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21 Sep 2023 ⏲ 11 Minutes Policy
Despite the Federal government’s historically corrective efforts to minimise income inequality, the desirability for the optimal equity-efficiency balance has not yet been achieved, leading to stifled economic growth. A potential solution to this a negative income tax, which can achieve a better income redistribution and hence a lower Gini coefficient. This article analyses Australia’s income inequality and the mechanics and value of a negative income tax. Note in this article, disposable income was utilised as an effective indicator of real income value to households, equivalised for consistent comparison.
Australia's Income Inequality
Across the 2021-22 financial year, the lowest 20% income bracket recorded an equivalent annual disposable income of $15,319 (2.94% of total disposable income), while the middle 20% equalled $86,551 (16.63% of total) and the highest 20% bracket recorded $238,916 (45.90% of total) (ABS, 2022). Ranked households showed high disparity between the highest and lowest income brackets, with this trend consistently increasing from the 2019-20 financial year.
Australia’s Gini coefficient of 0.32 in 2020 has remained constant, with minor fluctuations across a 13-year span (Treasury, 2023). This value ranks 20th from 30 OECD countries however, is slightly greater than the OECD average of 0.31 (AIHW, 2023). This indicates that Australia shows higher income inequality than a 30-country mean, with distribution of the Lorenz curve steeper-curved compared to OECD average (figure 1).
Figure 1: Australia and OECD Average Lorenz Curve
Disparity between income quintiles is largely driven by Australia’s growing wealth disparity trend. From 2003 to 2022, average wealth of the highest 20% bracket rose 82%; middle 20% increased 61% and comparatively, the lowest 20% only recorded 20% increases (ACOSS & UNSW, 2023). However, targeting progressive wealth redistribution taxes, as seen by France, reduced total savings and investments. Across 2000-2016, 60,000 millionaires were prone to exodus, instigated by reduced incentives. Total government tax revenue annually declined US$7.3 billion, adversely impacting GDP and economic growth (McDougall, 2021).
Inequality may also be appropriated to the lack of effectiveness of Australia’s income redistribution system. In figure 2, across the 2021-22 FY, after tax and transfer equivalised household disposable income remained strongly disproportionate, skewed to the highest quintile (28.9% difference to middle quintile, 40.7% difference to lowest). This trend was consistent with after-transfers of social assistance benefits and social transfer in-kind payments (ABS, 2022). This suggests that Australia’s income redistribution policies and progressive tax system are inefficient in curbing Gini coefficient and achieving lower income inequality across 13 years.
Figure 2: After-Transfer Equivalised Household Income (by quintiles)
Is a Negative Income Tax Better?
Negative income tax (NIT) provides citizens, whose marginal income is below a tax-threshold, with refundable tax credits. The threshold is set where the scheme is attractable to low-income households, and a percentage of tax can be refunded for additional income (Linke, 2018). In figure 3 below, area A shows the net benefits received by lower-income households, where an initial guaranteed income (G) is provided to compensate for after-tax income. As earned income increases, net benefits of the scheme are consumed as [net income (after-tax) – gross income (pre-tax)] until the threshold point (E1). Beyond Q1, middle- and high-income households pay positive tax (B).
Figure 3: Negative Income Tax: credits represented by Area A
Unlike other cash transfer subsidies, marginal value of tax-offset income increases as earned income increases, gradually diminishing until E1. Diminishing marginal benefits, and labour supply curve for lower-income households being relatively elastic, i.e. marginal increases in total income (wage + tax offsets) significantly increase labour supply, provides indication that substitution effect exceeds income effect. This is seen in figure 4, where the total effect is negative: point (A→B) exceeds (B→C). Thus, a higher budget constraint does not disincentivise employees from substituting labour for leisure.
Figure 4: Labour-Leisure Model for Low Income Households
Initial guaranteed payments and cut-off threshold for low-income households should be set at a lower efficient point, which incentivises lower-income households to increase labour rather than fixate on payments, further supporting the substitution effect. The tax credits could be funded by exploiting existing welfare payments, acting as substitutes rather than incurring new costs. NIT further reduces inefficiencies associated with other cash transfer models such as Jobseeker, by abolishing intermediate administrative and transfer costs (Mathys, 2017).
Modelled success is shown. Since implementation to 2013, Earned Income Tax Credits scheme has reduced America’s Gini coefficient by 0.34. Qualitative effects of higher income equality are noticed by improved standard of living, reduced wage disparity and reduced poverty (Hungerford & Thiess, 2013). This initially suggests effectiveness in reducing Australia’s income disparity and curbing Gini coefficient. However, more research is required to test the complex differences between America and Australia’s economies and employment.
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Compared to current welfare payments, NIT provides greater security in incentivising labour whilst reducing Australia’s income inequality, contributing to higher economic growth.
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References
ABS. (2022). Australian National Accounts: Distribution of Household Income, Consumption and Wealth. Retrieved from Australian Bureau of Statistics: https://www.abs.gov.au/statistics/economy/national-accounts/australian-national-accounts-distribution-household-income-consumption-and-wealth/latest-release#income
ACOSS & UNSW. (2023). INEQUALITY IN AUSTRALIA 2023: OVERVIEW.
AIHW. (2023). Measures of welfare and wellbeing for Australia and similar countries. Retrieved from Australia Institute of Health and Welfare: https://www.aihw.gov.au/reports/australias-welfare/international-comparisons-of-welfare-data#
Hungerford, T., & Thiess, R. (2013). The Earned Income Tax Credit and the Child Tax Credit. Retrieved from Economic Policy Institute: https://www.epi.org/publication/ib370-earned-income-tax-credit-and-the-child-tax-credit-history-purpose-goals-and-effectiveness/#:~:text=The%20EITC%20reduces%20the%20Gini,help%20to%20reduce%20income%20inequality.
Linke, R. (2018). Negative income tax, explained . Retrieved from MIT Management Sloan School : https://mitsloan.mit.edu/ideas-made-to-matter/negative-income-tax-explained
Mathys, Q. (2017). Simulating the Effects of an Unconditional Basic Income on Labor Supply Using Data from a Panel of Swiss Households .
McDougall, M. (2021). Lessons from history: France’s wealth tax did more harm than good. Retrieved from Investors' Chronicle: https://www.investorschronicle.co.uk/education/2021/02/11/lessons-from-history-france-s-wealth-tax-did-more-harm-than-good/
Miller, H. (2023). Australia’s wealth gap on the rise with inequality worst since 1950. (T. Burton, Producer) Retrieved from Australian Financial Review: https://www.afr.com/politics/federal/australia-s-wealth-gap-on-the-rise-with-inequality-worst-since-1950-20230428-p5d41b
Treasury. (2023). Income and wealth inequality. Retrieved from Australian Government Treasury: https://treasury.gov.au/policy-topics/measuring-what-matters/dashboard/income-wealth-inequality
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