The University of Sydney
WHY THE HENRY REVIEW FAMILY TAX
REFORMS ARE UNSUSTAINABLE
Women and Tax Seminar,
30 July 2010
Patricia Apps
Faculty of Law, University of Sydney, ANU, UTS and IZA
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B by “a single family per-child payment … withdrawn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
$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 +
PIT + LITO ($1,350)
0.00
0.15
0.19
0.34
0.30
0.38
0.45
Taxable Income $pa
$0 - $25,000
$25,001 - $180,000
$180,000 +
Review
0.00
0.35
0.45
2009-10 and HR rate scale on individual incomes
MTRs – Income tax rates + LITO
.5
.4
.3
-.1
0
.1
.2
ATR
.2
.1
0
-.1
MTR
.3
.4
.5
ATRs Income tax rates + LITO
0
50000
100000
Taxable income, dollars pa
MTR 2009-10
MTR HTR
150000
0
50000
100000
Taxable income, dollars pa
ATR 2009-10
ATR HTR
150000
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.
.2
-.1
0
.1
ATR
.3
.4
.5
ATRs: 2007-08, 2008-09, 2010-11 and proposed 2013-14 rate scales.
0
50000
150000
100000
Taxable income, dollars pa
200000
ATR 2007-08
ATR 2008-09
ATR 2010-11
ATR 2013-14
250000
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.
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
HR PIT + family payments excl. supp.
.4
.2
MTR
.4
0
.2
0
-.2
-.2
MTR
.6
.6
.8
.8
2009-10: PIT+ML+LITO+FTB A9
0
50000
100000
Primary income, dollars pa
MTR SE
MTR2
150000
0
50000
100000
Primary income, dollars pa
MTR SE
150000
MTR2
FT MTRs strongly to the left of SE MTRs – joint taxation
Individual taxation: FT family pays twice as much tax as SE family
Joint taxation: FT family pays more than twice as much tax as SE family
3-child family
HR PIT + family payments excl. supp.
.2
MTR
.4
-.2
-.2
0
0
.2
MTR
.4
.6
.6
.8
.8
2009-10: PIT+ML+LITO+FTB A
0
50000
100000
Primary income, dollars pa
0
50000
100000
Primary income, dollars pa
MTR2
MTR SE
150000
MTR2
-.4
-.4
-.2
-.2
0
0
ATR
ATR
.2
.2
.4
.4
.6
.6
MTR SE
150000
0
50000
100000
Primary income, dollars pa
ATR SE
ATR FT
ATR2
150000
0
50000
100000
Primary income, dollars pa
ATR SE
ATR FT
ATR2
150000
3-child family
-.4
-.2
0
ATR
.2
.4
.6
HR PIT + family payments excl. supp.
0
50000
100000
Primary income, dollars pa
ATR SE 2009-10
ATR SE HTR
ATR FT 2009-10
ATR FT HTR
150000
2009-10 system: Impact on “in-work” families
Quintiles of primary income
SE Taxes if zero 2nd earnings
Net tax $pa
Lost revenue $pa
ATR %
PT
Second earnings $pa
Tax on second earnings $a
ATR2 %
FT
Second earnings $pa
Tax on second earnings $pa
ATR2 %
30386
49122
64534
82842
172722
All
-9149
3577
-30.1
-1092
5894
-2.2
5969
6806
9.2
13248
9588
16.0
45135
9685
26.1
10822
7110
13.3
12808
4576
35.7
18385
6106
33.2
19466
5885
30.2
22110
7095
32.1
26046
9588
36.8
19763
6650
33.6
17055
6106
35.8
27744
9006
32.5
36761
11652
31.7
49224
16649
33.8
50486
15809
31.3
36985
11844
32.0
“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.
2 TARGETING FALLACY
Single 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.
Income $pa
1. Pre-reform
2. Reported
Reform
3. True reform
MTR %
Cash transfer
MTR %
Cash transfer
MTR %
Cash transfer
20,000
0.0
20,000
0
20,000
0.0
20,000
40,000
25.0
20,000
12.5
15,000
37.5
20,000
60,000
25.0
20,000
12.5
10,000
37.5
20,000
80,000
25.0
20,000
12.5
5,000
37.5
20,000
200,000
50.0
20,000
25.0
0
25.0
20,000
Reform replaces progressive MTRs with an inverted U-shaped scale
TARGETING FALLACY
Couple 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 FALLACY
Couple 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
MTR %
1. Pre-reform
Cash transfer
MTR %
2. Reported
Cash transfer
Reform
3. True reform MTR %
Cash transfer
20,000
0.0
20,000
0
20,000
0
20,000
40,000
20.0
20,000
7.0
15,000
32.0
20,000
60,000
20.0
20,000
7.0
10,000
32.0
20,000
80,000
20.0
20,000
7.0
5,000
32.0
20,000
200,000
40.0
20,000
14.0
0.0
14.0
20,000
TARGETING FALLACY
Couple 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
MTR% 2nd inc
1. Pre-reform
Cash transfer
MTR% 2nd inc
2. Reported
Cash transfer
Reform
3. True reform MTR% 2nd inc
Cash transfer
20,000
0.0
20,000
0
15,000
25.0
20,000
40,000
20.0
20,000
7.0
5,000
32.0
20,000
60,000
20.0
20,000
7.0
0
7.0
20,000
80,000
20.0
20,000
7.0
0
7.0
20,000
100,000
20.0
20,000
7.0
0
7.0
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 REFORMS
Labour 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 phase
2
child 0 – 4 phase
3
child 5 – 17 phase
4
post-child phase
5
retirement
ABS 2005 Time Use Survey - Time uses categories:
Labour supply
Household production: home child care and domestic work
Leisure
0
0
1000
2000
3000
Domestic and child care hours pa
4000
4000
3000
2000
1000
Market hours pa
LABOUR SUPPLY AND HOUSEHOLD PRODUCTION
1
2
3
Life cycle phase
Male labour supply
4
5
Female labour supply
1
2
3
Life cycle phase
Male dom+ccare hrs
Male domestic hrs
4
5
Female dom+ccare hrs
Female domestic hrs
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.
FEMALE LABOUR SUPPLY HETEROGENEITY
Preceding profiles represent the “average”.
High degree of heterogeneity in female employment emerges
in phase 2 and continues to the retirement phase.
Phase 1: Pre-children
80
60
0
0
20
40
Frequency %
60
40
20
Frequency %
80
100
100
Phase 2: Child 0-4
0
1-34
Males
35+
0
Females
35+
Females
Phase 4: Post-children
0
60
40
0
20
20
40
60
Frequency %
80
80
100
100
Phase 3: Child 5+
Frequency %
1-34
Males
0
1-34
Males
35+
Females
0
1-34
Males
Employment status - phases 1 to 4.
35+
Females
“Race to the bottom”
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”.
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
0
50000
100000
150000
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.
1
2
4
3
Primary income quintiles
Primary H1
Second H1
Primary H2
Second H2
5
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
SE: Saving if zero 2nd earnings
H1: Saving $pa
2nd earnings $pa
H2: Long term saving
2nd earnings $pa
Household income quintiles
All: Saving $pa
H1: Saving $pa
H2: Saving $pa
1
-12306
-11900
2005
-8196
12051
1
-12223
-12209
-12268
2
-6506
-4649
7812
1608
27028
2
-3866
-3821
-3941
3
-1514
358
9323
8005
32832
3
3282
3381
3191
4
3194
5921
12815
15878
42773
4
11509
11664
11428
5
26514
29344
12912
39068
47266
5
37850
38103
37733
All
1575
3423
11227
9681
32457
All
7325
3427
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.