Moves to a Basic Income-Flat Tax System in Australia: Implications for the Distribution of Income and Supply of Labour
Melbourne Institute Working Paper No. 05/04
Date: April 2004
Author(s):
Abstract
Problems with work disincentives and poverty traps apparent in the Australian tax-transfer system have led to a renewed debate about the advantages of universal benefits relative to means-tested benefits. This paper examines the implications of moving to a system where benefits are universal and the marginal tax rate schedule is simplified to a constant rate, refered to as a basic income flat tax system. The Melbourne Institute Tax Transfer Simulator(MITTS), a behavioural micro-simulation model of the Australian tax-transfer system is used to examine the distributional,labour supply and government expenditure effects of moving to a basic incomeflat tax system. Providing basic income levels that coincide with current benefit rates is costly, with a marginal tax rate of over fifty percent required for revenue neutrality. Such a system, while equitable, is found to reduce labour supply. If a version to inequality is high, this system is found to be socialy optimal, even after reductions in labour supply. Decreases in the marginal tax rate improve work incentives and increase the supply of labour, but increase inequality and impose a significant cost burden on government. A decline in the level of basic income of at least half is required to fund a reduction in the marginal tax rate to thirty percent. While the distortions to behaviour are minimal with this final system, it is extremely inequitable and social welfare reducing, even after a counting for changes in labour supply.