GUARANTEED MINIMUM INCOME REVISITED: PARADISE LOST OR GUIDING LIGHT?

by PETER SAUNDERS*

The main income support recommendations made by the Commission of Inquiry into Poverty are contained in Chapters Five and Six of its Main Report, Poverty in Australia. Chapter Five contains a list of proposals for improving the existing categorical, income tested system of pensions, benefits and allowances. These proposals were intended to improve the adequacy of payments, to enhance equity in the tax-transfer system, to improve co- ordination between income support and income tax arrangements, and to simplify administrative procedures. Many of these recommendations- notably the replacement of tax rebates by family allowance cash grants and the extension of supporting mother’s benefit to supporting fathers-were implemented in the years following release of the Report. As a framework for reform of the Australian income support system, the analysis in Chapter Five of Poverty in Australia was an important contribution and it had a significant impact. Many of its arguments are as convincing (indeed, relevant!) today as they were twelve years ago.

However, the Poverty Commission saw these proposed improvements as a step towards implementation of its main income support recommendation, the introduction of a guaranteed minimum income (GMI) scheme. A central feature of its proposed scheme was the complete integration of income support and income tax arrangements. The GMI payments would be universal and automatic, with a flat rate income tax designed to maintain an income-tested system by clawing back payments from those with private incomes. Such a scheme had much to recommend it in the Australian context. The tradition of income tested income support provisions, combined with the nonexistence of social insurance contributions and associated earnings- related benefit entitlements provided an ideal environment for the intro- duction of an integrated income related tax-transfer mechanism of the GMI type.

Consideratioiis of cost prevented the Poverty Commission from recom- mending a full non-categorical GMI scheme which would set the GMI payments for all above the poverty line. The tax rate required to finance such a scheme was estimated to be about 50%, a marginal tax rate which implied an income retention rate that was considered unacceptable. The GMI proposal preferred by the commission was thus a two-tiered arrange- ment, with a lower GMI payment for those not eligible for pension or benefit,

* Social Welfare Research Centre, University of New South Wales.

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and a poverty line payment for those in the eligible categories. This scheme thus maintained the principle of categorisation and the implied eligibility tests required to administer it. The tax rate implied by this two-tier proposal was 40%, the reduction from 50% reflecting the lower level of guaranteed income for those not satisfying eligibility for the categorical payments.

Despite the Poverty Commission’s support for GMI and the existence of a system which facilitated its introduction with minimal transition diffi- culties, the proposal has not featured subsequently in the income support reform debate in Australia. I have been unable, for example, to find even a passing reference to GMI in any of the documents produced to date by the current Social Security Review. Indeed, the three identified areas for focus of that Review-income support for families with children, social security and workforce issues, and income support for the aged-combined with the Review process itself, effectively served to eliminate consideration of GMI proposals from its deliberations. Yet the concept of a GMI continues to receive widespread support from within the welfare sector and from a broad spectrum of politicians. In this paper, I will explore some of the reasons for this divergence in attitudes to GMI, and assess its relevance in the contemporary Australian economic and social environment.

One of the major reasons for the disappearance of GMI from the policy agenda is, paradoxically, the successful implementation of many of the Poverty Commission’s proposals to improve the existing income support system. Seen in this dynamic context, the improvement in income support arrangements between 1975 and 1978 weakened the case for more radical reform of the system through the introduction of a GMI. In the last ten years, the income support system has shifted away somewhat from the simplified and rationalised vision contained in Chapter Five of Poverty in Australia, towards which policy was moving in the mid-seventies. This is no doubt due to the continued budgetary restraint and fiscal policy climate of the last decade, combined with the length and severity of economic recession. These economic developments have implications for the financing and conse- quences of GMI schemes, as will be explained further below. Before this, it is useful to outline the basic economics of the financing and redistributive impact of guaranteed income schemes.

As they are normally proposed, GMI schemes are self-financing in the sense that the tax rate (t) is set so as to raise sufficient revenue to finance the GMI payments at the desired level (g). Consider first the full-blown non- categorical proposal. If there are N units (individuals or families) in the population, then the total cost of the GMI payments is equal to the product of N and the average GMI payment level, g. If Y is average per capita income in the community, then the tax rate required to finance pavments can be derived from the formula

g.N = t.Y.N If the GMI payment is specified as a proportion (0) of average income,

so that g = 0.P, then equation (1) reduces to 0 = t: The tax rate is simply equal to the ratio of the GMI payment to average income. Thus if

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the GMI is set at 40% of average income, the required tax rate will be 40%, if the GMI is set at 50% of average income, the required tax ratio will be 50%, and so on. The simplicity of this financing aspect of the scheme arises from the linear tax schedule, because under this arrangement total tax revenue is dependent only on the total level of income and not on how that income is distributed.

In this simple GMI scheme, the breakeven income level is equal to average income, A person on average income will receive a proportion of their income as a GMI payment and pay the same proportion of their income in tax to finance the scheme. For those with incomes above the average, tax payments exceed GMI payments, while the reverse occurs for those with below average incomes. Thus the scheme redistributes income from those with above- average incomes to those with incomes below the average, the extent of redistribution depending upon the tax rate, or the ratio of the GMI payment to average income. Since the breakeven income level is equal to average income, the GMI payment bears the same relation to average disposable income as it does to average gross income. This is of relevance in the policy context where the GMI payment is fixed relative to the poverty line, and when the poverty line is expressed as a proportion of average disposable income in the community.

The above simple relationships become more complex once it is acknow- ledged that the income tax system must also finance other government activities. In this case, the overall tax rate is equal to the sum of the rate required to finance the GMI payments and that required to finance these other government activities. This was what led the Poverty Commission to reject the full non-categorical GMI proposal in favour of a two-tier system which maintains the categorical approach. Under the two-tier proposal, ignoring for the moment the tax rate required to finance other government activities, equation (1) above is replaced by:

gi Ni + gz Nz = t.P. (NI + Nz) (2) where gl and gz are the categorical and non-categorical GMI payment levels, respectively, and NI and NZ are the relevant population sizes. If gl = 0.H and gz = 4.T then (2) reduces to:

(3) where pl and pz are the proportions of the population in the categorical and non-categorical groups, respectively. Thus, for example, if 0 = 0.5 and q5 = 0.25 , while 20% of the population fall into the categorical group, the required tax rate is given from (3). by

i.e. a two-tier GMI scheme now requires a self-financing tax rate of only 30%. Again, however, we must add the tax rate required to finance other government activities to obtain the overall tax rate.

It is important to note from equation (3) that the GMI tax rate depends crucially upon the proportion of the population in the categorical group. To

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t = p1.0 + p2.4

t = (0.2].(0.5) + (0.8].(0.25] = 0.3 (4 1

see this, equation (3) can be rewritten by noting that pl + p2 = 1 so that pz = 1 - PI. The equation then becomes:

(5) The tax rate now depends upon the level of the lower level GMI payment

(4, paid automatically to everyone), the extra payment made to those in the favoured categories if%+), and the proportion of the population in the categorical group (PI).

This latter proportion has increased considerably since the time that the Poverty Commission costed its GMI proposals, as Table 1 illustrates. Despite a fall in recent years, social security pensioners and beneficiaries increased from 10.6% of the population in 1973 to 17.8% in 1986, a relative increase of 68%. This increase largely reflects the ten-fold increase in beneficiaries as a proportion of the population between 1973 and 1986, which in turn mainly reflects the increase in unemployment since 1973. Furthermore, the reliance on income tax as a source of revenue to finance other Common- wealth activities has also increased over the period. Between 1972173 and 1985/86, individual income tax revenue rose from 43.1% to 50.1% of total Commonwealth receipts, and from 40.1% to 46.8% of total budget outlays. For these reasons, the tax rate required to finance even a two-tier categorical GMI scheme would now exceed the 40% estimated by the Poverty Com- mission in 1973. Recalling that recent tax policies have reflected the political judgment that income tax rates should be lowered, particularly at the top end, it is not implausible that the tax rate now required to finance a two- tier GMI scheme would be close to, if not in excess of, the current top marginal rate of 49%. Thus, while tax policy is attempting to flatten marginal tax rates from the top down, the GMI scheme would in effect flatten them from the bottom up!

t = (0 - $1 p1 + 4.

TABLE 1 GROWTH IN SOCIAL SECURITY PENSIONERS AND BENEFICIARIES, 1973 TO 1986

(30 June) 1973 1978 1983 1986

Social Security Pensioners: -percentage of total population 10.1 12.3 13.0 12.7 -percentage of the labour force 23.0 27.6 28.6 26.9 Social Security Beneficiaries: -percentage of total population 0.5 2.9 6.0 5.1 -percentage of the labour force 1 .o 6.5 13.3 10.8 Social Security Pensioners and Beneficiaries: -percentage of total population 10.6 15.2 19.0 17.8 -percentage of the labour force 24.0 34.1 41.9 37.7

Sources: (i) Department of Social Security. Social Security Pensioners and Beneficiaries as a Proportion of the Population and the Labour Force Australia. 1976-1986, Canberra.

(ii) Estimates for 1973 derived from Department of Social Security, Annual Report 1972-73 and Ten Year Statistical Summary, 1969 to 1978.

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Because GMI schemes are designed with a tax rate sufficient to cover all guaranteed income payments, they are self-financing in the sense that there is no net impact on the budget deficit. They do, however, have a major impact on the overall levels of government expenditure and taxation, and are thus not revenue neutral in the conventional sense. Government expenditure increases for two reasons: First because the categorical GMI payments are normally set above prevailing pension and benefit rates; and second because the lower-tier payments extend coverage of the income support system. Combined with a linear tax schedule, income redistribution occurs in favour of those at the bottom of the income distribution and, depending upon the GMI payment level and thus the tax rate, also to those at the top of the income distribution.

There is a danger here that proponents of GMI may suffer from a form of fiscal illusion, favouring the scheme precisely because it is not revenue neutral, because it raises taxes to finance higher income support payments and extended coverage. It is easy to favour such an arrangement in principle, but does it have a practical relevance given the politics and economics of current budgetary policies? Proponents of GMI need to pose [and answer) the question of why it is that the population will be any more willing to finance an expansion of income support provisions under a GMI than they are prepared to finance under existing arrangements. This is not to deny that taxpayers are not indifferent to the uses to which public funds are put, a point emphasised in my own research (Saunders: 1987a, 1987b). But whether these arguments apply to a GMI scheme which provides an automatic payment, albeit at a reduced level, to all those with no private income, irrespective of the reasons for this, is another matter.

Relevant comparisons of GMI schemes thus need to be made within a revenue neutral, rather than a deficit neutral, context. This is, however, an extremely difficult comparison to make, precisely because the fundamental principle of GMI-the extension of income support to all as an automatic right of citizenship-necessarily implies a radical and costly departure from the existing income support system. Despite this difficulty, it is worthwhile exploring what a revenue neutral GMI scheme might look like. There is a sense in which the current system can be conceptualised as a two-tier GMI scheme in which the lower tier payment is equal to zero. [Thus in terms of equations (3) or (5) above, C#J = 0 so that the tax rate [t) is equal to p1.0, the product of the social security dependency ratio and the ratio of the level of payment to average community income.) Under this arrangement, however, the social security and tax systems are not fully integrated, as they would be under the GMI. Social security income [and assets) tests operate independently of the income tax system, but they overlap leading to the high effective marginal tax rates that characterise poverty traps.

One straightforward means of achieving integration would be to simply abolish the social security income test, leaving the tax system to clawback payments from pensioners and beneficiaries with private income. [Consistent treatment might also suggest an extension of the assets test to all citizens

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in the form of a wealth tax or some variant thereof.) Poverty traps would be eliminated as the income test would effectively be eased considerably (particularly for beneficiaries), although the cost of this income test relaxation would be substantial. Some increase in taxation would thus be required to finance higher net benefits to those pensioners and beneficiaries with private incomes. In effect, the proposal would further extend the poverty traps initiative introduced by the government in July 1987.

But this proposal is unlikely to find much favour among the proponents of GMI. Neither, incidentally, would the Poverty Commission itself have seen it as a priority, since they argued that ". . . maintenance and increase of the basic pension rate (has) priority over easing the means test" (Poverty in Australia, p. 57). More generally, problems would remain because of the different definitions of the unit for tax and income support, while pensions and benefits would still be taxable. Finally, there would be no concept of a universal right to a guaranteed income, a central feature of GMI proposals.

The GMI concept requires freeing all income support payments from tax, combined with a lower tier GMI payment which is positive. It thus inevitably involves large additional revenues to finance it. In effect, this extra revenue is obtained through abolition of the tax threshold, which is cashed-out to pay the lower tier GMI payments. Once the tax threshold is removed, the need for a separate social security income test also disappears, since the tax system now operates from the first dollar of private income. This would almost certainly imply some easing of the present income test (again particularly for beneficiaries), although the current free income zone would also be removed. Combined with the linear income tax, the GMI scheme thus involves some shuffling of effective marginal tax rates within the income distribution, particularly at the lower end. From the above perspective, the GMI scheme has certain similarities with the tax reform options proposed earlier this year by the Centre of Policy Studies at Monash University (Freebairn, Porter and Walsh, 1987). Their Targeted Threshold Scheme (Option T) proposed abolition of the tax threshold on an income tested basis. However, under this scheme the revenue thereby generated was to be used to finance tax cuts, particularly at higher income levels, rather than to finance expanded benefits at the bottom end of the income distribution.

As already explained, the two-tier GMI scheme described above retains the principle of categorisation embodied in the current system. To the extent that such categorisation reflects different needs among disadvantaged groups, this can be seen as more equitable than a scheme in which categorisation is abandoned entirely. It would also have a considerably less detrimental effect on incentives to work than a scheme which imposed no eligibility test other than the rights of citizenship. Under the two-tier scheme, eligibility for the higher level of payment would be subject to a work-test, or other eligibility criteria such as old age or invalidity. The lower payment level would not be work-tested and its effect on the incentive to work would depend on the level at which the payment was set. If it were high enough to provide a subsistence standard of living for those who chose this option,

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then the disincentive effects could be considerable. Against this, if it were set at a level below subsistence to reduce such disincentives, the question arises of why bother with the second tier payment level at all. Finally, the lower is the second tier payment relative to the higher level, the greater the financial incentives to establish eligibility for the favoured categories in order to receive the higher GMI payment.

The scheme would also have other effects on incentives to work. For many of those pensioners and beneficiaries who currently work part-time, the abolition of the free income zone would be of more financial significance than the lowering of their effective marginal tax rate. Against this, their pension or benefit would be freed from tax, so that the net impact on their financial position is uncertain, although many of those with lowest incomes would most probably be worse off than currently. It is significant to note in this context that abolition of the free income zone would be of much greater significance now than in 1973, because its level has increased considerably in the interim. In August 1973, for example, the free income zone was $20 a week for a single pensioner and $6 a week for a single unemployment beneficiary. After the July 1987 poverty trap measures, these limits have increased to $40 a week and $30 a week, respectively.

For those in full-time work, the incentive effects of a two-tier GMI scheme would vary according to the level of private income. However, even if in aggregate the higher tax payments exactly offset the lower tier GMI so that there would be no net income effect, there would still be a substitution effect associated with the overall increase in marginal tax rates, thus producing a disincentive effect. This is an important point, because even though the overall redistributive effect of a GMI scheme depends on the net outcome of both the GMI payment and the associated tax rate, the disincentive effect depends upon the gross rate of tax, which is relevant to decisions at the margin.

There is, of course, sufficent flexibility in the design of specific GMI schemes to permit an appropriate balance between the objectives of equity (redistribution) and efficiency (disincentives). Several alternative proposals designed to balance these competing objectives, and those associated with the overall cost of the scheme, were analysed in Appendix 6 of Volume 2 of Poverty in Australia. These proposals serve to illustrate one final and fundamental aspect of all GMI proposals. This is that they do not avoid the basic conflicts and tensions between competing objectives which any system of income support must inevitably face. More emphasis is given in GMI schemes to the goal of simplicity, but while this has much to recommend it, it is achieved at the cost of sharpening the tensions between equity and efficiency objectives.

It would be foolish to argue that the current Australian social security system does not have its deficiencies. But it has shown a quite remarkable degree of resilience during a decade of major economic and social change, and in an environment where expenditure restraint has increased the conflicts between competing income support policy objectives. Of major

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significance in this context has been the enormous pressures placed on the system by the high level and persistence of unemployment since the mid- seventies. None of the fundamental challenges currently confronting income support policy will be resolved by the introduction of a GMI scheme. Indeed, some of them would be exacerbated by its introduction. The concept of a GMI is appealing to many who champion the cause of the disadvantaged, and for them its failure to make any headway on the policy agenda may well signify a paradise lost. For others, it may continue to burn as a guiding light, but the problem with continued gazing towards the heavens is that one can get distracted from the very real problems faced down here on earth.

REFERENCES Commission of Inquiry into Poverty (1975). First Main Report, Poverty in Australia. Volumes

1 and 2. Canberra: AGPS. Freebairn. J., M. Porter and C. Walsh (1987). Spending and Taxing. Australian Reform Options,

Sydney: Allen and Unwin. Saunders, l? (1987a). “An Agenda for Social Security in the Years Ahead”, Australian Journal

of Social Issues, Vol. 22 (2). pp. 409-423. Saunders. I? (1987b). “Past Developments and Future Prospects for Social Security in Australia’’

in P. Saunders and A. Jamrozik (eds). Social Welfare in the Late 1980s: Reform. Progress or Retreat? SWRC Reports and Proceedings, No. 65, June. pp. 13-44.

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