Impact of new tax legislation on households

 

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Content type
Family Matters article
Published

September 1999

Abstract

The new tax legislation that was passed in July 1999 has two main parts: the replacement of existing indirect taxes by a new goods and services tax, and large cuts to personal income tax and increases in pensions and benefits. The net effect will be an increase in purchasing power for families. But will the benefits be as great as might initially be expected? This article is concerned with the likely effect of the new legislation on households and families.

 

 

Recent legislation passed by the Federal Government promises far-reaching changes to taxation which will have a large impact on Australian families. The legislation has two main parts - the replacement of existing indirect taxes for a new goods and services tax, and large cuts to personal income tax and increases in pensions and benefits. The net effect will be an increase in purchasing power for families. However, will the benefits be as great as might initially be expected?

A key issue in the debate leading up to the drafting of the current Federal legislation for the introduction of the Goods and Services Tax (GST), and the associated reductions in income taxes and increases in pensions, was the likely impact of the changes on households (1).

I and many others have pointed out that from many perspectives the original plans suggested by the Government (Costello 1998) were inadequate and unfair to low income households in particular. These criticisms led to pressure from the Democrats in the Senate to amend the original proposals, and the legislation that was passed in July (Howard 1999) implied a better deal for low income households.

This article is concerned with the likely effect of the new legislation on households.

The new tax legislation 

The new tax legislation has two main parts. The first part is the replacement of existing indirect taxes with a new indirect tax, the Goods and Services Tax or GST. Because the new indirect tax raises more revenue than the taxes it replaces, this part of the package imposes a net extra cost on Australian households. The cost will be manifest in higher average prices of household purchases, although the prices of some goods and services will fall.

The second part of the legislation more than compensates for the increased cost of the new indirect tax. This part involves primarily substantial reductions in income tax and increases in pensions and benefits. In the process, the arrangements for family allowances will be simplified and rates of payment increased. For families, this part of the legislation is the most important, and the changes to income tax and pensions dominate the effects of the new GST.

The GST

The GST is largely funded from the abolition of existing indirect tax and, of itself, is not likely to have large distributional consequences. In both the original government proposal and in the legislation recently passed, the new GST is expected to raise about 16 per cent of total government revenues, replacing existing taxes which raise about 13 per cent of government revenues. Thus the GST will result in a small increase in indirect taxes, and it is this small increase which is responsible for the expected average increase in prices of about 2.5 per cent in the medium term (three or four years).

The overall distributional consequences of this tax mix change are not large, although this does not mean that the change does not have significant impact on some groups. While the average change is of the order of 2.5 per cent, variation in spending patterns of households and the varying effect on different goods and services mean that the net cost to some households will be higher and for others will be lower than 2.5 per cent. In addition, the effects will take some time to work their way through and the price effects are more likely to be higher in the short term but settle down after some time to around 2.5 per cent.

Pension increases and income tax cuts

The most important direct effect on households will occur as a consequence of the increases in pensions and benefits and the cuts in personal income tax. Pensions and benefits are set to rise by 4 per cent with the introduction of the package and will be maintained in real terms 2 per cent above any increase in the consumer price index (Howard 1999). In addition, arrangements for pensioners will ensure that the increases are on top of the effect of existing legislation which requires pensions to be at least 25 per cent of average weekly earnings. The effect of these changes will mean that the gains are enduring. This corrects a fault with the initial government proposals which implied that the value of the pension increases would be eroded over time (Johnson et al. 1999:25).

The second major direct effect on households will be the reductions in personal income tax. Table 1 shows the old and new tax rates and the effect on disposable income. The changes raise the threshold at the first point from $5400 to $6000 and reduce the rate from 20 cents in every extra dollar earned to 17 cents. In the band from $20,000 to $38,000 the rate is reduced from 34 cents in the dollar to 30 cents, and in the band from $38,001 to $50,000 the rate is dropped from 43 cents in the dollar to 30 cents. Finally in the band from $50,001 to $60,000, the rate is reduced from 47 cents in the dollar to 42 cents.

The net effect of the changed rates is to reduce income tax by about 13 per cent over all households and to increase disposable income by about 4.3 per cent. However, the benefits are not evenly spread. The greatest proportional benefits go to individuals in the upper middle income range (those with income around $50,000 to $60,000) for whom disposable income is increased nearly 9 per cent. The smallest proportional benefit goes to low income people (incomes between say $20,000 to $38,000). For these people the tax cuts increase disposable income by around 3 per cent. In comparison, the benefit for those dependent entirely on pensions is 4 per cent. Thus the income tax cuts and pension increases taken together are regressive in impact.

Table 1. Personal income tax rates, current and new rates, and change in disposable income

Taxable income range, $

Current schedule, cents per $

New tax rates, cents per $

Increase in disposable income, % (a)

0 to 5,400

0

0

0

5,401 to 6,000

20

0

1.1

6,001 to 20,000

20

17

2.0

20,000 to 20,700

20

30

3.2

20,701 to 38,000

34

30

3.5

38,001 to 50,000

43

30

6.0

50,001 to 60,000

47

42

8.7

60,000 +

47

47

7.5

Notes: (a) Estimate for final tax band ($60,000) are calculated for a taxable income of $75,000.

Sources: Costello (1999); Howard (1999); calculations of author.


Other reforms

Other aspects of the reforms may not have an obvious immediate impact on households but in the long run may have quite important effects. First, the reforms as a whole involve a reduction in the budget surplus. A simple way to think about the budget surplus is that it is savings held by government for Australian households. Spending it means that it is not available for other uses.

A second important influence on households will be the consequence of the income base broadening measures in the tax package. The base broadening measures include: changing of arrangements for trusts; withdrawal of the savings rebate; inclusion of fringe benefits tax and superannuation in tax group certificates; better administration and reduced avoidance; and tightening of fringe benefits eligibility for non-profit organisations.

All of these measures will reduce income to households and will reduce the net direct benefits of the tax changes. The effect of base broadening on particular household types is unknown, and it has not been possible to make any estimates in this paper. However, the overall effect is likely to be significant. This can be seen by considering the impact of the measures on aggregate government expenditure and revenue in 2001 - 2002. While the pension increases are estimated to cost about $5 billion and the income tax cuts $12.4 billion a total of $17.4 billion, the base broadening is expected to raise $7.9 billion. That is, about 45 per cent of the benefits to households will be clawed back from base broadening.

Other impacts on households

The changes brought about by the new tax legislation should not be seen in isolation. Existing conditions influence both the wellbeing of households and the distribution of wellbeing over all households.

In recent times two other major impacts have affected the situation of low income households in particular. First, there have been increases in inequality of rewards from the market system which appear to accompany the internationalisation and liberalisation of the economy. Second, various policy changes made by state and federal government, which may be justified perhaps on efficiency grounds, have had the effect of reducing the level of budgetary support for low income groups.

Households vary in the pattern of expenditures according to the size and composition of the household and (to a lesser extent) according to their income (or more particularly of their total expenditure). It is therefore to be expected that households would be affected differently by the tax changes.

Effect of the legislation on families

Potentially disadvantaged households may suffer immediately increased cash costs in the form of higher prices for some of the things they buy, or they may suffer from loss of income either through reductions in wages or loss of hours of work, or in the case of businesses, loss of profits.

Much of the analysis is conducted in relation to direct cash effects whereas in the longer run the most profound distributional effects may be through changes in wages, hours of work or availability of jobs. There may also be many situations where there are short-term costs but long-term gains. There are some other important potential effects that it has not been possible to take account of in this analysis. While the analysis abstracts from the transitional costs of reform, these can be significant. In the case of the indirect tax reform proposals, there are also likely to be lags before the post reform prices fully settle down. And finally, the indirect tax reforms will lower taxes paid on exports and lead to a strengthening of the exchange rate. This will place downward pressure on the price of imports and of goods containing imports, including those purchased by households. The net result of this effect is likely to reduce pressures on prices.

Effects of the indirect tax changes on prices

The effects of the new tax legislation are considered in two parts: first, the likely effects of just the changes in the indirect taxes on households; and second, the impact of the changes in disposable income from the proposed personal income tax cuts and pension increases, and the net effect of these after consideration of the impact of the indirect tax changes. The discussion is concerned with the medium term of about thee to four years after implementation (in July 2000). The calculations relate to a term within which all reductions in selected taxes are fully passed forward but before changes in either producer or consumer behaviour are able to have second round effects.

The removal of a number of indirect taxes and their replacement with a broad based GST at the rate of 10 per cent on all goods and services (except basic food, education and health), and expenditures on charities, is expected to have varying effects on prices. The selected taxes to be abolished include the wholesale sales tax, some state financial taxes, some stamp taxes and a proportion of diesel fuel excise.

Table 2 shows the changed prices facing households from the removal of the selected indirect taxes in the first column of figures, the imposition of the GST in the second, and the net effect in the third.

Prices fall absolutely for food, health services, transport and personal care. Much of food (about 80 per cent) is zero rated, as is health. Transport prices fall because of the abolition of some fuel prices and because for much transport expenditure (on motor cars) the eliminated Wholesale Sales Tax (WST) of 22 per cent or 32 per cent is greater that the introduced 10 per cent GST. Personal care products also enjoy reductions in the net indirect tax cost as the new GST is smaller than the taxes to be eliminated on many personal care products. Miscellaneous goods and services contains education which is zero rated and increases only slightly. Prices rise for tobacco, fuel and power, clothing and footwear, and recreation and entertainment. Overall, average consumer prices rise by about 2.4 per cent

Table 2. Price changes from removing selected taxes and imposing GST, per cent of retail price

 

Removal of selected existing taxes

Imposition of 10 per cent GST

Difference in price

Current housing costs

-2.62

8.27

5.65

Fuel & power

-2.38

10.15

7.77

Food & non alcoholic beverages

-4.65

3.46

-1.19

Alcohol

-10.77

11.42

0.65

Tobacco products

-2.58

15.99

13.41

Clothing and footwear

-1.98

10.25

8.28

Furnishings & equipment

-6.18

10.21

4.03

Services & operation

-4.14

6.81

2.67

Medical care & health

-1.33

0.30

-1.03

Transport

-13.32

10.18

-3.14

Recreation & entertainment

-5.65

10.19

4.54

Personal care

-11.50

10.31

-1.20

Miscellaneous goods & services

-3.73

5.13

1.40

Renovations/ additions to housing

-5.70

10.20

4.50

All purchases

-4.97

7.35

2.38

Source: Calculations by Melbourne Institute models.


The price changes reported in Table 2 occur after all of the tax cuts have been fully passed through the production and marketing chain but before producers and consumers alter their existing pattern of expenditures. But discussion in the Senate hearings focused on the pattern of price change over the first few years. While Treasury officials have appeared confident that complete adjustment (or pass through) will occur over a relatively short period, perhaps a year or so, others are less sanguine. Complete adjustment may be delayed because upward pressure on costs is likely to be very fast depending only on the timing of the package itself. But downward pressure is likely to be slow depending on market forces applying competitive pressure and, to a lesser extent, government enforcement through the Australian Competition and Consumer Commission. Since much of the change is in the relatively dispersed services industries over which control is more disparate, coercion either by the market or by the government is likely to be slow.

Table 2 is concerned only with the effect of the changes in indirect tax. However, households may respond to changes in indirect taxes by changing their basket of purchases. Even though the net effect of the change results in higher average costs it is not necessarily true that this will be the case for all households. The changes may result in a more favourable set of prices for the pattern of expenditure of some households. The effect on particular households also depends on the strength with which households demand particular items.

Table 3 shows the net result of both of these effects on households of nine demographic types and a dozen or so total expenditure levels. The results in the table are measured by what is known as equivalent variations. This is a measure of the effect of the price increases on the wellbeing of the household, allowing for changes in the shares of goods and services bought by them in response to the changes in prices. Consequently the numbers in the table show what households would be willing to pay to avoid the indirect tax changes. For example, the table says a couple with no retired members and a total weekly expenditure of $400 would be willing to pay $7.60 a week to avoid the introduction of the legislation. That is, the household is the equivalent of $7.60 per week worse off as a result of the package.

The welfare cost of the new tax system varies from under $2 to over $40 per week for higher income households. All numbers in Table 3 are positive. This means that even with basic food zero rated, a 10 per cent GST replacing some existing taxes creates reductions in welfare for all groups, and a tax package will require both higher social security rates and personal income tax reductions to avoid a net cost to households.

Table 3. Equivalent variations for ten household types and income ranges for the introduction of a GST with food zero rated in the long term and the abolition of existing indirect taxes (a)

Household type (b)

Total expenditure range

Couples only with no retired members

Couples only with at least one retired member

Couples with one dependent child

Couples with two dependent children

Couples with three or more dependent children

Single parent with one dependent child

Single parent with two or more dependent children

Single persons not retired

Retired single persons

All households

Equivalent variation, $ per week (d)

$/wk

per cent

100

1.9

1.6

     

2.8

2.3

2.6

2.6

200

3.8

3.7

5.2

  

5.5

5.0

5.1

4.5

4.4

2.2

300

5.6

5.8

7.8

6.1

6.0

8.1

7.6

7.5

6.3

6.3

2.1

400

7.6

8.2

9.0

7.9

7.9

10.6

10.3

9.9

8.2

8.4

2.1

500

9.8

10.3

10.6

9.8

9.7

13.0

12.5

12.2

10.2

10.4

2.1

600

12.1

12.3

12.5

11.8

11.7

15.1

13.1

14.5

 

12.5

2.1

700

14.6

14.4

14.4

13.9

13.8

 

15.3

16.8

 

14.6

2.1

800

17.3

16.5

16.4

16.3

16.3

  

18.9

 

16.7

2.1

900

19.8

18.5

18.5

18.4

18.3

  

21.3

 

18.8

2.1

1000

22.7

 

20.7

20.8

20.7

  

24.7

 

21.0

2.1

1200

27.9

 

25.1

25.7

25.7

  

27.2

 

25.3

2.1

1400

34.6

 

31.3

31.7

33.1

  

29.7

 

29.9

2.1

1600

41.9

 

35.8

30.1

37.8

    

34.2

2.1


Notes: (a) the effects on households is restricted to price effects; (b) The household types shown here encompass about 80 per cent of the population. Remaining households have two or more income units and include groupings such as, two or more single persons living together or single persons living with couples with or without dependents. (d) Equivalent variations are based on calculations of household responses with fixed real income and real price changes generated from a general equilibrium model.
Source: calculations using DAWES (Demand and welfare effect simulator) ; for more information see Creedy (1998)

Inspection of the final column of Table 3 shows that the legislated package is proportional in its effect. The proportionate welfare loss for lower expenditure households is much the same as for higher expenditure households. It should also be noted that at any particular expenditure level, the magnitude of welfare losses varies by demographic group.

Thus while couple only households with no retired members with expenditure of the order of $200 per week can expect to face losses in welfare equivalent to a $3.80 increase in costs, single persons with the same total expenditure can expect increased costs of the order of $5.10 per week. Evidently the expenditure pattern of single persons is such that they will be more heavily penalised by the tax changes than couple households. The costs for households with retired members are also generally a bit lower than households of the same composition with no retired members.

Increases in household income

Table 4 shows the direct benefits of the legislation for households. These are primarily increases in government pensions and benefits, and reductions in personal income tax.(2) The table shows the expected change in disposable income of the legislated package for five income ranges and nine household types.

Table 4. Net change in disposable income for ten household types and disposable income ranges from direct effects of the income tax and pension changes, $ per week (a,b).

Household type (c)

Total weekly disposable income range

Couples only with no retired members

Couples only with both retired members

Couples with one dependent child

Couples with two dependent children

Couples with three or more dependent children

Single parent with one dependent child

Single parent with two or more dependent children

Single persons not retired

Retired single persons

1 —287

17.0

9.8

19.2

22.4

22.0

27.4

30.7

10.7

7.2

288-458

20.3

13.1

24.0

24.7

27.1

25.8

29.3

12.4

13.8

459-669

18.8

23.8

35.4

47.5

52.7

39.5

47.2

23.9

na

670-949

28.2

na

36.5

42.7

64.4

na

na

52.5

na

>950

59.5

na

72.4

72.7

70.6

na

na

81.2

na

Source: calculations from Melbourne Institute models.

Notes: (a) na means not applicable — there are not sufficient observations to warrant reporting (b) the calculations are responses for the replacement of the ten selected indirect taxes with a broad GST of 10 per cent and consequent changes in consumer prices assuming full passing forward but no consumer responses; (c) The household types shown here encompass about 80 per cent of the population. Remaining households have two or more income units and include groupings such as, two or more single persons living together or single persons living with couples with or without dependents.

The increased pensions and the income tax cuts produce large increases in household disposable income for all household types and at all income levels. The increases are greatest for the households with the highest disposable income.

In interpreting the table it is important to remember that: the results are averages for very broad groups; the results do not allow for consumer behaviour response; the results do not take account of income base broadening measures; and the results assume no second round effects of the smaller budget surplus required to fund the package.

The increase in net income of households needs to be set against the increase in costs shown in Table 3. The net effect on the purchasing power of families is shown in Table 5.

Table 5. Net change in purchasing power for ten household types and disposable income ranges from direct effects of the tax legislation, $ per week (a,b).

Household type (c)

Total weekly disposable income range

Couples only with no retired members

Couples only with both retired members

Couples with one dependent child

Couples with two dependent children

Couples with three or more dependent children

Single parent with one dependent child

Single parent with two or more dependent children

Single persons not retired

Retired single persons

1 —287

9.8

2.3

8.4

8.3

5.8

18.8

20.4

2.9

2.4

288-458

10.5

5.6

13.7

13.3

15.3

16.1

17.5

3.5

7.0

459-669

5.5

11.8

22.7

35.4

39.4

26.3

34.7

10.3

na

670-949

12.4

na

21.9

26.4

47.0

na

na

39.8

na

>950

37.1

na

50.7

49.4

43.4

na

na

65.4

na

Source: calculations from Melbourne Institute models

Notes: (a) na means not applicable — there are not sufficient observations to warrant reporting (b) the calculations are responses for the replacement of the ten selected indirect taxes with a broad GST of 10 per cent and consequent changes in consumer prices assuming full passing forward but no consumer responses; (c) The household types shown here encompass about 80 per cent of the population. Remaining households have two or more income units and include groupings such as, two or more single persons living together or single persons living with couples with or without dependents.

Discussion of household results

The material above suggests that households are big winners from the tax legislation. However, this conclusion needs to be tempered considerably. As is explained, the results do not take into account the effects of the reduction in the budget surplus nor the base broadening measures. The base broadening measures are estimated to claw back about 45 per cent of the benefit to households. Since the pattern of this clawing back is unknown, and in the absence of better information, all the benefits shown in Table 4 should be reduced by about 45 per cent, with consequent effects for Table 5.

The estimates are calculated for the average situation for very broad household types. Undoubtedly the averages will disguise a large variation so that some households will do considerably better than suggested and others considerably worse. For households where net gains are estimated to be small, such as for low income single persons whether retired or not, and for retired couples, there will certainly be some households with a net loss as a result of the legislation.

The results are estimated assuming all costs are fully passed forward. This will certainly not occur straight away and delays are likely to penalise households rather than advantage them.

Further changes in the tax system that will also affect the outlook for households will emanate from the Ralph committee inquiry into company and business tax. The report of the inquiry has just been released and there has not been sufficient time to incorporate its findings in this article. However, the changes to company and business tax will affect households in three ways: directly from changes in dividends; indirectly from affects on prices of goods and services; and indirectly from changes in the efficiency of the economy and flow on effects on wages and employment.

Summary and concluding comments

The tax legislation is complex and estimating the effects on households requires some strong assumptions. The prices of almost all goods and services purchased by households will be affected by the legislation. There will be considerable disruption and a lot of learning for individual consumers and business people. The overall package looks attractive and all main types of household appear to gain, but this is deceptive. The direct gains for households will be reduced when the base broadening measures take effect and there may be substantial lags before some of the price reducing effects of the abolishment of indirect taxes flow to consumers.

Some specific impacts on households of the legislation are as follows. The indirect tax changes are small and in general will raise household costs. Some household costs will rise more than others, in particular: costs for single adult households are higher; retired households are effected less; and overall the changes to indirect taxes are proportional. The pension increases and tax cuts will substantially increase household income. And on average, all major types of household will have increased net income (after deducting the increased costs), however the unquantified impact of base broadening and reduction in the budget surplus will considerably reduce the gains for households.

The results presented here concern the medium term. In the longer run there are likely to be efficiency gains for the economy and these will flow through to households. The legislation promises to better align prices for consumers and for producers. This may lead to changes in industry structure and efficiency leading to changes in employment, in wages, and in standards of living. Previous experience suggests that in the long term these more general effects can be at least as important as the direct impacts explored here.


Notes

(1) In this paper the terms household and family are used interchangeably. 


(2) In calculating the effect on disposable income, the changes in legislated package from the proposal suggested in the ANTS document (Costello 1998) have been included. The main effect of the legislated package over the previous proposals was to reduce the tax benefits for households in the top two quintiles by between 3 and 4 per cent, and to ensure that the changes to pensions are enduring.


References

  • Costello, P. (1998), Tax Reform - Not a New Tax a New Tax System: The Howard Government's Plan for a New Tax System, AGPS, Canberra.
  • Creedy, J (1998), Measuring Welfare Changes and Tax Burdens, Edward Elgar, Cheltenham.
  • Howard (1999), Attachment to letter to Meg Lees dated 28 May titled, Changes to the Goods and Services Tax (GST), p. 6.
  • Johnson, D. T., Freebairn, J. & Scutella, R. (1999), Indirect Taxes: Evaluation of the Government's Tax Package, Report No. 4 of Tax Reform: Equity and Efficiency, Melbourne Institute of Applied Economic and Social Research, University of Melbourne.

Dr David Johnson is Associate Professor and Deputy Director at the Melbourne Institute of Applied Economic and Social Research at the University of Melbourne. He is joint editor of the Australian Economic Review and has published widely in the area of social economics. Recent publications include: Trends in the Distribution of Cash Income and Non cash Benefits (AGPS 1995); and Poverty, Inequality and Social Welfare in Australia (Physica-Verlag, Germany 1996). In 1997 and 1998 David was a coordinator of a major project on the equity and efficiency effects of tax reform and a co-author of four influential monographs. The work of the tax reform project were widely reported in the media, influenced debate about tax reform, and David recently gave evidence before the Senate hearings on tax reform.

On 21 October 1999, as part of the seminar series organised and hosted by the Australian Institute of Family Studies, David Johnson addressed Institute staff and visitors on the topic of families and the GST. This article is an edited version of that address.

 

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