Greg Dwyer: Families package misses point

A study being published by the Business Roundtable this week evaluates the Working for Families package in terms of its stated goals - the Government's "top priority" objective of achieving faster economic growth and an alternative strategy of giving greater emphasis to tax reductions to boost household incomes.

The key objectives of the package are to "make work pay", to "ensure income adequacy" and to "achieve a social assistance system that supports people into work".

About 63 per cent of the additional assistance will benefit working families with dependent children. The balance will go to families with dependent children on a benefit (including families in work and also receiving a benefit).

Once fully implemented, family income assistance is forecast to raise the net income of affected working families by an average of about $4310 a year. The corresponding increase for families on benefits is $2550. New housing and childcare support are additional.

From an income support perspective, the dominant effect of Working for Families is to boost the incomes of sole parents. Almost 75 per cent of beneficiary families that will gain extra income assistance are forecast to be on the Domestic Purposes Benefit (DPB).

While the package redistributes a large amount of income, it does little to make taking up work more rewarding and so is unlikely to have a material effect on aggregate employment.

The Treasury's costing of the package assumes that just 2 per cent of sole parents will move off the DPB and into work. On this basis, family income assistance might encourage up to 2160 beneficiaries to move off the DPB and into work - at a cost of up to $84,600 per person.

A key flaw in the package is that it extends high effective marginal tax rates (EMTRs) further up the income tree, discouraging productive activities while doing little to ease the problem of high EMTRs as people move from benefits to work.

The EMTR (including ACC) of a single-income earner in a working family with two children on an income between $38,000 and $60,000 will be 64.2 per cent. It may be higher still if the family qualifies for housing or childcare support.

The Government's example of Rod and Barbara - a family with three children, earning $52,000 a year - illustrates the problem. Their family assistance increases by $520 to about $9340 a year. But each additional dollar earned by Rod is subject to 89.2 cents tax with the package compared with 59.2 cents before it. Barbara's EMTR rises from 41.2 to 71.2 cents in the dollar.

Families with dependent children risk being locked into high EMTRs over a wide range of incomes, from which many will have difficulty escaping.

Working for Families is also poorly targeted. A third of its cost comes from helping families earning over $35,000 a year after tax, including middle and upper income households.

The Government forecasts a striking reduction in child poverty. But providing higher income transfers without addressing the underlying causes of welfare dependency is likely to accentuate that problem over time.

Another key Treasury estimate is that the mean rate of tax on each additional dollar earned by all individual taxpayers (the mean effective marginal tax rate) in 2007/08 will be 29.7 per cent with the package and 28.6 per cent without it, an increase of 3.8 per cent. This will increase incremental deadweight costs - the loss of output caused by the impact on behaviour of taxes on the next dollar of income - and therefore reduce aggregate employment and economic growth.

National output - not redistribution - ultimately decides material living standards. Redistribution can make some people better off but only at the cost of making others worse off. Because costs are incurred in redistributing income, it involves a net reduction in national output and income.

A more desirable strategy would include the following elements:

* The adoption of more credible policies for economic growth to increase productivity, wages and general living standards.

* The encouragement of self-reliance and personal responsibility, with Government support for vital institutions such as the family.

* Income redistribution policies focused on the prevention and alleviation of hardship.

* Greater obligations imposed on most people receiving taxpayer support, including the introduction of time limits for benefits. Reliance on work incentives and higher income to induce people into employment are not sufficient.

While a modest increase in family assistance is warranted, the levels of family assistance should be reduced from those announced in Working for Families and be more tightly targeted.

A lower overall tax burden, including lower spending on the package, and a lower and flatter tax structure would provide more headroom to lower high EMTRs.

The total cost of Working for Families is equivalent to a 2 per cent increase in aggregate annual wages. A productive, growing economy would be generating such an increase every year or two.

* Greg Dwyer is the author of the study Dissecting the Working for Families Package, to be released this week by the New Zealand Business Roundtable.