Opinion & Commentary
The wrong sorts of tax cuts
The government has responded to criticism about the high rate of tax levied on low-income earners by arguing that low-income families in reality pay no income tax.
In a recent speech, Prime Minister John Howard took pride in the huge increase in the value of family payments under his government, and argued that these benefits were the equivalent of a substantial tax cut for low-income families.
"Since coming to office," he said, "the government has increased total assistance to families by over $6 billion a year". He went on: "A family with a single income of $35,000 with two dependent children (one under five) currently receives more than $10,000 a year in family tax benefits. They pay no net tax until their income reaches $41,808."
This claim rests on the argument that taking tax and returning it in the form of government payments is no different from giving them a big tax cut. In both cases, they end up with the same amount of cash.
But a dollar earned and retained is not the same as a dollar given up to the government and then returned in the form of a welfare payment. Earning and spending your own money is a sign of independence; relying on government hand-outs and top-ups is a sign of powerlessness.
Like everyone else, a single-income family with two children pays tax on every dollar it earns over $6000, and once it passes $21,600 a year it hemorrhages tax at a rate of 30 per cent. Howard is right that receipt of the family tax benefit (FTB) can balance or even outweigh the amount of tax the family ends up paying, but there are differences between this and a genuine tax cut.
Only some low-income households receive FTB. Families with dependent children qualify, but single people and couples without dependent children do not.
These latter two groups have fared poorly under this government: the $6000 tax-free threshold and the $21,601 cut-in for the 30 per cent rate remain unchanged.
Second, FTB is means-tested. This means that, unlike a tax cut, people receiving means-tested FTB payments are penalised if they work harder. If it really were the case that a two-child family on $35,000 pays "no net tax" until its income reaches $41,808, they would retain every extra dollar they earned until they reached this higher income.
What actually happens is that each extra dollar earned is reduced by 30 ? of income tax and a further 20 ? taper on the FTB means test. Low-income families face an effective marginal tax rate of at least 50 per cent on each additional dollar.
Third, FTB does not feel like a tax cut to recipients. Ninety per cent opt to receive it as a fortnightly payment. The remaining 10 per cent still have to pay tax up front and then seek reimbursement at the end of the fiscal year.
A government payment targeted at particular kinds of recipients, distributed as a cash handout and clawed back as soon as people increase their incomes is not a tax cut it's a welfare benefit.
To reap the incentive effects of tax reductions, it's necessary to reduce tax. Compensating people with selective welfare top-ups does not do the trick. Often, it makes things worse.
Profesrro Peter Saunders is social research director at The Centre for Independent Studies.
