Taxes and transfers

Taxation is the compulsory imposition of charges on individuals and entities by governments. Transfers are amounts paid by governments in cash or in kind, mainly to individuals who meet a set of criteria. Examples of cash transfer payments include pensions, allowances, and family payments. Transfers in kind include education and health care.

The amount of tax a government collects partly depends on how the government chooses to provide welfare to its citizens. The design of these taxation and transfer systems, and how they are implemented can vary, but they ultimately aim to achieve similar outcomes.

For example, government may provide an individual with a payment of $5,000 per year or it may provide a tax concession of the same amount. The overall effect is identical but in the first case both taxation and spending are higher than in the second case.

Two examples of providing welfare through the tax system are the tax-free threshold, where the first $18,200 of income is tax free, and some of the exemptions to the GST. Without the tax-free threshold, governments would raise more tax revenue but also increase welfare payments (see Box 1) to achieve the same policy objective. Similarly, GST exemptions on some foods, health and education, could be replaced by payments to households of the equivalent amount. In both cases, the change in tax revenue is offset by the change in expenses.

Governments choose to provide welfare through a combination of tax concessions and transfer payments. Tax concessions carry the risks of being difficult to target, are relatively non-transparent and may result in unintended consequences such as introducing ‘loopholes’. Direct transfer payments can be more accurately targeted but may be complex and expensive to administer. Governments may also be attracted to providing welfare through tax concessions because the size of the budget impact appears to be smaller.

Given that taxes and transfers work in tandem, it is important to consider them together. Without considering both, either component in isolation can be misleading.

Taxes and transfers across age groups and time

People pay different amounts of tax and receive different amounts of government benefits depending on their circumstances. These amounts may also change over time for people with similar circumstances, as tax and transfer policies change. 

One of the key demographic factors affecting taxes and transfers is age. Figure 2-1 shows the sizes of taxes and transfers for all levels of government, as a share of gross household income, for different groups according to the age of the head of the household (this means that, for example, government support for primary schooling is shown for the age of the parent rather than the child). While there have been some shifts in tax and benefits, the tax and transfer system has been in most part been stable for the last 40 years, particularly for those aged from 25 to 55.

Figure 2-1: Distribution of income benefits and taxes
(Share of household income)

Source: Government benefits, taxes and household income, Australia, 2015-16, Australian Bureau of Statistics (ABS), and PBO analysis.
Note: This data is based on the ABS’ Household expenditure survey, which is based on households rather than individuals. The survey results include a margin of sampling error such that small movements between years and age groups may be unreliable.

For those under 25, ‘direct’ taxes have declined slightly as a share of household income over the last 40 years, as more of this cohort have remained in education rather than working.

Most of the changes over time have related to the older age groups, particularly since the early 1990s. For those aged 55 and over, the levels of both taxes and transfers as a share of income have remained relatively stable, but the composition has changed. Direct taxes and direct benefits have both declined, while indirect taxes and benefits have increased.

This is in part due to the age qualification for the age pension and other pension-based benefits increasing from 60 to 65 for women reaching this age between 1995 to 2017[30]. It also reflects rising incomes and the ability for people to work longer as more white-collar work replaces blue­collar work. These changes result in people over 55 receiving fewer direct benefits, such as the age pension, but the level of indirect benefits, such as the medical and pharmaceutical benefits scheme, has remained broadly similar.

Those aged over 65 are receiving a similar amount of benefits as in the past, although the split between indirect and direct has changed over time. While direct benefits such as the age pension have also decreased as a proportion of total income, the amount of indirect benefits have increased, perhaps related to a higher proportion of people aged 75 and over, who require more medical services.

Taxes paid by those aged over 65 have remained largely constant as a share of income over time, but the composition of the tax has changed. Decreasing income tax is partly related to the maturing of the superannuation system, where incomes are concessionally taxed, and the introduction of more generous concessions. Indirect taxes have increased as a share of income for this cohort.