Change Abatement Rates

This post is by PaulL, a regular commentor and occasional contributor. It is the thirteenth post in a series on the financial incentives to work and the impacts of our tax and transfer system on household formation, and the sixth post on the “what could we do” subsection. The index to all posts in the series can be found here.

If moving tax rates and thresholds is an expensive way to make little different to effective marginal tax rates (EMTRs), would it make sense to instead directly address benefit abatement rates? The Jobseeker benefit has two abatement rates – 70% for most people, but 30% for sole parents over a small income range, so clearly there is recognition that the abatement rate can be a problem.

The advantage of directly working with benefit abatement rates is that it is targeted to the exact people you want. Changing tax rates impacts a lot of people up and down the income scale, and is therefore a more expensive way to change the EMTR.

Changing abatement rates results in benefits being paid to people on much higher incomes. Our sole parent family with two children continues to get at least a small amount of Jobseeker Benefit until they are working 28 hours a week, and earning $700 a week or $37,000 a year from paid employment.  If we adjust the abatement rate to 50% instead, the benefit is now payable out to 37 hours of work, $900 a week or $47,000. 

Lowering the main benefit abatement also changes the point where abatement on accommodation supplements commences, as these are set to start abating only after the main benefit is fully abated.  It does not, however, impact upon family tax credit abatement.

With this change our sole parent graph now looks as follows:

We’ve altered the EMTR at the points it was worst – reducing from a peak of 83% down to 72%, and in other areas of the curve from 75% down to 59%.  Most of the income curve now has some reasonable return to working at the EMTR level, particularly above 20 hours of work a week. 

Unfortunately, when we cross the 20 hour threshold this household needs to start paying for early childhood education (the first 20 hours are free), and so this impacts the overall return to working. The interaction of childcare with the benefit abatement leaves the household only keeping a net 13c in every extra dollar earned.

This policy works very well for addressing the primary EMTR, but really needs to be operated on concert with the earlier considered change to early childhood education to give all the desired benefit.

We can see this when we look at the incentives to earn additional hourly pay – to increase your pay from minimum wage to a higher hourly rate. In this example our same solo parent is working 20 hours per week.

Over the income range where the main benefit is abating (the yellow block) the EMTR is more reasonable at around 72%.  That means that if you get a pay rise of $1 per hour, the government is clawing back 72c of that, you keep 28c.

However, once the accommodation supplement abatement kicks in at around $46 per hour ($40,000 income for someone working half time, equivalent to an $80,000 full time income), the EMTR moves out to 82% again. These abatement rates are still a substantial drag on any increases to productivity.

We could also push up the family tax credit abatement threshold to $40,000 (from $32,000) and change the abatement rate to 20% instead of 27%.  And similarly reduce the accommodation supplement abatement from 27% to 20%.

This further improves the EMTR – our maximum EMTR is now 59% from 11 to 20 hours per week, and 35% beyond that. Again early childhood education hits the disposable pay, with only 29c in the dollar being net household income improvement up to 25 hours, then only 17c until 31 hours, and 10c beyond.

Again, combining this with the early childhood education package would leave us with much better incentives to work.

As a final option, consider if ECE was fully funded (therefore not a cost consideration), and we targeted a maximum EMTR of 50%.  We’d have an abatement rate of 40% on the main benefit, 20% on family tax credits (but starting at $60,000). Ideally we’d also move the 30% tax bracket up a bit, to $60,000 as well. 

This gives us a consistent EMTR of around 50% at all levels, and around 63% if you consider the costs of going to work. The accommodation supplement abatement pushes the EMTR back up to 75% at 48 hours of work. If this person was paid $32 per hour this higher EMTR would impact at 37 hours per week.

This would come close to meeting my definition of “solved.”

Costing this is difficult, there are many elements changing. It would definitely start to look like middle class welfare. The benefit would continue to be available to households to much higher income levels.

Changing the main benefit abatement rate means that the benefit is now not fully abated until $57K of taxable income.  Under the current system it is available only up to $37K of income.  Roughly speaking another 600,000 people have income in the $37K to $57K range. Not all of these people would be eligible for the benefit, some would have a working partner.  The jobseeker benefit costs around $3.2B per annum, if we added 50% to that cost we’d have another $1.6B of cost.  The other benefits explicitly don’t expect people to work, so I’ll ignore any impacts on them.

Funding early childhood education I costed in a previous post at $0.5 billion. I also costed a universal child benefit at $4.5 billion, in this scenario I’ve assumed an abatement threshold of $60,000. Assume $2 billion cost.

Moving the 30% tax bracket gives everyone above that income a tax cut, for a total of $2.3 billion.

So overall this package would cost around $6.5 billion.  These costings are very rough – modelling who would be eligible depends a lot on household composition and household income, I don’t have that data.

A package like this results in all sole parents having a maximum EMTR of 50%. It also delivers a similar result to couples where one is working and one moving off a benefit, and to couples where both are on a benefit. It assists also those with no children.

It is still expensive – 5% additional government spending and/or revenue reduction. The operating allowance is $4.5 billion, tax cuts of $2 billion or more are being discussed. It’s within the size of package that could be affordable. 

Furthermore, if this package reduced our benefit rolls there would be offsetting saving, and if this package incentivised increased productivity that would benefit the economy as a whole.

That’s starting to sound like a reasonable spend of money (at least to me).