Who really benefits from Australia's tax and social security system?

The Productivity Commission has just released a timely new working paper that sheds light on how Australia’s tax and transfer system functions to distribute income across the population both at a point in time and over people’s lifetimes.

Timely, because since the 2014 Budget, there has been considerable focus on how we should we deal with the budget gap between government spending and revenue.

The 2014 and the 2015 Budgets were controversial because of the perceived unfair impact of the (mostly stalled) Budget proposals on low income groups. In considering options to either cut spending or increase taxes, it is important to have a clear understanding of the distribution of welfare spending (who gets what?) and how spending is financed (who pays for it?). Are higher income groups already overburdened with taxes or are they actually benefiting too much from profligate spending on “middle class welfare”?

Effects of GST, returning to work

The report provides a descriptive analysis of the flow of personal income tax and GST and transfers to households under 2014-15 policy settings and also examines the impact of the tax and transfer system on returns to paid work. The most novel part of the Commission’s research is that it examines how families contribute via taxes and how they benefit from social security payments over the course of their lives, and it also projects tax and transfer flows forward to 2034-35.

The longer term perspective is important, since over time individuals pass through different lifecycle stages from singles to couples, to families with children, to “empty nesters”, and eventually back to surviving singles. As they move from being students to workers and eventually into retirement, individuals pay different levels of taxation and may receive different benefits.

This means that a cross section picture of taxes and benefits in a single year will not be able to identify whether people receiving benefits have either paid taxes in the past or will do so again in the future, and correspondingly whether those who are current taxpayers may need to rely on benefits some time in the future. In addition to these fairly predictable lifecycle stages, individuals are also exposed to a range of risks such as unemployment, illness, disability or family breakdown that can cause them to have to rely on benefits either for a short or long period.

Inevitably, there are a large number of technical issues involved in research of this sort. The Commission uses the Treasury’s CAPITA model to update the results of the ABS 2011-12 Survey of Income and Housing to 2014-15. In broad terms this is similar to the micro-simulation modelling undertaken by the National Centre for Social and Economic Modelling (NATSEM) at the University of Canberra.

It is also worth noting that the paper models the impact of personal income taxes and the GST which collect around $222 billion, or 63% of total Commonwealth revenue, but allocate social security spending of around $111 billion. The paper does not identify what is done with the additional taxes collected.

In projecting lifetime incomes it is assumed that people live all their life under the 2014–15 tax and benefit systems. The lifetime simulations model direct taxes and cash benefits, but not indirect taxes and non-cash benefits, such as healthcare and education. Clearly these types of estimates are artificial: no one lives their life under an unchanging tax and benefit system. But these simulations provide important information on the split between intrapersonal redistribution across the life cycle and interpersonal redistribution between rich and poor.

Our system is highly progressive

The point in time estimates confirm that Australia has both a highly progressive social security system and a progressive direct tax system. The lowest income group with private incomes less than $25,000 per year on average receive social security benefits of more than $18,000 per year, while the high income group between $175,000 and $200,000 per year receive benefits of about $120 per year. The low income group effectively pay no income taxes, while the high income group pay nearly $48,000 per year in taxes.

The lifetime distribution of benefits and taxes differs quite significantly, however, particularly for social security benefits. The middle income groups – those with annualised lifetime incomes between $25,000 and $100, 000 per year receive significantly more over time than these groups do in a single year – averaging between $4,000 and $7,000 per year. This reflects the fact that many in this group will end up receiving a part age pension after the age of 65, that many have children at some stage of their lives and that they can also experience periods of unemployment or disability.

However, these same groups pay more income taxes over their lives while higher lifetime income groups pay lower lifetime average taxes than annual taxes. Nevertheless, the distribution of net taxes (taxes paid minus social security benefits received) remains progressive across income ranges. Rather than increasing from minus $16,000 per year to $55,000 per year as they do on a current basis, net taxes rise from minus $14,000 per year to around $41,000 per year for annualised lifetime income.

The results also differ if households are ranked by their household wealth. Families with wealth between $200,000 and $500,000 (about 20% of the population) effectively pay average taxes of around 8% of their private income,which is less than that average rates paid by households with wealth between $15,000 and $200,000. The reason for this is that many of these middle wealth households are over 65 and own their own homes, but because of their low current incomes pay little in tax and receive some age pension.

More people benefit than is acknowledged

Overall, these estimates reinforce support previous findings that the Australian social security system remains well targeted by income. This less true in relation to wealth, but the policy options here are more complex since to achieve substantial savings in Age Pensions it would be necessary to either include the family home in the pension assets test or establish a large scale “reverse mortgage” scheme to encourage pensioners to draw down their housing assets in retirement, both options requiring considerable political courage and a degree of retrospectivity in terms of policy change.

A final issue that arises from this analysis relates to the question of whether people can be characterised as “lifters” or “leaners”and relates to the idea that it is only the rich that effectively pay (net) taxes. A lifecycle perspective shows that people whose lifetime annualised income is less than $25,000 actually pay more than 10% of their lifetime income in taxes (rather than near to zero), and this doesn’t include indirect taxes.

In contrast, middle income people over their lifetime receive far more in social security benefits than do people in these income brackets at a point in time. The implication is that a much wider range of people benefit from the welfare state and pay taxes to support it than is often acknowledged.

Peter Whiteford has received funding from the Australian Research Council and he received a fee for refereeing the Productivity Commission Working Paper on Tax and Transfer Incidence in Australia. He is a Member of the Chifley Research Centre's Commission on Inclusive Prosperity and is an independent Member of the Board of the National Disability Insurance Agency.