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Apps, Patricia --- "Tax Reform, Ideology and Gender" [1999] SydLawRw 17; (1999) 21(3) Sydney Law Review 437

Tax Reform, Ideology and Gender

PATRICIA APPS[*]

1. Introduction

The personal income tax is the cornerstone of the Australian tax system, raising about 40 per cent of total tax revenue. The rate schedule is progressive and, most importantly, applies to the income of an individual, not the combined income of family members. The findings of tax reform studies suggest that these design features of the personal income tax, together with its central revenue raising role, ensure a basic structure of taxation which is fundamentally sound and superior to that of many other countries, such as the US with its system of joint filing.[1] Despite this evidence, there has been a long standing view among policy makers that Australia relies too heavily on the personal income tax. It is argued that rates towards the top of the scale are too high and cut in at too low an income level. The problem can, ostensibly, be attributed to decades of ‘bracket creep’. The failure to adjust tax brackets for inflation however is in turn due to the loss of revenue from widespread non-compliance and use of tax minimisation schemes.[2] Successive governments have been surprisingly reluctant to treat these problems as key policy issues. Instead, the focus of policy makers has been on the need for lower and less progressive rates of tax on personal income with the revenue shortfall financed by a broad-based consumption tax.[3]

Given this policy agenda, Australians have been presented with a series of proposals for a tax-mix change of this kind since the mid 1980s. Now, following the re-election of the Howard government, we are seeing the implementation of such a system, with the introduction of the 10 per cent Goods and Services Tax (GST) proposed in the Government’s plan for a new tax system.[4] The new GST will replace the existing multi-rate WST and various other indirect taxes and, importantly, it will raise additional revenue for funding substantial cuts in income taxes concentrated at the upper end of the distribution.

A second long term focus of policy makers has been on contracting the ‘welfare state’ in its present form[5] and on simultaneously shifting towards a taxbenefit regime based effectively on joint income. The former has been implemented over time by moving towards a more highly income targeted cash transfer system, among other measures.[6] Unlike the personal income tax, eligibility for many cash transfers and family tax benefits depends on joint income. Consequently, increasing income targeted forms of family assistance can result in a significant shift towards a joint tax system. The government’s tax plan is designed to achieve this outcome. Important elements of its package include increased rebates for children (Family Tax Benefit (A)) means-tested on joint income. The package also offers increased rebates for the dependent spouse (Family Tax Benefit (B)). The latter are untargeted on primary earner income but tightly income-tested on the spouse’s own earnings from market sector employment. This feature of the Australian income tax justifies its classification as a system of partial joint taxation.[7] The Prime Minister has consistently supported joint taxation in the form of income splitting, asserting that the existing individual tax system is unfair because a single income family pays more tax than a dual income family with the same joint income. It therefore comes as no surprise that his tax plan represents a significant shift in this direction.[8]

This paper investigates the distributional implications of this kind of policy agenda and examines the incentive effects of the implied changes in effective marginal tax rates (EMTRs). The analysis takes account of the fact that the impact of a policy change can depend critically on family structure and employment status. A particular reform may, for example, have little or no effect on the labour supply of a single individual but a large negative effect on that of a two-parent family. The reason for the latter is that, in a two-parent family, one partner can specialise in work at home rather than in the market place, producing close substitutes for market goods and services. We would therefore expect the labour supply of that partner, typically the female, to be highly responsive to a change in the net wage, an expectation which is consistent with the available empirical evidence. Moreover, time use data indicate wide variation in specialisation in domestic work as a substitute for market work, across families with the same demographic profiles, wage rates and non-labour incomes, and so distributional effects can be evaluated reliably only by taking account of the contribution of domestic work to family welfare.

The focus of the paper is two-parent families. An important objective is to show that empirical estimates of the distributional effects of a policy change, and of measures of inequality generally, depend on the model of the family on which the analysis is constructed. Of central interest here are assumptions concerning household production and intra-family processes of exchange. These are testable on data for variables which, at least in principle, are observable. We first of all demonstrate that the policy agenda outlined can, to a limited extent, be justified on equity criteria, and therefore on an equity-efficiency trade-off argument, only on the basis of a model which contradicts the available data. We then show that if we specify an empirically plausible model, rationalisation of the policy agenda requires an ethical preference for a greater degree of intra-family inequality according to primary/secondary earning status. Given the strong correlation between earning status and gender, the finding is consistent with an ideological commitment to gender inequality. The analysis goes on to show that the reforms lead to a rise in inequality across families, and that this outcome depends crucially on taxing second earners at higher rates. The result suggests that discrimination on the basis of earning status is a key element of a reform agenda motivated by a commitment to a greater degree of overall inequality.

The paper is organised as follows. Section 2 discusses the distributional implications of the reform agenda and interprets the results in the context of alternative models of the family. Section 3 examines labour supply effects based on available estimates of wage and income elasticities, and outlines the potential impact on the household saving behaviour of two-parent families. The aim of Section 3 is to assess whether distributional losses can be justified in terms of efficiency gains. A concluding comment is contained in Section 4.

2. Distributional Outcomes and Alternative Models of the Family

A. Distributional Outcomes

The distributional effects of tax reform are frequently investigated in terms of the changes in average tax rates, computed as the difference between pre-reform rates and those implied by the reform, ignoring behavioural responses. There is a considerable volume of work of this kind on the outcomes of a tax-mix change combining a less progressive income tax and a more highly targeted welfare system, as in the Howard tax plan.[9] The results tend to be consistent across studies and are not surprising.

In general, the studies find that the reforms reduce relative tax burdens at the upper end of the distribution of household income, due to the combined effect of larger reductions in income taxes for high income earners and the regressive impact of the GST. Compensation, typically based on family income, together with a more tightly targeted welfare system, tends to maintain the pre-reform income levels of most groups at the bottom of the income distribution. Overall, the outcome is a shift in the tax burden from households with very high incomes towards those in the middle of the distribution. This general outcome applies in a straightforward way to single individuals and single-parent families, for a reform that is revenue neutral with respect to these groups. For two-parent families the effect is more complex. A revenue neutral reform for these households also shifts the tax burden from single to dual income families, due to the ‘joint tax’ elements and flattening of the income tax rate schedule. Thus, single income families as a group gain, as well as both household types in which there is at least one high income earner. Those who suffer significant losses are low to middle-wage dual income families.

To illustrate this outcome, we can take examples from the Howard tax plan document showing gains derived from the proposed income tax cuts and additional family benefits, net of GST effects, for different family types.[10] Tables 1 and 2 reproduce figures for couples with two children aged from 5 to 13 years. Table 1 illustrates the effects of the joint tax elements of the scheme. The table compares the gains for a single and a dual income family each with a ‘primary income’ of $30000 pa. The lower gain for the dual income family indicates the effect of the joint tax elements of the package (associated with Family Tax Benefits (A) and (B)). For the single income family the dollar value of the gain is $60.54 pw. In the dual income family the second income is only $15000 pa yet the gain is half that offered to the single income family. In other words, in a family in which the husband is the primary earner and the wife goes out to work, she is not only denied a gain but causes her husband to lose half of his. Under a revenue neutral reform a lower gain of this size for the dual income family implies a loss which contributes to financing the gain for the single income family.

Table 1: Effects of Joint Tax Elements

Primary
Second
Tax cuts +
Cut in
Rise in 2nd

inc $pa
inc $pa
add ben. $pw
ATR%
EMTR%
Single income family
$30000
0
$60.54
10.5

Dual income family
$30000
$15000
$29.03
3.4
10.9

Table 2 identifies the differential impact of flattening income tax rates, due to the proposed cuts in marginal rates on individual taxable incomes. The table reports the outcome for a single and a dual family each with a joint income of $60000 pa. The largest reduction in income tax rates, that of 13 cents in the dollar, begins at $38000 pa, an annual taxable income above that of both partners in the dual income family.[11] As a consequence the gain for the single income family is almost twice that for the dual family even though the employed partner in the single income family has twice the earning capacity of each partner in the dual income family.

Table 2: Effect of Flattening Income Tax Rates

Primary
income $pa
Second
income $pa
Tax cuts +
add ben. $pw
Cut in
ATR%
Single income family
$60000
0
72.17
6.3
Dual income family
$30000
$30000
37.67
3.3

Since the defining feature of the dual income family is a second income, and this is typically earned by the female partner, a reform which shifts the tax burden to dual income families implies a shift to working married women. Clearly a reform which provides the largest gains for high income earners is difficult to justify in terms of vertical equity. The question then arises as to whether the shift in the tax burden to married women in the workforce, and the consequent increase in the net-of-tax gender wage gap, improves horizontal equity by achieving more equal taxation of families with the same joint income. The answer to this question depends on the model of the family, and its assumptions concerning domestic production and exchange between family members, on which the analysis is based.

B. Alternative Models of the Family

To keep things as simple as possible, the discussion to follow is limited to three models which can be broadly classified as:

(i) The unproductive and altruistic model

(ii) The productive and paid model

(iii) The productive and unpaid model

These are special cases selected from a more general modelling framework which assumes an ‘as if’ two-stage household decision process.[12] At the first level the household decides how to distribute its full income[13] among family members on the basis of an ethically determined intra-household ‘sharing rule’.[14] At the second, each member makes consumption and leisure choices subject to their share of household full income.[15]

For the purpose of exposition the models are outlined with reference to a representative family comprising two adults, male and female, where the male partner has the higher income and is therefore the primary income earner. The male partner is assumed to be employed full time. Families in which the female partner is a non-participant or marginal participant in the workforce are classified as ‘traditional’ households, and those in which she has a significant workforce attachment, as ‘non-traditional’ households. Consistent with evidence from time use data, the two household types are assumed to have similar work-leisure preferences, where hours of work are computed as the sum of domestic and market hours. The discussion is also limited to households with similar family responsibilities.[16]

The standard argument for basing taxes and cash benefits on joint income can be shown to depend on the unproductive and altruistic model of the family. The model has two crucial assumptions. First, a partner specialising in work at home is totally unproductive and therefore makes no contribution to the welfare of family members. Second, the intra-household distribution of income, determined at the upper level of the decision process, is egalitarian. These conditions imply that a husband altruistically supports his wife by sharing equally his income with her through a process of ‘lump sum’ redistribution within the household.[17] Since there is no consumption of domestic goods, household income used to purchase market goods provides an accurate ordering of the welfare of families and of individuals.[18]

For example, in Table 2, the single income family in which one partner earns $60000 pa for 40 hours of work pw is no better off than the dual income family in which both partners work a total of 80 hours pw to earn the same income in the market place. The reason is that the partner recording a zero income in the single income family is totally unproductive at home. For reasons of altruism or ‘caring’, at the first level of the decision process the household chooses a distribution rule which, in effect, imposes a lump sum tax of $30000 on the husband’s income for the purpose of financing a lump transfer of the same amount to the wife. The government takes account of this ‘first best’ solution to the intra-household tax problem and, legitimately, treats all four individuals in the two household types as having the same individual incomes of $30000.

To illustrate the effect of the model’s domestic productivity and sharing rule assumptions on the welfare ordering of traditional and non-traditional households, Table 3 presents a quartile ranking of families defined on household income. The table shows the percentage of traditional and non-traditional families in each quartile, in ascending order across rows. The ranking is based on data for a sample of families selected from the Australian Bureau Statistics (ABS) 1989 Household Expenditure Survey (HES) file on the criteria that the primary earner is employed full time and the family has at least one dependent child under 15 years.[19]

Traditional households tend to cluster in the bottom quartile and non-traditional households in the upper quartiles. Basing progressive taxes and eligibility for cash benefits on joint income is consistent with vertical and horizontal equity because under such a regime households and individuals in higher percentiles of the welfare ordering pay proportionally more tax, and those in the same percentile pay the same tax.

Table 3: Quartile Ranking by Household Income

Quartiles
1
2
3
4
All
Household income $pa
25275
36249
45787
69589
44176
Traditional households %
85
54
25
11
44
Non-traditional households %
15
46
75
89
56

The assumption that a partner specialising in domestic work is unproductive contradicts casual observation and, as well, information available from time use surveys. Moreover, given gender differences in participation and employment, the model implies that, on average, the male partner finances a lump sum transfer to the female partner. This is also open to question on the basis of time use data. These data indicate that the female partner has less pure leisure. If partners have the same work-leisure preferences, and expenditure on leisure rises with full income,[20] the choice of fewer leisure hours by the female partner is consistent with a lower income. In fact it can be shown that, under the assumption of identical preferences, the data for families are consistent with a transfer, on average, from the female to the male partner.

The productive and paid model supports individual taxation at progressive rates. The model assumes that a partner specialising in domestic work is productive and receives an implicit wage income from the primary income partner in exchange for domestic output. The question which arises immediately in this case is: how productive is domestic labour? In most micro datasets information on domestic output is missing (mainly because economists have shown almost no interest in the empirical analysis of domestic work). We therefore need to make an assumption. We can assume that a partner specialising in domestic work does so either because she is more productive than her counterpart in market work or because she is less productive. While a productivity difference is required for the formation of the two household types,[21] we can however assume that the difference is small. This seems plausible for services, such as those relating to childcare, for which there are close market substitutes, particularly for households with low to average wage rates.[22] Under this assumption we require, for the purpose of family welfare comparisons, a measure of income which includes an imputed value for domestic output based on market price comparisons. An approximation for such a measure is provided by potential income, computed as the income a family could earn if both partners worked full-time in the market place.

Table 4 illustrates the effect of defining a welfare ordering on such a measure. The table presents a quartile ranking of the two family types defined on potential income, using the data sample described for Table 3.[23] In contrast to Table 3, traditional households no longer cluster in the lower quartile but tend to be evenly distributed across the ranking. Note that the ranking in Table 4 also implies that partners are equal, since they appear in the same percentile. This will be the case only if the intra-household sharing rule eliminates the effects of gender wage differentials in the market place. The model provides no explanation for why such redistribution should occur. More plausibly, we might expect the sharing rule to be defined on outside earning opportunities.

Table 4: Quartile Ranking by Potential Income

Quartiles
1
2
3
4
All
Primary income $pa
21203
28272
35316
52833
34406
Second income $pa
9296
8921
9554
11613
9770
Traditional households %
42
46
41
46
44
Non-traditional households %
58
54
59
54
56

A crucial implication of the ranking in Table 4 is that, for horizontal equity, traditional and non-traditional families in the same percentile should be taxed the same amount. However this is not a policy option because domestic production, like pure leisure, cannot be taxed directly. Given this constraint, a tax system which imposes a higher rate on the primary earner than on the second can have the effect of taxing home production indirectly. A progressive individual income tax achieves this effect because second earners are typically on lower pay.

To see the potential gain in horizontal equity from a progressive individual income tax, consider the distribution of burdens between the two family types under a flat rate income tax. Take, for example, the case of two families, one traditional and the other non-traditional, in which all partners have the same market wage (or reservation wage in the case of the non participant in the traditional household), those employed work the same number of hours, and all have zero non-labour incomes. Under a flat rate tax the single income family contributes only half as much as the dual income family to tax revenue. Ideally, they would pay close to the same amounts.[24] More equal taxation can be achieved by raising the marginal, and therefore the average, rate of tax on the primary income partner in each household and lowering it on the second in the dual income household. In an economy in which second earners have lower incomes this can be achieved by introducing progressive rates of tax on individual incomes. The reform also reduces the net-of-tax gender wage differential which, in the context of an exchange model in which domestic labour is productive and paid, can be expected to reduce intra-family inequality.[25]

Introducing progressive rates on joint income raises the marginal and average rates on the second earner’s income and therefore has the opposite effect. The Howard tax plan, in selectively disadvantaging dual income families on low to average wages and reducing the progressivity of taxes on individual incomes, is therefore inconsistent with both horizontal and vertical equity. The plan can also be expected to increase intra-family inequality, by widening the net-of-tax wage differential within the family.

The third model of the family we consider, the productive and unpaid model, is of interest because of the persistent reference to domestic work as ‘unpaid’ in almost all literatures, including ABS publications. While the assumptions of studies using this terminology are rarely specified explicitly, they can sometimes be unravelled from policy conclusions. For example, authors who label domestic work as unpaid and then argue that, because of the contribution that domestic work makes to national output, a wife who chooses to be a ‘home-maker’ should be paid a wage by government, clearly imply that domestic work is productive but unpaid. The model raises the obvious question: who consumes the domestic output of the ‘home-maker’? If we assume that the husband is a beneficiary, the model implies a high degree of intra-household inequality. In the traditional household the income of the male partner includes his own market income plus the value of his consumption of domestic output. That of the female partner is limited to value of her consumption of own domestic output.

Under these conditions a welfare ordering defined on either household or potential income, by placing partners in the same percentile, would give an entirely misleading picture of the distribution of well-being among individuals. The true ranking would be one in which wives in traditional households predominate in the lower percentiles and their husbands in the top percentiles. Faced with this distribution of individual welfares, the tax policy of a government concerned with vertical equity would be designed to redistribute income from ‘rich’ to ‘poor’ partners within traditional households, as well as from rich to poor households. Because only market incomes can be taxed, a system cannot be designed to achieve the former directly. Given this constraint, paying ‘dependent’ wives a wage for their unpaid work, using own income as the test for eligibility, could be seen as a ‘second best’ solution. However a policy of this kind has much in common with joint taxation, and tends to match Family Tax Benefit (B). The overall outcome is the provision of subsidies for traditional households financed by higher taxes on married women in the workforce. Thus the proposition that domestic work is unpaid is no less contentious in terms of its policy implications than the assumption that domestic work is unproductive.

3. Effects of Reforms on Labour Supply and Saving Behaviour

The preceding analysis suggests that the current tax policy agenda cannot be supported on conventional vertical or horizontal equity criteria in a modelling framework based on an empirically plausible view of the family. We now turn to incentive effects. It is frequently argued that lower and less progressive income taxes would improve the incentive to work, save and invest, and lead ultimately to efficiency gains that offset welfare losses due to ‘first round’ distributional effects, such as those described above.

To assess incentive effects we need first of all to identify the change in EMTRs with respect to individual incomes that they imply,[26] and then consider the empirical evidence on behavioural responses. As in most OECD countries, EMTRs under the Australian tax-benefit system tend to exhibit a ‘U’ shaped profile, skewed strongly to the left, with respect to earnings. They tend to be very high at low income levels, to fall as income rises and then to rise again at higher income levels. Since the current tax reform agenda shifts the tax burden from high income earners to a wide band of middle income households, it implies a more strongly left-skewed U shaped profile of EMTRs. It increases ‘on average’ EMTRs for those on low to median earnings and reduces them for those on the highest incomes. At the same time, the joint tax elements of the reforms reduce EMTRs for primary income earners and raise them for second earners. These marginal tax rate changes can be expected to alter household labour supply and saving decisions

A. Labour Supply Effects

To analyse work incentives we can draw on the results of empirical work providing estimates of labour supply responses to changes in the net wage.[27] While the available research produces widely varying estimates of wage and income elasticities,[28] there is considerable agreement on a number of general patterns. Most studies report a significant and large difference by gender. Labour supply elasticities estimated for married women as second earners tend to be much larger than those estimated for husbands as primary earners. On the basis of this result, tax reform studies find that, for efficiency, the female partner should face a lower marginal rate than the male partner. The result is a straightforward application of the Ramsey pricing rule (in its simplest form, ignoring cross elasticities).[29] The finding supports progressive individual income taxation on efficiency grounds because, as explained above, under such a system married women on lower pay face lower marginal rates than husbands. Flat rate taxation and joint taxation imply a greater efficiency loss because they conflict with the Ramsey rule. The optimal tax analysis by Boskin and Sheshinski[30] and, more recently, the tax reform study by Feldstein and Feenberg[31] demonstrate this efficiency result.[32] The findings imply that there is no equity-efficiency trade-off associated with a well-designed progressive individual income tax if domestic labour is at least as productive as market labour. A trade-off arises only if domestic labour is unproductive or less productive than market work, or unpaid.[33]

In a review article Heckman[34] is highly critical of many labour supply studies and rejects the findings of those that obtain large elasticity estimates for males.[35] He argues that careful examination of the research suggests that variation between female and male elasticities reflects wage and hours differences. Heckman concludes that male labour supply shows little wage and income responsiveness at higher wages and at greater hours worked, and that virtually all of the responsiveness found for this group is at or near the zero-hours point, the ‘extensive’ margin or point of entry and exit. He argues that a similar finding is supported by the evidence on female labour supply, and that the larger elasticities estimated for this group reflect the fact that women earn lower wages and are more concentrated at the extensive margin. The critique suggests an efficiency argument for reducing the left skew of the U-shaped income profile of EMTRs, by lowering EMTRs for those with the most responsive labour supply behaviour - low wage workers in general, and married women in particular – and raising them for those with the least responsive labour supplies - high wage and high income primary earners. Since the current direction of reform has the opposite effect, the likely outcome is an overall decline in labour supply, due especially to a decline in hours by married women, and a significant efficiency loss.

B. Impact on Household Saving Behaviour

Household Expenditure Survey data indicate that the principal savers in the economy are households in which both partners have a significant workforce attachment, at all levels of individual earning capacities. This suggests that a reform which reduces the participation and labour supply of second earners may also have a negative effect on saving behaviour.

Table 5 reports the annual saving profiles of traditional and non-traditional households for a quartile ranking defined on potential income. The figures are based on data for the sample of families selected from the ABS 1989 HES described previously. The upper half of the table shows the quartile saving profile of traditional households and the lower half, that of non-traditional households. The difference between the amounts saved by the two household types indicates the average increment in household saving when the second earner goes out to work. The increment is positive and substantial across the quartile distribution, and results in non-traditional households having positive saving rates, on average, in each quartile. Traditional households have a positive saving rate, on average, only in the top quartile. The results suggest that a reform which raises marginal and average tax rates for second earners, typically found to have responsive labour supplies, can be expected to have a large and significant negative effect on household saving and, in turn, on investment and growth.[36]

Table 5: Household Saving by Quartiles of Potential Income

Quartiles
1
2
3
4
All
Traditional households %
42
46
41
46
44
Saving $pa
-2580
-988
-173
5499
514
Saving rate: % household net inc
-13.83
-4.16
-0.61
13.71
1.85
Household net income $pa
18654
23778
28410
40124
27 734
Non-traditional households %
58
54
59
54
56
Saving $pa
1114
2509
5483
12241
5267
Saving rate: % household net inc
3.69
6.82
13.14
22.67
12.92
Second earner’s net income $pa
11522
13027
13303
13874
13028

The difference between the saving decisions of traditional and non-traditional households indicated in Table 5 is rarely noted in the literature, despite the fact that it is so evident in the data. The reason for this is that empirical work on household saving behaviour is generally based on a modelling approach in which it cannot be identified. The convention is to treat household consumption expenditure as separable from non-market activity (or labour supply) within each period of the lifecycle.[37] The key problem is that consumption expenditure is measured as spending on market goods only. Domestic work is treated as leisure.[38] This rules out the possibility that market services, such as childcare, are close substitutes for those provided at home. The approach can give an entirely misleading picture of household savings behaviour, as illustrated in Table 6. The table shows the saving profiles of traditional and non-traditional households and household net income, by quartiles of household income. In contrast to Table 5, similar saving profiles are recorded for the two household types, with non-traditional households saving slightly less in three of the quartiles.

Table 6: Household Saving by Quartiles of Household Income

Quartiles
1
2
3
4
All
Traditional households %
85
54
25
11
44
Saving $pa
-1955
860
4027
10038
541
Non-traditional households %
15
46
15
89
56
Saving $pa
-2380
987
3966
9778
5268
All households





Saving $pa
-2018
926
3982
9807
3188
Saving rate: % household net inc
-9.27
3.15
10.76
18.80
8.62
Household net income $pa
21763
29417
37021
52176
36981

A number of studies test the assumption of separability between consumption and leisure (measured as non-market time) and find that it is rejected by the data. Browning and Meghir,[39] for example, show that the participation and hours of work decisions of each partner can have a significant effect on the estimated parameters of a commodity demand system. Blundell, Browning and Meghir[40] support the result. However the authors of the latter article observe that ‘intertemporal allocation does indeed depend on labour force participation; for example, there are positive costs in going out to work’. In other words, consumption expenditure and labour supply are, in some cases, complements. The observation implies that having a second earner tends to reduce household saving, as indicated in Table 6, when in fact the opposite is the case, as shown in Table 5. This brief outline of the standard approach to analysing saving behaviour highlights the importance of using a model of the family that allows an empirically plausible treatment of domestic production, such as the productive and paid model. Based on a model of this kind it can be shown that a reform which undermines the progressivity of the tax system and raises effective rates for second earners can be expected to reduce household saving and economic growth.[41] The result supports the proposition that a progressive individual income tax, together with a less strongly targeted welfare system, is superior on conventional equity and efficiency criteria.

4. Concluding Comment

The preceding analysis has investigated the effects of the ongoing direction of taxbenefit reform in Australia, with its emphasis on reducing personal income taxation through a tax mix change, and on moving towards a more strongly targeted cash benefit system based on joint income. The results suggest that these policy changes are open to criticism for distributional and efficiency reasons. The paper first of all outlines the distributional limitations of the reforms, and shows that widely accepted rationalisations in terms of equity require a model of the family in which domestic labour is assumed to be unproductive or unpaid. Using a model which recognises that domestic work is both productive and paid, the study shows that the reform agenda can be expected to widen inequality within the family and across families, at a significant efficiency cost due to disincentive effects on labour supply and saving. These outcomes suggest that the current direction of tax-benefit reform, together with its adverse consequences for gender equity, is driven primarily by an ideological commitment to a greater degree of overall inequality.

The results support the view that Australia would be better served by a policy agenda which took a more constructive approach to the individual income tax as the centerpiece of the tax system. Such an approach would require a shift in the focus of reform, from grandiose tax-benefit plans with the adverse distributional and incentive effects described here, to carefully considered measures which reverse the growing culture of non-compliance and reduce the widespread use of tax minimiation schemes.



[*] Professor in Public Economics in Law. The study was supported by an ARC Large Grant.
[1] See, eg, Symons E & Walker I, ‘Tax Reform Analysis: The Effects of a Proportional Tax System’, in Head JG & Krever RE (eds), Flattening the Tax Rate Scale: Alternative Scenarios and Methodologies (1990) at 237–249; Feldstein M & Feenberg D, ‘The Taxation of Two- Earner Couples’ in Feldstein M & Poterba M (eds), Empirical Foundations of Household Taxation (1996) Ch2 at 39–73; Apps PF & Rees R ‘On the Taxation of Trade Within and Between Households’ (1999) 73 Journal of Public Economics at 241–263.
[2] Examples of the latter include the exploitation of family trusts, negative gearing and the proscribed payment system. For an excellent article on the need for reform in the area of family trusts, see Quiggin J, ‘A Relationship Taken on Trust’ The Australian Financial Review, (16 April 1997) at 20; and for an estimate of the loss of tax revenue from PAYE taxpayers switching to the proscribed payment system, see Buchanan J & Allan C, ‘The Growth of Contractors in the Construction Industry: Implications for Tax Reform’ in Buchanan J (ed), Taxation and the Labour Market, Working Paper 55, Australian Centre for Industrial Relations Research and Training, (University of Sydney, 1998) at 13–44.
[3] This focus is also surprising in the light of OECD estimates indicating that Australia has a directindirect tax mix which is close to the average of member countries. The comparison is based on total revenue from direct taxes, computed as the sum of collections from personal income taxation and social security, as well as taxes on profits. Australia is also recorded as one of the lowest taxed OECD countries. See OECD, Revenue Statistics of OECD Member Countries, 1965-1994 (Paris: OECD, 1996).
[4] Commonwealth of Australia, Tax Reform: Not a New Tax, A New Tax Plan, The Howard Government’s Plan for a New Tax System, circulated by the Treasurer, Peter Costello (Canberra: AGPS, 1998).
[5] The qualification ‘in its present form’ is an important one. Recent proposals for an Earned Income Tax Credit (EITC) program by a group of economists, referred to in the media as the ‘Five Economists’, indicate that some policy analysts are willing to see an expansion of the welfare state for the purpose of supporting labour market reforms expected to generate a new class of ‘working poor’. see, eg, Garnaut R, ‘Five Push for More Reforms in Jobs Strategy’ Australian Financial Review, (19 February, 1999). For a critical assessment, see Apps PF, ‘Economic Impact of a Family Tax Credit Program’, paper prepared for the Australia Centre Conference ‘Reform of Tax and Tax-Transfers in Germany and Australia’, ATAX, University of New South Wales, 1–3 September 1999.
[6] Other strategies include the introduction of mandatory occupational superannuation for the purpose of reducing reliance on age pension payments, and the increasing privatisation of segments of the public health care system.
[7] The classification is taken from Boskin MJ ‘Factor Supply and the Relationships among the Choice of Tax Base, Tax Rates, and the Unit of Account in the Design of an Optimal Tax System’ in Aaron HJ & Boskin MJ (eds), The Economics of Taxation (1980) at 147–157. The article defines joint taxation as a system under which the second earner in a dual income family faces a higher effective marginal tax rate than a single individual with the same income. Systems of partial joint taxation are those under which this condition applies to a limited range of the second earner’s income.
[8] The same direction of reform is implied by the EITC program of the Five Economists and by the Family Tax Credit program of the ALP as outlined at the time of the last election. These programs provide tax credits which are phased-in and subsequently withdrawn on the basis of joint earnings and therefore raise effective marginal tax rates for many second earners on relatively low pay. It can be shown that unless a Family Tax Credit program is financed by raising marginal rates for high income earners, there is a shift in the overall tax burden towards less well-off dual income families consistent with joint taxation (see Apps, above n5).
[9] See, eg, Brooks N, ‘Sales Tax Reform and Tax Mix Change: A Canadian Perspective’ in Head JG (ed), Fightback!: An Economic Assessment (1993) Ch11 at 243–307; Savage EJ, ‘Impact Analysis of the Fightback! Tax Reforms’ in Head JG (ed), Fightback!: An Economic Assessment (1993) Ch13 at 351–382; and Apps PF, ‘Effects of a Tax-Mix Change (1997) 13 Australian Tax Forum at 401–427. These studies examine predecessors to the Howard tax plan, including the reform proposed by the Liberal and National Parties, Fightback! (Canberra: AGPS, 1991).
[10] The gains reported in the Howard tax plan document are based on a non-revenue neutral reform, as well as on CPI assumptions which lead to an underestimate of losses for lower income groups from the GST and of gains for higher income groups. Simulations show that, under a revenue neutral reform, the lower gains reported for dual income families on relatively low rates of pay translate into significant losses.
[11] The proposed cuts in marginal tax rates on bands of individual taxable incomes are as follows: $6,000 – $20,000: -3% $20,000 – $38,000: -4% $38,000 – $50,000: -3% $50,000 – $75,000: -7 %
[12] For a formulation of the general framework, see Apps and Rees, above n1. The paper provides formal proofs for the propositions concerning outcomes discussed later in the paper.
[13] Full income is defined as the income that could be earned by working total time available.
[14] The ethics of the sharing rule enter formally through the welfare weights in the household welfare function. In Apps PF and Rees R, ‘Collective Labor Supply and Household Production’ (1997) 105 Journal of Political Economy at 178-190, we show that the parameters of the sharing rule cannot be identified using information on market variables alone. Data on domestic production and consumption variables are also required.
[15] The opportunity cost of time allocated to leisure is treated as an expenditure from full income.
[16] This allows us, at least for the moment, to ignore the complex set of issues associated with lifecycle investment and consumption decisions and with capital market failure which gives rise the economic dependency of children.
[17] A lump sum tax is defined as one that does not alter relative prices and therefore does not cause an efficiency loss due to substitution effects. This implies that the household, unlike the government, has full information on individual endowments and can achieve a ‘first best’ solution to the implicit intra-household tax problem. In general, information asymmetries rule out lump sum taxes as a policy instrument for government. The government is limited to taxing indicators of endowments (or ability to pay) such as observed income.
[18] A model based on similar assumptions has appeared relatively recently in leading international economics journals: see, eg, Chiappori PA, ‘Collective Labor Supply’ (1992) 100 Journal of Political Economy at 437–467. While recognising the multi-person nature of the household, the model assumes that non-market time is pure leisure, and so consumption is limited to that of market goods alone. In a traditional household in which the wife has no external income, this implies that she makes no contribution to the welfare of other family members and that her consumption of market goods is financed by a lump sum transfer from her husband. For a critical assessment of the model, see Apps PF & Rees R, ‘Labour Supply, Household Production and Intra-Family Welfare Distribution’ (1996) 60 Journal of Public Economics at 199–219.
[19] Traditional households are selected as those in which the spouse reports working less than 10 hours pw and non-traditional households, as those in which the spouse works 10 or more hours pw. The analysis is based on the 1989 HES rather than the more recent 1993 file because the latter omits hours of work and therefore does not permit the computation of individual wage rates from the data on earnings. Wage rates are required for computing potential incomes used later in the paper.
[20] In other words, we adopt the usual assumption that leisure is a ‘normal’ good.
[21] This is because the model attributes variation in domestic/market work choices across households with similar demographic characteristics, wage rates and non-labour incomes, to differences in domestic human capital and not to work-leisure preference heterogeneity. The available data on time allocations to pure leisure and work (market and domestic) suggest that the two household types do tend to have similar work-leisure preferences. See Apps and Rees, above n1.
[22] The assumption is unlikely to hold in the case of the few female second earners on high pay in protected labour submarkets, such as the CEO submarket.
[23] Potential income is computed using predicted wage rates for non-participants, corrected for selectivity bias and including an error term drawn randomly from the regression residuals of the wage equation.
[24] This assumes similar domestic productivities. If the traditional household is marginally more (less) productive in domestic work than the non-traditional household, the former should pay a correspondingly higher (lower) tax than the latter. For a formal proof , see Apps and Rees, above n1.
[25] See Apps and Rees, above n18.
[26] The reason for this is that behavioural changes inducing efficiency losses are those which involve substitution effects in response to relative price changes. Since the marginal rate of tax reduces the net wage for an additional hour of work, a higher EMTR implies a higher price for market consumption relative to that for non-market time, and this may induce substitution of the latter for the former. The size of the substitution effect, and therefore the efficiency loss or excess burden, can only be determined on the basis of empirical evidence.
[27] For a survey, see Killingsworth M & Heckman JJ, ‘Female Labor Supply: A Survey’ in Ashenfelter O & Layard R (eds), Handbook of Labor Economics (1991) Ch 2 at 103–204. For estimates based on Australian micro data, see Apps and Rees, above n18.
[28] An elasticity is defined, in the case of labour supply, as the ratio of the proportional change in hours of work to the proportional change in the net wage (or income), and is typically evaluated at data means.
[29] The Ramsey pricing rule refers to a longstanding result in optimal tax theory. The rule states that if one good cannot be taxed (such as leisure), the rates on those goods which can be taxed should, in general, vary inversely with the size of substitution effects. Ignoring income effects and cross elasticities, this implies that, for efficiency, tax rates should vary inversely with the size of labour supply and demand elasticities.
[30] Boskin MJ & Sheshinski E, ‘Optimal Tax Treatment of the Family: Married Couples’ (1983) 20 Journal of Public Economics 281–297.
[31] Feldstein& Feenberg, above n1.
[32] For a study which claims to obtain a conflicting result see Piggott J & Whalley J, ‘The Tax Unit and Household Production’ (1997) 104 Journal of Political Economy at 398–418. For a critical comment see Apps PF & Rees R ‘Individual vs Joint Taxation in Models with Household Production’ (1999) 107 Journal of Political Economy at 393–403.
[33] For a formal proof, see Apps and Rees, above n1.
[34] Heckman JJ, ‘What Has Been Learned about Labor Supply in the Past Twenty Years?’ (1993) 83 American Economic Review (papers and proceedings) at 116–121.
[35] An example is Hausman JA, ‘Stochastic Problems in the Simulation of Labor Supply’ in Feldstein M (ed), Behavioural Simulation Methods in Tax Policy Analysis (1983) Ch 2 at 47–82.
[36] For a formal analysis, see Apps PF & Rees R, ‘Household Saving, Time Allocation and Taxation’ (1999) (mimeo).
[37] In the standard life cycle model agents are assumed, in addition to having intertemporally additive utility functions, to have within period utility functions which are additively separable in consumption and leisure, where the latter includes domestic production.
[38] Examples include Blundell RW, Browning M & Meghir C, ‘Consumer Demand and the Life- Cycle Allocation of Household Expenditure’ (1994) 61 Review of Economic Studies 57–80. For a survey of the literature, see Browning M & Lusardi A, ‘Household Saving: Micro Theories and Micro Facts’ (1996) 34 Journal of Economic Literature 1797–1855.
[39] Browning M & Meghir C, ‘The Effects of Male and Female labor Supply on Commodity Demands’ (1991) 59 Econometrica at 925–51.
[40] Blundell, Browning & Meghir, above n38.
[41] See Apps and Rees, above n36.


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