Budget deficits are no excuse to neglect income inequality

By Professor Guay Lim. Melbourne Institute

Federal Treasurer Scott Morrison recently handed down another budget deficit. This means that the government expects to spend more than it receives. This adds to Australia’s problem of returning to surplus.

But budgets are more than just about getting back to black. One of the aims of fiscal policy is to meet social objectives, such as the redistribution of income and wealth to promote income equality.

Australia has a tax and transfer system that, in part, is aimed at reducing income inequality. The tax system is progressive; where higher marginal tax rates are imposed on higher income earners. It also operates an active transfer system; for example making welfare payments. These two features help to bring about a more equitable distribution of income/wealth.

Inequality in Australia has risen

The latest Budget includes a boost to social security and welfare which is largely due to the transition to the full National Disability Insurance Scheme. It also gives a small tax cut for middle-income earners (by raising the upper limit of the second highest tax bracket from $80,000 to $87,000).

Since the early 2000s, about 9% of GDP has been spent annually for social security and welfare purposes. In real per capita terms, welfare payments increased from about $3,900 in 1993 to just over $6,300 in 2015. This increase would seem to suggest that low income earners have benefited over time. However, analysing income inequality is more complex than just considering this.

A key study by the Productivity Commission, Trends in the Distribution of Income in Australia, examined the effect of taxes and transfers on households. Specifically, they examined changes in income inequality since the late 1980s and concluded that while there have been wide-spread economic gains, they have not been uniform. Specifically, growth for the top half of the distribution (above the median) has been greater than for the bottom half in both absolute and proportionate terms.

The general conclusion is that income inequality in Australia has risen. Plus, Australia has higher income inequality than most OECD countries

Guay Table 1

Table 1 shows degrees of income inequality according to the Gini coefficient, which is the standard measure of inequality in society; as well as estimates of the share of income going to say, the top (bottom) 20% of the distribution (the quintiles). The table illustrates the distribution of income for broad income groups classified by the World Bank. Statistics for Australia lie within the range for other high-income OECD countries.

Figure 1 shows where Australia’s Gini sits relative to a selection of 24 OECD counties. Taking a 10-year average, the Gini coefficient for Australia is 35.3 (where 0 corresponds with perfect equality) while the shares of income going to the top (bottom) quintiles are respectively 38.5, 7.0. Put simply, many other OECD countries have lower income inequality than Australia (and not just the Scandinavian countries).

Education and health are also important measures of inequality and both are big expenditure items in the Budget. They constitute about 7.4% and 15.7 of total expenses, respectively in the 2014/15 Budget, and about the same in the recent Budget.

Spending on education is down

Government expenditure on education has fallen in recent years, from about 2.7% of GDP in 2009/10 to 1.9% of GDP in 2014/15. We see from Figure 2, that taking into account all government expenditure (federal and states), Australia’s expenditure on education as a percentage of GDP is on the lower end of the spectrum.

Spending on health is up

Given that Australia has an ageing population, Federal expenditure on health has been creeping up from 3.6% of GDP in 2000/01 to 4.1% of GDP in 2014/15.

Figure 3 compares Australia’s total government (Federal and states) expenditure on health with other high income countries (average over 2004-2013). This shows that total health expenditure in Australia (expressed as a percentage of GDP) is less than that of other high-income countries (about 9% to 11%); but expressed as a share of total health expenditure (including the private sector), Australia’s public spending on health is 67% compared to 61%.

Guay figures 2

Any reduction in education and health expenditure by the government will need to be understood and debated by the general public. While a user-pay system might be considered fair, it can be difficult for low income earners and hence it can contribute to greater income inequality.

Ultimately, the biggest challenge for the Treasurer is to bring the budget back to surplus and reduce income inequality. A budget deficit is no excuse to neglect income inequality.

This piece draws on a longer Melbourne Institute Policy Brief, co-authored with V. Nguyen and T. Robinson.

Image credit: Gordon Haire/Flickr

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