The welfare state debate: who gets what and who pays for it? Part 2

The welfare state debate: who gets what and who pays for it? Part 2

ESSA Writers
January 17, 2014

Overall, the Australian welfare state performs two main functions – redistribution between rich and poor (the Robin Hood function), but it also provides 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 earlier, 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

However, as well as redistributing between rich and poor, Australia like all other developed welfare states redistributes considerable resources to older people. For example, households with a head aged 75 years and over have by far the lowest average private incomes, but they receive 43 per cent of all age pensions and 21 per cent of all health care spending, and pay less than 1 per cent of income taxes and 5 per cent of indirect taxes, which in combination boost their incomes from about one-third the population average to three-quarters. Similarly, households with a head aged between 65 and 74 years get 46 per cent of age pensions and 16 per cent of health care spending and pay 2.5 per cent of income taxes and 9 per cent of indirect taxes; this boosts their incomes from just over half the population average to just over three-quarters.

The welfare state also provides insurance against risks. According to the latest HILDA report:

  • Around 3% of the population are fired or made redundant each year and 10% over four years;
  • Around 8-9% of the population experience a serious personal injury or illness each year and 26% over four years. Between 15 and 17% of the population experience serious injury or illness to a close relative or family member each year and nearly 50% over a four year period. Around 10% experience the same each year for a close friend;
  • Around 1% experience the death of a spouse or child each year, and 3% over four years. Around 11% experience the death of another close relative or family member per year, and 40% over four years;
  • Around 3-4% of the population separate each year and more than 10% of women and men separated from spouse or long-term partner between 2004 and 2008. Separation or divorce is by far the most important cause of lone parenthood. Between 1% and 1.5% of the population change each year from being a couple with children to a lone parent and 4.1% over nine years.

As a result of these and other risks, many Australians experience significant changes in their economic circumstances both in any single year and cumulatively over time. Commentators on income mobility tend to focus on the positive impacts – low income young people finishing their studies and then moving into jobs and people moving up the occupational ladder. But the HILDA report also shows that each year between 2001 and 2008 between 40 and 50 per cent of Australians experienced a drop in income and roughly 10 per cent fell more than 20 percentiles in the income distribution.  Over the whole period, 44 per cent of the population moved more than 20 percentiles.  Around half of those in the richest income quintile in 2001 were still in that income group in 2008, but the other half were in lower income groups; only 30 per cent of those in the middle income group in 2001 were in the same group in 2008, with 30 per cent being worse off and around 36 per cent being better off.

This mobility is also important in thinking about who benefits from and who pays for the welfare state. There is a tendency to think of welfare recipients as if people were permanently dependent on payments – the ‘takers’ as described above, with the corollary that other people are ‘makers’ and permanently ‘independent’ of welfare.  However, the experience of risks and subsequent changes in incomes mean that over time many people change their status as recipients of welfare payments on the one hand or as taxpayers on the other. For example, in 2001 fully 37% of working age people received income support at some time in the year, although in 2008 this had fallen to 29.5% reflecting a period of strong economic growth. However, 65.7% of working age Australians lived in a household where someone received welfare at some time between 2001 and 2009.

In any one year in this decade between 5 and 7 per cent of working age Australians received 90 per cent or more of their income from welfare payments (not including family payments) but 15% of the population were in this position at some stage in the period, although only 1.2% were reliant for all 9 years. So people of working age who are “welfare dependent” for long periods of time are only a tiny percentage of the population, while many even very highly paid individuals face substantial risks of large income drops, particularly associated with health changes, but also changes in employment and family status. In summary, the welfare state – defined broadly to include health and education as well as social security payments – touches the lives of many more Australians than is commonly thought.  Nearly everyone may be a ‘maker’ or a ‘taker’ at different stages in their life course.

While recognising that the distinction between makers and takers is a false dichotomy, it should also be recognised that it is worthwhile to regularly review government spending to assess whether it is meeting its objectives. However, the idea that there are vast amounts of wasteful social security spending that can be easily 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.  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.

The difficulties that governments face in cutting ‘middle class welfare’ are not because governments are unnecessarily timid about cutting entitlements.  For substantial savings to be achieved in welfare spending it is probably necessary for there to be real financial pain, for example either to reduce benefit levels for those on modest incomes or more tightly targeted benefits – but it needs to be recognised that tighter targeting unavoidably means higher withdrawal rates on benefits and higher effective marginal tax rates over the range of incomes where benefits are withdrawn. Moreover, because Australia has the most targeted benefit system in the OECD, simply cutting benefits as a way of reducing the deficit would increase inequality more than in any other rich country.

It is also worth noting that there is a degree of inconsistency between some of the arguments  of those who favour cutting spending but not increasing taxes – on the one hand, there are those who argue that we should not increase taxes on higher income groups since they already pay a disproportionate share of the tax burden, but there are those (including sometimes the same people) who argue that we should cut government benefits going to higher income groups, when cutting benefits can have a similar effect on disposable income as increasing taxes.

Given the projected size of the Budget gap in coming years, it seems sensible to consider all options both on the spending side and the revenue side.  Reforms that encourage labour force participation can also help by maximizing the number of taxpayers relative to the number of people requiring support.  Most importantly in coming months and years it will be necessary to have a well -informed debate about who wins and who loses from welfare state and tax reform.