Tax/Benefit Reform:
Social Dividends and Flat Taxes


Keith Rankin, Economics Dept., University of Auckland, 18 June 1997

In his budget on June 26, Winston Peters is expected to announce plans to restructure the income support system. Indications are that the principle of benefit conditionality will be reinforced, leading to a further departure from the commitment to a universal welfare state as envisioned by the First Labour Government and by the Thaddeus McCarthy Commission in 1972.

An income support system with numerous eligibility criteria and cumulative means­testing itself creates a complex poverty trap; a problem of dependency. Indeed, welfare dependency can be defined as the creation of incentives for persons receiving targeted benefits to manage their lives so as to remain eligible for those benefits. One form of solution, therefore, is to reduce targeting instead of reducing benefits.

Reversing a trend to excessive targeting requires lateral thinking. A number of journalists had such an insightful idea about the 1996 tax cuts [eg Jane Clifton and Warren Berryman]; they saw them as a "social dividend of sorts". More accurately, the tax cuts were an extension of some existing social dividend or tax concession; a social dividend that should be regarded as interest on socially­owned property and not as a hand­out.

Following the 'tax cut as social dividend' idea, the social dividend could be assessed as the sum of all ordinary tax concessions. Prior to 1 July 1996, for a person on the upper tax rate of 33%, ordinary tax concessions amounted to $2,779 per annum. This arose because there was a nine cents in the dollar concession on the first $30,875 of gross income. (Nine percent of $30,875 equals $2,779.) For persons grossing more than $30,875, their incomes were effectively taxed at a flat rate of 33% and topped up with a social dividend of $2,779.

From July last year, the social dividend increased to $3,933. 111/2 percent of $34,200 (the new threshold) equals $3,933. That amounted to an increased return on social capital of $22 per week, payable in full to every individual receiving over $34,200 of private income.

Social dividends should be recognised for what they are, as benefits. There need be no pejorative connotation placed on the word 'benefit'. Other benefits include student allowances, payments made by the New Zealand Income Support Service, and the Independent Family Tax Credit which featured in the 1996 tax cut package.

Social dividends should not be restricted to people eligible for tax concessions. Members of 'dependent' households - retired persons, students and beneficiaries - also receive social dividends. They receive cash benefits in excess of $3,933 ($77 per week). The first $77 per week paid to each beneficiary is their social dividend.

Most 'independent' New Zealanders are entitled to something approaching a $4,000 social dividend. The welfare system is now so comprehensively targeted that almost every adult in a low income household receives or is eligible to receive some kind of income support in addition to their wages and ordinary tax concessions. Such support includes income top-ups to wage­earners or their partners: eg Accommodation Supplements, Family Support and the Guaranteed Minimum Family Income.

The existing multiplicity of benefits, taken together, comes very close to being a 'flat tax / social dividend' regime, albeit in an inefficient bureaucratised form. The formula - gross income, less 33%, plus $4,000 - serves as an adequate approximation to the annual disposable income of most adult New Zealanders. We can say that most of us are taxed at a flat rate of 33 percent, and entitled to receive a social dividend approaching $4,000. Winston Peters, as Treasurer, could save money by simply cutting out the red tape associated with the many different ways the present social dividend is paid out.

In advocating a social dividend of around $4,000 per annum, I am certainly not arguing that benefits should be limited to $4,000. Rather I am suggesting that the first $77 per week of an unemployment benefit, for example, could become unconditional, and the remainder would still be subject to conditions (such as those favoured by Peter McCardle) and means­testing.

This approach clears the ground for a manageable income support system. Taxes would be levied as a simple proportion of private income. Benefits would come in two types: universal dividends and means­tested transfers. (For superannuitants, their $100+ per week in addition to their social dividend could be paid as either an age dividend, a transfer, or a bit of both.)

I suggest the use of a points system - not unlike that used by the Immigration Service - for assessing eligibility for transfers. An initial level of points might be allocated to allow for an unemployment or sickness benefit at today's levels. Additional points would be awarded on account of, for example, disability and dependent children.

Transfers would thus be customised to recipients, and would be means-tested just once. For example, if the transfer abatement rate was set at 27% and the tax rate remained at 33%, then a beneficiary (transferee?) would get to keep 40% of any additional earnings. That amounts to an 'effective marginal tax rate' of 60%. A means-tested benefit set at $80 per week would disappear once the recipient's earnings approximate $300 per week.

My argument for an explicit 'flat tax / social dividend' regime is one of economic efficiency. I am making no value judgements about how high or low benefits should be. The figures I have used above as examples essentially preserve the status quo in terms of benefit entitlement.

A social dividend approach makes income support much simpler to administer, and makes it easier for political parties in the future to brand their fiscal policies. The dividend amount, the tax rate and the criteria for transfer payments should be contested in the political arena, and not set in accordance with the preferences of technocrats or advantaged segments of the community.

A fiscal contract of the form suggested not only recognises the importance of social capital by paying a transparent social dividend. The fiscal contract that underpins the welfare state is itself a crucial part of a civilised society's capital; of society's productive wealth. A non-judgemental welfare state, by reducing the individual costs of risk-taking, increases the supply of enterprising risk­takers in particular and of creativity in general. Indeed, the dependency debate should be more about fostering creativity, and less about workfare.


© 1997  Keith Rankin

Rankin File