Income tax and workforce participation

7.2 Personal income tax has been linked to workforce participation. The imposition of income tax, together with reductions in income support payments (‘transfers’) as people earn more income, reduces the financial rewards from work, which may make work less attractive.[1] Higher tax rates can reduce incentives to work since people have a smaller marginal gain from employment and they may consequently choose not to undertake paid work. Conversely, others may work more to achieve a certain target level of income that they consider adequate for their needs. In economic terminology, these contrary effects are described as the ‘income effect’ and the ‘substitution effect’.[2]

7.3 The Issues Paper discussed several aspects of the income tax system in relation to mature age workforce participation, including:

  • Effective Marginal Tax Rates (EMTRs);

  • the complexity of the tax transfer system;

  • tax exemptions for social security payments; and

  • tax offsets.

7.4 Responses from key stakeholders largely focused on systemic reforms to the tax system. For example, the Australian Council of Trade Unions (ACTU) stated that, having regard to the Inquiry’s framing principles of system coherence and stability, it would not support ‘significant structural change to one payment … in the absence of change to other forms of income support payments’.[3]

7.5 Systemic tax reform is beyond the scope of this Inquiry. Further, such a project was completed in 2009, when the Tax Review examined, and recommended cohesive reforms to, the tax transfer system with a particular focus on ensuring appropriate incentives for workforce participation.[4]

7.6 Consequently, this section does not propose reforms to income tax laws. It summarises the income tax issues raised in the Issues Paper and the responses from key stakeholders, and points to relevant Tax Review recommendations.

[1] See: The Treasury, Australia’s Future Tax System: Architecture of Australia’s Tax and Transfer System (2008), 239.

[2] FaHCSIA, Pension Review Report (2009), 18. Higher tax rates and smaller marginal gains from employment may mean that some people will choose leisure time over work.

[3] ACTU, Submission 38. See also: COTA, Submission 51; Olderworkers, Submission 22.

[4] The Treasury, Australia’s Future Tax System: Final Report (2010), pt 1, vii, Terms of Reference.