The fatal flaw in our social policies since 1991 remains to haunt us

I am really struggling to write about what I see happening right now. Reviewing the many hundreds of articles I have written over the past 40 years about family incomes, poverty traps and effective marginal tax rates, I am reminded that it is the sign of insanity to keep doing the same thing and expecting a different answer.

Yet I couldn’t stop having another go at it last week in the Daily Blog: “There is a truckload of trouble coming as the budget looms and the signals are ominous”. It is like shouting into a void.

By way of background: the neoliberal experiment begun by Labour in the 1980s was taken a lot further in 1991 with aggressive user pays policies and low flattish tax rate. The infamous Mother of all budgets sets out the direction in Jenny Shipley’s “Social Assistance: Welfare that Works. “Assistance will be closely targeted on genuine need and people will be expected to support themselves when they have the ability to do so.”

That translated meant use pays policies and social assistance only for the poor. The balanced mix of universal provision and targeted welfare was ditched for an extreme focus that limited social provision by aggressive income testing.

In 1992, a group of “leading economists” were invited to contribute to a series of articles in the Dominion Post called “Toward 2000, an Economic Odyssey” The usual suspects including Ruth Richardson, Michael Cullen and Rodney Hyde were generally upbeat with Rodney Hyde expecting Nirvana with government being reduced to a “pipsqueak” of no more than 3% of GDP. Possibly to achieve gender balance I was also asked. I remember the negative reaction to my pessimistic article “Omens of further Social Stress” in which I predicted we would see families drowning in a morass of low incomes and trapped in poverty by high effective marginal tax rates:

In a Daily Blog I wrote eight years ago Let’s have open slather on the 1990s I revisit the background to this problem:

In the mid-1980s, economists thought high tax rates on high income earners reduced their incentives to earn and save. Rogernomics was supposed to fix that. Government spending was to be cut sharply in the shift to userpays and tight targeting for social provisions and the tax scale flattened to give a low flat tax rate. While Lange had a cup of tea and moderated this a little, the problem of high tax rates was simply shifted from top income to low and middle income earners.

The snag is, the greater the amount of social assistance to be reduced as income rises, the longer is the range of income before all assistance has been bled out, unless a higher rate of abatement is imposed. A long income range defeats the purpose of welfare only for the poor, while a high rate of abatement imposes severe disincentive effects.

In advice to the incoming government in 1990, Treasury had warned:

As a general rule, the more people facing higher effective marginal tax rates [EMTR]over longer ranges of potential income, the greater the costs to society and the greater the probable loss of output.

So they were worried about the effect of overlapping abatements that mean very little is left in the hand when low income people earn a bit more- the high effective marginal tax rate (EMTR) problem .

Treasury identified high levels of benefits as a major factor preventing a more gradual abatement system and benefits were cut significantly in 1991. The Change Team on Targeting Social Assistance in 1991 was then tasked with designing a new ‘integrated’ system of targeted social assistance to solve the overlap problem of multiple targeted provisions.

The 1991 budget document ‘Welfare that Works’ contained the lie that the technocrats could make tight targeting of social provision work. They devised a complex system of Family accounts. They drew clever diagrams like this one to show how they would make welfare only for the poor by aggregating social assistance of all kinds onto a family based ‘smart card’. When a family increased its income by a dollar, entitlement would reduce by a uniform rate of abatement. Voilà, a miracle.

Unfortunately, while aggregating assistance onto a family-based ‘smart card’, abating at one rate worked in theory, the technocrats could not make it work in practice. One of the problems was that the typical modern family did not resemble the assumed nuclear family model. Another was that the scale of assistance to be targeted, even with the 1991 welfare benefit cuts, meant assistance would be paid well up the income scale even with a very high single rate of abatement. The integrated solution that had been used to justify the low flat-tax user-pays approach had quietly disintegrated leaving the unresolved welfare mess of a plethora of high and overlapping abatements.

While one might have expected a re-examination of the basis of the 1990s reforms, instead the welfare morass has been intensified in the name of target efficiency. It is one of the major reasons that hardship rates are high in low income working families even when gross income looks to be above the poverty line.

In the blog I gave an example of what I was seeing then (2017)- versions of which I have revisited every year:

Let’s take the example of a parent on the minimum wage of $15.75 per hour, earning $36,350 per annum. There are some Working for Families and rent subsidies but increasingly this family relies on foodbanks and loan sharks. Let’s say there is an opportunity to earn another $10,000. Once tax and ACC are paid (18.71%), Working for Families is abated (22.5%), student loan repayments are made (12%), Accommodation Supplement is reduced (25%) and KiwiSaver extracted (3%), the $10,000 has been effectively taxed at 81.21%. Furthermore, there may be a sudden drop in child care subsidies, and child support payments of between 18-30% may apply taking the rate to over 100%. Every family is in a different set of circumstances, and few will understand what is actually happening. They will know that at the end of the year despite their extra work effort they are no better off, may actually be worse off and will undoubtedly feel despair.

Nothing has changed and in fact it has just got even worse as I outline here: “There is a truckload of trouble coming as the budget looms and the signals are ominous”. And don’t think the ‘living wage’ is going to save low income families.