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For richer or poorer: the delicate art of messing with middle class welfare

Australia has one of the lowest poverty rates for families in work in the OECD. Flickr/adwriter

One of the most hotly debated features of Budget 2011 was the freezing of thresholds for some family payments. This has been described positively as a “war on middle class welfare” and negatively as punishing aspirational families.

The Treasurer argued that while the families affected are not wealthy, the government wanted to target families on “modest incomes”, and pausing indexation will make payments more sustainable.

The Opposition Leader signaled he may oppose these cuts, saying they are a form of “class war” that hammers everyday households.

In the Sydney Morning Herald, Gerard Henderson argued that family payments are not “welfare”, but are equivalent to tax relief supporting families in the important role of raising children.

Ross Gittins pointed out the next day that there are more important issues at stake than the immediate impact on families, since this debate goes to the heart of what sort of welfare system Australians want to have.

Taking it out of the tax system

The government has pointed out that Australia spends much more than the OECD average on cash payments for families with children, and is the third highest spender among rich countries.

Australia is a low spender, however, on child care and maternity and parental leave, despite the Baby Bonus and the new parental leave scheme.

Some countries also support families through tax allowances, and even though our payments are called Family Tax Benefits, nearly all spending in Australia is provided through benefits made by Centrelink.

One of the most striking features of changes since the 1970s is that governments moved assistance for families out of the tax system, first abolishing rebates for dependent children in the 1970s and then moving rebates for “dependent spouses” and sole parents into the benefit system in the 1990s.

This was done to target assistance to lower income families who could not benefit equally from tax relief. It also directed assistance to carers with responsibility for children, usually the mothers.

The Howard government partly reversed this, but only a small minority ever took the option of receiving help through the tax system. Because family payments are made by Centrelink they are labelled as “welfare”.

Family assistance

Another feature of our system is how much we target assistance to lower income families. Families not in paid work always received higher assistance per child.

In 1983, the Fraser government first introduced benefits for low-income working families.

These payments were greatly increased by the Hawke government as part of their initiatives to reduce child poverty – which they nearly halved in three years. Just before their child poverty package in 1987, the Labor government also income-tested the previously universal benefit for children, family allowances.

Family payments were increased by the Howard government to compensate for the introduction of the GST, and were extended further up the income scale in 2003 and 2004 to complement income tax cuts and to reduce effective marginal tax rates on working families.

Since 2007, the Rudd and Gillard governments have scaled these payments back, but not significantly. As Ross Gittins pointed out, the families most affected by recent changes may well be “middle class” but they can hardly be described as middle-income – less than 3% of Australian families have a single earner making $150,000 a year or more. This is not so much middle class welfare, as upper income welfare.

“Middle class welfare”

These trends should be put in perspective. The much criticized expansion of “middle class welfare” under the Howard Government increased the average real welfare payments for the richest 20% of working age Australians by around $1.60 per week.

Over the same period, the real earnings of this group went up by more than $500 per week. While their real taxes also went up, this was not in proportion to their income.

If the income taxes paid by the richest 20% of working age Australians were the same proportion of income as in 1996 then they would be paying $60 a week more than they currently do.

So the expansion of middle class welfare on average gave the richest 20% less than $2 per week, but changes in tax scales gave them 30 times as much.

High income welfare

A puzzling aspect of this debate is the fact that Australia actually has the lowest middle or upper class welfare in the OECD. Nearly all other OECD countries either provide tax relief or universal payments for all children.

Only 2.2% of Australian welfare spending goes to the richest 20% of the working age population. This has increased from 1.6% since 1996, but even this higher level is but a small fraction of the extent of upper income welfare that is common in most other rich countries.

In the USA, for example, about 16% of their lower welfare spending goes to the richest 20% of the working age population.

While our current system is expensive, it has important strengths. For families in paid work we have one of the lowest rates of child poverty in the OECD: the family benefit system is an essential way in which we help “make work pay”.

Incentives to work

The main reason why family payments go to middle income and some higher income families is that we have generous base rates of payment for lower income families and we try to not withdraw them at too high a rate in order to avoid disincentives to work. Correspondingly, if governments wanted to substantially cut “middle class welfare” they would need to either cut benefits for lower income families or increase effective tax rates on middle income families through a tighter income test (or both).

In restraining spending to reduce the deficit, it seems reasonable that the richest 20% of Australians who have enjoyed the largest real income increases should contribute, although this should include those without children as well as those with children.

At the same time, we should be conscious of the fundamental objectives of the system and make sure that we maintain the strengths of our approach.

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