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Helping the Working Poor: An Earned Income Tax Rebate for Australia
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Phil Hanratty
Economics, Commerce and Industrial Relations Group
Much attention is now being focused on ways to help the working poor
(i.e. those with jobs but with income and assets below the poverty line).
Increasing their wages can help but could reduce their employment if carried
too far. Another relevant policy option is an Earned Income Tax Rebate
(EITR). Reference is often made to the United States, which has utilised
such a tax benefit scheme since 1975.(1)
The Nature of an EITR
An EITR reduces the income tax burden on low-paid workers through a
tax rebate/credit which effectively increases the eligible taxpayer's
tax-free threshold. These workers' tax burdens could be reduced to zero
or could even become negative where the EITR is made 'refundable'. In
such a case, actual money payments would be made to eligible persons/
families.
Only those on low 'earned income' (e.g. low wages and salaries
and/or low self-employment income) and little other income would qualify
for the EITR. Those with substantial 'unearned income' (e.g. interest
receipts, dividends, rent and capital gains from assets) would not qualify
for the EITR, regardless of their earned income. The proper classification
of superannuation annuities/ pensions and social security payments into
these earned versus unearned income categories is less clear and would
require careful choice by those designing such a scheme for Australia.(2)
Australia's personal tax system already has a general Low Income Earner
Rebate. For those fully eligible, in 1996-97 tax payable will be reduced
by $150. The maximum rebate will be reduced by 4 cents for every dollar
by which the taxpayer's annual taxable income exceeds $20,700 and no benefit
will be available for those with taxable incomes above $24,450. An EITR
could operate in a similar fashion, but would be available only to those
on low earned incomes, and with unearned income below some threshold.
Rationales for an EITR
The United States scheme was originally put forward as a way of relieving
the financial burden of the US social security payroll tax on low-wage
working parents, using tax relief to compensate for compulsory contributions.
More recently, it has been touted as a way of helping the poor to 'help
themselves' by encouraging them to take work or to work more.
Both these issues are currently relevant to Australia and so consideration
of an EITR here would seem worthwhile. In particular, an EITR might be
an effective way of relieving the financial burden of compulsory superannuation
payments on the after-tax incomes of low-wage workers in Australia and
also of increasing the incentive to work for those now without jobs.
Up to now, compulsory superannuation contributions for low-wage workers
have been formally paid by employers, but many economists would argue
that a substantial portion (perhaps all) of the costs of such contributions
have effectively been passed on to workers through gross wages being lower
than they otherwise might be. An EITR might also be useful in passing
on more of these costs, or in generally lowering labour costs by allowing
lower gross wages and thus in helping to encourage higher employment growth.
Overall, an EITR would benefit low-wage workers either through higher
after-tax incomes or through higher employment. If this is the justification
for an EITR then it might be sensible to confine the definition of earned
income to the wages and salaries which form the base for levying superannuation
contributions. Here, self-employment income would be included in unearned
income.
Second, a contrast might be drawn between the receipt of unearned income,
which implies ownership of underlying physical and financial assets, and
the case of wages and salaries where the only underlying 'asset' is the
person themselves. For the same total income, unearned income recipients
will generally be more asset-rich than earned income recipients, as they
will generally have both their own ability to work as well as other assets.
Thus, their scope for consumption spending will be correspondingly higher
and their need of assistance will be less. There is a similar rationale
behind the use of both income tests and asset tests to determine eligibility
for social security payments in Australia.
Third, it might be argued that unearned income is somehow of a more
'morally dubious' character, compared to earned income. For example, we
know that substantial portions of asset ownership are acquired not through
saving out of the earned income of their present owners but through gifts
and inheritances. It could be judged that income from assets acquired
in the latter way are less deserving of tax relief than are other sorts
of income. Recipients of such income have not actually expended work effort
and abstained from consumption through saving in order to acquire the
underlying assets.
Problems of an EITR
One problem of an EITR is that it would probably discourage work effort
for certain categories of workers.(3) Such discouragement effects would
be strongest in the 'phaseout range' for EITR benefits. This is the income
range in which EITR benefits are gradually withdrawn to ensure that only
truly deserving 'low earned income' recipients are assisted by the scheme.
For example, the phaseout range of annual taxable income for Australia's
Low Income Earner Rebate, as noted above, is $20,700 to $24,450.
Work effort in the phaseout range for an EITR will be doubly vulnerable
to discouragement. Recipients will feel richer, because some of the EITR
will still be paid and this will allow increased leisure to be enjoyed
at the old level of disposable income, and the rewards to work at the
margin will now be lower, because not only are normal tax rates payable
but the EITR benefit itself is being gradually withdrawn. There may also
be reduced work effort for those below the phaseout range.
However, an EITR would probably encourage persons presently outside
the workforce to seek employment in jobs with wages low enough to qualify
for EITR benefits, because the after-tax financial returns from such work
will probably be greater.
Second, an EITR would entail higher tax rates on saving, over a certain
income range, for eligible persons/ families. The EITR's eligibility test
on unearned income would probably need to be reasonably strict, otherwise
these tax benefits would begin to lose their 'earned' character by allowing
increasing numbers of those with substantial assets into the scheme. However,
this implies that, at the margin of eligibility, tax rates for such asset
income would be higher than otherwise, again because both normal tax rates
and EITR withdrawal are involved.
It is often argued that such higher tax rates on saving would discourage
saving (i.e. acquiring assets) by people eligible for an EITR, and this
would contribute both to macroeconomic problems of low national saving
(e.g. current account deficits) and to 'poverty traps' where low income
people do not have enough incentive to escape poverty through a combination
of hard work and conscientious personal saving.(4)
However, it is widely believed that personal saving is not very sensitive
to after-tax rates of return, so the magnitude of these anti-saving effects
would probably be small.
Third, there may be problems of implementation. The receipt of EITR
benefits might require eligible persons/families to participate in the
tax assessment process through the submission of annual returns to the
Australian Tax Office (ATO). Many low income earners do not currently
submit annual returns. It might be necessary for the ATO to fill out annual
returns, and to collect the relevant information and documents, on behalf
of such people to ensure that they receive the EITR benefits. Alternatively,
these people might receive equivalent payments through the social security
system.
Implementation of an EITR will further strengthen incentives for taxpayers
to under-report their asset income in order to qualify for the EITR benefits.
Enhanced monitoring of such income flows, and greater use of the Tax File
Number system for the auditing of personal taxpayers, will probably be
necessary if substantial tax relief is to be offered through an EITR scheme.
Endnotes
- Scholz, John Karl. 'In Work Benefits in the United States: The Earned
Income Tax Credit'. Economic Journal, vol. 106, January 1996:
156-169.
- The former might be regarded as 'earned' to the extent that they
have been funded from superannuation contributions out of earned income.
The latter could be included in the same income category in order to
encourage these recipients to take up work. EITR benefits might also
be exempt from social security income tests.
- Browning, Edgar. 'Effects of the Earned Income Tax Credit on Income
and Welfare'. National Tax Journal, 48(1), March 1995: 23-43.
- It is important to note that the Government's Family Tax Initiative
will also suffer from problems of discouraging work effort and personal
saving, especially at the upper boundary of eligibility.
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