PC News - March 2016
How does Australia's tax and transfer system redistribute income?
Australia's personal income tax and transfer system is less progressive when measured on a lifetime basis rather than at a point in time, but it is still strongly progressive, according to a recent Commission Working Paper. The paper also found that many families pay income tax and receive transfer payments at the same time, and that some families with relatively high wealth receive more in transfers than lower wealth families.
Almost all families are affected by the tax and transfer system - they will pay personal income tax and GST and receive transfers at some point in their lifetimes. Taxes and transfers redistribute income, and in doing so, they alter people's incentives to work, save and invest in ways that can be reinforcing or offsetting. For example, consider a two-parent family with school-age children and only one parent in the paid workforce. If the second parent were to enter the paid workforce, not only would they be liable to pay additional personal income tax, but the family may not be eligible for the same level of family payments. In part, the financial incentive for the second parent to enter the workforce would depend on the combined effects of the tax system and the transfer system.
The Commission used a static microsimulation model to examine these interactions, including who pays income tax and GST, and who receives transfers. The modelling also included results from a lifetime perspective, rather than only focussing on a single year.
Australia's tax and transfer system
The tax system and the transfer system are administered independently and differ in many important ways. Nonetheless, it is common to analyse these systems together - and refer to the whole as the "tax and transfer system'.
The Australian tax system is composed of a large number of taxes including personal income tax, company income tax, superannuation fund taxes and fringe benefits tax. Indirect taxes include the GST; excise on alcohol, tobacco and fuel; customs duties; wine equalisation tax; and the luxury car tax.
In 2013-14, the Australian Government raised $352 billion in taxation revenue, equivalent to 23 per cent of Australia's GDP. Eight out of every ten dollars in tax revenue raised came from just three taxes: personal income tax, company income tax and the GST. Personal income tax accounts for almost half of all Australian Government tax revenue.
Transfer payments are defined in the Commission paper as cash payments provided by governments to individuals and families. Eligibility for most payments is determined by income and assets tests, and most payments have tapered withdrawal rates. In the Australian system, cash transfers come in four basic forms: pensions; allowances; supplementary payments; and family payments.
In 2013-14, transfer expenditure by the Australian Government totalled $125 billion, equivalent to 8 per cent of Australia's GDP. In 2013-14, transfer expenditure was equivalent to 35 per cent of total tax revenue. Transfer payments tend to grow as a proportion of tax revenue when the economy is weak and shrink when the economy is strong.
The five largest payments - the Age Pension, the Disability Support Pension, Family Tax Benefit Parts A and B, and the Newstart Allowance - accounted for two thirds of all transfer expenditure in 2013-14.
Tax and transfer incidence can be measured by income or wealth
Net taxes rise with income levels. On a cohort basis, families earning less than $25 000 per annum in private income1 pay less in tax in aggregate than they receive in transfers; but the cohorts above generally pay more tax (GST and income tax) than they receive in benefits. The average taxpayer in the $25-50 000 private income range receives more in benefits than they pay in income tax alone, but when GST is included, taxes paid are larger than transfers. Families with more than $125 000 in private income (about 15 per cent of the population) contribute more than half of all taxes.
Figure 1: Transfers are concentrated towards low income earners, and tax increases with incomeData source: Commission estimates
Total and average taxes and transfers by private income
Figure 2: Families with $200 000 to $1 000 000 of net assets receive more in transfers than some families with less wealthData source: Commission estimates
Total and average taxes and transfers by wealth
Figure 3: A large share of Age Pension transfers are directed to families with high levels of wealthData source: Commission estimates
Composition of total transfers by wealth
Average tax paid may also increase with wealth, but not as consistently as with income. As wealth rises, income tax generally increases, but the amount falls for families with $200 000 to $500 000 in net assets before increasing again. While transfers tend to decrease with wealth, a significant proportion of transfers are paid to families with net assets between $200 000 and $1 000 000. These observed patterns occur because some older home owners with relatively low private incomes pay little income tax and receive transfers (the family home is not included in assets tests for the Age Pension).
When looking at who receives different types of transfer payments, aged and disability payments represent the largest shares of transfers to families with low private incomes. In contrast, family payments represent the largest share of transfers to middle-income families. Furthermore, much Age Pension expenditure is directed to families with relatively high levels of wealth.
A sizeable portion of all families (nearly 20 per cent) receive transfers and pay income taxes at the same time. This "churn' is mainly due to the structure of family payments - families with children account for 80 per cent of families who simultaneously pay personal income tax and receive transfer payments.
The tax and transfer system also redistributes income from families of working age to families of retirement age. Average net tax flows (taxes paid less transfers received) are positive across all age groups except for those aged 60 and above.
GST is slightly regressive, but there is wide dispersion within income groups
The average amount of GST paid as a proportion of disposable income and as a proportion of expenditure decreases, although only slightly, with private income. For families with no private income, GST makes up about 7 per cent of disposable income, on average. In contrast, for families with private incomes greater than $150 000, GST accounts for about 5 per cent of disposable income, on average. However, there is wide variation within private income groups, particularly for some low-income families. For some families the share of GST relative to disposable income is over the statutory rate of 10 per cent, which can occur because of borrowing or dissaving.
Taxes and transfers may affect incentives to work
Effective marginal tax rates (EMTRs) are an indicator of the financial incentive from additional work. They not only account for the extra amount of personal income tax paid, but also take into account any transfers foregone, when a family earns additional private income. Among those families that earn a private income, but earn less than $25 0000 a year, two-thirds have primary income earners who face an EMTR of 20 per cent or less, while about one-quarter have primary income earners who face EMTRs greater than 40 per cent. The high EMTRs (more than 40 per cent) largely reflect the withdrawal rates of 50 to 60 per cent for the Age Pension and Newstart Allowance, and the imposition of income tax and the Medicare Levy.
Figure 4: The tax system is less progressive on a life-time basisData source: Commission estimates
Average income tax paid - annualised lifetime results compared to annual 2014-15 results
Another indicator of the incentive to work is the participation tax rate. This measures the additional tax paid and transfers (eg Family Tax Benefit) foregone when a person moves into employment. Scenarios showed that some families can face participation tax rates that exceed 50 per cent. This is particularly the case when a large loss of transfers is accompanied by increases in income tax paid.
Measuring tax and transfer incidence over time
As people age and progress through different stages of life, their income, wealth and personal circumstances change. This affects the amount of tax they pay and the amount of transfers they receive.
Tax and transfer flows are smoother over lifetimes than in a single year
The tax and transfer system can help smooth income flows over a person's lifetime. For example, a person may be a net taxpayer during prime earning years, but may be a net recipient earlier in life (for example, when studying) or later in life (when retired).
The Commission modelled what would happen if many different types of families, representative of those in today's population, were to fully live out their lives under the current tax and transfer system. The results suggest that the tax and transfer system is less progressive over lifetimes, although still progressive. Annualised tax impacts (figure 4) are also offset somewhat by transfers, which are larger for high-income families when measured on a lifetime basis. Thus the tax and transfer system smooths income over lifetimes, but still redistributes income from high- to low-income families.
Projections of tax and transfer flows show an increasing burden on younger cohorts in the future
Forward estimates of tax and transfer incidence in 2034-35 were projected using population growth projections and various assumptions for indexation of income tax thresholds, wage growth and inflation.
Income tax paid and transfer expenditure are expected to increase, across all scenarios. In terms of transfer payment category, average transfers for the Age Pension are expected to increase the most, while there is a decline in family and student payments. The former occurs because of the ageing of the population and the more generous indexation of Age Pension payments.
The projections indicate an increasing share of the tax burden will fall on the under-60 age group, though the size of the shift will depend on economic conditions, how tax and transfer policies change over time, and the extent to which the maturation of the Superannuation Guarantee reduces reliance on the Age Pension (a separate Productivity Commission report "Superannuation Policy for Post-Retirement' highlights this).
Tax and Transfer Incidence in Australia
- Read the Commission Working Paper released October 2015
1Private income refers to income before taxes, transfers or in-kind services are taken into account. It includes income from wages, salaries, superannuation, investments, and other non-government income.Return to footnote 1