The Welfare State Debate: who gets what and who pays for it?

The Welfare State Debate: who gets what and who pays for it?

ESSA Writers
January 14, 2014

The appropriate level and structure of public spending is high on the policy agenda. A recent Grattan Institute report Budget pressures on Australian governments argues that Australian Federal and State governments potentially face a combined annual deficit of around 4 per cent of GDP by 2023, of which around 2.5 per cent of GDP would be at the Commonwealth government level.  In a speech to the Institute of Public Affairs in early May this year, then Shadow Treasurer Joe Hockey said that ‘attacking spending’ and ‘looking for structural saves’ was increasingly urgent, and he referred back to a 2012 speech given at the Institute of Economic Affairs in London where he argued that ‘all developed countries are now facing the end of the era of universal entitlement.  Addressing the ongoing fiscal crises will involve the winding back of universal access to payments and entitlements from the state.’

To a significant extent, the media reaction to these developments has been to call for cuts in public spending, particularly in ‘middle class welfare’.  For example, Alan Kohler has argued that ‘Australia’s means testing regime is too loose. Too many people are getting too many benefits they don’t need because successive governments have tried to buy their votes. The health and welfare systems have been used as political tools, not safety nets. … As a result of poor means testing the health budget is out of control and ‘middle class welfare’ is blowing a huge hole in the budget.’  The Sydney Morning Herald has referred to the family assistance system as a ‘hotch potch ripe for an overhaul’, while former Labor Minister Gary Johns has argued in the Australian that too many  are on the receiving end of middle-class welfare, but that for low income households ‘there is no dignity in not paying tax … where is the dignity in not making a contribution?’

The new Government’s plan for a substantially more generous system of paid parental leave has also been labeled by the Australian Financial Review as costly middle-class welfare. In a similar vein in the Australian earlier this year, Adam Creighton described the Family Tax Benefit Part B as a relic of the Howard era and ‘a superfluous $4.5bn-a-year cherry on a welfare cake that is choking economic growth and operating contrary to other government policies’, arguing that it is ‘surely it is not unfair to rein in a benefit that is paid to families in the top 10 per cent of the income distribution, with household incomes up to $175,600’.

The preference for cutting middle class welfare is in part motivated by the view that increasing taxes should not be used to bridge the budget gap.  In an article in the Financial ReviewFleur Anderson suggested that ‘the middle class and the professions are staging a revolt as they find their growing share of the tax burden too hard to bear, after over a million people were made exempt from the tax system over the past 10 years’. The Financial Review and other commentators pointed to the latest ATO tax statistics for the 2010-11 financial year, which show that the top five per cent of income earners pay 34.1 per cent of net income tax, while the top 25 per cent of income earners pay just over two-thirds of net income tax. Correspondingly, about 45% of Australians pay no income tax at all, a figure very close to that used by Mitt Romney in the 2012 US Presidential election campaign when he argued that 47% of Americans pay no income tax and were therefore ‘moochers’.  In a similar vein, Nicholas Eberstadt subsequently argued that the United States is now ‘on the verge of a symbolic threshold: the point at which more than half of all American households receive, and accept, transfer benefits from the government’ and suggesting that there was now a divide between the “takers” and the “makers”.

So should we bridge the budget gap by cutting spending, increasing taxes or some combination of the two approaches?  It is worth noting the size of the gap as estimated by the Grattan Institute – in current terms 4 per cent of GDP is close to $60 billion and the Commonwealth share of this gap would be around $37 billion, and these amounts will be much larger by 2023.

In deciding which policy direction to follow it is also necessary to have a clear understanding of the distribution of welfare state 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?

Fortunately for those interested in accurate answers to these questions, 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.  These studies provide the most comprehensive accounting of government spending and taxation in Australia, as they not only include the impact of social security cash benefits and direct taxes, but they also take into account the effects of government spending on health care, education and community services, as well as the impact of indirect taxes, such as the GST.  In contrast, the ATO statistics referred to above are useful, but they only identify who pays income taxes and do not include the GST or other indirect taxes, and nor do they tell us what benefits households receive from governments.

Chart 1 shows the distribution of all benefits and taxes across different quintiles of households in 2009-10 – quintiles comprise equal groups of exactly 20 per cent of all households, with their incomes adjusted for the number of people in the household and ranked from the poorest to the richest in terms of their private income.

Chart 1: Benefits received and taxes paid (2009-10 $pw) by quintiles of equivalised private income, Australia, 2009-10


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

For example, the poorest 20 per cent of households received about $435 per week in cash benefits and they received services worth about $446 per week (mainly public health care); they paid negligible amounts of income tax, but around $105 per week in indirect taxes.  In contrast the richest 20 per cent of households received only $15 per week in cash benefits – or about one-thirtieth as much as the lowest income group – but they received $234 per week in government services, and they paid $756 per week in income taxes and $273 per week in indirect taxes.

In terms of government spending that benefits the richest households, health and education are far more important than social security.  The richest quintile received only 1.7 per cent of social security benefits, but benefited from $83 per week in education benefits, or around 14 per cent of government education spending, and $140 per week in health benefits, or 15.5 per cent 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). This targeting of social security benefits to the poor is much greater in Australia than any other country.  Even though Australia spends below the OECD average on social security benefits, the distribution of benefits is so progressive, and the level of taxes paid by the poor is so low, that Australia redistributes more to the poorest 20 per cent of the population than any other OECD country except Denmark (which spends about 80 per cent more than Australia).

It is also worth noting that of the cash benefits received by the richest 20 per cent of households, only $1 per week comes in the form of family payments, the usual suspect in 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 per cent are age and disability pensions, Veterans’ Affairs pensions and unemployment benefits.  This is not because the income-testing of these payments is lax, but because 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 pays around 58 per cent of income taxes and 30 per cent of indirect taxes, although they have 45 per cent of private income.   Direct and indirect taxes paid by the richest households amount to 46.5 per cent 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.

Chart 2: Direct and indirect taxes as per cent of income by quintiles of equivalised disposable income, Australia, 2009-10


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

Most importantly, of course these taxes pay for the benefits received by lower income households.

The overall scale of redistribution in Australia can be gauged from the fact that the richest 20 per cent of the population have private incomes that are more than 21 times higher than the private incomes of the poorest 20 per cent, but after benefits and services are received and taxes are paid that disparity is reduced to about 3 to 1 or by 86 per cent.  In terms of improving the incomes of the poor, social security and government services are roughly equally important: the social security system increasing their share from 2 per cent of private income to nearly 7 per cent of gross income.  Because the poorest income group pay a small fraction of one per cent of income taxes, their share of disposable income is increased to 8 per cent, with government services increasing this further to 11 per cent of final income. Although indirect taxes are regressive, taking 12.7 per cent of the income of the poorest households compared to 9.5 per cent of the income of the richest, they do not materially alter these disparities.

These ABS figures provide a snapshot of the distribution of benefits and taxes at a point in time, but in assessing proposals for reform it is worth revisiting the longer-term impact and objectives of the welfare state.

Part 2 of ‘The welfare state debate’ will be published on Friday 17 January.