Population ageing, taxation, pensions and health costs, CHERE Working Paper 2007/10

3 Taxes, family support and income tests

Australia is widely viewed as having a progressive tax on individual incomes.
However, the rate schedule of a country’s income tax system is set not solely by the
schedule of rates applying to personal income but also by the design of income tests
for benefits, exemptions, credits and offsets. The focus of the analysis here is on the
high rates of tax faced by married women as second earners under a system of
effective joint taxation, introduced by targeting the Medicare Levy (ML) exemption
and Family Tax Benefit Part A (FTB-A) on the basis of joint income, and the
withdrawal of Family Tax Benefit Part B (FTB-B) on the income of the second
earner. The Medicare Safety Net, which is linked to FTB-A, is also at fault. The
section first explains the structure of tax rates created by these policy instruments
based on hypothetical cases, and then goes on to present an empirical analysis of the
impact on families using household survey data.

3.1 Structures of tax rates

We compare two hypothetical families, the first with one partner in full time work and
the second with both partners in full time work, to show how the above policy
measures set high rates on the income of a second earner. For convenience, we label
the single-earner household “H1” and the two-earner household, “H2”. Each
household is assumed to have two children, one aged under 5 and the other under 13
years, and to decide first on the primary earner’s labour supply and then to choose the
labour supply of the second partner. The male partner is taken to be the primary
earner. All adults face the same gross wage and have zero non-labour incomes. Under
these assumptions the two households have the same primary incomes, but the H1
household has only half the joint income of the H2 household because the female
partner in H1 has chosen to specialise in the home production of childcare and related
services rather than in market work.

Figure 1a plots the profile of marginal tax rates (MTRs) that apply to the income of
the primary earner in each household when the 2006-07 schedule of MTRs on

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