Compensating households – how do the Government’s proposals stack up?

A major component of the government’s plans for a clean energy future is an assistance package to compensate for higher prices affecting households. The government will increase pensions, allowances and…

Does Gillard’s government’s household compensation package add up? jypsygen/flickr

A major component of the government’s plans for a clean energy future is an assistance package to compensate for higher prices affecting households. The government will increase pensions, allowances and family payments and cut income taxes.

From a political and social perspective, the adequacy of these compensation proposals will be critically important.

What is the impact on households?

Treasury modelling suggests that relative to the baseline, electricity prices are projected to increase by 10% on average over the five years after carbon pricing starts.

Direct energy consumption (transport, electricity, gas, household fuels) represents only 7% of average household budgets. Households also consume energy indirectly, through the energy embodied in the manufacture and transport of goods and services.

In total, consumer prices are projected to increase by 0.7% in 2012-13 under a $23 carbon price, so average household spending is expected to increase by just under $10 per week.

By 2015-16, it is estimated that carbon pricing will have raised the level of consumer prices by a further 0.2%, to a total of 0.9%. (It is worth noting that this impact is small compared with the effect of the 2000 GST, which raised consumer prices by 2.5%.)

In devising compensation it is important to go beyond these average impacts, and look at their distribution. While lower income households spend less in dollar terms on energy costs than higher income households, they spend a higher proportion of their overall budget.

For example, the average price impact for a single pensioner household in the poorest 20% of the population is estimated to be 1% of their income, while for a childless one-income household in the richest 20% of the population, the average price impact is estimated to be 0.6%.

Costs will also be higher for those with children. At any income level, some households will also have higher needs for energy, for example because of medical conditions.

How will it work?

The government proposes that there will be two rounds of income tax cuts and increases in pensions, allowances and benefits.

The centrepiece of the package is an increase in the income tax threshold from $6,000 a year to $18,200 in 2012-2013 and $19,400 in 2015-16.

Increasing the threshold potentially gives all taxpayers with incomes above $18,200 a tax cut of $1,830 a year and is very expensive, since the vast majority of taxpayers – including those with very high incomes – get the same tax cut as low income-earners.

Taxing the rich

The government considers that higher income earners can face the impact of higher energy prices without compensation. So the first tax rate will rise from 15% to 19% and the second rate on incomes over $37,000 a year, will increase from 30% to 32.5% and then 33%.

This means that the tax cut from the increase in the threshold will be gradually offset, so that overall people with taxable incomes under $80,000 a year get a cut that offsets their higher energy prices, while those above this income level will have no change in their tax bills.

Apart from compensating individuals below $80,000 a year, the increase in the tax threshold will mean that more than one million people will no longer need to file a tax return.

Increasing the tax-free threshold will therefore simplify life for low income earners and boost incentives to work.

Compensating the poor

For people in the social security system, pensions, allowances and family payments will rise. Initially, they will be paid a lump sum just before the introduction of the carbon price, in order not to lose out when prices start to rise.

Subsequently, the compensation will be provided as a separate regular indexed payment. In addition, people with exceptional expenses will be entitled to an additional $140 annually under the Essential Medical Equipment Payment.

The compensation for pensioners and allowance recipients will be sufficient to offset the projected increase in prices. For single pensioners with no other income, the cost of living impact is expected to be $204 in 2012-13, and they will receive a pension increase of $338. This overcompensation is intended to guarantee that no one who is on the lowest incomes in the community is disadvantaged.

Overall, pensioners and self-funded retirees will get up to $338 extra per year if they are single, and $510 per year for couples; families receiving Family Tax Benefit Part A will get up to an extra $110 per child and single income families with children will get $69 extra in Family Tax Benefit Part B; allowance recipients (the unemployed and young people) will get up to $218 per year for singles, and $390 per year for couples.

Don’t blame the tax for all of your power bills

In summary, the household compensation package seems well designed and likely to achieve its aims. But challenges face its reception.

Other factors may increase prices, so even though the package does compensate for carbon pricing, households may interpret other increases as being caused by it.

For example, over the past five years, real household electricity prices have risen by over 40%.

Price rises for similar reasons may wrongly be blamed on the carbon tax.