Working
for families – is it a handout?
By
Stuart Birks
6
April 2006
The “Working for Families” package is described on the internet at: http://www.workingforfamilies.govt.nz/.
The description includes the statement, “It pays
extra money to many thousands of
Richard Prebble’s The Letter
of
Perhaps we should not consider it as a benefit or even a payment.
Imagine a household with two adults and four children, having one income earner
on $100,000 annual pre-tax income. In 2005 it would have paid $30,270 in income
tax. Under the Working for Families package, it would receive $68 per fortnight
or $1,768 for the year.[1]
Should this household be considered to be a beneficiary household, or one
paying $28,502 in tax?
One approach to equity considers two dimensions, horizontal equity
and vertical equity. There is nothing particularly profound about the concepts.
Horizontal equity states that those in the same circumstances should be treated
the same. Vertical equity states that those in different circumstances should
have an “appropriate” difference in treatment.
The problem in applying these concepts lies in determining what are
the same and different circumstances, and what are appropriate differences in
treatment. Should we consider household income alone in determining the amount
of tax to be paid, or should household composition also be considered? With
income taxes, the amount of tax paid varies with income. In other words,
different incomes are considered as different circumstances. This is not the case with different numbers
of dependent children (for income tax in
The Jensen scale is one
Consider again our couple with four children and a single income of
$100,000 before tax in 2005. Income tax at $30,270 is just over 30% of income.
According to my information on the scale where the basic unit is one adult, this
household would need 2.69 times the after-tax income of an adult living alone
on the same living standard. As we are just looking at the issue of
differential treatment according to number of children, consider a comparison
to a couple with no children. They would need 1.54 times the single person’s
after-tax income.
Assuming single-income households, this indicates that an after-tax
income of this four child household of $69,730 gives an equivalent standard of
living to a single person with $25,922, or a couple with $39,920 (after tax).
This latter, for the couple, is the after tax income of someone earning
$51,925, but such a person is only paying 23% of income in tax. Is it fair
that, with two households on the same standard of living, one (a couple)
is paying 23% of income in tax, whereas another (a couple with four children)
is paying 30%? To put this another way, if these two households are on the same
income, the same tax would be paid by both, although the equal after-tax
incomes mean that the couple-only household has a standard of living 75%
(2.65/1.54 – 1) higher than the household with four children.
It could be said that people can choose the number of children they
have, so why should this affect the tax paid? Alternatively, it could equally
be said that people have some choice about the level of income they obtain by
deciding how hard to work, and yet we do not question income-related taxes.
Just as it could be argued that “Working for Families” payments are
actually reductions in tax for many households, it could equally be said that
the above discussion considers only income tax, rather than all taxes. What
would happen if we considered also GST?
It might be reasonable to assume that, with two households on the
same income, the one with more dependent children will have to spend more (and
therefore save less). GST is a fixed proportion of spending, so GST payments
increase as spending rises. Therefore, the share of income paid in GST rises
with the proportion of income spent. Hence, on this assumption about spending,
the household with more children is paying more GST. Both households being on
the same income, with no adjustments for children they are paying the same
amount of income tax. Hence the total tax paid by the household with more
children is higher than that of a household with fewer children. Is that
equitable?
There is yet another angle, one that can yield very different
results. Instead of considering solely payments, we could also consider the
benefits people receive from expenditure funded through taxes. In the extreme
case, when we overlook any redistributive objectives of taxation, a “fair” tax
structure is one where people pay according to the amount of public money spent
on them (an extreme, generalized user-pays system). In this situation, we
should note that public education expenditure benefits families with children.
Similarly, health care costs are higher for young and old, and will be higher
for larger households. On this basis, it could be argued that families with
children should pay more tax rather than less. To take this a stage further,
those sending their children to state schools obtain more taxpayer-funded
education than those using private schools. Should there be differences in tax
treatment?
For yet another dimension, those without children may benefit in
their old age from the taxes paid by others’ children. More generally, we may
all benefit from tax-funded expenditure on others. Such benefits could justify
cross-household tax-funded expenditure.
To summarise, it is a gross over-simplification to say that “Working
for Families” is making many families into beneficiaries. Rather, there may be
very good reasons to take account of family or household composition when
deciding on both tax and expenditure by the public sector.