Addressing disincentives to working

There is evidence to suggest that there is a disincentive problem due to Australia’s generous welfare system and the interaction of benefits with the tax system. In particular, the Australian system has progressive taxation and means-tested benefits. Therefore more tax is taken from higher earners and limited welfare payments are available to those who need them. Inevitably the system penalises people as they improve their incomes (Saunders, 2003).

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Research conducted by Guest, Wyatt and Schuwalow (1998) show that the unemployed face high marginal tax rates and other disincentives to working. The research investigates the implications of very high Effective Marginal Tax Rates (EMTRs) and the targeting of social security benefits. Empirical evidence cited from labour economics proposes that high EMTRs are a disincentive to work through the substitution effect.

An increase in EMTRs lowers the cost of not working and therefore encourages the substitution of leisure for work. The marginal costs of accepting additional work can also act as disincentives and can include work related expenses such as transport, childcare or clothing. The workplace relations minister, Tony Abbott also supports the disincentive argument, claiming that most unemployed people are accustomed to life on welfare and not motivated to find work (in Ruse, 2003).

The welfare and tax systems must be reviewed in order to address disincentives to work. A simple solution to the disincentive problem could be to raise the tax-free earnings threshold above the welfare minimum floor (Saunders, 2003). Workers could then retain more of what they earn and would require less welfare top up payments. Other solutions could be to reduce welfare payments to the point where individuals have little choice but to work or to place a time limit on welfare benefits.

It has been suggested that $2 billion could be saved if access to unemployment benefits were cut after six months (Editorial, Financial Review, 11 September 2003). It is recognised that neither of these suggestions are likely to be implemented, and both would be socially unacceptable. The best solution would be to ensure that potential labour receives a higher benefit for working than the benefit offered under the welfare system and to ensure that the unemployed are re-trained and placed in appropriate programs that encourage and entice individuals into the labour market.

Conclusion In conclusion, Australia maintains a stubbornly high rate of unemployment due to the existence of a natural rate of unemployment. Various reforms that may reduce our NAIRU have been presented. In particular, there is evidence showing that the unemployed in Australia face high marginal taxes and other disincentives to working. The tax and welfare systems must be reviewed to remedy this disincentive issue and assist in reducing our NAIRU.