‘Fairness test’ not so fair when it stalls policy debate

‘Fairness’ tops Bill Shorten’s policy agenda for the Labor Party, so it’s time we defined what’s fair and what isn’t. Paul Miller/AAP

Australia needs a mature, intelligent conversation about “fairness”, a word that has become the mantra of the Labor party and it’s leader Bill Shorten.

Addressing Labor’s national policy forum last year, Shorten said:

“Fairness drives prosperity, it underpins growth, it lifts living standards, it creates jobs, it gives everyone the chance to fulfil their potential.”

Politicians increasingly talk of the need for every policy proposal to pass the “fairness test”. Consider the recent examples: university fees, pension indexation, Medicare co-payments, superannuation tax concessions and other superannuation regulations, penalty rates and other workplace arrangements governed by the Fair Work Act, paid parental leave and the Newstart allowance.

If any single policy change is suspected of having disproportionate costs on low income earners it is voted down by Labor and the Greens, who also manage to sway most of the now key independent Senators. This is infantile and damaging to community wellbeing.

We need a more sophisticated holistic approach to evaluating the fairness of public policies. The entire annual government budget should be submitted to the Productivity Commission (PC), for an assessment of its affect on inequality. The Parliamentary Budget Office could possibly do the job if its remit were widened and it were resourced appropriately. It should not be given to the Australian Treasury whose budget and other forecasts have been woefully inaccurate and whose Intergenerational Reports have become politically biased.

The PC reported in 2013 detailed work on trends in income inequality in Australia. Their report shows the devilish complexities in measuring inequality compared with other measures of economic and social performance like unemployment, national income and housing affordability. So it will be difficult, but the PC has shown it’s up to the task through its analyses of other complex problems such as the socio-economic impact of climate change policies.

Inequality in Australia has risen very slightly over the past 25 years according to the PC’s 2013 report and the Australian Bureau of Statistics (ABS). Inequality was stable from 1989 to 2004, rose from 2004 to 2010 as the pre-GST boom benefited those with high income and wealth more than others, but it has declined since 2010 according to the ABS.

From 1995 to 2012, the incomes of households at the lowest 10% of the distribution increased by 47% after inflation and adjusting for household size. This compared with a 60% increase in incomes of the top 10% of households. Both low and high income households have become better off, but the high income households a little more so – hence the increase in income inequality.

Is this a problem that should cause parliament to reject every single measure that looks like it might have the effect of tweaking the income distribution? Rising incomes at the bottom and the top is the result of productivity growth and higher commodity prices over that period (the latter having recently declined). The question is: what would happen to productivity growth if we tried to even up the income distribution by rejecting any policy proposal that does not achieve this aim?

Redistribution problems

Here the evidence is unfortunately rather ambiguous. New research by the Organisation for Economic Cooperation and Development (OECD) has shown that inequality is bad for productivity growth. They found that between 1985 and 2005 the effect of rising income inequality in advanced countries, by a magnitude of a little more than the increase experienced in Australia over that period, reduced GDP by 0.65% per year on average. The reason is that low income earners tend to under-invest in the education of their children, so too many low income earners implies too little education which harms productivity. This tends to support the idea of redistributing household disposable incomes through taxes and welfare benefits.

But not so fast. Recent research by the International Monetary Fund has found that too much redistribution is bad for productivity growth. Redistribution implies higher taxes and/or lower tax breaks, which reduces the incentive to work, save and invest, all of which leads to lower productivity growth. This evidence is pertinent to Australia since we have one of the most redistributive tax-benefit systems in the world, due to our heavy use of means-testing. We means test a range of benefits and tax cuts, in particular family payments such as child care benefits, family tax benefits and the age pension. Means testing is a double-edged sword - it is fair in the eyes of many people, yet it implies high effective marginal tax rates as higher income implies a loss of benefits. And high effective marginal tax rates are disincentives to earn income.

All of this research focuses on effects of overall inequality. It is therefore not good enough to focus, as the Australian Parliament does, on individual measures. In a package of changes some measures will net out. For example tough pension rules and generous superannuation concessions could net out for many people in the long term – but in isolation both might be considered unfair. Similarly, university students may have more debt to repay through the tax system in due course, but their income tax rates may be lower due to lower government debt than would otherwise be the case. Indeed any analysis of the effect of a budget package on inequality must take account of the implied future tax liabilities.

Australia has an unhappy history of reform packages. Recall the “Fightback!” package under former Treasurer John Hewson in the 1980s, which allowed Paul Keating to destroy the Coalition government by attacking the parts of the package that were hardest to sell – like the GST that would apply on a child’s birthday cake. Joe Hockey’s first budget is a more modest package but has met a similar fate.

In part we need a cultural change when it comes to evaluating major public policy initiatives. A complete overhaul of the Senate electoral system is perhaps too much to hope for (New Zealand-envy is understandable). But a good place to start would be an objective analysis, each year, of the inequality implications of the budget package of the government and indeed the opposition’s alternative policies.