Henry's big idea is being ignored

IT IS interesting to ponder what Treasury Secretary Ken Henry thinks about the federal government's response to his report, Australia's Future Tax System.

Having laboured for many months, taken submissions, attended conferences and doubtless debated various alternatives, the final report contains 138 recommendations.

Effectively, the government initially picked up one and a half of those recommendations: the resource rent tax and the cut in corporate tax from 30 to 28 per cent (Henry had recommended 25 per cent). The increase in the rate of the superannuation guarantee charge from 9 to 12 per cent was not contained in the report, although there were a number of other recommendations related to superannuation.

There were two further announcements in the budget, although the concession on saving income (bank deposits) is much more modest than envisaged by Henry. The other uncontroversial recommendation taken up is the introduction of pre-filled personal income tax returns.

One of the problems with these kinds of reports is that, while the recommendations may make sense as a package, cherry-picking them almost always ends in bad policy and produces unintended and adverse consequences. Moreover, in choosing to take up such a small number of the recommendations, the government effectively by-passed the real centrepiece of the review: reform of the personal tax and transfer systems.

As is noted in the report, "workforce participation is strongly influenced by incentives in the tax and transfer system, and by the affordability of child care". While Australia's overall rate of workforce participation compares reasonably well with other developed economies, we fall down in respect of particular groups, notably women of child-bearing age and older workers.

If we take the former group, for instance, women of child-bearing age in Canada have a rate of labour force participation more than seven percentage points higher than us. And the gap between Australia and the US is two points.

Older people (those over 55) in Australia also participate at lower rates relative to a number of countries. Our cousins over the Tasman, for instance, participate at a rate nearly 15 percentage points higher than our older folk and, in the US, the rate is some seven points higher.

This is where the importance of disincentives to work comes in and why Henry's recommendations are so significant. Chief among these disincentives are: the interaction between the tax and transfer (most particularly, family payments) systems; the availability and affordability of child care; and the lure of welfare benefits that entail disincentives to work, even on a part-time basis.

Under present arrangements, high effective marginal tax rates (withdrawal of benefits plus payment of tax) for certain types of families (particularly, those with dependent children and one or both partners on relatively low wages) dissuade one, or sometimes both, partners from seeking any work or additional hours of work. In turn, this has led to an unacceptably high incidence of jobless families in this country.

On recent figures, about 13 per cent of all families with children aged under 15 do not have a parent employed, with lone-parent families at 44 per cent.

In the context of the current tax-transfer architecture, one of the problems for governments seeking to reduce high EMTRs is that it is fiercely expensive.

This is why the Henry review's radical recommendations on the "tax and transfer system for the 21st century" are so important. According to the report, the tax-free threshold should be lifted to $25,000; above that level, there would be only two rates: 35 per cent for incomes below $185,000 and 45 per cent for those above. By opting for such a high tax-free threshold, many of the insidious interactions between the tax and transfer systems would cease.

There should be three categories of income support payments: pension, participation and student. While there should be differences in the levels of income attached to these categories, in recognition of the need to encourage workforce participation in the latter two cases, the payments should be indexed in a consistent manner. There should also be consistency in the means testing applying to receipt of the payments and the payments should not be subject to income tax.

The Henry review also recommends that parents should be required to look for part-time work once their youngest child turns four, as a condition of payment. At the same time, a high rate of subsidy for child care (up to 90 per cent of actual costs) should apply to low-income families.

A number of other changes make up the full package, and some are controversial (the ideas of dropping the medical expenses tax offset and private health insurance rebate, for instance), but the great pity is that the real centrepiece of the Henry review is largely being ignored.

Judith Sloan is an economist and company director.