Labour supply decisions in the child-rearing phases tend to persist after the children have left home.

Expenditure data show:

4 Family income and saving track female labour supply

FAMILY LIFE CYCLE

Disincentive effects become evident when the data are organised according a family life cycle defined on presence and ages of children, rather than age of “head” as in economics literature.

Five phases:1 pre-child phase2 child 0 – 4 phase3 child 5 – 17 phase4 post-child phase5 retirement

ABS 2005 Time Use Survey - Time uses categories: Labour supply Household production: home child care and domestic work Leisure

LABOUR SUPPLY AND HOUSEHOLD PRODUCTION

Time use profiles show pivotal relationship between female labour supply and the demand for child care.

Phase 1 fall in female labour supply tracks a large rise in home child care hours

Male labour supply changes very little.

01

00

02

00

03

00

04

00

0

Ma

rke

t h

ou

rs p

a

1 2 3 4 5Life cycle phase

Male labour supply Female labour supply

010

0020

0030

0040

00D

omes

tic a

nd c

hild

car

e ho

urs

pa

1 2 3 4 5Life cycle phase

Male dom+ccare hrs Female dom+ccare hrsMale domestic hrs Female domestic hrs

FEMALE LABOUR SUPPLY HETEROGENEITYPreceding profiles represent the “average”.High degree of heterogeneity in female employment emerges in phase 2 and continues to the retirement phase.

Employment status - phases 1 to 4.

02

04

06

08

01

00F

requ

ency

%

0 1-34 35+

Phase 2: Child 0-4

Males Females

020

4060

8010

0F

requ

ency

%

0 1-34 35+

Phase 3: Child 5+

Males Females

02

04

06

08

01

00F

requ

ency

%

0 1-34 35+

Phase 1: Pre-children

Males Females

020

4060

8010

0F

requ

ency

%

0 1-34 35+

Phase 4: Post-children

Males Females

Effective rate structure of family taxation defines a non-convex piecewise linear tax system – drives lower average hours and heterogeneity. Two households can be equally well off at either high or low hours, and so small differences in characteristics can be transformed in to large difference in labour supply and, over time, in labour productivity.

The HR reform is unsustainable with a rising TDR from around 2010:

A change in policy that lifts female labour supply and productivity and, in turn, the tax base, is required to sustain the present levels of family benefits without increasing tax rates.

With no change in policy, a rise in tax rates can be expected to contract the tax base further, and set in train a “race to the bottom”.

“Race to the bottom”

4 JOINT INCOME: AN UNFAIR TAX BASE

Household income is an unreliable measure of living standards when families with similar characteristics make different second earner labour supply choices.

The degree of error in a ranking defined on household income (or consumption) will depend on the shape of the distribution of primary income as well as the degree of heterogeneity.

To illustrate: we rank households by primary income and split the records in each primary income quintile into two types:

• Type H1: second earner works at/below median second earner hours• Type H2: second earner working above median second earner hours

Labour supply heterogeneity and ranking errors

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Pri

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nd

se

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com

es,

do

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pa

1 2 3 4 5Primary income quintiles

Primary H1 Second H1

Primary H2 Second H2

Takes only a small increase in second earnings to shift the family from a low percentile of household income to a significantly higher point in the distribution.

To justify using household income at the tax base it is it is necessary to assume either that bought-in child care is costless or that home child care makes little to no contribution to the welfare of the H1 household.

Saving Primary income quintiles 1 2 3 4 5 All SE: Saving if zero 2nd earnings -12306 -6506 -1514 3194 26514 1575 H1: Saving $pa -11900 -4649 358 5921 29344 3423 2nd earnings $pa 2005 7812 9323 12815 12912 11227 H2: Long term saving -8196 1608 8005 15878 39068 9681 2nd earnings $pa 12051 27028 32832 42773 47266 32457

Household income quintiles 1 2 3 4 5 All All: Saving $pa -12223 -3866 3282 11509 37850 7325 H1: Saving $pa -12209 -3821 3381 11664 38103 3427 H2: Saving $pa -12268 -3941 3191 11428 37733 11227

If all second earners withdrew from work after the arrival of children, their annual earnings up to retirement would fall by over 25 per cent. Household saving would fall by over 75 per cent, from an average of $7,325 pa to $1,575.

Concluding comment

• Female labour is arguably the most mobile factor of production in the economy, because of its high degree of substitutability with household production, mostly child care, in the early phases of the life cycle.

• High tax rates can be expected to have large disincentive effects on female labour supply – losses of around 40 per cent

• Strong negative effects on saving, far more so than a tax on saving directly or a tax on capital income

• saving of prime working ages couples – losses of around 30 per cent

A fair and sustainable family tax policy: a strongly progressive individual based income tax and universal family payments.