Couple with children

I. Introduction

A tax-benefit system assessment, followed by reform proposals, basically requires knowledge about the total disposable income a family should get after paying tax and receiving benefits. It brings an understanding of how much of an additional dollar of income can be kept by families, the so-called Effective Marginal Tax Rate (EMTR). This rate is most often used when evaluating financial incentives for engaging targeted people in earnings generation or income increasing activities. Average effective tax rate (AETR) is another useful measure for assessing the size of benefits transferred to and from the government based on the income level and family type at a specific point of time. This rate is measured as a proportion of net payments to the income on which they are levied. Measurement of both these tax rates has been applied in various studies estimating the impact of tax burdens on different aspects such as economic growth, unemployment or wage-setting behaviour.

Australia has developed a significantly complex system of means-tested programs of government cash payments and tax concessions to ensure resources are delivered to those who need it most. However, these programs can generate high EMTRs and AETRs when the means-tests for two or more programs overlap or no taper rates exist, as well as when income tax is liable. High EMTRs and AETRs can create difficulties for Australian families and discourage people from entering the labour force or working longer hours when an increase in their earnings is subsumed by loss of benefits and higher income tax liability. It then can lock low-income families into a situation where they find it hard to increase their income, leading to the poverty trap situation.

High EMTRs and AETRs are not unique and can be experienced at different private income levels depending on different household characteristics. We will therefore calculate both rates, the disposable income as well as income components under various family types and over a large range of income changes. In this report, we focus on the case of Couple with children in two financial years: 2018-2019 vs. 2001-2002. This analysis consists of five sections: Introduction, Methodology, Assumption, Findings and Conclusion.

II. Methodology

The Average Effective Tax Rate (AETR) can be measured as:

$$ AETR_t^i = \frac{T_t^i}{Y_t^i}$$

where T - tax burden after receiving benefits, Y - private family income, t - year, i - family type. This rate summarises information about not only the tax rate structure (progressive or proportional) and possible tax reliefs (on the tax rate or tax burden), but also the benefit rate structure. Meanwhile, the Effective Marginal Tax Rate (EMTR) is calculated using the equation below:

$$ EMTR_t^i = \frac{\partial T_t^i}{\partial Y_t^i}$$

The calculation of EMTRs is therefore undertaken by comparing the disposable family income before and after the total private income of that family is increased by one dollar. Both EMTRs and AETRs are measured at the family levels, using our STINMOD+ model to calculate the disposable family income in the case of Couple with children. Note that families is used here as a colloquial term for income units and a dependent child is defined as being less than 16 years of age or a dependent student aged between 16 and 24 years.

While this methodology is expected to maximise the disposable family income of each household using the optimization principles, the model has some limitations. These limitations result from the complication of the model in both theory and practice. First, in the real world, income tests and means-tests are sometimes applied to the person who decides to claim the benefit instead of the person who should apply to optimise their disposable family income. Second, in a few cases, these tests are based on the individual or family private income received during the preceding financial year. STINMOD+ assumes the amount of income is the same in the current year as it was in the previous year. Third, it is also worth noting that EMTRs in this analysis do not take account of some kinds of costs such as childcare and transport costs, as well as other work-related costs such as clothing. Overall it must be stressed that, while the model is notably sophisticated, the results are nonetheless only estimates and do have limitations.

III. Assumptions

In this analysis, we focus on 3 family types:

  • Typical household 1: 35-year-old couple, with 3 and 7-year-old children, both work full-time, with private family income ranging from 0 AUD to 400,000 AUD.
  • Typical household 2: 35-year-old couple, with 3 and 7-year-old children, one works full-time and one is unemployed, with private family income ranging from 0 AUD to 200,000 AUD.
  • Typical household 3: 35-year-old couple, with 3 and 7-year-old children, one works full-time and one works part-time, with private family income ranging from 0 AUD to 300,000 AUD.

In addition, all these family types are assumed with zero assets and without paying any rent cost, childcare cost or private insurance. For independent members, they can be deemed as unemployed if the earning is zero.

IV. Findings

4.1. Typical household 1

Figures 4.1.1.a and 4.1.1.b demonstrate changes in disposable family income and its components along with changes in private income in the case of 35-year-old couple, with 3 and 7-year-old children, both work full-time in the financial years 2018-2019 and 2001-2002, respectively.

Figures 4.1.2.a and 4.1.2.b demonstrate changes in EMTR and AETR along with changes in private income in the case of 35-year-old couple, with 3 and 7-year-old children, both work full-time in the financial years 2018-2019 and 2001-2002, respectively.

4.2. Typical household 2

Figures 4.2.1.a and 4.2.1.b demonstrate changes in disposable family income and its components along with changes in private income in the case of 35-year-old couple, with 3 and 7-year-old children, one works full-time and one is unemployed in the financial years 2018-2019 and 2001-2002, respectively.

Figures 4.2.2.a and 4.2.2.b demonstrate changes in EMTR and AETR along with changes in private income in the case of 35-year-old couple, with 3 and 7-year-old children, one works full-time and one is unemployed in the financial years 2018-2019 and 2001-2002, respectively.

4.3. Typical household 3

Figures 4.3.1.a and 4.3.1.b demonstrate changes in disposable family income and its components along with changes in private income in the case of 35-year-old couple, with 3 and 7-year-old children, one works full-time and one works part-time in the financial years 2018-2019 and 2001-2002, respectively.

Figures 4.3.2.a and 4.3.2.b demonstrate changes in EMTR and AETR along with changes in private income in the case of 35-year-old couple, with 3 and 7-year-old children, one works full-time and one works part-time in the financial years 2018-2019 and 2001-2002, respectively.