Academic journal article The Economic and Labour Relations Review : ELRR

Removing Poverty Traps: Taxation and Welfare Reform in Australia

Academic journal article The Economic and Labour Relations Review : ELRR

Removing Poverty Traps: Taxation and Welfare Reform in Australia

Article excerpt

1. Poverty Traps

Poverty or welfare traps arise where the interaction of social security and income taxation systems result in net increases in disposable incomes that are insufficient to call-forth offers of market labour services and that lead to continuance in low-income welfare state dependency. Poverty traps are usually indicated by high "effective marginal tax rates" (EMTRs). Where increases in incomes from wages and sources other than state welfare transfers (1) lead to withdrawal of state welfare transfers, EMTRs state the percentage difference between increments in gross-incomes and incremental changes in disposable incomes.

Assessing whether the interaction of taxation and social security systems "trap" people in the poverty of state welfare dependency depends upon more than simply the levels of EMTRs (for example, whether EMTRs exceed the top of the PAYE tax-scale). Poverty traps are stronger the longer the ranges of non-transfer-incomes over which high EMTRs apply. Understanding the factors that most influence EMTRs and the ranges of non-transfer-incomes that attract high EMTRs points to key policy changes for taxation and welfare reform.

Although many studies on EMTRs are available for Australia, (2) wide understanding of the policy issues is inhibited by the complexity of EMTR calculations and their presentation (e.g., Edwards, 1985), or by a clouding of the key causal influences for high EMTR estimates (e.g., SSR, 1988). This paper uses a graphical exposition of poverty traps that highlights impact upon activity choice within and outside the labour market, and presents simple tabular data for 1990 that illustrate (a) the components of EMTRs, (b) income ranges for high EMTRs, and (c) upper non-transfer-incomes ranges for high EMTRs as a proportion of adult average weekly earnings (AWE). This highlights the need for reforms to target those elements of income taxation and social welfare interaction that are most significant for high EMTRs for persons seeking to move from state welfare dependency to wage employment.

Figure 1 shows a budget constraint between (a) expected money incomes from market labour activity, and (b) hours applied to non-market activity. This budget constraint shifts to A where state welfare transfer payments are received, and rises parallel with the original budget constraint between A and B where non-transfer-incomes are within the "free area" allowed to recipients of state welfare transfers. Notes to Figure 1 more fully explain the HABKG1' line. The BK section in Figure 1 illustrates the range over which substitution of time from non-market activity to market activity leads to the withdrawal of state welfare transfers and to smaller increases in disposable money incomes. EMTRs in excess of 100 percent give rise to reductions in disposable incomes with increases in market labour activity, and are thus marked examples of poverty or welfare traps. It is an empirical question to judge where EMTRs are "high" and are thus associated with continuance in the poverty trap of low-income state welfare dependency. For example, using data for AWE for fuU-time adult male non-managerial employees for Australia at May 1990 ($576.80) and for median AWE ($533.30) as an indication of wages received gives for persons moving from unemployment welfare dependency an EMTR of 40.25 percent. (3) That is, the relevant section of the budget constraint for these persons as illustrated in Figure 1 increases at 59.75 percent of each extra dollar earned at the relevant gross hourly wage.


2. EMTRs by Recipient Category

EMTRs are determined by six influences: (1) the amount of the base-rate of state welfare transfers, (2) the rate of expected hourly pay for market labour activity, (3) the relevant incremental marginal tax rate and steps in that rate scale, (4) any tax rebate withdrawal-rate, (5) the Medicare levy rate (including shade-in rate), and (6) the impact of Department of Social Security (DSS) income tests. …

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