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Can means testing of welfare really save the budget?


One suggestion for addressing Australia's budget deficit has been to make cuts to 'middle class welfare'are'—that is, welfare payments made to households other than those with low incomes.

The problem with such suggestions is that they are frequently light on details about precisely which welfare payments are the source of the 'problem' and what 'middle class' means. Nor do they tend to address the unintended consequences of making changes to eligibility for payments though tightening of means tests.

One way of making cuts to middle class welfare would be to ensure that payments are means tested. The problem with this strategy is that Australia already means tests just about every possible payment. Following the Labor Government's addition of means tests to Baby Bonus, Family Tax Benefit (B) and the Private Health Insurance Rebate, the only significant payment not currently means tested is Child Care Rebate (expected to cost around $2 billion this year).

As I've outlined in this paper, Australia is unique among western countries for the extent to which its social welfare programs are means tested. Indeed, according to the Australian National University's Peter Whiteford, 'Australia has the most 'target efficient' system of social security benefits of any OECD country'. While there was, for example, support across the political spectrum for a universal aged pension up until the late 1970s, the Australian welfare state turned in the direction of strengthened means testing under the Hawke-Keating Labor governments. New means tests were introduced for the age pension and family payments. Subsequently, the Howard Government both relaxed a number of existing means tests and introduced a series of new non-means tested initiatives. As noted above, Labor has since returned the payments system to tighter means testing.

Could we perhaps then tighten the means tests we already have to ensure that payments aren't accessed by the non-poor? While means tests ensure that the numbers of those who aren't poor accessing payments are relatively small, they do exist. 

The 2008 Harmer Pension Review, for example, found that the slow withdrawal rate of the Age Pension as private income increases means there is a small but significant group of people receiving Age Pension who have household income over one-and-a-half times the Age Pension rate and some four per cent receive incomes more than double the Age Pension rate. Similarly, pensioners can receive some pension even with assessable assets (that is, excluding the family home) up to around $1,000,000. Harmer found that while most pensioners do not have substantial savings or other assets, 5 per cent had assessable assets worth over $250,000. Further, under the Family Tax Benefit (A) means test, while families must earn less than $48,000 to receive the maximum rate of the payment, some rate of payment remains available to families up to $228,000.

There are, however, a few important challenges with changing means tests. First, any such changes need to ensure that they don't unnecessarily increase the complexity of the system, making it harder to navigate for recipients and harder to manage for governments. Second, tightened means testing implies a certain level of claw back of benefits as people's incomes increase. This produces high effective marginal tax rates for people moving from income support into paid employment. Increased private income reduces entitlements to income support and increases income tax liabilities. Often the return from extra income is much reduced by the combination of tax and income tests. Finally, there is also the need to continue to provide incentives for self-provision through savings.

With these challenges in mind, the Henry Review of the Tax System proposed that means testing 'could be improved so that income and assets are more fairly assessed and incentives to work and save are strengthened'. In essence, assets would be included in a common means test for all income support payments (including Age Pension and Newstart Allowance) through being deemed to have produced income.

According to the Review:
This would involve deeming an income on most assets ... The deeming rates would be based on the returns expected from a portfolio of assets held by a prudent investor.
 The comprehensive means test base would be fairer and less complex. Under the current two-part means test, people can receive different levels of government payments even though they have the same level of wealth. This is because some assets are assessed under both tests, while other assets are assessed only under the assets test.
 The Review  proposed that the new means test not apply to family payments, which would continue to be assessed on only taxable income. Again, the Review was concerned here that means tests in this area be applied 'in a way that minimises workforce disincentives'.

Arguably, the biggest challenge in implementing the Henry proposal in relation to means tests would be political. It is possible that many people would resist the idea that they had to turn their holiday homes, art collections and vacant land investments into income producers.

The challenge then for those looking for savings through means testing is to specifically identify where they would make changes and how they would balance these against other objectives such as incentives to work and save.