Wednesday, October 17, 2007

SPIN DOCTOR: Do tax cuts encourage people to work?

Talkback callers were relentlessly negative about the government’s promised $34 billion tax cuts yesterday, and not just in Canberra. Most saw them as crude pre-election bribes.

But not the Prime Minister and Treasurer. According to them the cuts are about “workforce participation”.

The Prime Minister referred to the workforce 12 times in launching the policy. The Treasurer, 15 times.

On Adelaide radio yesterday Mr Costello claimed that the “whole idea of the tax plan” was to entice people who are at present unemployed to go out and get a job.

“We are saying to low income earners that in three years’ time you won’t have to pay a dollar in tax until you earn $16,000 or more. So you can come into the workforce and you know, probably work a day a week without actually having any tax liability,” he said.

“We are saying to working mothers who may be thinking of coming back into the workforce after the children go off to school or whatever, that you won’t be facing a tax rate which is higher than 15 cents in the dollar. And of course we will be saying to the higher income earners that the top rate of tax will be 42 cents and falling to 40 cents as part of our goal, and so you that you get to keep more of what you earn"...

But does it really work that way? On Monday the Treasurer pointed to Treasury modeling that he said showed that all of the tax cuts introduced since 2000 had boosted, “in a cumulative way, the number of people in the workforce by 300,000 and the changes which we announce today will boost the estimated workforce by around 65,000”.

But he wouldn’t release the modeling. So it’s hard to tell how the Treasury came up with the numbers and what kind of tax cuts it found did boost employment and what kind it found did not.

Fortunately someone else has tackled the question using a similar economic model to that used by the Treasury, the so-called Melbourne Institute Tax and Transfer Simulator.

At the request of the Committee for the Economic Development of Australia Dr Nicholas Gruen last year examined “the impact of marginal tax cuts on Australia’s labour supply” and found that whether there was an impact at all depended on what was cut.

Cutting the top marginal rate, one of the things promised by the Coalition, did little to increase the number of hours workers worked.

Dr Gruen points out that 30 per cent of full time workers already work long hours, as do 56 per cent of managers. Cutting tax rates would be unlikely to squeeze more out of them.

Lower tax could help attract more skilled workers from overseas, although the extent of the gain is “unclear and probably small”.

But to these people the top marginal rate is irrelevant. What matters is the average tax rate, or “How much tax will I pay on any given income?”.

Adjusting thresholds to cut the total tax paid is the best way to attract those workers, rather than cutting the top rate charged to Australia’s millionaires.

The best way to get unemployed Australians into work is to cut tax at the very bottom of the scale, either by boosting the tax free-threshold or by boosting the low income tax offset to achieve the same effect, something the government has done on this occasion, although not on every one of them.

It would get a bigger bang for its buck by going further and introducing a negative income tax, sometimes called an Earned Income Tax Credit – where tax office actually tops up low-income earner’s pay.

The Coalition has baulked at that idea, seriously put forward by CEDA. Labor may not.