Tax-welfare churning and the welfare state: Are welfare state opt-outs a viable solution?

Adam Stebbing, Macquarie University

Peter Saunders The Government Giveth and the Government Taketh Away: Tax-welfare Churning and the Case for Welfare State Opt-Outs, Sydney, Centre for Independent Studies, 2007 (165 pp). ISBN 9-78186432-165-4 (paperback) RRP $29.95.

The expansion of the Australian welfare state over recent decades has surprised many, especially those commentators who diagnosed its imminent crisis in the 1980s and predicted the widespread retrenchment of social programs. Social spending has increased as a proportion of GDP from around seven per cent in 1960 to about eighteen per cent in 2001 (Castles 2004; Whiteford 2005). Meanwhile, tax revenue has also grown from about 26 per cent of GDP in 1975 to around 31 per cent of GDP in 2003 (OECD 2006, p. 19). Increases in both social expenditure and tax revenue have corresponded with an increase in the proportion of the working age population who receives income support from the government as their major source of income—from less than five per cent in 1965 to more than sixteen per cent in 2004 (Saunders 2004, p. 1).

So, what are the ramifications for Australian society of the expanded role of government? In The Government Giveth and the Government Taketh Away, Peter Saunders (of the Centre for Independent Studies) declares that the expansion of the Australian welfare state has transformed our society into ‘a nation of supplicants’ that is increasingly, but also unnecessarily, reliant on the state to meet its basic needs (p. 4).

We become supplicants, Saunders argues, because extensive ‘tax-welfare churning’ in contemporary welfare states makes us needlessly dependent on social welfare (that is, the social services and benefits provided by the state). Tax-welfare churning occurs when governments tax individuals and then spend tax revenues on providing income and services ‘back’ to those same individuals. To remedy churning and to restore the self-reliance of individuals, Saunders proposes a system of welfare state opt-outs.

THE PROBLEM: TAX-WELFARE CHURNING

Saunders estimates that two forms of tax-welfare churning—simultaneous and lifetime churning—affect at least $90 billion of the $182 billion spent annually on the Australian welfare state (p. 34). Simultaneous churning occurs when the taxes paid by individuals fund social welfare that provides them with immediate assistance. For example, the taxes levied on middle income earners may fund state subsidised health services through Medicare (the public provider of universal health insurance). Simultaneous churning is estimated to affect around eighteen per cent of income received by Australian households (p. 33). Although it involves the top 60 per cent of income earners to some extent, simultaneous churning is primarily concentrated in the third and fourth quintiles of household income (p. 24). It is also more likely to be experienced by families with dependent children whose taxes are cancelled out by the social welfare they receive (p. 25).

Lifetime churning involves the state undertaking ‘intra-personal income-smoothing over the life-course’ (p. 28). It occurs when the taxes individuals pay during high earning periods of their lives cover all or part of the financial cost of the social welfare they receive through low earning periods of their lives. For instance, the taxes of many middle-income earners (that exceed the value of their current usage of social welfare) can be conceived of, in part, as contributions towards the aged pensions they are likely to receive in retirement. Saunders (p. 34) estimates that lifetime churning affects half of the state-funded social welfare that individuals—including many low and middle income earners—receive over their life-course, which means that many Australians self-finance most or all of the social welfare they receive over their lifetimes. (However, his discussion of the current extent of lifetime churning remains general due to a lack of data.)

For Saunders, churning is primarily a social problem.

Saunders contends that simultaneous and lifetime churning are primarily social problems since they undermine the self-reliance of individuals by needlessly binding their wellbeing to the state. He argues that many individuals, who would otherwise be self-reliant and could afford private sector alternatives to social welfare, are forced to depend on the state for their wellbeing after paying the taxes required to maintain tax-welfare churning (Saunders p. 40). By unnecessarily confining many individuals to a dependency relationship with the state, churning denies them the opportunity to make choices about how to look after themselves. These constraints placed on choice lead to disempowerment, as individuals experience neither the self-worth nor the ‘satisfaction derived from having control and responsibility for one’s own life’ (p. 50).

Since it has increased the number of individuals dependent on the state for social welfare, Saunders links tax-welfare churning to two further social consequences. First, churning has reduced the role and influence of civil society, because the welfare state is now responsible for many activities traditionally undertaken by families and grassroots organisations (Saunders p. 54). Second, churning politicises everyday life and civil society, because it increases both the scope of the welfare state programs and the proportion of the population affected by social policies (Saunders p. 55).

Although he emphasises the social problems that he sees churning as causing, Saunders also presents three economic arguments against it. First, churning reduces economic efficiency because individuals are forced to use public services that have higher administrative, compliance, and enforcement costs than services purchased directly from private enterprises. Second, churning is unsustainable, because the state will not be able to bear the burden of the higher health and superannuation demands associated with an ageing population in the near future (Saunders p. 48). Third, churning acts as a disincentive to work since people do not get to enjoy the full benefits of their labour due to the high taxes they must pay to maintain the welfare state (Saunders p. 45).

THE SOLUTION: WELFARE STATE OPT-OUTS

Because of its wider social and economic consequences, Saunders argues that we must eliminate as much of the $90 billion of tax-welfare churning as possible while maintaining redistribution to those whose lifetime incomes are insufficient to meet their needs. Saunders’ solution to the churning problem is a system of welfare state opt-outs that would allow individuals to make their own arrangements for their welfare or offers them incentives to do so. The key idea underlying his proposals for welfare state opt-outs is that:

people who agree to take more responsibility for themselves should be allowed to retain more of their taxable income so they can afford to buy replacement services, but that those who prefer to remain in the state system can stay as they are (p. 98).

Saunders’ solution is a system of welfare state opt-outs.

Welfare state opt-outs require individuals to relinquish their entitlements to social welfare. In return their tax contributions are reduced so that they can invest in private services. Opt-outs do not provide individuals with the choice to make no provision for their welfare—they would be allowed to choose between either public or private welfare services (Saunders p. 73).

Although Noel Pearson (2005) and Vern Hughes (2004) have previously recommended developing welfare state opt-outs, Saunders’ proposal has two novel features. Previous opt-outs schemes have been confined to a single social welfare program, but Saunders proposes extending opt-outs to health, superannuation, family payments, education, and unemployment support. He also suggests increasing the options available to individuals when they spend or invest their funds. For example, one could opt-out of Medicare and choose to invest instead in a friendly society, private health fund or medical savings account (p. 99). The other novel feature of his system is that individuals would only be able to withhold part or all of their previous tax contributions, rather than claim a tax discount for the total value of previous entitlements (p. 99). Saunders (p. 100) also proposes limiting the opt-outs of wealthier people to the portion of their taxes that are contributing to their current welfare use. The point is to restrict redistribution from others to those who can afford to look after themselves.

Saunders’ arguments have far reaching implications for the welfare state. His case against tax-welfare churning frames the welfare state as a parasitic artefact inherited from the 20th century, which is largely unnecessary and a source of dependency in contemporary society. His case for welfare state opt-outs calls for the privatisation of major social welfare programs so that individuals can achieve self-reliance through exercising choice. However, before we sound the death knell for the welfare state, there are problems with both the cases against churning and for opt-outs that we should consider.

IS TAX-WELFARE CHURNING REALLY A PROBLEM?

Four lines of reasoning challenge the validity of Saunders’ case against tax-welfare churning. The first is that tax-welfare churning only restricts the independence of individuals if we define self-reliance as the ability to exercise choice in the private market. The problem with this narrow conception of self-reliance is that an individual who relies on the market for protection from potential social risks is not necessarily more independent than an individual who depends on the state—both rely on others for their well-being, whether it be on the state, the market, or for that matter, the family (Goodin 1988, p. 343). Since people who rely on social welfare and private welfare services depend on others, the ability of individuals to choose between public and private sources of welfare will increase their options, but may not provide them with greater independence. Although the idea of choice is inherently tied up with the ideal of self-reliance, ‘choice’ does not hold the moral imperative associated with having ‘control over one’s life’. This undermines Saunders’ argument against tax-welfare churning, because it reduces the moral consequence of churning from personal disempowerment to limited choice.

Choice is increasingly an inbuilt feature of the the welfare state.

The second criticism of the case against tax-welfare churning is that it understates the extent of choice available to individuals who use social welfare. Choice is increasingly an inbuilt feature of the publicly-funded benefits and services that comprise the welfare state. For instance, recipients of the family payments Family Tax Benefit Part A and Part B can choose to receive their benefits in three ways: as a direct payment each fortnight from Centrelink; as periodical reductions in the tax withheld from wages; or as a single payment made through the tax system at the end of every financial year (Centrelink 2007). More significantly, regardless of whether families receive family tax benefits as a direct payment or tax reduction, they receive a cash benefit that they choose how to spend. Another example of a policy with inbuilt choice is the Child Care Benefit, which subsidises the government-accredited childcare chosen by families, regardless of whether it is offered by public or private providers (Centrelink 2007). The ability of the recipients of social welfare to exercise choice counters, to some extent, Saunders’ contention that tax-welfare churning forces individuals to become dependent on the state due to a lack of choices.

The third argument concerns the assertion that private services achieve greater economic efficiency than public services. A brief comparison of Medicare with private health insurance demonstrates that private services are not always more economically efficient than public services. Medicare spends about five per cent of its revenue covering administrative costs—significantly lower than the average of eleven per cent expended by private health insurance funds (McAuley 2005, p. 169). Nevertheless, the ‘stronger economic case against private health insurance lies in the capacity of a single national insurer to exercise purchasing power in the market’ and thereby keep downward pressure on prices (McAuley 2005, p. 170). This example shows that tax-welfare churning does not necessarily result in higher costs than private services.

The first three lines of reasoning identify problems in the way Saunders understands the problem. The fourth goes one step further, to argue that churning has benefits for both individuals and society as part of a broader system of social risk management. Quiggin (2007) conceives of the welfare state as a set of institutions that protect individuals from social risks such as ill health, unemployment, family breakdown, disability, ageing, and poverty. He argues that social risks should be pooled collectively through the welfare state as ‘we have the capacity to share and manage risks more effectively as a society than as individuals’ (Quiggin 2007, p. 10).

Opt-outs would impose a double burden on the young.

From this perspective, lifetime and simultaneous churning—or income smoothing and risk-pooling respectively—are not problems. Rather, they are vital processes through which individuals contribute to and withdraw from the collective risk management system. In particular, lifetime churning has long been conceived of as a beneficial feature of the welfare state. As Harding and colleagues note, the welfare state has ‘been designed to assist households through the course of their lifecycle, by redistributing income from periods of relative affluence during the lifecycle to periods of relative greater need’ (2004, p. 24). The major difference between this perspective and Saunders’ is not that individuals should collectively pool their risks, but that the welfare state is an effective risk-pooling mechanism.

THE IMPLICATIONS OF WELFARE STATE OPT-OUTS

The problems with the case against tax-welfare churning undermine Saunders’ general calls for the privatisation of the welfare state, but two implications of welfare state opt-outs also directly challenge their viability. First, the transition to a system of welfare state opt-outs would foster extensive generational inequalities. Opt-outs would impose a double burden on the younger generation—they would have to finance their own private welfare and pay for the social welfare of the older generation, because lifetime churning primarily involves transfers from younger to older people and from families without children to those with children (Whiteford 2005, p. 20).

Saunders (p. 100) acknowledges that double financing is inevitable to some extent, but responds that many individuals are already opting-out of the welfare state and financing public services for others through their taxes. He provides the example of education, contending that the one third of parents with children in private schools is also forced to pay for public schools through their taxes (p. 100). However, he does not take into account the funding that private schools receive from the federal government. The extent of federal funding is relevant to our discussion of churning since many parents with children in private schools pay income taxes to the federal government, even though schools receive most of their funding from state governments. As Gittins (2007) notes, the two thirds of students who are enrolled at public schools only receive ‘31 per cent of the [federal government’s education grants] … while the private schools get 69 per cent’. So, if Saunders’ example of education is anything to go by, it is likely that the current level of double financing pales in comparison to the burden that an extensive system of opt-outs would place on the younger generation.

It would be premature to adopt Saunders’ proposal.

The second implication of welfare state opt-outs is that the government would have to restrict the behaviour of individuals and expand the scope of its regulations. As Saunders notes, a system with opt-outs would require the state to maintain a safety net to provide for the lifetime poor and individuals who make bad choices (p. 73). If individuals were left with the opportunity to take their opt-outs and given the choice to make provision for their own social risks, they might choose to not take out social insurance and ‘free ride’ on the safety net in the eventuality that they encountered social risks—particularly uncommon risks.

To prevent individuals from free riding on the safety net, Saunders (p. 73) argues that the state should require those who opt-out to maintain compulsory savings or insurance. Ironically, to ensure that individuals take out some form of insurance against social risks, the system of opt-outs would require the state to maintain an active role in collective risk-pooling through ‘a significant extension’ of regulation (Whiteford 2005, p. 19). This suggests that opt-outs would have only limited impact on the self-reliance of individuals and the choices available to them, for although they would not have to access social welfare, they would still be subject to extensive government regulation.

Taken together, these criticisms of the ‘problem’ of tax-welfare churning and of the remedy of welfare state opt-outs suggest it would be premature to adopt Saunders’ proposal and implement the extensive restructuring of the welfare state that it would entail. This is by no means to argue that the welfare state as currently configured is a perfect set of institutions that could not benefit from reform. However, Saunders’ proposals clearly do not offer a more viable alternative.

REFERENCES

Castles, F.G. 2004, The Future of the Welfare State: Crisis Myths and Crisis Realities, Oxford University Press, Oxford.

Centrelink 2007, About payments [Online], Available: http://myaccount.centrelink.gov.au/wps/portal/payments [2007, July 20].

Gittins, R. 2007, ‘More privilege for the privileged’, Sydney Morning Herald, 23 May.

Goodin, R.E. 1988, Reasons for Welfare: The Political Theory of the Welfare State, Princeton University Press, Princeton.

Harding, A., Lloyd, R. & Warren, N. 2004, Income distribution and redistribution: The impact of selected government benefits and taxes in Australia in 2001–02, paper presented to 28th General Conference of The International Association for Research in Income and Wealth, Ireland, August 22–28 [Online], Available: https://guard.canberra.edu.au/natsem/index.php?mode=download&file_id=574 [2007, July 10].

Hughes, V. 2004, ‘A cure for health care’ Policy, vol. 20, no. 1.

McAuley, I. 2005, ‘Private health insurance: Still muddling through’ Agenda, vol. 12 no. 2, pp, 159–178.

Organisation for Economic Cooperation and Development (2006) Revenue Statistics 1965–2005: 2006 Edition, Organisation for Economic Cooperation and Development, Paris.

Pearson, N. 2005, Welfare Reform and Economic Development for Indigenous Communities, Centre for Independent Studies Lecture, Sydney, 25 October.

Quiggin, J. 2007, The risk society: Social democracy in an uncertain world, Centre for Policy Development, Occasional Paper No. 2 [Online], Available: http://cpd.org.au/sites/cpd/files/u2/JohnQuiggin_The_Risk_Society_CPD_July07.pdf [2007, August 1].

Saunders, P. 2004, Australia’s Welfare Habit and How to Kick it, Duffy and Snellgrove, Sydney.

Whiteford, P. 2005, The welfare expenditure debate: Economic myths of the left and right revisited, paper presented to the Australian Social Policy Conference, Sydney, 20–22 July [Online], Available http://www.sprc.unsw.edu.au/ASPC2005/papers/Paper7.pdf [2006, September 20].

Adam Stebbing is a PhD Candidate at the Department of Sociology at Macquarie University.