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Economy

Jun 6, 2013

Debunking the 'middle-class welfare' furphy

Don't believe what you read. Australia actually has the lowest level of middle-class welfare in the developed world, argues ANU academic Peter Whiteford.

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There’s been plenty of commentary in the media about the need for “cuts to middle-class welfare”, as the federal budget deficit refuses to close. And this comes in tandem with the expectation that taxes should not be increased. Peter Whiteford decided to look deeper into the issue. 

Should we deal with the growing budget gap by cutting spending or increasing taxes — or by some combination of the two? Before we try to answer that question we need a clear understanding of the current distribution of welfare spending (who gets what?) and how spending is financed (who pays for it?). Are higher-income groups already overburdened with taxes or are they actually benefiting too much from profligate spending?

The Australian Bureau of Statistics has published studies of government benefits and taxes and their impact on household incomes since the 1980s, with the most recent results being for 2009-10.

Chart 1 shows the distribution of benefits and taxes in 2009-10 across households divided into five equal groups, or quintiles, ranked from the poorest to the richest in terms of their private income. (In these figures, household incomes are “equivalised”, or adjusted for the number of people in the household. Tax expenditures are not separately identified, but are included in the measured distribution of taxes or, in the case of the health insurance rebate, in non-cash benefits.)

Chart 1: Benefits received and taxes paid (dollars per week) by quintiles of equivalised private income, 2009–10

Source: Calculated from ABS, Government Benefits, Taxes and Household Income, Australia, 2009-10, Cat. No. 6537.0

The poorest 20% of households received about $435 per week in cash benefits and received services worth about $446 per week (mainly public healthcare); they paid negligible amounts of income tax but around $105 per week in indirect taxes (excises, rates and the GST). In contrast, the richest 20% of households received only $15 per week in cash benefits (or about one-30th as much as the lowest-income group), received $234 per week in government services (mainly education and healthcare), and paid $756 per week in income taxes and $273 per week in indirect taxes.

Not surprisingly, government spending on health and education is far more important than social security for the richest households. The richest quintile received only 1.7% of social security benefits, but benefited from $83 per week in education benefits, or around 14% of total government education spending, and $140 per week in health benefits, or 15.5% of health spending. Overall, the non-cash benefits received by the richest were worth nearly 16 times as much as the cash benefits they received ($234 per week compared to $15 per week).

Of the cash benefits received by the richest 20% of households, only $1 per week came in the form of family payments, the most common target of the criticism of middle-class welfare and the main target for reduced spending in the 2013-14 budget. Most of the social security benefits received by the richest 20% were age and disability pensions, veterans’ pensions and unemployment benefits. This is not because the income-testing of these payments is lax; income tests in the social security system are based on the nuclear family, so this “leakage” to high-income households is mainly the result of aged or disabled people or the unemployed sharing a house with their parents or their children.

On the tax side, the richest quintile of households paid around 58% of income taxes and 30% of indirect taxes, although they had 45% of private income. Direct and indirect taxes paid by the richest households amounted to 46.5% of all taxes paid; so while indirect taxes offset some of the progressivity of income taxes, the overall tax take is still progressive, as shown in Chart 2. Most importantly, of course, these taxes pay for the benefits received by lower-income households.

Chart 2: Direct and indirect taxes as percentage of income by quintiles of equivalised disposable income, 2009–10

Source: Calculated from ABS, Government Benefits, Taxes and Household Income, Australia, 2009-10, Cat. No. 6537.0

The overall scale of redistribution in Australia can be gauged from the fact that while private incomes among the richest 20% were more than 21 times higher than the private incomes of the poorest 20%, that disparity was reduced to about three-to-one, or by 86%, after benefits and services were received and taxes paid. In terms of improving the incomes of the poor, social security and government services are roughly equally important, with the social security system increasing its share from 2% of private income to nearly 7% of gross income …

Overall, the Australian welfare state performs two main functions — redistribution between rich and poor (the Robin Hood function) and insurance and consumption smoothing (the “piggy‐bank” function). In Australia we tend to focus on the idea that the welfare state should mainly be about redistribution to the poor, which is why we focus so much on concerns about middle-class welfare. But as I have argued previously, Australia actually has the lowest level of middle-class welfare in the developed world and targets its spending to the poor more than any other OECD country.

It is certainly important to review government spending regularly to assess whether it is meeting its objectives. But the idea that there are vast amounts of wasteful social security spending that can easily be cut back simply does not accord with the reality that the Australian benefit system is the most targeted to low-income groups of any developed country. A further tightening of this targeting will unavoidably mean higher withdrawal rates for benefits and higher effective marginal tax rates over the range of incomes where benefits are withdrawn. For large savings to be achieved it is necessary either to cut social security spending well down the income distribution and shift the consequences of adverse risks and contingencies onto households, or cut spending in the politically popular areas of health and education.

* Peter Whiteford is a professor in the Crawford School of Public Policy at the Australian National University. This is an extract from Professor Whiteford’s article at Inside Story.

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