Rethinking the Costs of Targetting

In the Budget, the Rudd government chose to deliver the Howard tax cuts and to make their savings by tightening up means testing. It represents a strategic choice about the best way to achieve income redistribution. The question is whether it is the right choice.

There are broadly two approaches to the vexing issue of redistributing income. One is to have a strongly progressive income tax system and to use it to fund universal services. The other is to have a low flat tax
system and to target government hand outs to the most needy.

Neoliberals argue the first system is inefficient. The inefficiency arises firstly from‘churning’ – the cost of taxing people and then giving them their own money back through universal services and payments. There is an efficiency cost in circulating the money through lots of hands. Secondly, they argue, a progressive income tax system distorts incentives for high income earners. So the neoliberal’s prefered approach is to go for low taxes and targeting.

The costs of churning, however, need to be considered against the costs of targeting.

The first and most pressing cost of targeting is the practical challenges created by trying to decide who is in and who is out of a target group. Targeting payments to low-income earners has created serious poverty traps, where the poorest people face very high marginal tax rates as they try to get back on their feet.

Secondly, targetting also creates social divisions. Pauline Hanson swept to power on the back of downwards envy over targeting. Middle income people struggling to make ends meet took umbrage at
what they saw as the indolence of those that fell into the target group. Where the division crosses a racial divide, it becomes socially divisive.

Finally, there is the old saying that if you want to have a safety net for the poor, you should never let it become a system for the poor. When it stops being a concern of the average citizen, it is allowed to fall into decay.

We need to reconsider the costs of targeting.

Further reading:

Mr Turnbull commissioned a report from an economist, Henry Ergas, which was handed to the Opposition last July and debated by its shadow cabinet in August. It proposes moving to a single flat tax rate

New York Times “Going Dutch – how I learned to love the European welfare system” – highlights the differences between these two approaches, as played out in the USA and Netherlands.