Brian Fallow: Income splitting hardest on poor

Biggest slice of tax cake will go to higher single-income families under Peter Dunne's scheme. Photo / Kenny Rodger

Unfair, unaffordable and unlikely to happen.

That just about sums up Peter Dunne's bill to allow income splitting for tax purposes for couples with dependent children.

Its avowed objectives sound fair enough: "To give parents greater choice in their work and caring roles, to give families with children additional financial support, and to acknowledge the contributions of those who forgo income to care for children."

But that is specious. It should read, "To give some parents greater choice", "to give the right kinds of families additional support" and "to acknowledge the contributions of those who can afford to forgo income to care for children".

By definition it does nothing for sole parents, yet theirs are the families among whom child poverty is most prevalent.

In addition, as the regulatory impact statement accompanying the bill spells out, "the most significant gains would go to higher single-income families, with the lowest gains going to low-income families."

Officials estimate that 78 per cent of the value of the tax credits paid would go to couples with a joint income of $70,000 or more.

No credit would be paid to partners with the same marginal tax rate.

A couple where one partner earns $140,000 a year and the other earns nothing would be $9000 better off under the income splitting regime. In that case it would be cheaper to pay the non-earning partner the unemployment benefit.

But a couple where both partners earn $70,000 would get nothing.

Defenders of the scheme say that is only fair. It remedies an anomaly in the status quo where two couples with the same joint income pay different amounts of tax.

However that reflects the fact that we have long had a progressive income tax system, under which those on higher incomes pay a higher proportion of their incomes in income tax.

Insofar as that is a problem, this year's Budget went a long way towards reducing it.

The tax cuts, and in particular the elimination of the 38 per cent tax bracket, made the tax scale a lot less progressive.

Dunne's scheme would make it less progressive still, at least for taxpayers who have both partners and dependent children.

How much this would cost other taxpayers depends on how you define dependent children. If the age limit is set at 18 as it is for Working for Families tax credits, and consistent with parents' legal responsibilities under the Care of Children Act, it would benefit 310,000 couples and cost $460 million in its first year.

The Treasury points out that it would absorb 45 per cent of the allowance for new spending in next year's Budget.

Restricting the scheme to couples with children under 6 would halve the cost.

Either way it is a lot of money in these hard fiscal times.

The obvious question is if that sort of funding is available for giving children a better start in life would it not be better spent enhancing the existing welfare payments or Working for Families tax credits? The obvious answer is yes.

The Ministry of Social Development has just updated its richly informative report on household incomes.

It found that just over two-thirds of two-parent families had two earners, compared with the early 1980s when just half of them did.

But the proportion has dropped from nearly three-quarters in 2004.

The report's author, Bryan Perry, offers two explanations. One is the rapid and historically large rise in the number of births between 2003 and 2007. The other is Working for Families, which "gave couples greater choice about working and caring for their children by making it easier to manage on less income from the labour market".

The most common arrangement, applying in 43 per cent of cases, is for both parents to work full-time, in contrast to the early 1980s when only a fifth of couples had both working full-time and the dominant pattern (52 per cent) was one in full-time work and the other with no paid employment.

Since 1976 the proportion of "partnered" working mothers of dependent children has risen from 40 per cent to 70 per cent, the majority of them full-time.

Over the same period the proportion of sole mothers employed has risen from 40 to 50 per cent, and again the majority work full-time.

There are different definitions of poverty but one plausible one is to belong to a household whose income after housing costs is less than 60 per cent of the median at the time.

On that basis one child in four was poor last year, up from 22 per cent in 2007. It had dropped from 28 per cent in 2004, when Working for Families was introduced. But the child poverty rate is still twice as high as in the mid-1980s.

On the same measure 56 per cent of sole parents (at least those not living within wider households) are below the poverty line.

They are three times as likely to be poor as the population as a whole.

Income inequality has reduced since the introduction of Working for Families, at least by one measure.

The 80/20 ratio ranks people by income and compares the income of someone one-fifth from the top to that of someone one-fifth of the way up from the bottom. After adjusting for housing costs, the ratio had climbed from 2.4 times in 1984 to 3.1 times in 2004 but has since narrowed again to 2.8 times.

But by another measure, the Gini coefficient, inequality increased markedly between the mid-1980s and mid-1990s and has not changed much since then.

Working for Families tax credits are calculated on an income-splitting basis. So the advocates of income splitting for tax purposes need to explain why they do not argue instead for making it more generous.

Working for Families is income-tested. It is hard to escape the suspicion that it is the targeting of that form of assistance that they object to.

But if it is objectionable it is because it does nothing for the children of beneficiaries, not that it does nothing for families at the higher end of the income distribution.

National is committed under its support agreement with United Future to supporting the income splitting legislation to first reading in Parliament. Whether it supports it on the way back from a select committee is a different story.

It entails a steep opportunity cost, crowding out other things the Government might want to do.

And at a time when its policy is to encourage welfare beneficiaries into the workforce it would find it hard to justify dispensing middle-class welfare to make it easier for the partners of the well-paid to stay home.