Opinion & Commentary
Tax and welfare as carrot and stick for jobs
Last week’s cabinet reshuffle saw Rudd confidant Mark Arbib take over employment, signalling that job creation and protection will be a high priority. With unemployment set to bite, the government will need to reform incentives to work to ensure a new generation of unemployed aren’t condemned to languish on welfare rolls into the next economic cycle.
Tax reform is a good place to start.
On 1 July, the Low Income Tax Offset (LITO) will be increased from $1,200 to $1,350, and in 2010 it will again increase to $1,500. Any taxpayer who earns under $30,000 qualifies for the full amount of the LITO, while those earning up to $60,000 receive a pro-rata amount.
This effectively means that low income earners will have their tax free threshold increased. From July anyone who qualifies for the full LITO will have an effective tax free threshold of $15,000, up from $14,000 in this financial year. From July 2010, this will rise to $16,000. Because a smaller portion of their income is taxed, LITO recipients finish with higher disposable incomes than they would otherwise have.
The LITO enjoys bipartisan support. The scheduled increases were initially announced by then-Treasurer Peter Costello and were taken up by current Treasurer Wayne Swan. While the LITO is not perfect – its downside is that it increases the effective marginal tax rate for middle income earners – it is a good way to boost the living standards of low income earners but doesn’t ‘cost’ the government as much revenue as an across the board tax cut.
But could it do more?
The LITO is a tax instrument, and as such its only concern is income. Anyone who earns under the prescribed amount qualifies, regardless of where the money comes from. Each boost to the LITO represents an increase in disposable income not only for low-income workers but also for pensioners and working age income support recipients.
Similar policies have been adopted in other countries. However, while being designed to boost the disposable incomes of the poor they also have the explicit aim of boosting workforce participation. To qualify recipients must receive income from work, providing a strong incentive for people outside of the workforce to seek a job. The Earned Income Tax Credit in the USA is the most successful example of this. Introduced in the 1970s, it has become the largest anti-poverty program in the US. Similar schemes exist in New Zealand and the United Kingdom which specifically target working families.
Reforming the LITO to make it conditional upon workforce participation would provide a big incentive for those outside of the workforce to look for a job.
For many welfare recipients – such as the severely disabled and their carers – any move into the workforce is out of the question. However a growing consensus is emerging that those welfare recipients who might be able to work should do so.
Nearly one in five Australians of working age now relies on taxpayer-funded income support. As this figure grows the welfare system will become increasingly unsustainable. Recent social policy reforms made by the current and former governments – such as increasing the pension age and tightening welfare eligibility for sole parents and the disabled – demonstrates that they are aware that growing welfare dependency and low workforce participation are problems which need to be urgently tackled.
During a time of rising unemployment it might seem counter-intuitive to provide incentives for more people to move into the workforce, but providing inducements to move into jobs as they become available means that the newly unemployed are less likely to slip into long-term joblessness.
More radically, the LITO could be used as an instrument to top up the wages of the low paid while exercising restraint in real wage growth. This could lead to increased job creation at the low skilled end of the jobs market, as bosses respond to lower wage costs by hiring more workers.
In the late 1990s the ‘Five Economists’ proposed just this: by letting wages fall and simultaneously providing tax incentives to work, policymakers can increase both the supply of jobs and the demand for them – all without hurting the hip pockets of workers.
The proposal was not taken up and the high minimum wage remains one of the cornerstones of our social welfare framework, but to tackle rising unemployment and rising welfare dependency we may again need to consider such sweeping reforms.
In the meantime, a tweaking of the LITO – or scrapping it altogether in favour of something that looks more like the US Earned Income Tax Credit – would provide an excellent opportunity to increase the incentive to look for a job.
Our welfare to work system already provides an effective ‘stick’ to help push people into the workforce. Targeting the scheduled increases in the LITO only to those in work would provide a complementary ‘carrot.’
Jessica Brown is a Policy Analyst at The Centre for Independent Studies. Her paper Breaking the Cycle of Family Joblessness was published by the CIS.
