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The 2023 Commonwealth Budget provided a number of different forms of additional transfers of government funds to support those on low incomes as compensation for the income reduction effects of on-going inflation.

Direct income grants included the $40 a fortnight increase in the JobSeeker, Youth Allowance and Austudy transfer payments, and extension of eligibility for children from 8 to 14 years for the Single Parent Allowance. Means-tested subsidies for electricity of $500 for those on social security benefits and up to $650 for small businesses, and a 15% increase in the means-tested Rental Assistance Allowance, provide subsidies for particular products purchased by those on low incomes. Increases in payments to general practitioners for services provided to low-income customers also lower costs of living; as they are partly justified as helping to correct for external benefits and public good properties of health care, they are not considered further.

This blog criticises the use of subsidies for particular consumer products relative to direct income grants as a policy intervention to improve the wellbeing of low-income households, and in the 2023 Budget context, to compensate for inflation.

Providing inflation relief

Direct income grants to those on low incomes are effective government policy interventions to provide compensation for higher living costs caused by inflation. Specific income augmentation policy examples include increases in social security payments and reductions of income taxation at the lower levels of income. These policy options do not add to distortions of household consumption choices. With the additional nominal income, households with different preferences choose to continue to purchase a similar mix of goods and services prior to the inflation. If well designed, the restoration of real incomes can be targeted at those most in need of support to minimise budget outlays.

By contrast, subsidies for particular products, with energy and housing the 2023 Budget examples, distort consumption and production decisions with a loss of efficiency. Particular product subsidies are less comprehensive than general income grants in offsetting the costs of inflation for some sectors of the wider population on low incomes adversely affected by inflation.

An example

The energy subsidy illustrates decision distortion and efficiency costs of a particular product subsidy as a policy intervention to reduce the welfare loss of inflation. While the energy subsidy is in the form of a lump sum payment independent of quantity of energy purchased, many households perceive the subsidy, and lower average energy bill, as a lower marginal cost of energy and an addition to other government policy interventions to reduce the domestic prices of coal and gas. The lower relative consumer price for the subsidised product for households directly in receipt of the product subsidy induces an increase in relative consumption of the subsidised product (namely, energy) and less of other products.

Further, there are flow-on decision distortion and efficiency costs of a selective product subsidy from the increase in demand. The increase in demand flows on to an increase in supply of energy and some reallocation of scarce production inputs from the production of other products.

These production efficiency losses are important for traded products, including those used in the production of energy. Setting domestic relative prices different to international relative prices involves well-known resource misallocation decisions and efficiency costs. World prices represent the social opportunity costs. Arguments that the policy interventions to reduce the domestic prices of energy inputs as a short-term response to a short-term bump of global prices, say because of the Ukraine-Russia war, falsely assume government has better forecasts than the private sector and that this information cannot be provided to, or responded by, private sector decision makers. Inflation does not provide an efficiency argument for subsidising the prices of products which increase at a faster rate than the average price during a phase of inflation.

For domestic market products, with the rent assistance increase and housing an example, the increase in demand likely raises the market price of housing with adverse redistribution effects. Not all low-income households adversely affected by inflation will be in receipt of the subsidy. In addition, some will be adversely affected by the subsidy-induced increase in the market price.

Indexation of social security payments and income tax brackets

A future policy package to protect low-income households from the adverse effects of inflation would involve automatic indexation of all social security payments. Indexation would be changed from the Consumer Price Index to Average Weekly Earnings for JobSeeker, Austudy and Youth Allowance in line with other social security payments. The Average Weekly Earnings index provides a comparison with other households. Personal income tax brackets also would be automatically indexed to remove the disposable income reducing effect of bracket creep in the form of higher average tax rates for all as is done in many other countries.  In the event of inflation running ahead of wages growth, as has been the current inflation event, consideration could be given to a short-term advance of the indexation increase.


Other Budget Forum 2023 articles

The Costly and Unfair Stage 3 Tax Cuts Will Undermine the Progressive Income Tax and Worsen Inequality, by Kathryn James, Guyonne Kalb, Peter Mares, Miranda Stewart and Roger Wilkins.

Inflation Forecast, Fiscal Policy and Personal Income Tax Rates, by Chris Murphy.

Will the Budget Reduce Inflation? By Michael Coelli.

Stage 3 Tax Cuts and JobSeeker – A Slightly Different View, by Andrew Podger.

Equity Is Hard to Achieve When Unfairness Is Baked into the System, by Robert Breunig.

A Small Investment in the Budget With a Big Policy Return? By Nicholas Biddle.

Labor Could and Should Have Gone Stronger on the Petroleum Resource Rent Tax, by Rod Sims.

How Removing Parenting Payments When Children Turned 8 Harmed Rather Than Helped Single Mothers, by Kristen Sobeck.

Straightening Out the Super Tax Breaks Debate, by Brendan Coates and Joey Moloney.

The Priorities of Australians Ahead of Budget 2023-24, by Nicholas Biddle.

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