Easing the transition from welfare to employment requires tough decisions

The current focus on foreign and defence policy does not mean the suspension of domestic policy development. It's impossible to be a force for good in the wider world without a strong and secure domestic base. International crises cast domestic issues into different perspective but don't make them go away. Although issues of war and peace inevitably distract people from bread-and-butter concerns, they can also suspend safety-first politics and give national leaders renewed determination to amend what's within their power to fix.

As a counterpoint to the problems of the wider world, providing a fair go for struggling Australian families is more urgent than ever. In particular, how do we give Australian families the best possible chance to make a better life for themselves and tackle the sense that many people are still running faster without advancing on an economic treadmill?

ACOSS wants the Government to create more jobs. ACCI wants the Government to create new regulatory structures that will allow business to create more jobs. The welfare reform roadmap just released and the commitment to new policies on work and family are marks of a government which has always looked for fresh ways to tackle the most intractable social and economic problem of the past quarter century. Unlike its predecessors, this Government has not ignored the impact of the social security system on unemployment and is determined to ensure that paid work is consistently more attractive than the alternative.

"Perhaps it is a weakness of democracies," wrote the Adelaide University historian, Sir Keith Hancock, "that, having willed an end, they try to shuffle out of willing the means." "Australians," he continued, "certainly, constantly confuse end and means and they do this because their easy-going good nature and intellectual laziness make them reluctant to refuse favours, to count the cost, to discipline the policies they have launched. These policies, therefore, yield diminishing returns until, at last, they may become a positive danger to the national purpose which has called them into existence".

Hancock was writing about "protection all round" and analysing the foreseeable but unplanned outcomes of policy based on wishful thinking. Policies to boost employment are especially prone to the magic pudding syndrome or to the counterproductive influence of unintended consequences and easily degenerate into attempts to buck markets rather than address the structural factors which drive them. The former Labor government's Accord, for instance, had worthy objectives: to boost employment and to provide a better life for people doing it tough. Unfortunately, lower wages and higher welfare payments created more potential jobs but fewer workers prepared to fill them. The orthodox "cure" for unemployment became ineffective because of new work patterns and a welfare system which undermined the appeal of entry-level jobs.

Comprehensive social security is part and parcel of modern civil society but has a range of harmful side-effects. Failure to acknowledge the way universal, more-or-less unconditional welfare changes people's behaviour has seriously compromised Australian governments' efforts to deal with unemployment.

Unemployment is a much more complex social and human phenomenon than is apparent from the average press release. Unemployment happens to people, not economies. Behind the statistics are hundreds of thousands of quite different human situations. People's finding, losing or failing to find work is a function of personal factors such as the motivation of job seekers and the goodwill of employers as well as "impersonal" ones such as the state of the economy and condition of particular industries. Even so, some systemic issues can make a big difference to how people organise their lives. If, for instance, people can receive almost as much money through the welfare system as through paid employment they can hardly be blamed for concluding that work does not pay.

It is generally believed that a 48.5 per cent top marginal tax rate (with Medicare levy included) cutting in at just $60,000 a year constitutes a significant disincentive to earn and achieve and places Australia at competitive disadvantage in seeking to hold and attract the best talent. Unfortunately, the interaction of the tax system and the welfare system means that people moving from unemployment to work generally face effective marginal tax rates of nearly 70 per cent and sometimes over 100 per cent. Adults on Newstart who earn an additional dollar pay 17 cents income tax. On top of the 17 cents lost through tax, they lose an additional 50 cents through benefit clawback once they've earned $31 a week producing a 67 per cent effective marginal tax rate for part-time work in excess of about three hours a week. If 48.5 per cent tax discourages people with responsible jobs, what about the impact of 67 per cent on unemployed people? What is thought to be a significant disincentive to well-qualified people doing interesting jobs can hardly fail to discourage less well-motivated people working for about $10 an hour.

Progressive income tax is supposed to mean higher tax rates at higher incomes but that's not how it works in practice for people who are also receiving social security benefits. Financial incentives are certainly not the only determinant of labour market behaviour but they are an important one.

High effective marginal tax rates mean that moving from welfare to work can make depressingly little difference to people's disposable income. For instance, a single person on Newstart renting privately whose earned income increases from $75 to $375 a week, after tax and social security clawback, is just $53 a week better off.

The interaction of a needs-based, highly targeted welfare system with a progressive tax system becomes even more complex for low to middle-income families receiving multiple benefits (with cumulative and often different thresholds and withdrawal rates). For families, the worst poverty traps can occur when moving from low to middle levels of earned income. For instance, a couple renting privately with three teenage children whose earned income increases from $610 to $860 a week is actually $28 a week worse off after paying tax and losing part or all of their rent assistance, family payments and Austudy. The social consequence of 850,000 children living in 435,000 jobless families is not so much a dramatic increase in poverty (thanks to a tightly targeted welfare system) but a significantly greater incidence of early school leaving, unemployment and teenage parenting in the next generation.

Under these circumstances, the wonder is not that Australia has a persistent sub-culture of unemployment but that more people do not opt out of participation in the workforce. The fact that so many people persevere in modestly paid jobs testifies to the resilience of the work ethic and people's appreciation that there's much more to work than pay alone. Most people, most of the time, work for the satisfaction and companionship of a job well done as much as for money but incentives do matter and sooner or later perverse incentives start to warp people's best instincts.

Because there is no lobby group to assert this inconvenient truth, business leaders only recently learned that comparatively poor people faced higher effective tax rates than they did. Too many welfare activists have still not learned that doing the best for their clients generally means losing them. And policy professionals have been slow to recognise how tackling one problem can end up causing another.

The way two generations of well-intentioned but ad-hoc policy making has turned a theoretically progressive into a practically regressive tax transfer system is a classic illustration of that democratic reluctance to discipline policies detected by Hancock 70 years ago. There are lobbies for every interest except the national interest which is why governments find it so hard to discriminate between the ceaseless cries for help. Who could deny the rigours of life on social security or fail to want to help people in need? But benefits for some always mean burdens for others. Heavier burdens on those who are net contributors to the social security system are the inevitable result of larger payments to those who are net beneficiaries - with consequent pressures on the social fabric. To limit the burden on the general community, it makes sense to target benefits strictly to those in need - but it's in the nature of targeted systems to subsidize problems rather than solutions. Higher taxes to pay higher social security bills make it difficult for average families to make ends meet. Many try harder (often by finding second and third incomes), some give up (often unintentionally) and pass into the unemployment subculture and most become more inclined to question a system which no longer strikes them as fair.

The Howard Government is committed to a simpler, fairer welfare system with more built-in incentives for people to find work. As Senator Vanstone said at the launch of the Government's welfare reform paper in December: "Leaving the system the same could be unfair to many people particularly if it locks them out of opportunities or incentives to move to greater independence."

The paper canvassed three broad options: "mini" reform to remove the worst disincentives to work from the existing benefit system; "midi" reform to create a uniform working-age benefit with different supplements and requirements for people in different circumstances; and "maxi" reform to integrate the new working-age benefit fully into the tax/transfer system so that at any given level of income and in any particular household type people can earn an extra dollar and keep a reasonable percentage for their efforts. Mini reform is unlikely to stop unemployed people retiring onto the disability pension. Midi reform won't end the problem of people simultaneously paying tax and receiving benefits and thus finding themselves exposed to punitive effective marginal tax rates. Maxi reform has the potential to develop into a new round of tax reform, this time for direct rather than indirect tax, with the same problems of compensation for people who might be worse off.

There will be an understandable desire to focus on specific problems such as the difficulties of working families with children or the inadequate returns from entry-level work. The trouble with changes specifically targeted to these problems (such as a new maternity payment or an earned income tax credit) is that they shift disincentives rather than eliminate them. The current uncoordinated system is the result of precisely such well-intentioned, "non-ideological", incremental rather than architectural policy-making. Too often, governments have tackled smaller problems in ways which make bigger ones worse.

Paradoxically, sweeping changes (which challenge the electorate to focus on the national interest) might be less vulnerable to scare campaigns than modest changes (where people inevitably focus on "what's in it for me"). The 1998 election demonstrated that voters can be persuaded to support reform which they fear could make them somewhat worse off provided they're confident it should make the country as a whole substantially better off. Reform of personal income arrangements, especially reform for low-and-middle families, could have wider appeal than reform of indirect tax because it would be reform with a social conscience as much as reform for a stronger economy.

In the end, Hancock's rueful judgment about the polity is a reflection on the historical quality of our political leadership. When democratic electorates reject good policy, it's the leadership rather than the voters who have failed. Governments are at their best when determined to make a difference rather than mind the shop. Governments don't achieve democratic legitimacy just by winning elections but also by making good use of the influence, authority and power that they have. In the coming year, let's renew our commitment to reshape our systems and institutions to reflect better the best values of the Australian people.