Equity, Tax Reform and Redistribution

Equity, Tax Reform and Redistribution
Research Paper No.28

Policy Review Branch
Development Division
Department of Social Security
April 1985
EQUITY, TAX REFORM
AND REDISTRIBUTION
Submission prepared by the Department of Social Security for the Economic Planning Advisory Council
meeting of 29 March 1985.
The authors of this paper are Ann Harding and Peter

Whiteford.
Considerable assistance was provided by Lynelle Briggs,

Judi Robinson, Roger Smith and David Cocking.*
Policy Review Branch,

Development Division,
Department of Social Security April 1985.
* Many thanks also to other members of Development Division for helpful comments on earlier drafts,
to officers of the Australian Bureau of Statistics, and to the Department's word processing operators,
particularly Robyn Soxsmith and Sylvia Gloster.
ISBN 0 642 51595 4 C.J. THOMPSON COMMONWEALTH GOVERNMENT PRINTER
SUMMARY OF KEY POINTS
Interaction of the Taxation and Social Security Systems
The social security system, like the taxation system, has a major effect on income distribution. While
the two systems are often considered separately they are so closely linked and interact to such a degree
that exclusive concentration on one system alone may frustrate achievement of equity goals. The social
security and taxation systems, for example, have overlapping populations and income tests. Personal
income tax and social security cash transfer mechanisms can also be alternative mechanisms for
achieving equity goals. Similarly, social security recipients and other low income groups pay (and are
disproportionately affected by) indirect taxes.
This suggests that unless the taxation and social security systems are considered together when
designing tax reforms, adverse and unintended distributional effects could easily result. A corollary is
that whether any particular tax or social security measure is progressive or regressive when considered
in isolation is less important than the effect of overall changes to tax-transfer arrangements.
Equity and the Reform of the Direct Tax System
The narrowness of the income tax base, tax avoidance and evasion and consequent revenue constraints
have directly affected the living standards of low income groups, by reducing the revenue available to
finance such redistributive measures as increases in the basic tax threshold and social security cash
transfers, and reductions in marginal tax rates. Tax reforms aimed at reducing tax avoidance and
evasion, broadening the income tax base or introducing new taxes which more fully recognise the
additions to "capacity to pay" bestowed by capital gains, inheritances and gifts, employment fringe
benefits and ownership of wealth must therefore be considered desirable.
Much of the tax reform debate has focussed on the need to reduce the tax burdens and marginal tax rates
of those earning average weekly earnings and above. However, the absolute or relative declines since
the mid 1970's in the disposable incomes of low income groups and families, in comparison to taxpayers
without children at AWE, and the higher effective marginal tax rates facing social security recipients
(which exceed those of taxpayers on the highest incomes) suggest that these groups warrant priority in
any tax-transfer reforms.
Equity Implications of Broadening the Indirect Tax Base
While a major extension of the indirect tax base may reduce work disincentives and increase tax paid by
tax avoiders and evaders, it will also create major inequities.
Data on the expenditure patterns of households show that extension of wholesale sales tax to the major
currently excluded item of food would create vertical and horizontal inequities, ie. it would adversely
affect low income households more than middle and upper income households, and at every income level
would affect those with children more than those without. Low income households with children would
be particularly hard hit.
Introduction of a broad-based, uniform-rate goods and services tax (GST) could also be both vertically
and horizontally inequitable. For example, on the basis of 1984 HES data, it could take up to 5 times as
high a proportion of income from the poorest households as from the most well-off. Similarly, families
with children could pay up to 40 per cent more of their incomes in additional tax than those at the same
income level without children.
If the tax burden on low income groups were not to be increased following introduction of a GST, major
increases in social security payments, other outlays, or new tax measures such as tax credits or negative
income tax schemes would be required, as many low income groups do not pay sufficient income tax to
be compensated via personal income tax cuts.
For social security clients, the existing automatic six monthly indexation increases in pensions and
benefits based on the CPI will not provide adequate compensation because:
• there is a lag of up to 10 months between price increases and the 'flow-on' to pensions and
benefits;
• the CPI may not adequately reflect the effect of tax and price changes on social security clients, as
their consumption patterns differ from the 'average' captured in the CPI;
• part of the compensatory payments may be lost in income tax;
• the real value of savings or of non-pension/benefit incomes may be reduced by a new indirect tax;
and
• those who are dissaving (eg. by running down their savings or going into debt) would lose.
In addition, many social security payments and income test thresholds are not automatically indexed.
Special compensatory initiatives may be required for families with children, the recipients of income-
tested cash transfers from other Government Departments such as Veterans' Affairs and Education, and
for low income earners in the workforce without children, who do not pay sufficient income tax to be
compensated via tax cuts, yet who are also ineligible for any existing social security cash transfers.
These factors suggest that adequate compensation for low income groups from the losses associated with
the introduction of a GST would probably require:
• immediate ad hoc increases in all social security rates substantially higher than the estimated
effects of the new indirect tax on the CPI (with appropriate adjustments being subsequently made
when any normal pension indexation increases fell due);
• adjustments to the income tax threshold or pensioner/ beneficiary rebates so that part of the
additional compensatory pension increases were not subsequently returned in income tax;
• some further increase in pension and benefit rates to create a "buffer zone' which would ensure
protection against losses arising from dissaving, the decline in the value of savings and/or non-
pension/benefit incomes (which particularly affects the aged), and the additional indirect taxes
borne by those pensioners and beneficiaries whose expenditure patterns are not average;
• the adjustment of all social security income and asset test thresholds by the average increase in
indirect taxes paid by pensioners and beneficiaries;
• major increases in family allowances and family income supplement; and
• the introduction of new social security cash transfers or tax credits for low income groups in the
workforce, or rationalisation of the existing system into a guaranteed minimum income or
negative income tax scheme.
Tax Reform and Redistribution
Altering the tax mix in conjunction with any appropriate compensation measures may improve equity in
the income distribution. However, unless there is some redistribution of income to low income groups
which improves their absolute standards of living, a key objective of tax reform in the minds of many
would remain unsatisfied. What prominence this objective is to have is one of the as yet unresolved
issues in the wider debate about tax reform.
CONTENTS PAGE
1. Introduction 1
2. The Interaction of the Taxation and Social 3

Security Systems
3. Equity and Priorities for Tax Reform 7
3.1 Broadening the Income Tax Base and Reducing 7

Tax Avoidance and Evasion
3.2 Changes to Personal Income Tax Schedules 9
3.3 Effective Marginal Tax Rates and Poverty 17
Traps
3.4 Contributory Financing of Social Security 20
3.5 Broadening the Indirect Tax Base 21
3.5:1Wholesale Sales Tax 22
3.5:2. Taxation of Services 24
3.5:3. Goods and Services Tax 26
4. Measures to Protect Low Income Groups and 32

Families with From Indirect Tax Changes
4.1 Indexed Social Security Pensions and Benefits 33

4.2 Non-Indexed Social Security Payments 38
4.2:1. Pensions and Benefits 39
4.2:2. Assistance For Dependent Children 39
4.2:3. Other Payments 41
4.3 Other Government Transfer Payments 42
4.4 Low Income Groups Currently Receiving No 42
Social Security Assistance
4.5 Compensation and Women 48
4.6 Costs of Compensation 49
5. Measures to Protect Low Income Groups and 50

Families with Children From Direct Tax Changes
6. Compensation and Redistribution 52
7. Summary and Conclusions 56

Appendices
Appendix One: Extract From Government Taxation 62
Policy Statement by the Prime Minister:
31 October 1984
Appendix Two: Effective Marginal Tax Rates Faced 63
by Social Security Recipients
Appendix Three: Contributory Financing of Social 67
Security
Appendix Four: Additional Statistical Tables 72
Appendix Five: The Incidence of Broad-Based 81
Consumption Taxes
Appendix Six: Guaranteed Minimum Income Schemes 84
Bibliography 86
TABLES PAGE
Table 3.1 Average and Effective Marginal Tax Rates in 11
1976-77 and 1984-85 for Various Categories
of Taxpayers
Table 3.2 Real Changes in Components of 12

Incomes Between 1976-77 and 1984-85
Table 3.3 Changes in Real Disposable Incomes of 14

Various Family Types, 1976-77 to
1984-85 (estimated): Per Cent
Table 3.4 Expenditure on Food as a Percentage of 23

Disposable Income for Various Household
Compositions and Income Groups
Table 3.5 Effect of a Tax Which Increases 25

Expenditure on Food by 10 Per Cent:
By Household Composition and Income
Table 3.6 Additional Indirect Tax and Additional 28

Tax as a Percentage of Disposable Income
After Imposition of a GST Which Increases
Household Expenditure by 10 Per Cent:
By Household Composition and Income
Table 4.1 Comparison of Income Tax Payments and 41

Hypothetical GST Payments for Single Earner
Couples with Children at Various Low
Income Levels
Table 4.2 Weekly Earnings of Low Income 44
Employees (August 1983)
Table 4.3 Comparison of Income Tax Payments 45

and Hypothetical GST Payments for Low
Income Taxpayers Without Children
Table 4.4 Weekly Earnings of Low Income 49

Employees: Distribution by Income
and Sex (August 1983)
Table 6.1 Illustrative Social Security Expenditure 53

Priorities
APPENDIX FOUR : ADDITIONAL STATISTICAL TABLES

Contents
Table 1 Effect of a GST on Families 73

in 1975-76
Table 2 Effect on the Disposable Income of 74

Single Pensioners of a GST Which
Increases Their Expenditures by
10 Per Cent
Table 3 Effect on the Disposable Income of Single 75

Adult Unemployment Beneficiaries of a GST
Which Increases Their Expenditures by
10 Per Cent
Table 4 Effect on the Disposable Income of Married 76

Pensioners of a GST Which Increases Their
Expenditures by 10 Per Cent
Table 5 Effect on the Disposable Income of Married 77

Unemployment Beneficiaries of a GST Which
Increases Their Expenditures by 10 Per Cent
Table 6 Pension Type By Income As Assessed, 78

December 1984: Per Cent
Table 7 Beneficiaries by Total Non-Benefit Income, 79

November 1984: Per Cent
Table 8 Pension Type By Type of Non-Pension Income, 80

December 1984: Per Cent
1.INTRODUCTION
In the Government Taxation Policy Statement of 31 October 1984 the Prime Minister announced nine
principles for tax reform (Appendix 1). This submission concentrates on the fifth and sixth of these
principles, which are:
• any reform package must result in a tax system which is fairer, so that Australians are only required
to pay tax according to their capacity to pay, and the overall system must be progressive; and
• any tax reform must not disadvantage recipients of welfare benefits, and should reduce or remove
'poverty traps'.
These two principles suggest that, at a minimum, social security recipients and other low income groups
should not be adversely affected by tax reform, and that the overall equity of the system should be
improved. Accordingly, this submission identifies some of the major inequities in the current taxation
system and the resulting priorities for reform. These inequities include:
• negative aspects of the increasing interaction between the social security and income tax systems,
including the high effective marginal tax rates facing recipients of income-tested government
assistance and the consequent creation of poverty traps;
• the decline relative to taxpayers without children at average weekly earnings since the mid-1970s
in the disposable incomes of low income groups and of all families with children, due, amongst
other reasons, to the decline in the real value of the tax threshold and family allowances; and
• the narrow definition of income used in the personal income tax system, which fails to recognise
fully the increases in capacity to pay tax resulting from receipt of such items as fringe benefits and
capital gains.
Possible solutions to these problems are then discussed.
As noted above, it is clear that low income groups should not be adversely affected by any tax changes
which address these or other problems. Consequently, this submission also analyses those tax measures
which would increase the tax burden of low income groups, and then discusses possible methods for
either exempting low income or disadvantaged groups and families from such taxes or for returning the
additional revenue collected from such groups to them, so that their real incomes remain the same.
PAGE 1
This submission's discussion of compensation for any tax reforms is not based on such questions as which
low income groups are most deserving of compensation, but is simply based on distributional neutrality.
In other words, if the tax burden upon the poor is not to be increased, then any new taxes they pay must
be offset, so that their net position remains constant.
However, the redistribution of income, rather than just the maintenance of the current income distribution,
can also be seen as an important goal of tax reform. Compensation might ensure that the living standards
of low income groups do not decline after tax changes, and that they remain at the same level in an
unequal income distribution. Redistribution, on the other hand, would mean improvement in their
absolute and relative living standards. Accordingly, this submission also canvasses issues associated with
redistribution rather than just compensation.
The scope of this submission is not confined to a small group but embraces well over half of the
Australian population including some 2.7 million pensioners and beneficiaries and an estimated 1.5
million or more low income earners, who are principally employees. In addition, there are some 4.4
million children for whom family allowances are paid.
This submission is restricted to the Federal sphere. Discussion generally excludes State and local
government taxes and welfare systems, although, for example, changes to such taxes may well be part of
any comprehensive tax reform package, and may also affect low income groups. Issues associated with
business taxation are also not addressed.
Part 2 of this submission discusses the interaction of the Federal social security and taxation systems, and
shows that when income distribution is considered it is necessary to analyse the effects of the two systems
together.
Part 3 analyses some of the inequities currently created by the taxation and social security systems,
including the narrowness of the income tax base, tax avoidance and evasion, high effective marginal tax
rates, and trends in disposable incomes of various family types since 1976-77. It also identifies some
priorities and possible measures for tax reform.
Part 4 looks in detail at the compensation required by pensioners, beneficiaries, low income groups and
families with children if a distributionally neutral result is to be achieved after any broadening of indirect
taxes, and estimates the costs of any compensation required because of such tax changes.
Part 5 discusses the implications for pensioners, beneficiaries and low income groups of some proposals
for reform of the direct taxation system and possible measures to protect them from any negative effects
of changes.
Part 6 discusses whether redistribution rather than just compensation should be integral to tax reform, and
estimates the costs of some redistributive measures.
PAGE 2
2.THE INTERACTION OF THE TAXATION AND SOCIAL SECURITY SYSTEMS
The taxation and social security systems are two key instruments which have a major effect on income
distribution. Since their interaction affects the way in which incomes and standards of living are
distributed throughout the community, it is necessary when considering policy changes to either system to
examine both together, so that the combined effects of change can be exposed and any unintended
consequences of change avoided. Thus, while the tax or social security systems are frequently considered
in isolation, exclusive concentration upon only one system may frustrate broader equity and
redistributional objectives.
The tax and social security systems can be shown to be unavoidably linked in many ways:
1. The two systems do not have discrete populations with the result that, for example, Social Security
initiatives affect many taxpayers while tax initiatives have direct
consequences for many welfare recipients. Large numbers of individuals and families have
entitlements under both the tax and social security systems. Thus, the living standards of many
taxpayers are vitally affected by their receipt of either the dependent spouse or sole parent rebates in
the tax system, and family allowances, family income supplement or additional pension/benefit for
children currently paid through the social security system.
The interaction between the tax system and the social security system has increased markedly since
most social security pensions and benefits became taxable in the mid 1970s, to the extent that the
basic rates of social security poverty-alleviation payments now exceed the income tax free
threshold. This is because basic rates of most pensions and benefits have been automatically
indexed for inflation, but the tax free zone has not. This situation has necessitated special tax
measures, such as the pensioner and beneficiary tax rebates, which have been introduced in the last
three Budgets to ensure that those who are largely dependent on pensions and benefits do not have
their already low incomes reduced by income tax. Another reason for increasing numbers of people
being affected by the interaction between the tax and social security systems lies in the rapid growth
in the number of unemployment beneficiaries since the mid-1970s, many of whom have spent part
of the year as social security recipients and the remainder in work.
The full extent of the overlap between the tax and social security systems is not, however, widely
appreciated. The most recent data shows that in 1980-81 some 580,000 or more than 10 per cent of
all taxpayers received Australian
PAGE 3
Government pensions and benefits some time during the year, and paid more than $800 million in
tax (on both their social security and private income). Those taxpayers who received some pension
or benefit during that year thus contributed about 5 per cent of all revenue collected from personal
income tax(l). More recent figures are not yet publicly available.
2. The tax and social scurity systems can have very similar and related effects on th economic
behaviour of individuals, in particular on incentives to work and save. Just as many people nave
entitlements under both systems, so too do they have liabilities. The income test on pensions and
benefits is analogous to income tax, in that both reduce the benefit to an individual of additional
income. Once pensioners' and beneficiaries' incomes enter the taxable range, the combined effect of
liability for income tax and the reduction of pension or benefit through social security income tests
can produce "effective marginal tax rates" far higher than the top rate of 60 per cent applied to
taxpayers on the highest incomes. ("Effective marginal tax rates" refer to the amount of income lost,
through the withdrawal of assistance by income or means tests and/or the payment of tax, for each
additional dollar of private income.) Pensioners and beneficiaries face effective marginal tax rates
of 100 per cent or more over certain private income ranges, and attempts to increase their disposable
incomes (eg. through part-time work) can leave them no better off or even worse off. (Effective
marginal tax rates are discussed in more detail in Part 3 of this paper.)
3. Many tax and social security measures can be alternative mechanism for achieving the same policy
aims. Assistance to families with children, for example, can be provided through tax rebates or
deductions to taxpayers with children, or through cash transfers such as family allowances (although
with somewhat different distributional effects). Social security cash transfers can thus be
appropriately regarded as broadly equivalent to "tax credits" or "negative income taxes".
This issue is important, because perceptions of the income redistribution effected, of its cost, and of
the level of government involvement may be influenced by the instruments used. For example,
social security outlays are generally seen as representing a cost to taxpayers and as contributing to
the size of the government sector. By contrast, similar "tax expenditure" measures effected in the
taxation system (by reducing income tax liabilities)
(1) Commissioner of Taxation, (1982: 25, 127) and Guilfoyle, 1982.
PAGE 4
are often not regarded as a cost to anyone, and tend to be seen as reducing the size of the
government. But both cash transfers and assistance through reductions in tax liability have similar
implications for the Budget deficit or surplus. Neither cash transfers nor tax assistance, however, in
themselves, add to or detract from the "size" of the government or public sector in the sense of
involving the government in "using-up" real resources (apart from any administrative costs).
Rather, they simply redistribute disposable income between individuals and families.
Perceptions of social security outlays as a "cost" while tax concessions are perceived as "costless" is
unfortunate, as it means that tax expenditures may be subject to less scrutiny than social security
outlays, irrespective of the actual merits and efficiency of direct expenditures in comparison to tax
expenditures.
4. Indirect taxes raise prices and directly affect all taxpayers, including all social security recipients.
Indirect tax measures which are not co-ordinated with
social security initiatives may, for example, lead to any pension increases designed to improve the
real position of pensioners being eroded by indirect tax increases.
The preceding examples suggest that the tax and social security systems must be considered together
when designing tax reforms, to ensure that tax initiatives are adequately coordinated with social security
programs and do not have unintended distributional effects. Cuts in income tax, for example, would be of
limited assistance to maximum-rate pensioners and beneficiaries who currently pay little or no income
tax. A cut in income tax may, therefore, widen the gap between low income families and others.
Similarly, while the extension or introduction of capital taxes could in itself be a progressive measure, if
the new revenue was used solely to increase the disposable incomes of taxpayers through personal income
tax cuts, the poorest groups in society would receive little or no benefit. Thus, a nominally progressive
tax change could actually be to the relative disadvantage of low income groups. Redistribution is,
therefore, not simply a matter of collecting more tax revenue or collecting the same revenue in a more
progressive manner, but also relies critically on which groups receive the benefits from revenue.
A corollary is that whether any particular tax or social security measure is nominally progressive or
regressive when considered in isolation is less important than the effect of overall changes to tax-transfer
arrangements. Recent studies suggest that while taxation in Australia and other member countries of the
Organisation for Economic Co-operation and Development (OECD) has contributed little to income
redistribution, cash transfers (and, to a lesser extent, the social services) have been an effective
redistributive tool
PAGE 5
(Harding, 1984; Saunders, 1984). Harding also found that the net effect of Australian federal taxation and
outlays on social security, education, health and housing was to make the income distribution
substantially more equal. This has direct implications for tax reform. It suggests, for example, that while
the introduction of any new indirect tax could raise the price of many goods and services and thus lower
the real living standards of all households (but particularly low income groups and families), the effects
on these groups could be largely offset through extensive social security and other outlay or tax
initiatives. Such measures, introduced in conjunction with a regressive tax, could therefore increase
rather than decrease overall equity in the income distribution. Thus, it is the overall effect of tax and
social security changes that is crucial.
PAGE 6
3. EQUITY AND PRIORITIES FOR TAX REFORM
The taxation system and, in particular, the personal direct tax system have been extensively criticised in
recent years for failing to achieve their equity objectives. While submissions to the Economic Planning
Advisory Council (EPAC) have also highlighted other issues, such as efficiency and incentives, the need
for greater simplicity, or the reduction of income tax burdens, equity concerns have nevertheless been
central to the debate on tax reform, not least because of the inter-relationship between equity and these
other objectives.
The two major avenues for tax reform that have been suggested by these earlier submissions (office of
EPAC: 1984) have involved either:
• reforming personal direct tax arrangements, with initiatives aimed at one or more of the following:
- broadening the direct tax base or introducing new taxes on capital gains, wealth and capital
transfer taxes and more effective taxation of 'in-kind' employment fringe benefits;
- further reducing tax avoidance and evasion;
- changes to the personal income tax schedule, eg. to provide income tax cuts to relieve the tax
burdens and reduce the marginal tax rates of pay-as-you-earn (PAYE) taxpayers; and
- introducing a levy or some other form of contributory financing of social security; or
• reforming the indirect tax base.
3.1 Broadening the Income Tax Base and Reducing Tax Avoidance and Evasion
The income tax threshold and marginal tax rates are designed to ensure that income tax is progressive.
Yet the most recent data on the incidence of personal income tax on households in 1975-76 suggests that
income tax is only mildly progressive at the bottom and top ends of the income spectrum and roughly
proportional for middle income groups (Warren, 1979). Prominent critics have argued in recent years that
the actual progressivity of the income tax system is now even lower or non-existent, due to such factors as
the narrowness of the income tax base, tax avoidance and evasion, and tax concessions (eg. Head, 1984;
Mathews, 1983). This has direct implications for equity.
As income tax should ideally be levied according to "capacity to pay", a decision must be made about the
appropriate measure of capacity to pay. In Australia, income has been the main
PAGE 7
measure used, but it has been narrowly defined and comprises mainly money income from wages,
salaries, profits, dividends, interest and rent. The exclusion from the definition of income of most capital
gains, imputed income from capital and other types of income such as inheritances and gifts, together with
problems with the assessment of employment fringe benefits (1) and the partly related growth in tax
avoidance and evasion, raise major issues of equity:
• first, to the extent that excluded items are concentrated in the hands of high income earners, their
omission from the tax base reduces vertical equity. For example, a recent study of fringe benefits
(Jamrozik et al,1981) found that they are mainly received by those on high salaries and that
income tax minimisation was one of the most important reasons for their growth;
• second, the narrowness of the direct tax base also introduces horizontal inequities, as those with
similar total incomes or capacity to pay may face different effective tax burdens, because they
derive part of their income from capital gains, substantial inheritances or employment packages.
Similarly, some would consider it inequitable that while the narrow income tax base means that
taxpayers generally are able to escape tax on assets, pensioners' entitlements are assessed
according to a wider definition of economic welfare, which includes both income and asset
holdings;
• third, the narrowness of the direct tax base and consequent tax avoidance has presumably raised
personal income tax rates over those which could have prevailed had the tax base been broader,
thereby affecting all taxpayers, including low income groups;
• fourth, increases in the tax free zone have been made more difficult, because less revenue has been
raised (which has reduced the capacity to finance this and other redistributive measures), and
because the benefits of raising the tax threshold could flow through to tax avoiders and evaders as
well as others; and
(1) Employment benefits include low interest loans, payment of health expenses, entertainment and
other allowances, and the generous tax treatment of superannuation contributions and benefits. In
most cases, the value of these to the recipient is defined as assessable income and thus is legally
taxable, but in practice tax is often partly or fully evaded because of administrative and practical
difficulties involved in measuring their value
(Groenewegen, 1979:98)
PAGE 8
• consequently. the tax burdens of pensioners, beneficiaries and other low income groups have
increased as their money incomes have increased faster than the tax threshold, and their incomes
have moved further into the taxable domain (fiscal drag). The actions that governments have taken
to protect pensioners and beneficiaries (through the introduction of special tax rebates and making
some additional payments non-taxable) have increased the complexity of the system and have
raised effective marginal tax rates for these groups over the private income ranges where the
special rebates are tapered away. They have also introduced issues of equity between those who
derive their income from pensions and benefits and other equally low income earners in
employment.
On both horizontal and vertical equity grounds, therefore. there is a clear case for broadening the income
tax base or for introducing new taxes to more fully reflect the additions to capacity to pay bestowed by
capital gains and capital transfers, the ownership of wealth, and fringe benefits.
3.2 Changes to Personal Income Tax Schedules
Much of the tax reform debate has focussed on the need to reduce the personal income tax burdens and
marginal tax rates of wage earners, particularly for those at average weekly earnings (AWE) and above
(eg. Boyd et al. 1984: Spry, 1985). While this may be considered a problem. it should be noted that the
tax burdens of those at AWE have not increased substantially since the mid 1970s (1). Average tax rates,
(1) There are, of course, always difficulties associated with examining a series of data over time, and
looking at trends in the disposable incomes of pensioners, beneficiaries and other taxpayers is no
exception.
The choice of the base year can have a significant influence on the results, in this submission, 1976-77 has
been chosen for a number of reasons. First, major changes were made to the tax schedules in 1975-76 and
1976-77 which make accurate comparisons of tax liabilities before and after these years much more
difficult. In 1975-76 concessional deductions for specified expenditures were replaced by tax rebates, and
in 1976-77 child tax rebates were replaced by family allowances. Second. 1976-77 was the first full year
of current arrangements of assistance for families, of automatic indexation of the basic rates of pensions
and benefits, and of the taxation of most pensions and benefits. Consequently, there is some consistency
over this period in the provisions affecting pensioners and beneficiaries and families generally. While
1976-77 represents a peak year for assistance to low income families with children, the levels of
assistance available then. while still relatively low, were closer to the levels of assistance provided
through the tax and social security systems in a wide range of overseas countries. It therefore provides a
relevant base for analysing trends in the disposable incomes of these particular groups.
PAGE 9
which measure the proportion of total income paid in tax, are a better guide to tax burdens than marginal
tax rates. While the highest marginal tax rates facing single taxpayers at AWE have increased from 35
per cent in 1976-77 to 46 per cent now, their average tax rate remains almost unchanged at around 22 per
cent (Table 3.1). Similarly, the average tax rate for single income couples with children earning AWE has
also remained constant at about 17 per cent. Average tax burdens for those at 150 per cent of AWE and
their marginal tax rates have increased only marginally. In contrast, the average tax rate of single
pensioners with real private incomes of $30 (in 1984 dollars) has increased from zero in 1976-77 to about
5 per cent now, while their marginal tax rate has jumped from zero to almost 70 per cent. Married
pensioners with small non-pension incomes have been similarly affected.
Because increasing average tax rates may merely reflect increasing real incomes, many would consider
trends in real disposable incomes a better guide to the fortunes of various taxpayers. Table 3.2
summarises movements in some of the key determinants of disposable incomes since 1976-77 and shows
that there have been real increases in:
• general community incomes, reflected in movements in AWE;
• most tax rebates; and
• the basic rates of indexed pensions and benefits (although these have been influenced by the
Medicare effect and other factors - see later discussion).
However, there have been real declines in the tax free zone, cash transfers for children, unemployment
benefits for single adults without children and the young unemployed, and in the pension tree areas.
PAGE 10
TABLE 3.1 AVERAGE AND EFFECTIVE MARGINAL TAX RATES IN 1976-77
AND 1984-85 FOR VARIOUS CATEGORIES OF TAXPAYERS
1976-77 1984-85
Effective Effective
Average Marginal Average Marginal
Tax Rate Tax Rate** Tax Rate Tax Rate**
% % % %
Single Taxpayer 21.9 22.7
at AWE
35.0 46.0
Single Income 16.6 17.7

Married Couple with
Children at AWE 35.0 46.0
Single Taxpayer at 28.2 30.6

150% of AWE
45.0 47.33
Single Income Married 24.7 27.2

Couple with Children
at 150% of AWE 45.0 47.33
Single Pensioner with 4.9

$30 Private Income
69.59
Married Pensioner 2.6

Couple with $50
Private Income 79.38
1. Based on estimated annualised AWE for 1984/85 of $20430 and for 1976-77 of $9339.
(Following changes to the AWE series in 1981 there are difficulties in comparing AWE
estimates before and after this change. The 1976-77 figure has been calculated by the
Department of Social Security. using a methodology suggested by the ABS.)
2. The effect of any health care levies has been excluded; annual tax scales used.
3. Private income levels of pensioners and beneficiaries are the free areas applying in 1984-85;
deflated by CPI to determine equivalent real private incomes in 1976-77.
4. These figures are slightly different to those presented in earlier editions of this paper because of
revised AWE estimates.
Denotes no income tax liability.
Shows effective marginal tax rate on next dollar of income; includes effect of social security income tests.
PAGE 11
TABLE 3.2 REAL CHANGES IN COMPONENTS OF INCOMES BETWEEN 1976-77 AND 1984-85
Income Component(l) Percentage Change

Since 1976-77 In
Real Terms
Pensions and Benefits %

• Additional pension/benefit for children -9
• mothers/guardians allowance(2) -20
• Standard rate of pension and sickness
benefit(3) +8
• Married rate of pension and benefit(3) +9
• Single adult rate of unemployment
benefit (for those without children) -4
• single junior rate of unemployment and
sickness benefit
- standard rate -36
- for those in receipt of benefit for -31
6 months and over
Single pension free area -23
Family allowances -23
Tax Measures
• Dependent spouse and daughter-
housekeeper rebates:
- for those with children +6
- for those without children -15
• Sole parent rebate +14
• Basic tax threshold -17
• Single pensioners' tax threshold -1
• Single beneficiaries' tax threshold -14
Wages
• Gross Average Weekly Earnings(4) +12
1. Family Income Supplement is not included in this table because it was introduced only in 1983.
2. Based on movements in higher rate of mothers/guardians allowance.
3. These increases are effectively overstated because of declining inflation rates and the Medicare
effect (see discussion in text).
4. Based on an estimate of Average Weekly Earnings of $392.90 a week for 1984-85; excludes any
health care levies.
PAGE 12
All the variables identified in Table 3.2 interact to affect disposable incomes. The net results are shown in
Table 3.3, which sets out changes in real disposable incomes since 1976-77 for a wide range of family
compositions and income levels. It shows, for example, that both the relative position and the real living
standards of many sole parent pensioners whose only source of income is social security payments have
declined substantially since 1976-77. This is because the 8 per cent real increase in the single pension
rate and a 14 per cent increase in the sole parent tax rebate have not been sufficient to offset the very
substantial real reduction in cash transfers for children. The table also shows that, despite an increase in
tax burdens resulting from the declining value of the income tax free zone, the real disposable incomes of
very low income working families with children have substantially improved because of the introduction
in 1983 of the family income supplement. Without this payment, the position of a two parent, two child
family where only one spouse works for 50 per cent of AWE would have remained relatively unchanged
since 1976-77. These examples illustrate that cash transfers have had a greater impact on the living
standards of many low income groups than have changes to taxation arrangements in recent years.
Many taxpayers on AWE have fared relatively well in terms of trends in real disposable incomes since
1976-77. For example, the disposable incomes of single taxpayers on AWE have increased by 10.9 per
cent, while those of single income married couples without children earning AWE have increased by 9.3
per cent. It should be noted that the gains made by all social security recipients are overstated, partly
because of the effects of indexation lags in a period of declining inflation, and partly because of the
"Medicare" effect. Basic rates of pensions and benefits have risen in real terms, partly due to the lag in
the indexation adjustment of pensions and benefits. Because the rate of inflation has been declining in
recent years, the indexation increases that are made to pensions and benefits in any year are higher than
the CPI increases in that same year.
Second, following the introduction of Medicare, the CPI actually declined in the six months to June 1984
because of the sharp decline in health insurance costs, and no indexation increase was consequently due to
pensions in November 1984. Most pensioners received no offsetting benefit from Medicare and the
dropping of health insurance costs, as they already received free health care. In recognition of this, an
increase in pensions was announced in the 1984-85 Budget partly to compensate pensioners for the
estimated CPI increase which would have occurred if Medicare had not been introduced. These factors
should be borne in mind in comparisons of disposable incomes of social security clients and others in
1984-85.
PAGE 13
TABLE 3.3: CHANGES IN REAL DISPOSABLE INCOMES OF VARIOUS FAMILY TYPES,
1976-77 TO 1984-85 (ESTIMATED): PER CENT
HOUSEHOLD TYPE PENSIONER/BENEFICIARY NON-PENSIONER/BENFICIARY

(with no private income)
Pensioner Beneficiary with Nil Private Income Wage and Wage and Wage and Wage and
with Nil Salary Earner Salary Salary Salary
Private with Private Earner with Earner with Earner with
Adult Adult Junior
Income Income of Private Private Private
Sickness Unemp- Unemploy
50% AWE (1) Income of Income of Income of
loyment ment and
(2) 75% AWE 100% AWE 150% AWE
Sickness
-36.0
Single Person +8.4 +8.2 -4.3 -31.3 +6.8 +9.7 +10.9 +8.3
Sole Parent,
One Child +1.6 - - - - +9.0 +10.3 +8.0
Sole Parent,
Two Children -1.2 - - - - +7.7 +9.2 +7.2
Sole Parent,
Three Children -3.4 - - - - +6.3 + 8.0 +6.4
Sole Parent,
Four Children -4.9 - - - - +5.0 +6.9 +5.6
Married Couple, No
Children +4.7 +7.7 +9.3 +7.2
- One Spouse Working +8.6 +8.4 +8.4 - +7.5 +5.6 +6.8 +9.7
- Both Working (3)
Married Couple,
One Child +13.1 +8.4 +9.8 +7.7
- Both Working (3)
Married Couple,
Two Children +18.2 +7.2 +8.8 +6.9
- Both Working (3)
Married Couple,
Three Children +22.4 +5.9 +7.6 +6.1
- Both Working (3)
Married Couple,
Four Children +26.1 +4.6 +6.5 +5.3
- One Spouse Working -1.0 +1.5 +1.5 - +27.4 +1.6 +3.4 +6.9
- Both Working (3)
1. At this income level, PIS would be payable where there were children.
2. At this income level sole parents would be financially better off on supporting parents benefit.
3. Distribution of income assumed to be 60:40 per cent
4. Average weekly Earnings is estimated to be $392.90 a week for 1984/85. Includes all rebates, family
allowances and family income supplement. Excludes health levies.
In stark contrast to the gains made by middle income taxpayers earning AWE, the real disposable incomes
of significant numbers of social security clients have actually declined since 1976-77, and they might
therefore be regarded as deserving priority in any tax/social security reform package (especially as the
Medicare and declining inflation effects mean that their cuts in disposable income are actually
understated). These groups include:
• single adult unemployment beneficiaries (-4.3 per cent);
• sole parent pensioners with two or more children (-1.2 to -4.9 per cent for those with four
children); and
• married pensioner couples with four or more children (-1.0 per cent for those with four children).
one of the most significant trends revealed in Table 3.3 is an increase in horizontal inequity, as shown by
the relative shift in the tax burden towards those with children. Taxpayers at AWE without children have
fared better than those at the same income level with two or more children, while social security clients
with children have been similarly disadvantaged relative to those without children. In addition, two
income families with combined incomes at AWE or below who are not eligible for FIS have fared badly
compared to single income units at the same income levels.
overall, therefore, trends in disposable incomes since 1976-77 suggest that groups who have suffered a
decline in their disposable incomes relative to single taxpayers earning AWE and who might therefore be
considered most in need of assistance from tax-transfer reform are:
• all pensioners and beneficiaries with children, particularly sole parent pensioners;
• all wage and salary earner families with children, whose income is above the level which would
entitle them to family income supplement (or who do not take up their entitlement to FIS);
• single and married pensioners and beneficiaries without children; and
• two income families with combined incomes at or below AWE.
While any changes to the personal income tax schedules following tax reforms should address these
trends, there are also other major issues of concern. Because most pensions and benefits have been
indexed for inflation while the tax threshold has not, increasing numbers of social security recipients have
faced tax liabilities.
PAGE 15
In 1983-84 some beneficiaries with children faced income tax liabilities on their basic rates of income
support payments; some applied for tax relief under the special hardship provisions of taxation legislation
but this remains an inadequate way of dealing with the problem (eg. because many beneficiaries may not
realise that they can apply for relief). In addition, there is some evidence that low income groups are
experiencing severe difficulties in paying current or previous income tax assessments, and may not be
fully informed of relief provisions (see case studies in Victorian Social Security Consultative Committee,
1985).
This general problem has been ameliorated to some extent by introduction of the beneficiary and
pensioner rebates, and by making payments for the children of beneficiaries non-taxable, but beneficiaries
with minimal amounts of private income may still be liable for income tax (eg. in 1984-85 full-year single
sickness beneficiaries and married beneficiaries without children will pay income tax when their private
income exceeds $1 a week). under the existing income tax schedules, almost all unemployment and
sickness beneficiaries will pay tax in 1985-86. To some extent this subverts the purposes of the social
security income test free zones, or "free areas", which permit small amounts of non-pension/benefit
income without reduction in social security payments. These are designed to allow recipients to
supplement their poverty-alleviation payments without reductions in their payments, and to encourage
self-help.
While increasing the pensioner and beneficiary rebates provides a partial solution to this problem, further
increases in the rebates raise major issues of equity between social security recipients and low income
workers receiving the same income but with higher tax liabilities, and also extend high marginal tax rates
over a wider income range and thereby further discourage self-help. The high effective marginal tax rates
facing recipients of income-tested assistance are explored in detail in the next section.
Finally, because of the special rebates, most pensioners and beneficiaries who are wholly or largely
dependent upon their income support payments do not currently pay any personal income tax. As a result,
any tax changes which reduce the tax liabilities only of those who pay sufficient income tax to gain the
full benefit of the tax cuts could make the income distribution more unequal. To prevent this, equal "tax
cuts" would need to be given to social security recipients in the form of higher payments. In addition,
depending upon the magnitude of the tax cuts, additional assistance may have to be channelled to low
income groups in the workforce who pay insufficient tax to take full advantage of any tax cut.
PAGE 16
3.3 Effective marginal Tax Rates and Poverty Traps
In designing and administering redistributive mechanisms there are other important issues apart from the
incidence of tax-transfer arrangements to consider. Continuing emphasis on achieving progressive policy
results can create its own problems; while income-tested programs are designed to concentrate assistance
on those most in need, the combination of income-tested programs together with income tax can produce
high effective marginal tax rates (EMTRs)(1). This is widely regarded as unfair, as well as having
adverse effects on disposable incomes and incentives to work and save. It may also create incentives to
avoid or evade income tax and social security income tests. In some cases, overlapping income tax and
income tests can produce 'poverty traps'. These are situations when EMTRs reach a level where low
income groups seeking to increase their income find themselves only a little better-off, no better-off or
even worse-off than if the attempt to secure additional private income had never been made.
It is not widely appreciated that social security clients frequently face effective marginal tax rates far in
excess of those applying to taxpayers with the highest incomes. In recognition of these problems, the
Prime Minister has stated that tax reform should reduce or remove such poverty traps. For example,
single unemployment and sickness beneficiaries will face EMTRS under prevailing tax scales of 62.5 per
cent on non-benefit income between $20 and $70 a week and of 100 per cent above that point until
benefits cut out. Where there are children, the rates rise to 125 per cent over the range where non-taxable
additional benefit for children is withdrawn - in other words, the incomes of beneficiaries with children
can actually fall over certain income ranges if they attempt to earn additional income. Some details of
effective marginal tax rates currently faced by pensioners and beneficiaries are at Appendix 2.
Other circumstances where EMTRs can approach or exceed 100 per cent are:
• where 'sudden death' income tetsts exist, ie. when assistance is suddenly terminated when income
exceeds a specified level, rather than being graduallly withdrawn via a tapered income test. This
occurs in the case of the income test on Pensioner Health Benefits (PHB) cards, which provide a
range of direct and indirect financial benefits such as free pharmaceuticals and concessional
telephone rental. A number of concessions are also available from State governments and other
authorities, and are often linked to eligibility for the PHB card, including property rates and local
transport concessions. The maximum value
(1) As noted earlier, this is the amount of income lost, through the withdrawal of assistance by income
or means tests and/or the payment of tax, for each additional dollar of private income.
PAGE 17
of benefits linked to the PHB card following the introduction of Medicare is estimated at about $20-
28 a week, and the average value some $8-12 a week (Cox and Foster, 1985:6). Where non-pension
income exceeds the income limits governing eligibility for cards the full loss is incurred. The
income limits for those without children are currently $60 a week for single persons and $98 a week
for pensioner couples, and are indexed twice a year. Not surprisingly, the income test can
encourage pensioners to "minimise" their private income to below the PHB card cut-out point;
• when families are entitled to several forms of income-tested assistance. Many social security
recipients, for example, also receive income-tested public housing or education assistance, and
overlapping income tests frequently produce EMTRs which approach or exceed 100 per cent; and
• where effective marginal tax rates may be less than 100 per cent, but where unavoidable costs
associated with working may be greater than the increase in net income. For example, a sole parent
pensioner with one child who has the opportunity to increase private income from, say, $50 to $100
a week, by working four days part-time rather than two, will increase his or her disposable income
by only $22 a week. This net gain may not be enough to cover the additional costs associated with
child care, travel to work, etc. Thus, the sole parent may feel 'trapped' into a situation where the
opportunity and desire to work are present, but the economic rationality to do so is not.
A large number of pensioners and beneficiaries actually experience high EMTRs. Numbers of people
experiencing EMTRs of 100 per cent and over are far smaller, but this may simply reflect a behavioural
response to the presence of a severe poverty trap. For example, some case studies suggest that the
behaviour of sole parents can be affected by high EMTRS (Victorian Social Security Consultative
Committee,1985).
By definition, it is unavoidable that those receiving income-tested payments will face higher effective
marginal tax rates than usual over the income range where payments are being withdrawn. In the end, it
is a matter for judgement as to the extent to which the problems of high effective marginal tax rates and
"poverty traps" can be resolved when balanced against other concerns. The goal of reducing effective
marginal tax rates in order to increase incentives to work and save may conflict with other goals, such as
the provision of more adequate payments, target efficiency, containing the cost of programs and more
general equity concerns. The conflict between these competing objectives can be easily illustrated in the
case of unemployment benefit. For example, if it was decided to liberalise the benefit income tests to
equate with pension income test conditions in order to reduce the higher marginal tax rates facing
beneficiaries, then married unemployment beneficiaries would be entitled to assistance until their private
income exceeded 90 per cent of AWE.
PAGE 18
A range of possible options (in ascending order of magnitude of cost) to address the problem of poverty
traps include:
• relief measures targetted to specific problems - for example, abolition of the separate income test for
supplementary rent assistance, so that rent assistance was withdrawn under the general pension
income-test, or increases in the income disregard for those with children to better reflect child care
costs;
• general relaxation of social security income tests liberalisation of income-tests could involve
standardisation and increases in the free areas, and/or reductions in the withdrawal rate. Relaxation
of the income test would address the major underlying source of problems, but the costs could be
high;
• changes to the income tax system - The present special rebates could be maintained or increased,
and if the taper on these rebates was abolished, there would be a reduction in marginal tax rates at
low income levels. More general tax initiatives which might be justified on broader equity grounds
(eg. increases in the tax free zone or a reduction in the first rate of income tax) would also have the
side effect of reducing EMTRS for some pensioners and beneficiaries, if only modestly. For
example, the reduction of the first rate from 30 to 25 per cent in the 1984-85 Budget reduced
marginal tax rates for social security recipients by between 2.5 and 5 per cent;
• greater integration of the tax and social security systems - some smoothing and lowering of effective
marginal tax rates could be achieved through partial integration of the two systems. The Asprey
Committee, for example, discussed in 1975 a proposal involving the outright abolition of the means
test then current and the introduction of a separate tax rate scale for social security recipients.
Alternatively, withdrawal of social security payments could be achieved through social security
income tests with all social security payments being made non-taxable. Neither of these two
alternatives, however, allow for substantial reductions in EMTRs . While offering some
administrative advantages, these options would also involve a number of problems and may involve
nothing more than rationalisation and redistribution of EMTRS within the existing recipient
population. A major lowering of withdrawal rates could only be achieved by providing assistance to
new recipients and by incurring additional costs ; and
• the introduction of a guaranteed minimum income (GMI) scheme - full integration of the tax and
social security systems implies some form of GMI, although the form of this could vary. Appendix
6 describes alternative GMI approaches, but it should be noted that a GMI generally
PAGE 19
implies very much greater costs than those of the existing social security system. The main
rationale for a GMI is to ensure that all those on low private incomes receive support, not just those
who satisfy existing categorical requirements. Full integration also requires detailed consideration
of complex issues, such as the appropriate tax and social security income unit.
3.4 Contributory Financing of Social Security
A possible option for tax reform is the introduction of a social security levy (similar to the Medicare levy)
or of social security contributions. A number of reasons have been advanced for such a change.
First, there may be a greater willingness to pay tax if it is specifically earmarked for social security
outlays, because taxpayers may feel that they will eventually reap the benefits of these tax payments.
Alternatively, the costs of social security will be made more visible, and will be felt by all taxpayers. In
the context of tax reform, a further reason advanced for change is that the Australian revenue structure is
out of step with other countries, Australia and New Zealand being the only OECD countries without
explicit social security contributions. However, the financing issue cannot be considered separately from
the social security benefit structure. The Australian system is designed to provide flat-rate poverty
alleviation payments rather than payments related to previous earnings. This reflects a different emphasis
upon the various objectives of social security, and it is not at all certain that an earnings-related system is
preferable to the Australian one unless it is considered desirable to strike a different balance between
these objectives.
Appendix 3 provides a more detailed discussion of these issues.
PAGE 20
3.5 Broadening the Indirect Tax Base
The Australian federal indirect tax system currently features:
• very heavy excise taxes on a small number of goods (tobacco, alcohol and oil-based products);
• lower differential-rate wholesale sales taxes of 7.5, 10, 20 and 32.5 per cent, applied to a wide range
of goods, with widespread exemptions for "necessities"; and
• the general exclusion of services from the tax base.
Hence, even though indirect taxes make a significant contribution of some 26 per cent of total Australian
taxation revenue, less than 40 per cent of private final consumption expenditure is subject to taxation
(Treasury, 1983). Clearly, greater taxation of consumption expenditure could provide an important source
of additional revenue. In particular, those consumers who are currently able to avoid or evade personal
income tax, and who use these additional resources for personal consumption, could pay more tax if the
scope of indirect taxes was widened. Some argue that this result would be more progressive than current
arrangements (Mathews, 1983).
Nevertheless, flat-rate taxes on consumption and expenditure will be regressive unless adequate
compensatory measures are simultaneously introduced. This is because consumption tends to decline as
income rises - that is, low-income earners spend proportionally more of their income on goods and
services than do high income earners, who typically save more. (Savings are, of course, only subject to
consumption taxes when spent.) A tax on consumption, therefore, tends to fall relatively more heavily on
low-income groups.
There is evidence, for example, that existing sales taxes in Australia are regressive, despite the differential
rate structure, which taxes 'luxuries' more heavily and exempts necessities. Warren shows that in 1975-76
sales taxes took about twice the proportion of the income of the lowest income group as of the highest
(1979:23).
In addition, consumption taxes also produce horizontal inequities, because on average and at almost every
income level families with children spend proportionately more of their income on goods and services
than those without children. As a result, consumption taxes bear more heavily on families with children.
As Mathews points out, however, consumption taxes at the same time may improve horizontal equity
between wage and salary earners and other income recipients (1983:10).
PAGE 21
There are three major options for indirect tax reform. These are:
• alterations to the existing wholesale sales tax, eg. extension of the base to currently exempt items
such as food and clothing, or changes to the rate structure;
• the taxation of services; and
• introduction of a new goods and services tax, such as a value added tax or a retail sales tax. The
abolition of wholesale sales or other taxes might accompany the introduction of such a broad-based
consumption tax.
3.5:1. Wholesale Sales Tax
Among the most important items exempted from the existing wholesale sales tax base are virtually all
food and clothing, drugs and medicines, building materials, and fuels and power. Of these, the only ones
likely to yield substantial additional revenues are taxes on food and clothing (Treasury,l974).
Calculation of the effect of taxing such goods requires information about how much money is spent on
such items by households at different income levels and of various family compositions. The most recent
source of such information is data from the 1984 Household Expenditure Survey (HES) conducted by the
Australian Bureau of Statistics (ABS). Only data from January to June 1984 are currently available, and
the estimates are subject to large sampling variability and are affected by seasonality. While all data used
in this paper have standard errors of less than 25 per cent and most of the data have standard errors of less
than 10 per cent, it must be emphasised that usage of the survey for this purpose is subject to reservations
and qualifications, and that the following analysis only provides broadly indicative estimates of the effects
of various indirect tax options.
Full analysis of various indirect tax options on the basis of the 1984 HES data has not yet been completed.
However, Table 3.4 shows expenditure on food as a percentage of disposable income for various
household compositions and income levels. It indicates that lower income households spend a greater
proportion of their disposable income on food than upper income households, and would consequently be
more adversely affected by inclusion of food in the sales tax base.
It also suggests that the proportion of income spent on food increases with family size.
PAGE 22
TABLE 3.4 EXPENDITURE ON FOOD AS A PERCENTAGE OF DISPOSABLE INCOME FOR VARIOUS HOUSEHOLD
COMPOSITIONS AND INCOME GROUPS
ANNUAL HOUSEHOLD INCOME (GROSS)
HOUSEHOLD $4000 $6000 $8000 $9000 $10500 $12500 $15000 $20000 $25000 $35000 MORE MEAN
COMPOSITION TO TO TO T0 TO TO TO TO TO TO THAN
$5999 $7999 $8999 $10499 $12499 $14999 $19999 $24999 $34999 $44999 $44999
Single Adult over 18 27 23 25 22 23 21 17 14 13 11 13 17

- no children
Single adult over 18 35 35 33 29 26 23 22 18 19 16 17 22

with children
Married couples. 59 32 30 34 26 24 24 21 15 14 12 18
- no children
Married couples * * 37 44 23 24 26 23 18 15 13 19
- 1 child
Married couples * 52 45 32 35 31 25 23 19 16 15 21
- 2 children
Married couples. * * * 35 20 32 31 37 21 20 16 25
3 or more
children
Note: This table is based on sample survey figures which art subject to standard error: Most have a standard error of less than 10 per cent
and all have a standard error of less than 25 per cent.
* Too few households to give statistically valid result

Disposable Income is average weekly income minus income tax payments.
Sources Unpublished 19B4 HES Data PAGE 23

While this emphasises that, at all income levels, the imposition of a tax on food would disadvantage those with
children relative to those without, Table 3.4 also shows that the effects would be especially severe for those on
low incomes with dependants. The cost of food in married couple households with two children accounted for
over 50 per cent of the disposable income of households with incomes between $6000 and $8000. This means
that a sales tax which raises food prices by 10 per cent could effectively take about $6 a week from such
households' incomes, and raise the proportion of disposable income spent on food and associated taxes to
around 60 per cent.
Table 3.5 shows the effect of a tax which increases expenditure on food in various households by 10 per cent.
For example, it indicates that a tax which increased expenditure on food by 10 per cent would add about $6.80
a week to the food bill of married couple households with one child earning $9000 to $10500 a year; this
represents about 4.4 per cent of their disposable income.
While the preceding analysis examined the possible extension of the sales tax base to include food, it would
also be possible to increase tax revenues by increasing rates of tax on currently taxed items. It is difficult,
however, to calculate the effects upon low income groups with any precision, as this would depend upon the
mix of tax rates and schedules adopted. Perhaps in an attempt to make sales tax less regressive, "luxuries" are
currently taxed at 32.5 per cent, but necessities, which take a greater slice of the income of low income groups
than of others, are exempt from tax. However, as Warren (1979) and Kakwani (1983) have shown, sales tax is
currently regressive, and there seems to be little scope for imposing additional taxes on the very limited number
of goods which are disproportionately consumed by high income households. Thus, if the sales tax base were
changed or rates of tax increased, particular attention would have to be paid to low income groups and families,
who would probably be disadvantaged. Compensatory mechanisms would be similar to those described in Part
4 for a goods and services tax.
3.5:2. Taxation of Services
It is difficult to predict precisely the effects on equity of the taxation of services, because detailed data from the
1984 HES about expenditure upon services by income level are not yet available. on first glance, it seems
unlikely that the lack of tax on professional services (lawyers, architects accountants and stockbrokers, etc), for
example, bestows major benefits upon the poor. However, data from the 1975-76 HES suggested that the
general taxation of services might be regressive. Kakwani, for example, has calculated that taxing child
minding, legal fees, medical and dental services, dry cleaning and other clothing and footwear services; rail,
bus, train or taxi fares; vehicle servicing; postal, telephone and telegram services;
PAGE 24
Table 3.5 EFFECT OF A TAX WHICH INCREASES EXPENDITURE ON FOOD
BY 10 PER CENT: BY HOUSEHOLD COMPOSITION AND INCOME
Household Composition Average Food New Tax New Tax As

and Gross Annual Income Expenditure Payments of Disposable
Income
$pw (1) $pw %
Single adult, over 18, no dependants
- $4000 - $5999 25 2.50 2.7

- $9000 - $10499 37 3.70 2.2
- $15000 - $19999 47 4.70 1.7
- $35000 - $44999 69 6.90 1.1
- mean 43 4.30 1.7
Single adult, over 18, with dependants
- $4000 - $5999 38 3.80 3.5

- $9000 - $10499 53 5.30 2.9
- $15000 - $19999 66 6.60 2.1
- $35000 - $44999 102 10.20 1.6
- mean 65 6.50 2.2
Married couples, no dependants
- $4000 - $5999 48 4.80 5.9

- $9000 - $10499 59 5.90 3.4
- $15000 - $19999 65 6.50 2.4
- $35000 - $44999 88 8.80 1.4
- mean 69 6.90 1.8
Married couples, I child
- $4000 - $5999 (2) (2) (2)

- $9000 - $10499 68 6.80 4.4
- $15000 - $19999 73 7.30 2.6
- $35000 - $44999 94 9.40 1.5
- mean 82 8.20 1.9
1. Rounded to nearest dollar

2. Too few households to give statistically valid result
3. Disposable income is average weekly income minus income tax payments.
Source: Unpublished 1984 HES data
PAGE 25
beauty, health and hair services; education, some financial services and sports services generally would all be
regressive (1983a). The only major services on which expenditure was more unequally distributed than income
were meals in hotels and restaurants, air fares and freight, live theatre, overseas holiday fares and packages,
holiday packages in Australia, professional subscriptions, and domestic services (excluding child-minding). It
therefore seems likely that the taxation of many services would be regressive, particularly as tax avoidance and
evasion would be likely to be even further encouraged in such areas as domestic services.
moreover, if a tax on services was introduced, those services provided or financed by governments might need
special consideration. For example, if new taxes increased the price of such services as public transport, child
care, home help, legal aid and "meals on wheels", which assist considerable numbers of low income groups,
Kakwani's research suggests that the effects could be regressive.
3.5:3. Goods and Services Tax
The possible introduction of a broad-based tax on goods and services such as a value added tax or a retail sales
tax, has received some attention in Australia. The impact of these or other forms of goods and services tax
(GST) on low income groups will depend on:
• what items are taxed - a comprehensive or selective tax base;
• the rate structure - the same tax rate for all goods and services, or zero rating and differential rates;
• whether other taxes are abolished, eg. wholesale sales or payroll tax;
• the treatment of excise taxes, eg. abolished or added onto a GST;
• other compensatory changes in the tax system, eg. reductions in personal income tax or introduction of
capital taxes; and
• more broadly, any compensatory changes in government outlays, eg. increased social security spending.
On the question of a selective or a comprehensive tax base, it seems clear, as outlined earlier, that inclusion of
food in the tax base of a GST would most penalise low income earners and families with children. Although
the 1984 HES data has not yet been fully analysed, the inclusion of most other currently exempted goods and
services in a GST base would also seem likely to particularly disadvantage families with children and those on
low incomes.
PAGE 26
It is difficult to calculate the impact on low income groups of a uniform or differential rate GST without details
about the composition of the base and tax rate. In addition, modelling the effect of the possible simultaneous
removal of other taxes such as wholesale sales tax is very complex. Therefore, purely for illustrative purposes,
the following examples generally examine the effects of a GST which raises household expenditure by 10 per
cent. This makes no assumptions about the rate of GST which would produce a 10 per cent expenditure
increase, or about the movement in the CPI.
Table 3.6 provides a rough example of the impact of a GST which raises the total expenditure of all income
groups by 10 per cent, assuming that the same basket of goods and services were to be purchased. The table
shows that if a GST added 10 per cent to prices, married couple households without children with income of
$6000-$8000 per year could pay on average an extra $19 a week in indirect tax. A household of the same
composition but with income of $35,000-$45,000 could pay an additional $51 in indirect tax.
While the high income household would thus pay more GST in absolute terms, the new tax as a percentage of
disposable income may provide a more appropriate indicator for gauging the impact of the GST on households.
Thus, in the above example, while the new indirect tax would take about 14 per cent of the income of the
poorer household, it would take only 8 per cent of the income of the high income household. Similarly, in the
case of sole parent households, the new GST would account for about 16 per cent of the disposable income of
those receiving $8000-$9000 a year, 9.5 per cent for those receiving $15,000-$20,000 a year, but only 8.5 per
cent for those receiving $25000 to $35000 a year.
In more practical terms, if there were no compensatory measures, these figures imply that a GST which raised
expenditures by only 10 per cent could trigger off a financial crisis in poorer households while being fairly
easily accommodated by high income households. The 1984 HES found that households whose principal
source of income was wages and salaries, self-employment or superannuation were, on average, saving part of
their incomes. However, households principally reliant on government cash benefits whose head was aged less
than 65 years were on average dissaving. For example, households principally reliant on unemployment
benefits had average incomes of $183 a week and expenditures of $244 a week. In the case of sole parents,
income averaged $170 a week and expenditure $201 a week. This suggests that the income of these groups is
already inadequate relative to their needs, and that the imposition of any additional indirect taxes without
compensatory measures could be expected to drive poorer households into debt, lead to the further run down of
savings, the forced sale of assets or more attempts to cut back on consumption of goods normally considered
essential by Australian society.
PAGE 27
TABLE 3.6: ADDITIONAL INDIRECT TAX AND ADDITIONAL TAX AS A PERCENTAGE OF DISPOSABLE INCOME AFTER
IMPOSITION OF A GST WHICH INCREASES HOUSEHOLD EXPENDITURE BY 10 PER CENT: BY HOUSEHOLD

COMPOSITION AND INCOME.
ANNUAL HOUSEHOLD INCOME (GROSS)
HOUSEHOLD $4000 $6000 $8000 $9000 $10500 $12500 $15000 $20000 $25000 $35000 MORE MEAN
COMPOSITION TO TO TO TO TO TO TO TO TO TO THAN
$5999 $7999 $8999 $10499 $12499 $14999 $19999 $24999 $34999 $44999 $44999
Single Adult over 18 11 14 19 18 22 23 25 32 37 53 78 24

- no children 11.5 11.5 12 10 11.5 10.5 9 9 8.5 8.5 8.5 9.5
Single adult Over 18 13 18 26 26 20 34 30 34 41 74 82 32

- with children 12 13.5 16 14 13.5 14 9.5 9 8.5 11.5 8.5 11
married couples. 30 19 15 30 26 26 32 40 42 51 61 36
- no children 36 13.5 11 14 13 11.5 11.5 11.5 9 8 7 9.5
Married couples * * 24 30 22 31 32 39 40 52 69 42
- 1 child 17 20 10 13 11.5 11.5 8.5 8 7.5 9.5
married couples * 25 26 24 25 32 35 37 42 54 75 42
- 2 children 20.5 17 13.5 12.5 13 12 10.5 9 9 8 10
married couples. * * * 24 25 31 35 44 46 37 73 45
or more 12.5 12.5 12.5 12.5 12 9 9 8 10.5
children
Note, This table is booed on sample survey figures which are Subject to standard error, Mat have a standard error of less than 10 per cent
and all have a standard error of less than 25 per cent.
* Too few households to give statistically valid result
Disposable Income is average weekly income minus income tax payments.
Source: Unpublished 1904 HES Data
PAGE 28
Table 3.6 also shows that because on average households with children generally spend more of their income
than those without children, a GST would correspondingly hit them harder. For example, at almost all income
levels a GST which added 10 per cent to the total expenditures of all households would affect sole parent
households more than single adults. Unfortunately, sample cell sizes from the 1984 HES six monthly data are
not large enough to trace the effects of a GST on low income families with children; however, the 1975-76
HES data showed that the proportion of income consumed increased sharply with the number of dependants at
low income levels (Appendix 4 : Table 1).
These effects of broad-based consumption taxes upon low income earners have confronted all policy-makers,
and most OECD countries have adopted a differential tax rate structure in order to reduce or overcome the
equity problems. It is hoped that by subjecting "necessities of life" to zero or very low rates of tax and
"luxuries" to rates above the standard rate, that a proportional or perhaps even progressive consumption tax
may result.
However, such an approach raises major problems, as the 1975 Taxation Review Committee and, more
recently, the New Zealand Government explained when rejecting differential rates in favour of a uniform rate
(Douglas, 1984). One of the central issues is the difficulty in objectively defining luxuries and necessities,
especially given changing social mores. This is well illustrated by the current Australian sales tax, which
imposes "luxury" tax of 32.5 per cent on hair brushes, shampoos, ballpoint pens and cigarette lighters. In
addition, any neutrality and economic efficiency gains resulting from the shift to a GST are immediately
reduced or eliminated by differential tax rates as, for example, high taxes on luxury goods distort consumption
patterns and put these items even further beyond the reach of low income earners.
Low or zero rates on necessities also drastically reduce the size of the potential tax base. For example,
Treasury has estimated that almost two-thirds of the additional revenue that could be received from extending
the coverage of sales tax would come from taxes on food and clothing (1974;10). Most of this additional
revenue would come from middle and high income households rather than the poor. While the extra tax would
take a greater proportion of the income of the poor, middle and high income households spend about two to
three times more on food in each week in dollar terms (ie. as Table 3.5 showed, single adult households with
incomes between $4000-$6000 a year spend about $25 a week on food, while those on $35000-$45000 a year
spend about $70). Thus, in this sense, the exemption of necessities from any tax base could be said to assist
middle and high income earners more than the poor. In addition, the exemption of food assists those buying
caviar and fillet steak as much as those buying bread and sausages. It could, therefore, be more efficient to tax
all goods and services, and return the relatively small amount of total revenue collected
PAGE 29
from low income households to them, through such mechanisms as social security cash transfers. Additional
problems raised by the exemption of necessities are that in order to raise a given amount of revenue higher tax
rates must be imposed on the remaining non-necessities (with resulting greater efficiency losses) and that the
possibilities for tax avoidance and evasion are immediately increased.
Nonetheless, many would consider such reductions in efficiency, simplicity and revenue an appropriate price to
pay for reductions in regressivity, especially if it appeared that the final result could be to make indirect taxes
proportional or progressive. Two major overseas studies have attempted to measure the incidence of value
added taxes. They conclude that in most of the European countries studied, the VAT is proportional or
progressive in effect (OECD, 1981; Adams, 1980). These studies have been extensively quoted as suggesting
that the widely held belief that indirect taxes are regressive is wrong (eg. Sandford, 1981; Office of EPAC,
1984; 16-17). However, these results must be subject to very severe reservations, given the data deficiencies
and methodology employed. A detailed critique is contained in Appendix 5. Perhaps the major conclusion
which can be drawn from these studies is that while a differential tax rate can be less regressive than a uniform
structure, some degree of regressivity (and a consequent need for compensating measures for low income
groups or families) will almost certainly still exist.
An additional consideration is that preliminary results from simulations by the Economic Planning Advisory
Council based on the 1984 HES suggest that exemptions and differential tax rates may not only be an
inefficient but also a relatively ineffective method of attempting to protect the poor (Warren, 1985). Similarly,
after analysis of the 1975-76 HES data, Kakwani concluded that his results "cast doubt on the commonly held
belief that indirect taxes can be made more progressive by making a distinction between luxuries and
necessities" (1983a:76). It is not clear whether a more equal distribution of income in Australia than in other
OECD countries or differing consumption patterns have affected the results, but this research indicates that
there are almost no goods and services disproportionately consumed by middle to upper income groups, and
that differential tax rates consequently will not produce a proportional or progressive indirect tax. It is possible,
however, that heavier taxes on mildly regressive goods and services (such as women's footwear) and lesser
taxes on very regressive goods and services (such as children's footwear) would be less regressive than a
uniform rate GST. Such a tax would, of course, be far more difficult to administer, eg. in the above example,
an arbitrary decision would have to be made about when girls become women. It would also open up avenues
for tax avoidance and evasion.
PAGE 30
Overall, therefore, it may be that a uniform, broadly-based indirect tax is preferable, if compensatory measures
are adequate. If compensatory measures appear unlikely to sufficiently protect the real living standards of the
poor and families with children, differential rates of tax, and zero rating or exemption of food must be
considered, despite the relatively minor gains in equality and major losses in efficiency that would result.
In conclusion, there are strong efficiency reasons for reforming the indirect tax system in itself and it is possible
that replacement of sales tax by a new GST which raised the same amount of revenue would not have major
equity effects. However, any major shift in the tax mix towards indirect taxes appears certain to have
substantial adverse effects on equity. As the main reasons advanced for tax reform appear to arise from the
perceived failings of the current direct tax system, the most direct solutions to the problems of the direct tax
system may lie in its reform - that is, in broadening the personal income tax base to reduce opportunities for
avoidance and evasion, taking account of the additions to resources bestowed by capital gains and capital
transfers, taxing more effectively the fringe benefits associated with employment, and addressing the more
complex issues of privileges flowing from the ownership and inheritance of wealth.
It has been argued that broadening of the indirect tax base is an alternative solution to one of these problems,
that of tax avoidance and evasion (Mathews:1983). This avenue of tax reform is therefore desirable on equity
grounds to the extent that the current problems of the direct tax system arise mainly from avoidance and
evasion and not other sources; that reforms of the direct tax system through, say,anti-avoidance and evasion
legislation cannot be sufficiently successful in practice; and that broadening the indirect tax base will actually
have a greater impact on tax avoiders and evaders than any other alternative.
Whether this is the preferable avenue of tax reform is not certain. However, changes to the indirect tax base
provide only an indirect means of achieving the equity objectives of tax reform, and are a very blunt instrument
of redistribution. In addition, broadening the indirect tax base raises very major equity problems in itself.
While these specific problems can be partly addressed through a mix of income security and other outlay and
tax changes, these changes may amount only to compensation for the effects of indirect tax changes.
Redistribution could still remain as an unfulfilled objective.
PAGE 31
4 MEASURES TO PROTECT LOW INCOME GROUPS AND FAMILIES WITH CHILDREN FROM
INDIRECT TAX CHANGES
Any individual tax reform measure that may be considered will inevitably involve winners and losers - ie. some
people will be required to pay relatively more tax while others will pay relatively less. one of the major
arguments for a shift towards a broad-based indirect tax is to increase the tax paid by current tax avoiders and
evaders. However, such a change would also sharply increase taxes paid by pensioners, beneficiaries, and other
low income groups, as well as by all families with children. It would thus shift the tax burden towards some of
the poorest groups in our community. This could not be considered a desirable product of tax reform. On the
contrary, the relative or absolute declines in the disposable incomes of families with children and of low
income groups, discussed earlier in Part 3, strongly suggest that tax reforms that do not involve some
improvement in the position of these groups are questionable. At the very least, their current real living
standards must be protected through appropriate compensatory measures.
The Prime Minister's tax reform principles indicate that the tax burdens on individuals in low income groups
will not be increased by tax reforms. Accordingly, this section discusses possible compensatory initiatives for
pensioners, beneficiaries, other low income groups and families with children which may be required in order
to achieve a distributionally neutral result - that is, merely to pay back to these groups the additional indirect
taxes they would pay if the indirect tax base was broadened.
In designing such measures it is important to note that if any indirect tax increases are to be offset by reductions
in income tax, those low income groups who pay little or no income tax cannot be fully compensated by such
means as tax cuts. Thus, to avoid a pronounced shift in the tax burden towards those who can least afford tax
increases, compensation will have to be channelled through either increases in direct outlays or tax credits.
Those groups requiring particular attention in this regard are:
• social security pensioners and beneficiaries receiving indexed payments;
• social security pensioners and beneficiaries receiving non-indexed payments;
• all people with dependent children;
• those receiving other government transfer payments eg. Veterans' Affairs payments and education
allowances; and
PAGE 32
• low income groups currently receiving no social security assistance and whose incomes are too low to
take full or any advantage of any personal income tax cut, eg. low income workers without children.
The precise nature of any compensatory increases in assistance to these groups that would be required would
depend upon the degree of comprehensiveness of the new indirect tax base, whether the tax rate was uniform or
differential and any accompanying alterations to the tax mix or other indirect taxes. Given current uncertainties
about these issues, the following examples generally assume, for illustrative purposes only, the introduction of
a GST which adds a net 10 per cent to household expenditure (thus avoiding the need to make assumptions
about the fate of sales tax or other taxes, the rate of the new tax, or the increase in the CPI). While the
extension of the sales tax base, the introduction of a new tax on services, or the introduction of a new broad
based consumption tax may have very different price effects, the analysis is only intended to demonstrate the
methodology to be employed and the many issues which should be examined in designing compensatory
measures.
4.1 Indexed Social Security Pensions and Benefits
Pensions, sickness benefits and unemployment benefits for adults and those with dependants are indexed
automatically in May and November of each year by the movement in the CPI in the six months to the
preceding December and June respectively. Thus, it may appear as though these social security clients will be
fully protected from the effects of indirect tax changes reflected in price movements. However, this protection
from the full effects of indirect tax changes is only partial. This is because:
1. Aggregate movements in prices as reflected in the CPI may not accurately reflect the impact of indirect
tax increases on low income groups, due to their different consumption patterns. For example, while
food is currently given a weighting of 21 per cent in the CPI (ABS, 1982:8), unpublished 1984 HES data
suggest that single adult households with incomes between $77 and $115 per week spend some 24 per
cent and married couples with two children and incomes between $115 and $154 a week about 26 per
cent of their total expenditure on food. Yet single adult households with weekly incomes between $673
and $865 devote only 13 per cent of their total expenditure to food. Therefore, a constant percentage
increase in food prices would affect a low income household much more severely than a higher income
household. Whether other items in the CPI and the weightings attached to them accurately reflect the
expenditure patterns of social security clients, other low income groups and families is therefore a critical
issue in the context of tax reform.
PAGE 33
Research on this subject suggests that over time the aggregate price increases faced by low income
households are similar to those experienced by middle and high income households, although there may be
significant variations in particular years (Copeland, 1982:25; Hancock, 1974; Warren, 1984:218). While
this may be true in the long term and in periods when there are not substantial indirect tax changes, it is
likely that low income groups could be heavily penalised by certain changes to the indirect tax mix. If, for
example, currently untaxed items such as food were made subject to a standard uniform rate of GST, and
the current sales tax of 20 and 32.5 per cent was also replaced by a lower rate GST, the subsequent changes
to the CPI would be most unlikely to mirror the actual effects on low income groups. In these
circumstances, percentage increases in social security cash transfers well above any CPI movement could
be required, if full compensation was to be effected.
2. The lag between CPI increases and "flow-on" adjustment to pensions and benefits also requires attention.
Price increases occurring in July, for example, are not reflected in pension/benefit increases until 10
months later. This general problem would be ameliorated by more timely adjustment of rates for price
movements, but this is difficult to achieve because of lags in the collection and publication of price
movements, and administrative constraints. Consequently, if major indirect tax changes were made,
immediate ad hoc increases in pensions and indexed benefits would be required. Appropriate adjustments
could be made to subsequent indexation increases.
3. Some social security recipients could experience an effective decline in their real disposable incomes if
theincreases were subsequently partly lost through income tax. This indicates that measures such as a
compensatory increase in the pensioner and beneficiary rebates or the tax threshold may be required.
4. The existence of dissaving means that automatic indexation increases resulting from any indirect tax rises
would not fully protect social security clients. For example, if a GST increased their expenditure and the
CPI by 10 per cent, then full-rate married pensioners spending all of their current income of $153.30 would
be compensated for the increased indirect tax burden by an automatic 10 per cent pension indexation
increase of $15.35. However, married pensioners who spent $180 a week on necessities (and were thus
increasing their debts or running down savings) would face a 10 per cent indirect tax bill of $18 a week if
they purchased the same basket of goods and services, although they would also receive only the $15.35
pension indexation increase. In other words, such pensioners would experience an effective decline in
their incomes of about $3 a week.
PAGE 34
Not enough is currently known about the reasons for and incidence of dissaving, but some small surveys
have suggested that many low income groups find their needs substantially exceed their incomes (eg,
Smith, 1982: Gilbert, 1984). The HES data also indicates that this type of problem could be very
widespread, although it must be borne in mind that the income and income tax statistics in the HES are
less reliable than the expenditure data. However, as noted earlier, the results show that, on average, all
households who were receiving government cash benefit as their principal source of income and whose
head was under 65 years of age were dissaving quite markedly. The majority of beneficiaries and many
pensioners could be consequently penalised if account was not taken of dissaving when designing
compensatory measures. Further, all HES data merely shows the average expenditure pattern for
particular types of households. As a result, even though the HES data suggested that, for example, on
average, age pensioners aged over 65 were only marginally dissaving, there would clearly be some who
were saving and others who were dissaving.
The phenomenon of people dissaving because their expenditure exceeds their income does, however, raise
several complex issues. On the one hand, it may be felt that expenditure is a better measure of the real
economic resources available to dissavers than is their income. For example, some may consider it
reasonable that social security clients should use their savings in order to support themselves. on the other
hand, it should be appreciated that any failure to allow for dissaving when designing compensatory
measures will disadvantage many who are already experiencing severe financial difficulties and shift the
relative tax burden towards many who can least afford it. Resolution of this problem requires an increase
in social security payments somewhat higher than the increase suggested by movements in the prices of
goods and services purchased by pensioners and beneficiaries.
5. Another issue is the impact of any consumption taxes on different age groups. For example, the real value
of the savings accumulated by the aged may be reduced by a new indirect tax, as they would be able to buy
fewer goods and services with their savings. This suggests that consideration might be given to special
compensatory measures for the aged.
PAGE 35
6. Further measures would be required to protect the real incomes of those receiving part-pension or benefit
or with non-pension/benefit incomes around the pension/benefit income test free area. There are three
major issues here. First, adjustment to all pension/benefit income and asset test free areas(l) or income
disregards(2) would be required, so that their real value was maintained. For example, single pensioners
with non-pension incomes of $30 a week and gaining full pension might be compensated for the decline
in the purchasing power of their pension resulting from a 10 per cent GST-induced increase in prices by a
similar pension increase. However, the general price increase would mean that it would cost them $33 to
buy the same goods they previously purchased with their $30 of private income. If there was no
adjustment to the free area, any attempt by such pensioners to maintain their previous standard of living
by earning an extra $3 a week would result in the loss of $1.50 of pension and 59 cents in income tax.
Pensioners with higher levels of private income would face a similar cut in real income. Thus, if the free
areas in the pension and benefit income and asset tests, the income disregard for children, and the
threshold of the 100 per cent taper for beneficiaries (and the pensioner and beneficiary rebates) were not
appropriately increased after the introduction of any new consumption tax, pensioners and beneficiaries
with private incomes around or above the free areas would be immediately disadvantaged. In time others
might face similar problems. In addition, while the fringe benefits income test limits are indexed every
six months, higher increases might be required if the CPI did not accurately reflect the changes in
pensioner living costs.
(1) "Free areas" refer to the amount of income a pensioner or beneficiary can earn before pension or benefit
payments are reduced. For example, payments to a single pensioner are not reduced until private income
exceeds $30 per week, and are reduced by 50 cents for every dollar of private income above this level. It
should be noted that the issue of those with private income is different to dissavers: in the former case
expenditure exceeds income, in the other the problem is to maintain the purchasing power of private
income.
(2) Pensioners (but not beneficiaries) are allowed an additional $6 of private income per child before their
pension is reduced, ie. their free area is $6 higher per child.
PAGE 36
Apart from indexation thresholds, a second issue is the possible decline in the purchasing power of the non-
pension/benefit incomes of social security clients. A serious problem is created by pensioners and beneficiaries
with fixed private incomes, eg. those receiving non-indexed small weekly superannuation payments. These
groups could not increase their incomes in response to a new indirect tax, and their standard of living would
consequently fall. In many cases, this fall would be very substantial, as revealed in Tables 2 to 5 in Appendix
4. For example, if a new GST increased the expenditure of a married pensioner couple with $70 of private
income per week by 10 per cent, the couple would pay an extra $1106 a year in indirect tax if they were to
purchase the same basket of goods and services. A 10 per cent increase in the basic pension rate and the free
area would still leave them $580 a year worse off (Table 4). This couple could not be compensated via income
tax cuts, as they currently pay no income tax.
If their private incomes did not increase, more than one million pensioners and beneficiaries with non-pension/
benefit incomes could not be fully compensated for a GST which increased their expenditures by 10 per cent
through income tax cuts, because they do not pay enough income tax (Appendix 4: Tables 6 and 7). However,
the private incomes of tone pensioners and beneficiaries may be indexed to price movements or be increased in
the aftermath of a GST. Nonetheless, substantial numbers receive incomes which may not rise following a
GST, such as non-indexed superannuation or compensation payments, maintenance, United Kingdom pensions,
interest from credit unions, bonds and banks, or, less predictably, income from shares (Appendix 4: Table 8).
Perhaps the only solution to this problem would be to increase pension and benefit rates by more than the
increase in prices experienced; this would help to protect the real living standards of those with private
incomes, and actually improve the real position of those wholly dependent on pensions and benefits.
PAGE 37
4.2 Non-Indexed Payments
Non-indexed social security payments comprise:
• age pension for those 70 years and over and receiving pension under the special income test;
• unemployment, sickness and special benefit for 16 and 17 year olds without dependents;
• additional pension and benefit for children;
• mothers/guardians allowance;
• supplementary assistance/allowance; remote area allowance;
• mobility allowance;
• family allowance;
• family income supplement;
• handicapped child's allowance; and
• double orphan's pension.
As with indexed payments, protection from losses for recipients of non-indexed payments resulting from a
GST would require
ad hoc increases in rates at the time the new tax was
introduced. Designing compensation for these groups would also raise some further difficulties. For
example, the full price effects of a new indirect tax may take some time to flow through. While this is less of
a problem with indexed payments because automatic indexation would ameliorate the problem, if estimates of
the final price effects upon which an immediate ad hoc increase for non-indexed payments was based were
understated, then further ad hoc increases would be required.
Problems could also arise in the face of second or third round effects of the new tax. In the UK, for example,
the introduction of VAT not only resulted in an initial round of price increases, but subsequently fed into
union wage demands, and thereby triggered off a second round of price rises (Sandford, 1983:19). The best
way to ensure that social security clients are protected from any such effects (or from adjustments to the rates
of indirect tax in the future) would be to automatically index currently unindexed payments to price
movements (with further immediate increases if the CPI did not accurately reflect the impact of the GST on
low income groups or those with children). This would also mean that non-GST price increases would also
flow on, and provide some 'buffer' against second and third round effects of the GST.
PAGE 38
4.2:1 Pensions and Benefits
Unemployment and sickness benefits for single 16 and 17 year olds and the "frozen rate" of age pension
payable to those aged 70 and over are not automatically indexed. If a GST were introduced, the real purchasing
power of these payments would be even further reduced. Compensation issues in the case of the 'frozen rate' of
pension are unclear in the light of changes by successive Governments to bring conditions of this payment into
line with that available to other pensioners. However, a clearer case for compensation of junior unemployment
and sickness beneficiaries exists.
4.2:2. Assistance for Dependent Children
On average and at almost every income level, families with dependent children would be more severely
affected by a GST than families without dependent children. This is because those with children generally
spend a greater proportion of their income on consumption. This indicates that those with dependents would
require additional compensation as a number of prominent advocates of tax reform have recognised (eg.
Groenewegen, 1984:121).
Pensioners and beneficiaries with children currently receive non-indexed family allowances and a non-indexed
payment of $14 per child per week, while sole parent pensioners and beneficiaries receive an additional $10 per
week through the non-indexed mothers/guardians allowance. The pensions income test free area (but not the
benefit free area) is also increased by $6 per week for each child. Unless adequate increases in assistance to
these families and to free areas were made following the introduction of a GST, the real living standards of
pensioners and beneficiaries with children would be reduced, and there would be a further shift in the tax
burden onto the poorest families with children. Compensation for pensioners and beneficiaries with children
might require increases well above any CPI increases, for reasons explained in detail earlier (eg. the CPI might
not accurately reflect the consumption patterns of those with children).
The design of compensatory changes for those who have children but who are not pensioners or beneficiaries is
more complex, for appropriate social security measures will depend critically upon the form of any income tax
changes. For pensioners and beneficiaries with children who pay little or no tax, compensation for the effects
of a GST can only be made through cash transfers. However, for families with children who are not pensioners
or beneficiaries, a number of possible trade-offs between tax and social security compensatory initiatives exist.
All such families receive family allowances, and in addition, very low income families in the workforce who
are not receiving a pension or benefit can currently receive up to $14 a week for each dependent child through
the family income supplement (FIS).
PAGE 39
The most likely approach to designing income tax cuts is to maintain effective disposable incomes; if, for
example, all prices increased by 10 per cent after introduction of a new GST, this approach would imply a $30
income tax cut for everyone with a disposable income of $300 a week, irrespective of the number of children or
other factors affecting the propensity to consume (1). such an approach would have revenue implications. For
example, in the illustration above, single taxpayers who were saving $100 a week and spending $200 would
pay only an extra $20 a week in indirect tax in the short term, but receive a $30 income tax cut. They might, of
course, pay the additional new indirect tax when they spent their savings; on the other hand, their savings might
never attract the extra indirect tax for which they had already been compensated (eg. they might be spent
overseas, be passed on to children upon death many years later, or be spent on items probably not subject to a
GST, such as property).
Apart from these problems, this approach raises major difficulties for low income groups who do not pay
enough income tax to be compensated via tax cuts for their new indirect tax burden. If, for example, a new
GST raised the expenditures of low income groups by 10 per cent, the new indirect tax paid by all single earner
couples with children with incomes below $245 a week would exceed their income tax payments (Table 4.1).
Thus, single earner couples with dependent children earning $200 a week currently pay $518 a year in income
tax. Following introduction of a GST which raised their total expenditures by 10 per cent, they would pay an
extra $988 a year in indirect tax if they bought the same basket of goods and services. Consequently,
compensatory changes to the income tax schedule which led to this family paying no income tax at all would
still leave them more than $450 a year out of pocket.
The number of families potentially in this position should not be underestimated. Some 25,000 families with
dependent children are currently receiving FIS, and they are largely clustered in the income ranges shown in
Table 4.1 As overseas research shows that take-up of FIS by eligible groups may be low (Dapre et al, 1981:56),
the actual number of families in this position may be very significantly higher. This suggests that a move to
broaden the consumption tax base would require new initiatives or very substantial increases in FIS, to protect
those low income families with children paying little income tax, in addition to increases which protected the
real purchasing power of FIS and family allowances.
(1) If income tax cuts were based on expenditure patterns more complex compensatory measures would be
required.
PAGE 40
TABLE 4.1 COMPARISON OF INCOME TAX PAYMENTS AND HYPOTHETICAL GST PAYMENTS
FOR SINGLE EARNER COUPLES WITH CHILDREN AT VARIOUS LOW INCOME LEVELS
Gross Income Current Disposable GST Payments

Weekly Annual Income Tax Income - 10% of
Income Income Expenditure
178 9256 213 9043 904
200 10400 518 9882 988
244 12688 1135 11553 1155
1. Values are shown to nearest whole dollar.
2. In calculating income tax due, the average tax scale applying over 1984-85 has been applied and the effect
of the Medicare levy has been ignored.
3. In calculating disposable income the effect of family allowances and family income supplement for
children has been ignored, on the assumption that their purchasing power will be maintained after
introduction of a GST. Rebates for dependent spouses have been included.
4. GST payments show additional indirect taxes payable if a GST raised expenditures by 10 per cent,
assuming that 100 per cent of disposable income is spent. HES data show that this assumption is
reasonable for households at these income levels. HES data also indicate that many of these households
dissave, and that additional GST payments are thus underestimated in such cases.
4.2:3 Other Payments
The extent to which indirect tax changes would affect the price of rent and lodging and thus justify increases in
the rate of supplementary rent assistance is not clear. For example, building and construction materials
currently attract no tax, but if they became subject to a GST some increase in rents might be expected to follow
in the medium term. While the amount of any real increase in the rate of rental assistance will have to be
determined if the tax mix is changed, it is clear that the rate should be adjusted in line with any relevant price
changes induced by a new consumption tax.
Handicapped childs allowance is payable to families caring for a handicapped child in the home. Both the rates
of payment and the income test associated with this program would need to be adjusted to compensate families
receiving this payment from any GST effects.
PAGE 41
Double orphans pension is payable free of income test to guardians and institutions. If a GST were introduced,
the rate of this pension would need to be increased to protect recipients.
Mobility allowance is paid to assist severely handicapped people who are unable to use public transport to meet
the additional travel costs incurred by their disability when undertaking employment or vocational training.
Those in this position who are able to drive cars receive a sales tax exemption on the purchase of a new motor
vehicle, and mobility allowance provides some equivalent assistance for those who cannot benefit from this
concession. The issue of a rate increase for mobility allowance therefore could rely not only on any general
effects of an indirect tax on transport costs, but also on what, if any, measures were taken in relation to those
currently receiving sales tax exemptions.
Remote area allowance recognises the additional costs faced by pensioners and beneficiaries in remote areas in
comparison to those in urban areas. Maintenance of the real value of the allowance would require its
adjustment by price movements and if a consumption tax increased price differentials between urban and
remote areas, greater increases would be required. Such increases would also need to be considered in the light
of any changes to the income tax zone rebates, which provide similar assistance to other taxpayers in remote
areas.
4.3 Other Government Transfer Payments
A number of other Government Departments provide cash transfers or grants to groups in specified
circumstances including Veterans' Affairs, Housing and Construction, Employment and Industrial Relations
and Education (eg. TEAS for tertiary students and payments for Transition Allowance Scheme participants).
Some cash transfers are also made by State governments. While the issues of possible compensation for these
groups are not the responsibility of the Department of Social Security, it seems that consideration should be
given to similar compensation in these areas, in order to prevent recipients from being adversely affected by tax
changes.
4.4 Low Income Groups Currently Receiving No Social Security Assistance
Any requirement that the tax burdens of most individuals remain roughly the same after a shift to consumption
taxes can be met for middle to high income groups through income tax cuts, for pensioners and beneficiaries by
social security rate increases and income test adjustments, and for all families with children by increases in
family allowances and FIS. However, there are two groups who could face substantial indirect tax payments
but not benefit fully, if at all, from income tax cuts, and who are currently ineligible for any social security cash
transfers. These are low income single people and couples without dependent children who are in the
workforce.
PAGE 42
It is, however, extremely difficult to calculate how many people would be in this position. The number
receiving low taxable incomes is a notoriously unreliable guide to the number in poverty, because, for example,
of tax avoidance and evasion, income splitting, and part-year workers. The Australian Bureau of Statistics
conducts two major surveys of the earnings of employees(l), the most recent of which were carried out in May
and August 1983.
Table 4.2 indicates that well over half a million full-time adult employees and a further 330,000 full-time
juniors earned less than $220 a week in August 1983. Because these figures are based on self-reporting by
employees of their earnings they must be regarded as overstating the number of low income full-time
employees (eg. because some workers may confuse their net pay with their gross pay). on the other hand, the
other ABS survey, which would tend to understate the number of low income workers (eg. because it excludes
agricultural employees), found that 500,000 full-time adult and junior employees had earnings of less than $220
a week (in May 1983 dollars).
The extent to which a consumption tax could disadvantage these groups is revealed in Table 4.3. It shows the
amount of tax paid by low income earners under the current personal income tax scales, and the amount of
additional indirect tax they would pay if a consumption tax was introduced which raised their expenditures by
10 per cent. For example, single full-time workers earning $178 a week would pay an additional $800 a year in
indirect tax if a GST raised their expenditures by 10 per cent, while employees with a dependent spouse earning
the same income would pay an extra $884 a year in indirect tax.
While in this case, single taxpayers could be fully compensated for the extra tax by-cuts in their income tax, the
examples in Table 4.3 show that those with dependent spouses earning less than $200 a week would be
severely affected by a GST which added 10 per cent to their expenditure, for the additional GST would exceed
the amount of income tax currently paid, and full compensation via income tax cuts would thereby be
impossible. Even if the tax threshold was adjusted in this case so that those on these incomes paid no income
tax, single earner couples with weekly incomes if $178 would still lose $470 a year, reducing their already low
disposable incomes by around $10 a week.
(1) These are Distribution and Composition of Employee Earnings and Hours, Australia, (ABS, 1984a) and
Weekly Earnings of Employees (Distribution), Australia (ABS, 1984b).
PAGE 43
TABLE 4.2 WEEKLY EARNINGS OF LOW INCOME EMPLOYEES (AUGUST
1983)*
Number of Employees
Weekly Aged Aged 20 Total
Earnings 15-19 & Over
$ a week ‘000 ‘000 ‘000
Full Part Full Part Full Part Time
Time Time Time Time Time
Under 160 203.3 146.4 349.7
144.5 442.6 587.2
160-180 57.8 104.7 162.5
* 60.1 62.8
180-220 66.5 312.2 378.8
* 70.9 72.8
TOTAL 327.6 563.3 891.0
149.1 573.6 722.8
Subject to unacceptable sampling error.
1. Full-time employees are those who worked 35 hours a week or more during the survey week.
2. Part-time employees are those who usually worked less than 35 hours and did so during the survey week.
3. It should be noted that some of these low income earners may also be pensioners and beneficiaries.
However, the issue of possible over-compensation for these groups (if they receive both social security
rate increases and income tax cuts) is of relatively minor importance as, for example, only 4 per cent of
pensioners receive earned incomes (Appendix 4: Table 8).
SOURCE: ABS (1984b).
PAGE 44
TABLE 4.3 COMPARISON OF INCOME TAX PAYMENTS AND HYPOTHETICAL GST PAYMENTS FOR SINGLE PERSONS
AND SINGLE EARNER COUPLES AT VARIOUS LOW INCOME LEVELS*
INCOME INCOME TAX DUE DISPOSABLE INCOME GST PAYMENTS - 10%

OF EXPENDITURE
WEEKLY* ANNUAL SINGLE SINGLE SINGLE SINGLE SINGLE SINGLE
INCOME INCOME PERSON EARNER PERSON EARNER PERSON EARNER
COUPLE COUPLE COUPLE
178 9256 1243 413 8013 8843 801 884
200 10400 1548 718 8852 9682 885 968
244 12688 2165 1335 10523 11353 1052 1135
* These income levels are those shown in Table 4.2 indexed by full-time AWE for all persons to
September 1984 levels.
1. Values are shown to nearest whole dollar.
2. in calculating income tax due average tax scales applying over 1984-85 have been applied and the effect of the Medicare levy has
been ignored. Single earner couples receive the dependent spouse rebate for those without dependent children.
3. GST payments show additional indirect taxes payable if a GST raised expenditures by 10%,and 100% of of disposable income is spent.
RES data shows that this assumption is reasonable for households at these income levels. RES data also indicates that many of these
households dissave and that addition GST payments are thus underestimated in such cases.
PAGE 45
Given the magnitude of these effects, the number of low income workers likely to be affected in this way is a
critical issue. While the numbers in Table 4.2 are likely to be overstated, it suggests that up to 1.6 million
full and part-time employees would currently earn less than about $245 a week (in 1984 dollars). To these
must be added other low income groups such as the self-employed and farmers, many of whom are likely to
be experiencing hardship.
About one third of these low income employees are juniors, many of whom may still be living at home.
While it may be argued that they are less in need of compensation than other low income groups, it must be
recognised that many will belong to low income families who are already facing financial difficulties, while
others will be living away from home and be severely affected by any decline in the purchasing power of
their already low incomes.
The remaining 1.1 million low income adult employees can be divided into four groups:
• those with dependent children;
• single income couples without children with incomes less than about $220 a week;(l)
• single income units with incomes under $150 a week;(1) and
• low income earners belonging to households with two or more income earners.
Low income adults with dependent children could in theory be compensated via major increases in FIS or
family allowances, as discussed in section 4.2:2. For the second group, of single income couples without
children with incomes less than about $220 a week, who could not be compensated via income tax cuts
following a GST which increased their expenditures by 10 per cent, a clear cut case for compensation exists.
However, the third group, of single income units with incomes less than about $150 a week, might be
regarded as less in need of compensation (eg. because many are part-time workers). The implications of a
decision not to compensate this group should be fully appreciated. First, as many of these workers are part-
time, it would shift the tax burden away from full-time and towards part-time employees - a questionable
move on both equity and efficiency grounds. Second, many of the part-timers would not be working part-
time out of choice but because they could not find full-time work, and failure to compensate them
(1) These income levels are based on a GST which adds 10 per cent to expenditures. Higher GST
increases would raise these thresholds while lower increases would reduce them.
PAGE 46
would therefore doubly penalise some of the most disadvantaged groups in our community. Third, many
single income units on these incomes could already be in poverty, and any lack of full compensation would
further reduce the purchasing power of their already low incomes and make the income distribution even
more unequal.
Finally, many low income workers would be secondary income earners, and in some cases belong to
households with a middle to high primary income. This is not, necessarily, an adequate reason for failing to
compensate such groups. First, as mentioned earlier, it would appear inequitable to penalise those who have
been forced by general economic conditions to work part-time, or to transfer the tax burden from full to part-
time workers. A transfer of the tax burden to secondary income earners may also have very adverse
efficiency effects, because existing research suggests that these groups have very high labour force
elasticities and are more greatly affected by marginal tax rates than high income earners (Apps et al. 1985).
Thus, if the revenue collected from indirect taxes on low income full and part-time secondary income earners
is used to finance reductions in marginal tax rates for middle to high income groups rather than for low
income groups, the total size of the economic "cake" may be reduced, as secondary income earners leave the
paid labour force.
Another issue is that secondary income earners frequently make a vital contribution to keeping their families
out of poverty, and available data from the 1978-79 Income Survey suggests that wives' labour force
participation rates are highest when husbands' incomes are relatively low (O'Loughlin et al, 1984:173).
Thus, failure to take account adequately of secondary income earners when designing compensatory
measures will disadvantage many low to middle income families and make the income distribution more
unequal.
In conclusion, it appears likely that many thousands of income units receive incomes that are so low that
compensation for any major shift to broad-based consumption taxes through income tax cuts is impossible -
and yet who are either ineligible for any social security pension or benefit or who cannot be adequately
compensated by existing mechanisms. While the exact impact of tax changes will, of course, vary with the
specific tax reforms introduced, this suggests that any major broadening of the consumption tax base would
need to be accompanied by new types of social security payments or of tax credit schemes for these groups.
A further alternative is absorption of current pensions, benefits and other cash transfers into a guaranteed
minimum income (GMI) or negative income tax scheme. Clearly, these sorts of options require further
analysis so that their implications can be fully understood. While such an analysis is outside the scope of the
present paper, Appendix 6 provides a brief description of alternative GMI plans.
PAGE 47
4.5 Compensation and Women
When assessing the compensatory measures required following any major shift to a broad-based
consumption tax, it should be appreciated that failure to compensate fully low income groups will result in a
major shift in the tax burden from men to women.
Almost 60 per cent of all pensions and benefits are paid to women, and any lack of adequate compensation
for social security recipients will therefore mainly disadvantage women rather than men. Similarly, family
allowances, family income supplement and handicapped childs allowance are generally paid to the mother.
Women are also disproportionately represented among low income groups in the workforce. Table 4.4
shows that about 590,000 male employees earned less than $220 a week in August 1983, compared to
1,023,000 female employees. Thus, inadequate compensation for these groups will again particularly
penalise women.
A final issue is the possible effect of any consumption tax on the distribution of income within the family.
Clearly, for all two income families consisting of a female low income earner and a male middle to high
income earner, inadequate compensation for low income groups will tilt the family distribution of income
towards the male. In addition, while in many cases women will be more directly confronted by GSTinduced
price increases, most of the income tax cuts will go to males. This may have adverse repercussions, as
existing research suggests it cannot be assumed that income is equitably shared within families (Edwards,
1985).
The future of family allowances in any tax reform package is also of relevance here. If, for example, family
allowances were superseded by a child tax credit or rebate and generally paid to the main income-earner, the
distribution of income within families would be affected.
This suggests that the intra-family distribution of income should be a vital consideration in any tax reform
measures.
PAGE 48
TABLE 4.4 WEEKLY EARNINGS OF LOW INCOME EMPLOYEES: DISTRIBUTION BY INCOME
AND SEX (AUGUST, 1983)
Weekly Male Employees Female Employees

Earnings Full Part Total Full Part Total
Time Time Time Time
under $160 178.6 171.2
111.3 475.8
289.9 647.0
$160-$180 80.1 82.4
8.3 54.5
88.4 136.9
$180-$220 202.8 176.0
10.1 62.7
212.9 238.7
TOTAL 461.5 429.6
129.7 593.0
591.2 1022.6
1. Full-time employees are those who worked 35 hours a week or more during the survey week.
2. Part-time employees are those who usually worked less than

35 hours and did so during the survey week.
SOURCE: ABS (1984b).
4.6 Costs of Compensation
Any substantial move to a broad-based consumption tax would sharply increase social security outlays. It is
estimated that a 10 per cent increase in the basic rates of all social security cash transfers and income test
thresholds alone would cost about $1.6 billion if made in 1985-86, and around $1.7 billion if made in 1986-
87. This takes no account of those who would become newly eligible for small amounts of pension or benefit
following such increases. (It also excludes any increases in the outlays of other Departments, such as
Veterans' Affairs or Education.)
Clearly, any major shift to a GST would not only sharply increase social security outlays, but also the share
of total Budget outlays (And, possibly, gross domestic product) devoted to social security and welfare. This
increase would, of course, be illusory, in the sense that social security recipients would merely be repaid the
extra indirect taxes they had contributed. Their actual welfare might not be improved. Nonetheless, there
could be strong opposition to such increases, or to further increases in social security outlays in the future.
This might thus reduce the scope for redistributive measures.
PAGE 49
5. MEASURES TO PROTECT LOW INCOME GROUPS AND FAMILIES WITH CHILDREN FROM
DIRECT TAX CHANGES
As noted earlier, low income groups could generally benefit indirectly from more effective capital taxation
through any consequential increases in the tax threshold, reductions in the lower marginal tax rates, or
through redistributive measures financed by the additional revenue collected.
Most pensioners and beneficiaries would not be greatly directly affected by the introduction of a more
comprehensive system of capital taxation or by the more effective taxation of employment fringe benefits.
This is because:
• the social security pension income and assets test arrangements effectively exclude from eligibility
those with high incomes and those with considerable asset holdings;
• the social security benefit income test, particularly in conjunction with strict eligibility conditions, also
excludes all but those with modest incomes; and
• these groups have little or no access to employment benefits which are, as noted previously,
disproportionately concentrated on high income earners.
Nevertheless, depending on the form and scope of any capital tax, it is possible that problems may arise for
certain social security recipients:
• wealth taxes are usually set at a level which allows them to be met out of income; if a wealth tax was
introduced, many age pensioners with minimal incomes could become liable for additional taxes
because of their assets, and could subsequently be forced to sell some of those assets;
• another issue is the interaction between the pensions assets test and any wealth tax: unless the wealth
tax replaced the assets test, or pensioners were excluded from any wealth tax (or wealth tax free
thresholds were appropriately set), those who had their pensions reduced because of their asset holdings
could face a wealth tax on the same assets. This might be regarded as "double taxation";(l)
(1) Farmers and some other self-employed persons may have low incomes but substantial assets.
Treatment of these groups may require more detailed consideration.
PAGE 50
• gift or estate duties could also affect pensioners or their children, eg. those whose pension entitlement
was reduced under the assets test provisions because they gave their assets to their relatives could also
face new gift duties or transfer taxes. Similarly, the children of those pensioners who had sizeable
illiquid assets and had thus availed themselves of the Pensioner Loans Scheme might subsequently face
not only the repayment of any pension to the Government, but also death duties on the assets of the
pensioner parent.
While not all of the above effects might be considered undesirable, it should be appreciated that many of the
aged have not always been asset rich, but have taken a lifetime to accumulate some assets and/or have
received bequests and life insurance or superannuation lump sums late in life.
Consequently when designing any capital tax changes, such life cycle factors might be taken into account.
For example, if one or more forms of capital taxation were introduced it might be necessary to modify the
pensions assets test or any proposed tax in order to avoid excessive disadvantage to pensioners.
Social security clients could benefit from some of the tax reforms described above. For example, if income
or capital gains tax was assessed on the real (ie. inflation adjusted) value of interest payments or share sales,
age pensioners with private incomes from such sources could benefit. The majority of the non-pension
income of pensioners is from bank, credit union and bond interest (Appendix 4:Table 8).
Pensioners, beneficiaries and other low income groups may also be indirectly affected by capital taxes. It is
not yet clear, for example, how capital taxes would affect the price of housing or rent. However, if private
rents generally increased, this would have a severe impact on some three quarters of a million pensioners and
beneficiaries, and other low income groups renting privately. Compensation for this effect would require
increases in the rate of supplementary (rental) assistance/allowance, and would increase the need for its
extension to unemployment beneficiaries and other low income private renters.
On the other hand, a move to tax wealth, capital transfers, capital gains and employment benefits could
improve the relative position of low and middle income groups compared with high income and asset-
holding groups. As indicated above, these taxes would affect those higher income groups currently
advantaged by investments in non-taxable assets or by receipt of employment benefits. However, as
explained earlier, this would be critically dependent upon how the revenue from such taxes was used. If new
direct tax measures were used solely to finance income tax cuts, most pensioners and beneficiaries would
derive no benefit.
PAGE 51
6. COMPENSATION AND REDISTRIBUTION
Any changes in tax/transfer arrangements necessarily involve some degree of redistribution, either in terms
of the redistribution of tax burdens or in the relative or absolute living standards of individuals.
The distinction between relative and absolute tax burdens and living standards is important, as it is possible
to seek a more equitable distribution of tax burdens which, while having an effect on relative living
standards, need not necessarily involve any improvement in the absolute living standards of those with the
lowest incomes. A major shift to indirect taxes accompanied by compensatory reductions in personal income
tax and compensatory increases in Government cash transfers, for example, would involve a major shift in
relative tax burdens and the relative living standards of all Australians. However, it would not necessarily
improve the absolute living standards of anyone, including the poor.
If as is widely assumed, such a tax reform package increased net revenues, one logical claim on that
additional revenue would be to improve the absolute living standards of the poor, and others who, while
perhaps not poor, live in meagre circumstances. Similarly, a move to impose a fairer share of the tax burden
on those who enjoy the benefits of relatively tax-free assets or wealth would result in a redistribution of
relative tax burdens, but achieve little in terms of the absolute living standards of the financially
disadvantaged, unless some or all of the additional revenue were directed to them through other progressive
tax/transfer changes.
If one objective of tax reform is to be to improve the absolute living standards of low income groups, it is
necessary to ascertain and cost measures to achieve this. Tax reforms would then need to have as a design
feature the capacity to raise sufficient revenue (net of any compensatory measures) for this purpose. Some
illustrative tax/transfer priorities aimed at improving the living standards of the lowest income groups appear
in Table 6.1. The cost of even this range of modest initiatives would be substantial.
PAGE 52
TABLE 6.1 ILLUSTRATIVE SOCIAL SECURITY EXPENDITURE PRIORITIES
Priority Current
Approximate
Full Year Cost
$M
Social Security Pension/Benefit Rates
1. Raise unemployment benefit for adults without children to

the single pension rate 185
2. Achievement of the Government's commitment to raise

pensions/benefits to 25% of AWE (includes the costof 1. above) 990
Assistance For Low Income Private Renters
3. Increase current $15 a week maximum rate

- for first $5 a week increase 65
4. Income test as an addition to the pension 70

(if 3+4 introduced simultaneously,
the total cost would be significantlyhigher)
5. Extend to adult unemployment beneficiaries after six weeks on benefit 250
Assistance For Low Income Families

6. Increase additional pension/benefit and family income supplement
for children - for each 20% increase in current
maximum rate of $14 a week per child 130
7. Increase mothers/guardians allowance payable to sole

parent pensioners - for each 20% increase in current maximum rate
of $10 a week per family 30
General Family Assistance
8. Increase family allowances

- for each 20% increase 300
Non-Indexed Payments
9. Maintain November 1984 130

real value of unindexed
social security payments
PAGE 53
Social Security Income Tests
10. Increase pension/benefit 100

income test free zones
('free areas') by $10 a week
11. Reduce effective marginal tax at least 250*

rates for pensioners by
lowering income test
withdrawal rates from 50% to 25%
in conjunction with abolition of
the 'frozen rate" pension for
those aged 70 and over
* Does not include costs for any persons who become newly
eligible for assistance.
The income test initiatives above should be considered against the high effective marginal tax rates and
consequent poverty traps faced by pensioners and beneficiaries. Reducing these effective marginal tax rates
would be consistent with the principle of a fairer tax/transfer system, and is related to the concern to reduce
marginal tax rates for middle income PAYE taxpayers.
There is a strong case for maintaining the real value of non-indexed cash transfers to low income groups,
particularly as the bulk of this expenditure is directed to pensioner and beneficiary families with children who
typically have no income apart from their social security payments. Because current rates of income-tested
social security payments for children are modest (eg. the additional pension or benefit for each child is
currently $14 a week) compared with the actual costs associated with raising children, real increases in levels
of assistance for children are a high priority.
Increases in family allowances which are also unindexed, and which have effectively been increased only
once since 1976, also provide an important source of income for low income households. More generally,
family allowances are also an important mechanism for achieving horizontal equity between families with
and without children in tax/transfer arrangements.
PAGE 54
Some three quarters of a million pensioners and beneficiaries rent in the private market. While the
Government has accorded a high priority to increasing levels of rent assistance the maximum level of
assistance ($15 a week) is still low compared with average private rent levels (some $75 a week). The
situation of unemployment beneficiaries is particularly acute as the unemployed are not currently entitled to
even this modest level of assistance. The income test applying to rental assistance is also particularly
stringent, as all entitlement ceases when non-pension/benefit income reaches $30 a week (total weekly
income at this point is currently about $122 a week for single people and $183 a week for married couples).
Finally, increasing basic rates of pensions and benefits to 25 per cent of AWE is an outstanding 1983 and
1984 Government election commitment aimed at establishing and maintaining an adequate level of poverty
alleviation payments. The basic single rate of pension was about 23.5 per cent of AWE in the December
quarter 1984.
PAGE 55
7. SUMMARY AND CONCLUSIONS
Both the taxation and social security systems have a major effect on income distribution; while the two
systems are often considered separately, they overlap so extensively that exclusive concentration upon
changes to only one system may frustrate achievement of broader equity goals. Examples of this interaction
include:
- overlapping populations, eg. more than 10 per cent of all taxpayers receive social security pensions and
benefits at some time during the year; similarly, many individuals have entitlements under both systems,
eg. sole parents receive the sole parent rebate through the tax system and family allowances through the
social security system;
- overlapping "income tests", eg. the income test on pensions and benefits is analogous to income tax (in
that both reduce the benefit to an individual of additional income), and they interact to produce high
effective marginal tax rates; and
- the interchangeability of many tax and social security measures for achieving equity objectives, eg.
assistance to families with children can be provided through tax rebates or deductions to taxpayers with
children, or through cash transfers such as family allowances.
This suggests that the two systems must be considered together when designing tax reform. A corollary is
that whether any particular tax or social security measure is progressive or regressive when considered in
isolation is less important than the effect of overall changes to tax-transfer arrangements.
Much of the tax reform debate has focussed on the need to reduce the tax burdens and marginal tax rates of
those earning average weekly earnings and above, but the relative decline in the disposable incomes of, and
the higher effective marginal tax rates experienced by, social security recipients and low income groups
suggest that they warrant priority in any tax/transfer reforms:
- analysis of trends in disposable incomes since 1976-77 indicates that while those at AWE have
experienced substantial real increases in their disposable incomes, those of many social security
recipients have actually declined, while the disposable incomes of other social security recipients and
most families with children have declined relative to those of taxpayers without children at AWE; and
PAGE 56
- social security recipients face effective marginal tax rates (EMTRS) of up to 125 per cent, far higher
than the 60 per cent rate applying to the richest taxpayers; such EMTRs mean that social security
recipients may be "trapped" into poverty, as attempts to increase their disposable incomes may leave
them little better off or even worse off than if the attempt had never been made.
Tax reforms may affect low income groups in two major ways:
- some changes may make social security recipients and other low income groups better-off or worse-off
in absolute terms, eg. an increase in indirect taxes or, say, a lowering of the income tax threshold,
without other changes, would increase the real tax burdens on pensioners and beneficiaries and thus
lower their living standards; and
- any tax change may alter the relative position of low income groups, eg. cuts in personal income tax
which do not flow through to pensioners and beneficiaries (because their incomes are too low to take
either full or any advantage of personal income tax cuts) may widen the gap between the disposable
incomes of the poor and other members of the community.
The exclusion from the income tax base of most capital gains, imputed income from capital, inheritances and
gifts and many employment fringe benefits creates vertical and horizontal inequities, and directly affects low
income groups, by raising income tax rates above those which could otherwise have prevailed and by
reducing the revenue available to finance redistributive measures. To this extent, low income groups could
benefit from appropriate income or capital tax reforms.
However, some pensioners and beneficiaries could be adversely affected, eg. those whose pensions had been
reduced because of their asset holdings might also face a wealth tax on the same assets. This might be
regarded as "double taxation".
Some have regarded broadening of the indirect tax base as a way to reduce possible work disincentives
created by marginal tax rates, and to catch tax avoiders and evaders and thus improve the equity of the
system. However, it must be recognised that expansion of the indirect tax base will create major inequities
for low income groups and require large increases in social security outlays if the poor and families with
children are to be protected from a further decline in their living standards.
Data on the expenditure patterns of households show that extension of wholesale sales tax to the major
currently excluded item of food would create vertical and horizontal inequities, ie. it would adversely affect
low income households more than middle and upper income households, and at most income levels would
affect those with children more than those without:
PAGE 57
- low income households with children would be worst off; expenditure data suggest that a uniform tax
on food as a percentage of disposable income would be about 5 times higher for poor families with
children than for high income families without children.
The effects of a new tax on services are also likely to be regressive, and special consideration would have to
be given to publicly provided services, such as public transport or personal care services.
Introduction of a broad-based, uniform-rate goods and services tax (GST) could also be both vertically and
horizontally inequitable. For example, on the basis of 1984 HES data, it could take up to 5 times as high a
proportion of income from the poorest households as from the most well-off. Similarly, those with children
could pay up to 40 per cent more of their incomes in additional tax than those at the same income level
without children:
- thus, the imposition of a broad-based indirect tax, without compensatory measures, could be expected
to drive poorer households into debt, lead to the further run-down of savings, the forced sale of assets,
or more attempts to cut back on consumption of goods normally considered essential by Australian
society.
While the regressivity of new broad-based indirect taxes can be marginally reduced through exemption of
"necessities" and/or differential rates on "luxuries", available evidence suggests that this is an inefficient and
possibly relatively ineffective method of assisting low income groups, and that any claims that a GST can be
progressive are incorrect. However, if compensatory measures are not adequate, the exemption of necessities
and other measures must be seriously considered despite the marginal equity gains and major efficiency
losses which would result.
Any major shift to broad-based consumption taxes would almost certainly entail some degree of regressivity.
While the additional consumption taxes may be offset for most taxpayers by income tax cuts, most
pensioners, beneficiaries and other low income earners will be unable to benefit fully if at all from such
income tax cuts, because they do not pay enough income tax. Consequently, compensation will have to be
provided through additional government outlays, including social security cash transfers, or through new tax
credits or negative income tax payments.
Following any major shift to a broad based GST, automatic CPI indexation of social security payments will
not be sufficient to compensate pensioners and beneficiaries because:
- of the lag of up to 10 months between price increases and the "flow-on" to pensions and benefits;
PAGE 58
- depending upon the tax changes, the CPI may not adequately reflect the effect of tax and price changes
on social security clients, as their consumption patterns differ from the "average" captured in the CPI;
- part of the compensatory payments may be lost in income tax;
- the real value of savings may be reduced by a new indirect tax, as pensioners and beneficiaries would
be able to buy fewer goods and services with these savings;
- those who are dissaving (eg. by running down their savings or going into debt) would lose, as they
would be partially compensated by automatic indexation procedures for the decline in the purchasing
power of their pension, but not for the decline in the purchasing power of their additional spending; and
- varying consumption patterns mean that if compensation only reflects the average indirect tax increases
experienced by pensioners and beneficiaries, some will inevitably 'win' while others will "lose".
The above factors suggest that adequate compensation will probably require:
- immediate ad hoc increases substantially higher than the estimated effects of the new indirect tax on
the CPI (with appropriate adjustments being subsequently made when the normal pension indexation
increases fall due);
- adjustments to the income tax threshold or pensioner/beneficiary rebates so that part of the additional
compensatory pension increases are not subsequently returned in income tax; and
- some further increase in pension and benefit rates to create a "buffer zone" which will ensure
protection against losses arising from dissaving, the decline in the value of savings (which particularly
affects the aged), and the additional indirect taxes borne by those pensioners and beneficiaries whose
expenditure patterns are not average.
To protect those pensioners and beneficiaries who receive private income in addition to their pensions, all
social security income and asset test thresholds would also need to be indexed by the average increase in
indirect taxes paid by pensioners and beneficiaries:
PAGE 59
- the living standards of those with private incomes could decline after introduction of a GST, as their
private incomes might not be increased in compensation for the new indirect taxes they were paying
out of their private income. While the non-pension/benefit incomes of some recipients may be indexed
or may increase after a GST, the private incomes of others may be fixed. In such cases,
some might pay sufficient income tax to be compensated via income tax cuts. However, over one
million pensioners and beneficiaries with private incomes pay too little income tax to be fully
compensated for a GST which increases their expenditure by 10 per cent. Protection of these groups
might require a further increase in the "buffer zone".
All non-indexed social security cash transfers, including junior unemployment benefits, additional
pension/benefit for children, family income supplement and family allowances would require immediate ad
hoc increases to maintain their real purchasing power. Particular problems may arise if price increases take
many months to flow through, if there are second or third round effects such as higher wage demands, or if
there are further adjustments by governments to the indirect tax system in the future. One solution would
be to extend the automatic indexation provisions to all non-indexed payments, as this would reduce or
eliminate the need for ad hoc measures in the future (although higher ad hoc increases might be required
immediately if the CPI did not accurately reflect the price changes experienced by low income groups).
As noted earlier, families with children are likely to be more severely affected by a major shift to a GST
than those without. Pensioners and beneficiaries with children would be protected by full implementation
of the compensatory procedures described above. However, designing compensation for families with
children who are not pensioners and beneficiaries would be much more complex. Social security
compensatory measures will depend critically upon any income tax offsets introduced. Income tax cuts
may attempt to maintain the effective disposable incomes of all taxpayers. While this would have revenue
implications, the major equity problem is that many thousands of low income families with children would
probably not pay enough income tax to be compensated via income tax cuts for their new indirect tax
burden, and compensation could therefore involve a substantial increase in the rate of family income
supplement.
A number of other Government Departments provide cash transfers or grants to groups in specified
circumstances, including Veterans' Affairs, Housing and Construction, Employment and Industrial
Relations and Education, (eg, TEAS for tertiary students and payments for Transition Allowance Scheme
participants). While the issue of possible compensation for these groups is not the responsibility of the
Department of Social Security, consideration should be given to similar compensation in these areas, in
order to prevent their clients from being adversely affected by tax changes.
PAGE 60
Two groups who could face substantial indirect tax payments if there was a major shift to a GST, but not
benefit fully, if at all, from income tax cuts, yet who are also currently ineligible for any social security cash
transfers are low income single people and couples without children in the workforce. Protecting these
groups might require introduction of new social security cash transfers, tax credits, or a new guaranteed
minimum income or negative income tax scheme which covered all low income groups.
If these low income employees are not adequately compensated, there will be a major shift in the tax burden
from men to women because women predominate in these income ranges. Further, while women may more
directly experience GST-induced price increases, the majority of any offsetting income tax cuts will go to
males. As existing research shows that it cannot be assumed that income is equally distributed within
families, the effect of any tax reforms on the intra-family distribution of income should be kept firmly in
mind.
The above measures would be very costly, but would not improve the real living standards of those affected.
It is estimated that a 10 per cent increase in social security cash transfers and all income test thresholds
would cost about $1.6 billion in 1985-86 and $1.7 billion if made in 1986-87. However, this would merely
involve the return to low income groups of the additional indirect taxes they had paid. The growth in outlays
could nonetheless attract strong criticism and reduce the scope for additional outlays to finance redistributive
changes in the future.
The preceding discussion has been confined to merely compensating low income groups for tax changes, not
to actually improving their net position. However, many would regard redistribution to low income families
and individuals as a key objective of any tax reforms. Some major redistributive priorities are discussed in
Part 6 of this Submission.
PAGE 61
APPENDIX ONE - EXTRACT FROM GOVERNMENT TAXATION POLICY STATEMENT BY THE
PRIME MINISTER: 31 OCTOBER 1984
Nine Point Tax Review Principles
First, there must be no increase in the overall tax burden, as measured by the share of Commonwealth
Government tax revenue in gross domestic product, next year or through the Government's next term in
office.
Second, any reform must continue the process already begun by this Government, and provide further cuts in
personal income tax.
Third, taxation changes must contribute to smashing tax avoidance and evasion, which remain as features of
the tax system which the Government inherited.
Fourth, any reform must lead to a simpler system, which therefore all Australians can understand more
easily, and which therefore makes tax avoidance and evasion more difficult.
Fifth, any reform package must result in a tax system which is fairer, so that Australians are only required to
pay tax according to their capacity to pay, and the overall system must be progressive.
Sixth, any tax reform must not disadvantage recipients of welfare benefits, and should reduce or remove
"poverty traps".
Seventh, if any reform package which includes changes in indirect taxes is contemplated, it must be
acceptable to the various groups in the Australian community whose response will determine whether we can
maintain moderation in wage movements.
Eighth, any reform must provide the best possible climate for investment, growth and employment in
Australia.
Ninth, any reform package must have widespread community support, including support at a widely
representative National Tax Summit of economic organisations and community groups.
PAGE 62
APPENDIX TWO - EFFECTIVE MARGINAL TAX RATES FACED BY SOCIAL SECURITY
RECIPIENTS
The examples in this Appendix have been chosen to illustrate a variety of situations in which pensioners and
beneficiaries face high effective marginal tax rates. The following points should be noted:
• the rates of pensions. benefits and additional payments used are those applying from 1
November 1984:
• the tax scales used are those applying from 1 November 1984. not the average scales for
1984-85:
• consequently, the income level above which the pensioner rebate begins to phase-out for the
purposes of these examples is $5595;
• the examples assume that the private income is earned by the husband in married couples; and
• the examples include the effects on disposable income of family allowances, which, however,
since they are neither income-tested nor taxed, do not affect effective marginal tax rates.
PAGE 63
UNEMPLOYMENT AND SICKNESS BENEFICIARY COUPLE, ONE NON-BENEFIT
INCOME, WITH 2 DEPENDENT CHILDREN
NON-BENEFIT INCOME TOTAL BENEFIT DISPOSABLE INCOME EFFECT MARG

TAX RATES
EFFECT MARG
NON BENEFIT INCOME TOTAL BENEFIT DISPOSABLE INCOME TAX RATES
($/wk) ($/wk) ($/wk) (%)
0.00 - 14.29 181.30 194.05 - 208.34 0
14.29 - 20.00 181.30 208.34 - 212.62 25
20.00 - 70.00 181.30 - 156.30 212.62 - 231.37 62.5
70.00 - 198.30 156.30 - 28.00 231.37 - 231.37 100*
198.30-226.30 28.00 - 0.00 231.37 - 224.37 125
226.30-240.38 nil 224.37 - 234.93 25

* Plus loss of Health Care Card after $138.
SOLE PARENT WITH 2 DEPENDENT CHILDREN
EFFECT MARG
NON-PENSION INCOME TOTAL PENSION DISPOSABLE INCOME TAX RATES
($wk) ($/wk) ($/wk) (%)

0.00 - 42.00 129.90 142.65 - 184.65 0
42.00 - 70.94 129.90-115.43 184.65 - 243 .02 50
70.94 - 225.80 115.43- 38.00 243.02 - 257.19 62.5
225.80 - 240.38 38.00- 30.71 257.19 - 260.84 75
240.38 - 278.13 30.71 - 11.83 260.84 - 268.38 80
278.13 - 292.77 11.83 - 4.51 268.38 - 268.38 100
292.77 - 301.80 4.51 - 0.00 268.38 - 270.10 81
301.80 - 375.00 nil 270.10 - 320.61 31

* Plus loss of Fringe Benefits after $100
PAGE 64
SINGLE SICKNESS BENEFICIARY
NON BENEFIT INCOME TOTAL BENEFIT DISPOSABLE INCOME EFFECT MARG

TAX RATES
($/wk) ($/wk) ($/wk) (%)
0 - 0.08 91.90 91.90 - 91.98 0
0.08 - 7.77 91.90 91.98 - 96.79 37.5
7.77 - 20.00 91.90 96.79 - 105.96 25.0
20.00 - 69.66 91.90 - 67.07 105.96 - 124.64 62.5
69.66 - 70.00 67.07 - 66.90 124.64 - 124.74 72.5
70.00 - 136.90 66.90 - 0.00 124.74 - 124.74 100
136.90 - 143.92 nil 124.74 - 128.59 45
143.92 - 240.38 nil 128.59-199.98 26
MARRIED AGE PENSIONER COUPLE, BOTH UNDER 70 YEARS, ONLY ONE INCOME
NON PENSION INCOME TOTAL PENSION DISPOSABLE INCOME EFFECT MARG
TAX RATE
($/wk) ($/wk) ($/wk) (%)

0.00 - 30.94 153.30 153.30 - 184.24 0
30.94 - 50.00 153.30 184.24 - 196.15 37.5
50.00 - 75.87 153.90 - 140.36 196.15 - 201.81 78.125
75.87 - 79.52 140.36 - 138.54 201.81 - 202.95 68.75
79.52 - 97.36 138.54 - 129.62 202.95 - 209.64 62.5
97.36 - 121.25 129.62 - 117.67 209.64 - 216.21 72.5
121.25 - 201.64 117.67 - 77.48 216.21 - 245.96 63
201.64 - 334.90 77.48 - 10.85 245.96 - 290.26 66.75
334.90 - 356.60 10.85 - 0.00 290.26 - 296.12 73
356.60 - 375.00 nil 296.12 - 308.82 31
Plus loss of Fringe Benefits after $98.
PAGE 65
SINGLE PERSON OF AGE PENSION AGE, BUT UNDER 70 YEARS
EFFECT MARG
NON-PENSION INCOME TOTAL PENSION DISPOSABLE INCOME TAX RATES
($/Wk) ($/Wk) ($/Wk) (%)
0.00 - 15.69 91.90 91.90 - 107.59 0
15.69 - 30.00 91.90 107.59 - 116.54 37.5
30.00 - 59.66 91.90 - 77.07 116.54 - 125.80 68.75
59.66 - 74.05 77.07 - 69.87 125.80 - 128.86 78.75
74.05 - 78.31 69.87 - 67.74 128.86 - 130.17 69.25
78.31 - 213.80 67.74 - 0.00 130.17 - 180.30 63
213.80 - 240.38 nil 180.30 - 199.98 26
* Plus loss of Fringe Benefits after $60.
SINGLE INVALID PENSIONER
EFFECT MARG
NON PENSION INCOME TOTAL PENSION DISPOSABLE INCOME TAX RATES
($/wk) ($/wk) ($/wk) (%)

0.00 - 30.00 91.90 91.90 - 121.90 0
30.00 - 88.36 91.90 - 62.72 121.90 - 151.08 50
88 . 36 - 136.73 62.72 - 38.53 151.08 - 163.17 75
136.73 - 143.92 38.53 - 34.94 163.17 - 163.53 95
143.92 - 213.80 34.94 - 0.00 163.53 - 180.30 76
213.80 - 240.38 nil 180.30 - 199.98 26
* Plus loss of Fringe Benefits after $60
PAGE 66
APPENDIX THREE - CONTRIBUTORY FINANCING OF SOCIAL SECURITY
A number of critics of the Australian direct tax system (Mathews, 1983), including some previous
submissions to EPAC (Kelman, 1984) have noted that Australia shares with New Zealand the distinction of
being the only OECD countries with no explicit social security contributions. Such contributions make up a
very significant proportion of total taxation revenue in most OECD countries, generally amounting to 30 to
40 per cent of total revenues, but ranging as high as 47 per cent in Spain and as low as 1.8 per cent in
Denmark (OECD, 1984).
It should be noted that the financing issue cannot be considered in isolation from the benefit structure. Under
many of the social insurance systems in other OECD countries, cash benefits are designed to replace, at least
partially, the income that is lost when a worker retires, becomes severely disabled or dies. The worker's
entitlement to benefits is based on past employment and the level of benefit received is often related to
earnings in covered work - the more the worker earns, the greater, usually up to a ceiling, is his or her
protection. The system is contributory, coverage is usually compulsory and benefits are not normally means-
tested. In addition to contributions from employees, there may be levies on employers. A variety of
supplementary mechanisms are required, however, to protect those who have not been "covered", whose
entitlement is too low or whose benefits have been exhausted. These usually involve general revenue
financing - in recent years such financing has also played an increasingly important role in the basic social
insurance schemes.
In contrast to such schemes, cash benefits paid by the Australian Department of Social Security are financed
entirely out of general revenue, and benefits are flat-rate and predominantly either income or assets-tested.
They are payable for as long as the contingency (eg. unemployment) exists. However, while there are major
differences between the Australian social security system and those of most OECD countries, the differences
should not be exaggerated. For example, in Australia the general revenue financed minimum income support
system is but one, albeit the most important, element of overall social security arrangements. In addition,
there are State Government mandated compensation arrangements for work injuries and deaths and road
accident injuries and deaths, private life and contingency insurance arrangements and occupational
superannuation, which are in turn supported and promoted by Federal Government tax concessions, paid sick
leave provided and financed by employers, and the overall health care system (1). Income support
arrangements in Australia therefore can be regarded as "mixed", with general revenue financing
predominating. Other countries' social security arrangements also tend to be mixed, incorporating for
example, general revenue as well as contributory financing, with the latter predominating.
(1) For further details, see McAlister, Ingles and Tune, 1982.
PAGE 67
The balance that different countries achieve between their financing methods and their benefit structures can
be expected to vary according to the priorities that are placed on the differing objectives of providing social
security. Therefore, any suggestion that the Australian tax transfer system is 'unbalanced' because of the lack
of contributory elements should be assessed against a range of often conflicting objectives in tax transfer
arrangements and the priorities accorded to these different objectives. Relevant issues include:
(1) Poverty alleviation - Payment of flat-rate, income-tested benefits means that the impact on poverty
alleviation can be greater for a given level of expenditure. In this sense, the Australian system is
currently conducive to greater "target efficiency" than earnings-related schemes. However, "target
efficiency" may not be the same as economic efficiency and may have costs in that regard. Also,
poverty alleviation may be reduced if rates of benefit or take-up are low.
(2) Earnings replacement - Overseas social security systems typically give greater priority to earnings
replacement objectives than to poverty alleviation. The provision of flat-rate benefits, however, does
not necessarily mean that earnings replacement rates are necessarily low for low income earners. It is
by no means certain that the lowest income groups in Australia fare badly compared to similar groups
in other countries, particularly if it is borne in mind that social insurance arrangements elsewhere can
mean that entitlements to support can be nil or can be exhausted.
(3) Taxable capacity - It may be considered that a contributory approach could provide a "new" source of
revenue to finance social security spending, and that in this way there may be greater opportunities to
provide higher benefits to the poor, or alternatively that the costs of social provision will be made
clearly visible to, and felt by, all taxpayers. This issue is central to any debate on contributory
financing in the context of tax reform, but the questions involved are perhaps, in the final analysis,
unanswerable. By its nature, contributory social insurance cannot help many of the poorest - those who
effectively have little capacity to "buy" their protection - unless a significant degree of redistribution is
involved in the program. That is, the poverty alleviation objective can conflict with the earnings
replacement objective, with the result that many contributors may feel that they are not getting value
for money. This in turn may mean that many may regard their social insurance contributions as no
more than an additional tax. Thus, taxable capacity may in fact be similar under either a general
revenue financed or a social insurance scheme depending upon social attitudes towards these
objectives.
PAGE 68
In addition, this suggests that much of the concern about the "unbalanced" tax structure in Australia
mistakes appearances for reality. The fact that social insurance contributions make up 30 to 40 per
cent of total revenue in many OECD countries necessarily means that income tax as a proportion of
revenue is reduced in those countries, while in Australia the relative significance of personal income
tax correspondingly appears higher. However, to the extent that social security contributions fulfil at
least some of the same objectives as part of income tax (and vice versa), it may be considered more
meaningful to compare personal income tax plus employee social security contributions across
countries. Such a comparison reveals a vastly different picture - for example, in 1981, Australia
ranked fifth highest in the OECD in terms of personal income tax as proportion of total revenue, but
eleventh (or in about the middle of OECD countries) in terms of personal income taxes plus employee
social security contributions as a proportion of Gross Domestic Product (OECD, 1983).
Whether the Australian tax structure is significantly out of step with those of other developed countries
is therefore a matter for judgement. However, this sort of comparison does indicate that, on average,
where the social insurance approach is employed more overall revenue is , raised. It is extremely
uncertain, however, whether or to what extent this additional revenue is used for redistribution. one
suggestion is that a large proportion of gross transfers may simply go back to higher income earners
who made high contributions.
(4) Fiscal flexibility - General revenue financing may allow a greater degree of flexibility in budgetary
policy than does the contributory approach. For example, during economic recession, contribution
rates may have to rise to compensate for declining revenues and increasing costs. Such increases may
be contrary to the Government's general fiscal policy stance. Moreover, contributions with their quasi-
contractual benefit promises may lock in governments to commitments that ultimately may prove
difficult to sustain.
(5) Administrative simplicity - While the structure of social insurance schemes may vary widely, in their
most developed form they generally imply much greater administrative complexity, with the need for
mechanisms to determine and collect contributions (perhaps from employers as well as employees) and
to determine and pay benefits on the basis of these contributions. It might also be noted that to some
extent such public mechanisms may displace private superannuation or insurance arrangements.
PAGE 69
(7.) Public acceptability and coverage - The earlier discussion of taxable capacity suggests that social
insurance schemes can attract some greater degree of public support, since benefits paid out may
generally be perceived as entitlements "earned" by past contributions rather than as a "charitable"
payment. However, to the extent that a social insurance scheme is financed on a 'pay as you go' rather
than a funded basis, the effect may be little different from general revenue financing. That is, public
acceptability of general revenue financing as producing an entitlement to benefits is fundamentally a
matter of social attitudes.
A basic problem with social insurance is that there is no logical connection between those who can
afford to pay contributions and those who need assistance. This may result in two classes of social
security recipients: those with previous attachment to the labour force, and those with no such
attachment or whose eligibility has lapsed. The need to cater for such groups, particularly those
handicapped from birth, new entrants to the labour forcer the long term unemployed and single
mothers who are not widows, means either that a substantial *public assistance or 'welfare' system
must be developed, or that contributory ,requirements must be watered down. Either course, however
may come into conflict with the objective of maintaining the acceptability of high contributions for
'self-insurance', and may lead to pressures to keep public assistance meagre, rigorously means-tested
and stigmatised. In contrast, general revenue financing may facilitate equality of treatment for all
judged to be in need, irrespective of the causes of their need. In this sense, general revenue financing
may inherently have greater potential to be redistributive. Through its links with contributions, the
insurance approach implies that the inequalities of the labour market and the broader society are
carried, at least to some degree, through to the social security system. similarly, flat-rate benefits
financed from general revenue avoid some of the complexities associated with issues such as the
treatment of married women who have been in the labour force vis-a-vis other married women who
rely on their husbands' contribution credits. The current financing of the social security system can
therefore be seen as expressing "the community's right to break or modify the relationship between
earnings ability and the right to consume which a contributory system implicity accepts" (McAlister,
Ingles and Tune, 1982: 30).
In considering these arguments, it should be emphasised that the advantages and disadvantages of financing
social security expenditure through contributions will depend upon the specific design of the scheme
considered. Factors which will be important in this regard include:
PAGE 70
• The contribution structure - whether there is an earnings-related levy with or without a ceiling and
threshold, a flat-rate levy, or an earmarked component of personal income taxes.
• Who pays the contributions - whether employees employers or both, and the level of Government
subsidisation.
• How contributions are handled - whether kept in separate fund or absorbed into general revenue.
• The benefit structure, including the treatment of those who for whatever reason have failed to make
contributions whether earnings-related with a floor or ceiling, flat rate, or with a means-tested
component.
• The financing method - whether the scheme is on a pay-as-you-go basis or is fully or partially funded.
PAGE 71
APPENDIX FOUR - ADDITIONAL STATISTICAL TABLES
Contents
Table 1 : Effect of a GST on Families in 1975-76
Table 2 : Effect on the Disposable Income of Single Pensioners of a GST which Increases Their
Table 3 : Effect on the Disposable Income of Single Adult Unemployment Beneficiaries of a GST
which Increases Their Expenditures by 10 Per Cent
Table 4 : Effect on the Disposable Income of Married Pensioners of a GST which Increases Their
Table 5 : Effect on the Disposable Income of Married Unemployment Beneficiaries of a GST which
Increases Their Expenditures by 10 Per Cent
Table 6 : Pension Types By Income As Assessed, December 1984: Per Cent
Table 7 : Beneficiaries by Total Non-Benefit Income, November 1984: Per Cent
Table 8 : Pension Type By Type of Non-Pension Income, December 1984: Per Cent
PAGE 72
TABLE 1 EFFECT OF A GST ON FAMILIES IN 1975-76 *
ADDITIONAL INDIRECT TAX PAID PER WEEK

AND AS A PERCENTAGE OF DISPOSABLE
INCOME
HOUSEHOLD Under $177 $309-$442 $751 or more
COMPOSITION PW PW PW
$ % $ % $ %
1 adult 11 11.6 27 8.6 61 9.7
1 adult 17 13.6 33 9.8 44 6.5**

with children
2 adults 17 13.1 29 8.8 53 6.6
no children
2 adults 24 23.3 35 10.4 50 5.1

1 child
2 adults 30 38.7 33 9.8 70 8.2

2 children
2 adults 34 37.9 37 10.7 59 7.3

3 or more children
* Table shows additional indirect tax paid and additional tax as a percentage of disposable income,
after imposition of a GST which increases household expenditure by 10 per cent.
All dollar amounts updated by CPI to December 1984 levels.

** $575 pw or more
Source: Based on expenditure and income patterns in 1975-76 HES. ABS (1978b; 10-15).
PAGE 73
TABLE: 2EFFECT ON THE DISPOSABLE INCOME OF SINGLE PENSIONERS OF A GST WHICH INCREASES THEIR EXPENDITURES BY 10 PER CENT
1 2 3 4 5 6 7 8 9 10 11 12
PRIVATE PENSION/ TOTAL TAX DISPOSABLE HYPOTHETICAL NEW NEW TOTAL NEW TAX NEW DISP INCREASE DROP IN
INCOME BENEFIT ANNUAL LIABILITY INCOME GST TAX PENSION/ ANNUAL LIABILITY INCOME IN DISP INCOME AFTER
WEEKLY LEVEL INCOME (3-4) (5 x 0.1) BENEFIT lNCOME (8-9) INCOME GST (6-11)
(1+2)x52 (7+1)x52 (10-5)
0 91.59 4762.68 - 762.68 476.27 100.75 5239.00 - 5239.00 476.32 -
10 91.59 5282.68 - 5282.68 528.27 100.75 5759.00 88.69 5670.31 387.63 140.64
20 91.59 5802.68 105.79 5696.89 569.69 100.75 6279.00 292.37 5986.63 289.74 279.95
30 91.59 6322.68 309.48 6013.20 601.32 100.75 6799.00 496.06 6302.94 289.94 311.58
50 81.59 6842.68 513.17 6329.51 632.95 92.25 7397.00 787.43 6609.57 280.06 352.89
70 71.59 7362.68 767.39 6595.29 659.53 82.25 7917.00 965.15 6951.85 356.56 302.97
100 56.59 8142.68 1027.60 7115.08 711.51 67.25 8697.00 1180.97 7516.03 400.95 310.56
(1)Based on average pension/benefit levels and average tax scales applying 1984-85; assumes 100 per cent of disposable income is spent.
(2)Column 7 shows amount of pension or benefit received after a compensatory 10 per cent increase in rates of payment and income test
thresholds.
(3)Column 12 shows the effect on the disposable incomes of pensioners and beneficiaries, following a GST which Increases their
expenditures by 10 per cent, offsetting increases in rates an free areas, and no compensatory changes in current income tax scales.
In many cases this decline exceeds current income tax liability and full compensation via income tax cuts is thereby impossible.
PAGE 75
TABLE 3: EFFECT ON MM DISPOSABLE INCOME OF SINGLE ADULT UNEMPLOYMENT BENEFICIARIES
OF A GST WHICH INCREASES THEIR EXPENDITURES BY 10 PER CENT
1 2 3 4 5 6 7 8 9 10 11 12
WEEKLY LEVEL INCOME (3-4) (5 x 0. 1) BENEFIT INCOME (8-9) INCOME GST (6-11)
(1+2)x52 (7+1)x52 (10-5)
0 81.12 4218.24 - 4218.24 421.82 89.23 4639.96 - 4639.96 421.82 -
10 81.12 4738.24 - 4738.24 473.82 89.23 5159.96 147.79 5012.17 273.93 199.89
20 81.12 5258.24 176.89 5081.35 508.14 89.23 5679.96 289.36 5390.60 309.25 198.89
30 76.12 5518.24 246.23 5272.01 527.20 85.23 5991.96 372.57 5619.39 347.38 179.82
50 66.12 6038.24 384.91 5653.33 565.33 75.23 6511.96 511.25 6000.71 347.38 217.95
70 56.12 6558.24 523.60 6034.64 603.46 65.23 7031.96 649.94 6382.02 347.38 256.08
100 26.12 6558.24 523.60 6034.64 603.46 38.73 7213.96 719.27 6494.69 460.05 143.41
See footnotes to Table 2
PAGE 25
TABLE 4: EFFECT ON THE DISPOSABLE INCOME OF MARRIED PENSIONERS OF A GST WHICH
INCREASES THEIR EXPENDITURES BY 10 PER CENT
1 2 3 4 5 6 7 8 9 10 11 12
PRIVATE PENSION TOTAL TAX DISPOSABLE HYPOTHETICAL NEW NEW TOTAL NEW TAX NEW DISP INCREASE DROP IN
WEEKLY LEVEL INCOME (3-4) (5 x 0.1) BENEFIT INCOME (8-9) GST (6-11) INCOME (6-11)
(1+2)x52 (7+l)x52 (10-5)
0 152.78 7944.56 - 7944.56 794.46 168.06 8739.12 - 8739.12 794.56 -
10 152.78 8464.56 - 8464.56 846.46 168.06 9259.12 - 9259.12 794.56 51.90
20 152.78 8984.56 - 8984.56 898.46 168.06 9779.12 - 9779.12 794.56 103.90
30 152.78 9504.56 - 9504.56 950.46 168.06 10299.12 - 10299.12 794.56 259.80
50 152.70 10544.56 - 10544.56 1054.46 168.06 11339.12 107.30 11231.82 687.26 367.20
70 142.78 11064.56 - 11064.56 1106.46 160.56 11989.12 399.14 11589.98 525.42 581.04
100 127.78 11844.56 313.61 11530.95 1153.10 145.56 12769.12 795.14 11973.98 443.03 710.07
120 117.78 12364.56 621.29 11743.27 1174.33 135.56 13289.12 1004.01 12285.11 541.84 632.49
130 112.78 12624.56 737.07 11887.49 1188.75 130.56 13549.12 1108.45 12440.67 553.18 635.57
See footnotes to Table 2
PAGE 76
TABLE: 5: EFFECT ON THE DISPOSABLE INCOME OF MARRIED UNEMPLOYMENT BENEFICIARIES OF A GST WHICH INCREASES THEIR EXPE
10 PER CENT
1 2 3 4 5 6 7 8 9 10 11 12
INCOME BENEFIT ANNUAL LIABILITY INCOME GST TAX PENSION/ LIABILITY INCOME IN DISP INCOME AFTER
WEEKLY LEVEL INCOME (3-4) (5 x 0.1) BENEFIT INCOME ANNUAL (8-9) (10-5) INCOME GST (6-11)
(1+2)x52 (7+l)x52
0 152.78 7944.56 - 7944.56 794.46 168.06 8739.12 275.24 8463.88 519.32 275.14
10 152.78 8464.56 186.46 8270.11 827.81 168.06 9259.12 413.92 8845.20 567.09 260.72
20 152.78 8984.56 340.70 8643.86 864.39 168.06 9779.12 552.60 9226.52 582.66 281.73
30 147.78 9244.56 410.04 8834.52 883.45 164.06 10091.12 635.82 9455.30 620.78 262.67
50 137.78 9764.56 548.72 9215.84 921.58 154.06 10611.12 774.50 9836.62 620.78 300.80
70 127.78 10204.56 687.41 9597.15 959.72 144.06 11131.12 913.18 10217.94 620.79 338.93
100 97.78 10284.56 687.41. 9597.15 959.72 117.56 11313.12 961.72 10351.40 754.25 205.47
* See footnotes to Table 2
PAGE 77
TABLE 6 PENSION TYPE BY INCOME AS ASSESSED*- DECEMBER 1984 - PERCENT
INCOME AS AGE INVALID WIVES/SPOUSE WIVES/SPOUSE SEA & REHAB & WIDOWS WIDOWS SPB SPB TOTAL
ASSESSED CARERS (AGE) CARERS (INV) WIVES WIVES A B&C FEMALE MALE
($PW) SP CARERS
SINGLE: NIL 19.8 57.2 1.8 70.8 54.6 33.4 70.2 79.9 34.2
0-10 30.2 27.7 23.6 21.9 7.9 28.6 5.9 3.5 25.0
10-20 14.7 5.3 39.5 2.2 9.5 12.6 6.1 2.4 12.1
20-25 5.0 1.7 12.7 1.1 3.4 4.9 1.9 1.1 4.1
25-30 4.3 1.6 7.8 0.6 3.9 4.4 2.6 1.2 3.7
30-49 6.8 2.4 9.5 1.1 6.5 6.8 4.0 2.2 5.9
49-60 2.2 0.8 1.7 0.5 2.1 2.2 1.3 0.9 1.9
60 + 17.0 3.3 3.4 1.7 12.3 7.1 8.0 8.9 13.1
TOTAL 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
MARRIED: NIL 8.8 37.1 15.9 40.9 3.9 73.9 15.6

0-10 27.9 24.1 26.8 23.1 21.7 7.7 26.9
10-20 21.8 11.6 19.8 11.1 27.5 2.7 19.4
20-25 9.3 5.7 9.6 5.5 10.7 1.9 8.5
25-30 4.9 2.7 5.0 2.6 9.5 1.9 4.5
30-4 9 9.0 5.5 9.4 5.5 12.0 3.6 8.3
49-60 1.6 1.1 1.8 1.2 3.6 1.4 1.5
60 + 16.6 12.3 11.7 10.2 11.0 6.9 15.3
TOTAL 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Income an Assessed is total non-pension income less deductions for dependent children and students, and in the case of a married couple
is the combined IAA of the couple, halved to give the income as assessed of of each partner. Total non-pension income is the total of
the assessable amounts of non-property income and income from property declared by the
pensioner.
PAGE 78
TABLE 7 :BENEFICIARIES BY TOTAL NON- BENEFIT INCOME*- NOVEMBER 1984: PERCENT
NON-BENEFIT INCOME SINGLE MARRIED

$PW
UB SB SpB UB SB SpB
NIL 85.7 87.3 84.5 69.8 65.8 74.2
0-20 9.4 9.5 10.8 15.2 17.1 13.4
20-40 1.6 1.7 2.5 4.0 5.1 4.6
40-60 1.2 0.8 1.2 2.9 3.4 2.8
60-70 0.5 0.2 0.4 1.3 1.3 0.9
70-80 0.4 0.2 0.2 1.0 1.2 0.6
80-100 0.6 0.2 0.3 1.5 1.5 1.1
100-120 0.4 0.1 0.1 1.2 1.3 1.0
120-140 0.1 0.0 0.0 1.0 1.1 0.5
140-160 0.0 0.0 - 0.8 0.8 0.4
160 + 0.0 0.0 0.0 1.3 1.3 0.4
TOTAL 100.0 100.0 100.0 100.0 100.0 100.0
Non-benefit income is all assessable income (casual and continuing)

declared by a beneficiary or spouse.
PAGE 79
TABLE 8 PENSION TYPE BY TYPE OF NON-PENSION INCOME*- DECEMBER 1984 : PERCENT
TYPE OF NON AGE INVALID WIVES/SPOUSE WIVES/SPOUSE SEA & REHAB & WIDOWS WIDOWS SPB SPB TOTAL
PENSION 1NCOME CARERS (AGE) CARERS WIVES WIVES & A B&C FEMALE MALE
(INVALID) SP CAPERS
Disability Pension 7.0 2.4 2.8 2.0 1.1 0.5 0.4 3.9 0.2 0.5 5.2
Service Pension 0.0 0.0 - 0.0 - - 0.0 1.9 0.0 0.0 0.1
Superannuation 9.5 2.8 1.2 0.3 0.3 0.3 1.7 5.9 0.0 0.7 7.0
Compensation 0.3 1.0 0.2 0.4 0.1 0.8 0.2 0.3 0.1 0.5 0.4
Misc. Income 3.7 1.6 2.1 1.1 0.9 0.6 3.1 2.9 2.0 2.8 3.1
Earnings 2.3 3.2 6.6 7.9 94.4 3.5 14.1 5.5 9.7 10.7 4.3
Maintenance 0.2 0.4 0.1 0.2 0.1 0.3 26.8 2.3 22.1 1.7 3.0
UK Pension 4.4 0.1 2.6 0.1 - - 0.4 5.7 0.0 - 3.2
Value of Board/
Lodging 0.9 0.9 0.4 0.3 0.1 0.3 0.7 1.4 0.8 0.8 0.9
Bank Interest 59.8 34.2 52.1 38.4 44.5 19.0 27.9 43.0 20.0 24.0 50.7
CU/PBS Interest 21.0 10.3 21.5 13.7 11.5 7.5 10.8 16.8 8.3 8.8 17.8
Interest from Bonds 28.2 10.1 24.5 13.8 5.1 2.4 5.9 14.5 1.8 3.2 21.8
Income from Shares 6.3 1.1 2.8 0.9 0.8 0.3 0.9 2.0 0.3 0.9 4.5
Income from Realty 3.0 1.6 3.7 2.3 0.4 0.6 1.5 1.8 0.4 1.2 2.5
Income from loans/

invests 10.9 4.7 7.4 3.8 3.3 1.3 2.1 5.0 0.6 1.0 8.4
Self Deprived Incomes 0.1 0.0 0.1 0.0 0.1 - 0.0 0.0 0.0 0.0 0.1
(deemed maintained)
No Non-pension
Income 17.6 49.0 25.3 43.4 3.7 70.6 39.1 33.3 54.1 59.1 26.8
TOTAL 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
ALL PENSIONERS
Non pension income is all assessable income declared by a pensioner

APPENDIX FIVE - THE INCIDENCE OF BROAD-BASED CONSUMPTION TAXES
Two major overseas studies have attempted to measure the incidence of Value Added Taxes (VAT)(1). They
conclude that in most of the European countries studied the VAT is proportional or progressive in effect (OECD,
1981; Adams, 1980). These results have been quoted as "proving' that the widely held belief that indirect taxes
are regressive is wrong (eg. Sandford, 1981; Office of EPAC, 1984:16-17). However, the results of these studies
must be subject to very severe reservations, given the data deficiencies and methodology employed.
One of the major data deficiencies in such studies is the understatement of income in the surveys on which the
studies are based. In particular, understatement of income often appears to increase as income increases (Adams,
1980;23,36), thereby resulting in understatement of the degree of regressivity of VAT as a percentage of income.
A second difficulty is that consumer expenditures are normally aggregated into broad categories such as 'food' or
'maintenance and running of motor vehicles'. These broad categories frequently contain items attracting zero,
standard and luxury rates of tax. Researchers are consequently forced to make an assumption about the average
VAT rate applying to the broad expenditure category. The uncertainty introduced by this procedure is
exacerbated by the lack of knowledge about who bears tax on exempt goods.
In addition to these and other data deficiencies, a critical methodological issue is the base against which
regressivity is to be measured. A consumption base measures consumption tax as a percentage of consumption.
A comprehensive uniform VAT therefore appears proportional against a consumption base. A disposable income
base measures consumption tax as a percentage of disposable income; as low income groups spend more and save
less of their income than high income groups, the same VAT appears regressive when measured against a
disposable income base. A gross income base measures consumption tax as a percentage of gross income; it
income tax is progressive and
the proportion of income paid in income tax thus increases as income increases, then the same VAT will appear
even more regressive than when measured against disposable income. The apparent incidence of a VAT is thus
critically dependent upon the base adopted.
(1) Available studies have concentrated on the incidence of a VAT, since that is the relevant tax in the
European Economic Community. A retail sales tax or, more generally, a goods and services tax (GST) could be
designed to have similar effects to those of a VAT, and consequently the conclusions of this Appendix apply just
as strongly to a GST.
PAGE 81
The debate about which base is the most appropriate remains unresolved. Kakwani concludes that an income
base is preferable to a consumption base, provided that the income definition is sufficiently comprehensive
(1983:74). The gross income base is frequently used when comparing the impact of various types of taxes and
has been utilised in a number of Australian tax incidence studies (Bentley et al. 1974; Warren, 1979; Kakwani,
1983). Although it suffers from some serious deficiencies (Douglas, 1984:22), it is nonetheless useful for
emphasising that the same VAT can appear either progressive or regressive depending upon which base is used.
In the Adams study, the impact of VAT in the United Kingdom, Ireland, Belgium, and Germany was examined.
In the case of Ireland, the data dealt only with urban areas, and considerable understatement of income by
recipients casts major doubts upon the results when measured against an income base (1980:31). In the Belgian
study, results were not available for the population as a whole, but only by four occupational groups and only by
income quartiles. When data for all four occupational groups was pooled, the Belgian VAT appeared slightly
regressive against an income base (1980:35). There was insufficient data to test the incidence of VAT in
Germany (1980:35), while the accuracy of the British results suffered from arbitrary decisions taken about actual
tax rates applying within broad expenditure categories and uncertainty about exempt goods (1980:27). There
therefore appears to be remarkably little firm evidence to support Adam's conclusion "that there is a marked
tendency for the structures (of VAT) presently in force to result in a progressive tax base with wealthier
households paying a larger proportion of income ... in tax" (1980:21), particularly as no data were gathered on
wealth.
Similarly, while the recent OECD report concluded "that value added taxes are not regressive, at least over the
income ranges covered by this report, but tend to be more or less proportional" (1981:6), many might regard this
conclusion as misleading. The actual data presented in the study supports this conclusion only for VAT measured
against a consumption base. VAT as a proportion of disposable income was, however, also calculated by the
OECD. Close examination of the tables in the report shows it to be regressive in the majority of countries, either
for some or all income ranges and household compositions. The report did not examine VAT as a proportion of
gross income, and it was impossible to recalculate incidence for all of the countries examined because gross
income figures were frequently not given. However, in the two cases where the calculations could be made, of
Germany and the Netherlands, VAT was mildly regressive when measured against gross income.
PAGE 82
The above discussion suggests that claims that a retail sales tax or a VAT can be progressive taxes should be
treated with great caution. Perhaps the major lesson to emerge from these overseas studies is the extreme
difficulty of offsetting the strongly regressive effects of broad based consumption taxes through differential tax
rates. Thus, while the United Kingdom exempts or applies a zero tax rate to an extremely wide range of goods
and services (including most food, fuel and power, passenger transport and children's clothing), the OECD results
still show that such indirect taxes are regressive for four person households in the U.K. (measured against a
disposable income base) (1981:49). This demonstrates that while an indirect tax with differential tax rates can
require less assistance to be channelled to low income earners through increased outlays or other tax changes than
does a uniform rate, the need for compensatory measures will almost certainly still exist. Overseas experience
thus suggests that it is extremely difficult to design a VAT which is progressive, unless revenue raising and
efficiency requirements are to be totally abandoned.
PAGE 83
APPENDIX SIX - GUARANTEED MINIMUM INCOME SCHEMES
The term "guaranteed minimum income" (GMI) is used to refer to programs which have the common objective of
providing the persons to whom they relate with a basic level of income support. All GMIs employ three basic
variables - an income guarantee, a withdrawal rate applied against a "tax base', and a break-even level of income
where net payments become zero. The relationship between these variables is such that any two determine the
third.
This simple and general form of GMI can be varied according to the level of the guarantee and the withdrawal
rate, the break-even level that is considered desirable, the taxation and income security arrangements that the GMI
is integrated with or supersedes, or the eligibility criteria that are imposed. Consequently a GMI can be of four
broad types:
• an income-tested, categorical scheme;

• a social dividend or demogrant;
• a tax credit scheme; or
• a negative income tax.
Under the definition used above, selective-categorical payments such as age pensions in Australia are a form of
GMI - they provide an income guarantee to eligible persons in selected population categories. An income or
means test is applied so that as private income increases the guarantee or benefit is withdrawn until the break-
even level is reached when no assistance is provided.
However, the term "guaranteed minimum income" has commonly been envisaged as referring to programs which,
through an integration of the taxation and income security systems, potentially provide support to all rather than
part of the population, and with low income as the only criterion for assistance. For example, under a social
dividend scheme, a demogrant is paid to all income units, regardless of income level, and the payment itself is not
initially offset against positive tax. Families with no independent incomes would receive only the social dividend,
which would be their guaranteed income, and they would not pay tax. All families with private income would
receive the full social dividend and would pay tax, which could be less, equal to or more than the dividend
received. A demogrant scheme was proposed by Senator McGovern in the U.S. Presidential campaign in 1972.
Family allowances in Australia are also a form of social dividend limited to persons with children.
In a tax credit scheme, positive tax is applied at all levels of private income, but each taxpayer is allowed a credit
to be deducted from that tax. The size of the credit would depend on the number of dependants the taxpayers had,
but not on his or her private income. At low levels of private income, the tax credit would exceed positive tax
payable and a transfer payment would be made from the Government to the taxpayer. At the
PAGE 84
break-even level, the positive tax would equal the tax credit, and no payment would be made, nor would any tax
be payable. Above the break-even level, the positive tax would exceed the tax credit, and the taxpayer would start
to pay tax. A distinguishing feature of the tax credit scheme, in comparison with a social dividend, is that the
taxpayer receives or pays only the net amount.
Negative income taxation (NIT) involves the use of the tax system to pay income subsidies that would close
some portion of the "poverty gap", ie. the difference between an individual's or family's private income and the
income they would need in order not to be officially defined as poor, say, or some proportion of the difference
between private income and the tax threshold. In this situation the income guarantee is the amount received
when pre-allowance income is zero; the tax base is the difference between the level of actual income and some
standard, either the family's poverty line or the tax threshold; the negative tax rate or withdrawal rate is the
proportion of this difference that is paid out.
There is some difficulty in distinguishing a negative income tax from a tax credit, and these two terms in
particular have often been confused or used interchangeably. One usual distinction is that tax credits are
integrated with the tax system and all income units face a standard rate of tax (perhaps with a surtax at higher
income levels), while under a NIT those receiving assistance face a higher rate of tax until they exceed the
break-even level, where they are subject to standard positive tax rates. In this sense, a NIT is little different
from pre-existing welfare provisions except that it may apply to all income units rather than those who satisfy
categorical eligibility requirements. As well, tax credit are often envisaged as providing only a supplement to
income rather than a level for adequate support. For instance, in 1972 the British Government considered a
child tax credit that would have provided a supplement to income for families with children, and Canada
introduced a similar child tax credit in 1979. On the other hand the Priorities Review Staff recommended an
Australian tax credit scheme that would have provided payments sufficient for people to live on.
In considering negative income tax and tax credit schemes there are a number of additional issues to be
addressed. In order to ensure that these schemes actually fulfil their welfare functions, payments must
necessarily be made on a regular basis, as is the case in the social security system, but not currently in the tax
system. Additionally, any problems of low take-up of pensions and benefits will also become relevant to the tax
system. There is, for example, some evidence of low take-up of child tax credits in Canada. This suggests that
considerable attention should be paid to the administrative aspects of any proposed negative income tax or tax
credit scheme.
PAGE 85
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PAGE 89
DEVELOPMENT DIVISION: SERIES OF RESEARCH PAPERS
RESEARCH PAPER NO 1 UNEMPLOYMENT BENEFIT RECIPIENTS IN AUSTRALIA, 1970-1980:

AN ANALYSIS (REVISED) (NOVEMBER 1981)
RESEARCH PAPER NO 2 A REVIEW OF THE CHARACTERISTICS OF LONG-TERM

UNEMPLOYMENT BENEFIT RECIPIENTS IN AUSTRALIA, 1970-1977
(NOVEMBER 1978)
RESEARCH PAPER NO 3 CHANGING FAMILY PATTERNS AND SOCIAL SECURITY

PROTECTION: THE AUSTRALIAN SCENE (MARCH 1979)
RESEARCH PAPER NO 4 UNEMPLOYMENT STATISTICS IN AUSTRALIA (JULY 1979)
RESEARCH PAPER NO 5 A REVIEW OF THE CHARACTERISTICS OF SOLE-PARENTS ASSISTED

UNDER THE SOCIAL SERVICES ACT (MARCH 1980)
RESEARCH PAPER NO 6 RESEARCH QUESTIONS ON INCOME SECURITY FOR SOLE PARENTS

(MARCH 1980)
RESEARCH PAPER NO 7 CHARACTERISTICS OF SOLE MOTHERS RECEIVING STATE

ASSISTANCE SUBSIDISED UNDER THE STATES GRANTS (DESERTED
WIVES) ACT (MARCH 1980)
RESEARCH PAPER NO 8 ADDITIONAL DATA REQUIREMENTS OF THE DEPARTMENT OF

SOCIAL SECURITY (APRIL 1980)
RESEARCH PAPER NO 9 THE RELATIONSHIP BETWEEN THE AUSTRALIAN SOCIAL SECURITY

AND PERSONAL INCOME TAXATION SYSTEMS - A PRACTICAL
EXAMINATION (DECEMBER 1980)
RESEARCH PAPER NO 10 SURVEY OF INVALID PENSIONERS OCTOBER 1979: DATA ON MAJOR

CAUSES OF INVALIDITY AND ON OTHER IMPAIRMENTS, 2ND
EDITION (OCTOBER 1981)
RESEARCH PAPER NO 11 THE FINANCE OF SOCIAL SECURITY: SOME IMPLICATIONS OF THE

INTERACTION BETWEEN SOCIAL SECURITY AND PERSONAL COME
TAX (DECEMBER 1980)
RESEARCH PAPER NO 12 WORK INCENTIVE EXPERIMENTS IN THE UNITED STATES AND

CANADA (JUNE 1981)
RESEARCH PAPER NO 13 WORK TEST FAILURE - A SAMPLE SURVEY OF TERMINATIONS OF

UNEMPLOYMENT BENEFIT (JUNE 1981)
RESEARCH PAPER NO 14 STATISTICS ON THE DISTRIBUTION OF INCOME AND WEALTH IN

AUSTRALIA (OCTOBER 1981)
RESEARCH PAPER NO 15 POPULATION PROJECTIONS AND SOCIAL SECURITY

(NOVEMBER 1981)
RESEARCH PAPER NO 16 AS HIS WIFE: SOCIAL SECURITY LAW AND POLICY ON DE FACTO
MARRIAGE (DECEMBER 1981)
RESEARCH PAPER NO 17 TAXATION EXPENDITURES: SUBMISSION BY THE DEPARTMENT OF

SOCIAL SECURITY TO THE INQUIRY INTO TAXATION
EXPENDITURES BY THE HOUSE OF REPRESENTATIVES STANDING
COMMITTEE ON EXPENDITURE (MARCH 1982)
RESEARCH PAPER NO 18 SOLE PARENTS ON PENSIONS: A SAMPLE SURVEY OF CLASS 'A'

WIDOW PENSIONERS AND SUPPORTING PARENT BENEFICIARIES
(JUNE 1982)
RESEARCH PAPER NO 19 FINANCING SOCIAL SECURITY: AN ANALYSIS OF THE

CONTRIBUTORY 'SOCIAL INSURANCE' APPROACH (JUNE 1982)
RESEARCH PAPER No 20 DEVELOPMENTS IN SOCIAL SECURITY: A COMPENDIUM OF

LEGISLATIVE CHANGES SINCE 1908 (JUNE 1983)
RESEARCH PAPER No 21 SURVEY OF MORBIDITY CHARACTERISTICS OF CHILDREN

RECEIVING HANDICAPPED CHILD'S ALLOWANCE, 14 MARCH 1982
(DECEMBER 1983)
RESEARCH PAPER No 22 SOME IMPLICATIONS OF THE INTERACTION OF THE PERSONAL

INCOME TAXATION AND SOCIAL SECURITY SYSTEMS
(MARCH 1984)
RESEARCH PAPER NO 23 PERMANENT INCAPACITY: INVALID PENSION IN AUSTRALIA

(APRIL 1984)
RESEARCH PAPER NO 24 GOVERNMENT SUPPORT OF RETIREMENT INCOMES IN AUSTRALIA

(APRIL 1984)
RESEARCH PAPER NO 25 THE ECONOMIC AND SOCIAL CIRCUMSTANCES OF THE AGED

(APRIL 1984)
RESEARCH PAPER NO 26 RETIREMENT INCOME PROVISIONS OVERSEAS (APRIL 1984)
RESEARCH PAPER NO 27 A FAMILY'S NEEDS: EQUIVALENCE SCALES, POVERTY AND SOCIAL

SECURITY (APRIL 1985)
RESEARCH PAPER NO 28 EQUITY, TAX REFORM AND REDISTRIBUTION (APRIL 1985)

Equity, Tax Reform and Redistribution

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Equity, Tax Reform and Redistribution

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Equity, Tax Reform and Redistribution

Research Paper No.28

The authors of this paper are Ann Harding and Peter

Considerable assistance was provided by Lynelle Briggs,

Policy Review Branch,

Interaction of the Taxation and Social Security Systems

Equity and the Reform of the Direct Tax System

Equity Implications of Broadening the Indirect Tax Base

• part of the compensatory payments may be lost in income tax;

• major increases in family allowances and family income supplement; and

Tax Reform and Redistribution

2. The Interaction of the Taxation and Social 3

3. Equity and Priorities for Tax Reform 7

3.1 Broadening the Income Tax Base and Reducing 7

4. Measures to Protect Low Income Groups and 32

4.1 Indexed Social Security Pensions and Benefits 33

5. Measures to Protect Low Income Groups and 50

6. Compensation and Redistribution 52

7. Summary and Conclusions 56

Table 3.2 Real Changes in Components of 12

Table 3.3 Changes in Real Disposable Incomes of 14

Table 3.4 Expenditure on Food as a Percentage of 23

Table 3.5 Effect of a Tax Which Increases 25

Table 3.6 Additional Indirect Tax and Additional 28

Table 4.1 Comparison of Income Tax Payments and 41

Table 4.3 Comparison of Income Tax Payments 45

Table 4.4 Weekly Earnings of Low Income 49

Table 6.1 Illustrative Social Security Expenditure 53

APPENDIX FOUR : ADDITIONAL STATISTICAL TABLES

Table 1 Effect of a GST on Families 73

Table 2 Effect on the Disposable Income of 74

Table 3 Effect on the Disposable Income of Single 75

Table 4 Effect on the Disposable Income of Married 76

Table 5 Effect on the Disposable Income of Married 77

Table 6 Pension Type By Income As Assessed, 78

Table 7 Beneficiaries by Total Non-Benefit Income, 79

Table 8 Pension Type By Type of Non-Pension Income, 80

Possible solutions to these problems are then discussed.

(1) Commissioner of Taxation, (1982: 25, 127) and Guilfoyle, 1982.

- further reducing tax avoidance and evasion;

- introducing a levy or some other form of contributory financing of social security; or

• reforming the indirect tax base.

3.2 Changes to Personal Income Tax Schedules

• general community incomes, reflected in movements in AWE;

• most tax rebates; and

Single Income 16.6 17.7

Single Taxpayer at 28.2 30.6

Single Income Married 24.7 27.2

Single Pensioner with 4.9

Married Pensioner 2.6

Income Component(l) Percentage Change

Pensions and Benefits %

Single pension free area -23

Family allowances -23

HOUSEHOLD TYPE PENSIONER/BENEFICIARY NON-PENSIONER/BENFICIARY

• single adult unemployment beneficiaries (-4.3 per cent);

• single and married pensioners and beneficiaries without children; and

• two income families with combined incomes at or below AWE.

3.4 Contributory Financing of Social Security

Appendix 3 provides a more detailed discussion of these issues.

The Australian federal indirect tax system currently features:

• the general exclusion of services from the tax base.

• the taxation of services; and