Presentation to the Wellington WEA, 25 July 2005.
Keywords: Social Policy;
There is one outstanding fact about New Zealand poverty. Choose any reasonable poverty line, and you will find that over 80 percent of the poor are children and their parents. The figure would be even higher if one included other adults living in households with children. The economic problem of poverty is overwhelming children and the families they live in.
We should not be surprised. Given low unemployment a person can earn a modest income for her or himself. New Zealand Superannuation is indexed to these wages. These people share in the rising prosperity of the nation. But how can the children of the nation share, unless there is some public mechanism to steer a share of the nation’s income in their direction?
We like to say – we use to say – that New Zealand is the best place in the world to raise children. There is still a lot going for the New Zealand child. Many – but not all – experience a good physical and social environment, a loving family, and real opportunity. But the complacency of the ‘best place in the world to raise children’ slogan has meant we have one of the least supportive financial environments for children. International comparisons among rich countries suggest we are low on financial transfers to families with high on child poverty.
Official figures estimate that in 2001 New Zealand had about 29 percent of children in poverty, using the official poverty line. It thinks that in the 2004 year there was still 21 percent below the line, reflecting the effects of the fall in unemployment, rise in real wages and various government initiatives such as cheaper access to health care and the phasing in of the ‘working for families’ package which is redistributing income in favour of children with working parents. But as welcome as these changes are, there is no room for complacency: 180,000 children together and their parents are still be below the official poverty line.
Can we do better? Can we get reclaim the ambition that New Zealand should one of the best places in the world to raise children? We can. But to attain the goal we must think much more systematically about the poor, their needs and how to respond effectively to them.
Who Are The Poor?
So first, who are the poor? Given our failure to focus on children as central in poverty, we should not be surprised that the popular image of the poor is largely different from the reality. Of those who live in poor families:
– over half are Pakeha;
– over half live in two parent families;
– over half depend on earnings rather than benefits;
– over half own their own homes (with a mortgage) rather than rent.
The reason why the research picture of the typical poor family is rather different from the public image is that while ethnic minorities, single parent families, beneficiaries and renters have a higher proportion who are poor, they are a much smaller group in the entirely of the community, and so in total they are not the dominant group among the poor.
Focussing on these minority groups as the poor has two serious impacts.
First it divides the community. Emphasising the Polynesian single family living on a benefit in a rented house – a most untypical poor family – means that any family that does not have these characteristics but is in as great, or greater, need feels left out and resentful. We saw the effect of that alienation after Don Brash’s Orewa speech. The claims that policy favoured the Maori were extremely exaggerated. But the mainstream rhetoric suggested otherwise, and people felt angry, including, ironically, Maori who also believing the rhetoric could not understand why they were not receiving more from the misrepresented policies.
Over-emphasising the minorities also distorts policy, making policy delivery inefficient. It is not much use trying to eliminate poverty by targeting a small proportion of the poor. Conversely effectively targeting all the poor will address the problems of the Polynesia poor, and the single family poor, and beneficiary poor and the rental poor. That does not mean we should neglect them. Policy needs to be sensitive to the special circumstances of those in minority circumstances just as it has to be as to be sensitive to the majority.
Most of all, it needs to keep its eye on the ball. In the case of poverty the ball is children and their parents. Solve that one, and we decimate the number below the poverty line. A substantial proportion of the residual are in situations not particularly amenable to economic interventions. For instance there is a growing number of unemployed who suffer from psychiatric or drug abuse problems.
Resolving poverty among children and their families will affect other families who are already above the poverty line. That is because we cannot exclusively target on those below, as I shall shortly explain.
Additionally there are families who have solved their income deficiencies problems by making great sacrifices. A psychiatrist once remarked to me that all one (anonymous) patient needed was sleep therapy? ‘Sleep therapy’ I innocently asked. ‘Yes’, I was told. The mother was looking after the kids in the day, working at night: what she needed was eight hours good sleep a day. If we were to supplement her family’s income, the likelihood is she would have given up the shift work, and spent more quality time with the children. One might say they solved the household fiscal deficit, but created a social one.
Does Poverty Matter?
But, you might ask, ‘does poverty matter? I grew up poor, and look how well I did?’ The research does not argue that poor children will inevitably suffer in the long term. Some will be successful, often because of bit luck added to exceptional talents. What the research shows is that poor children are less likely to prosper.
Let me illustrate with an anecdote. Over a hundred children lived other in the street where I grew up. Only three of us got to university (two graduated) at a time when the university intake was 15 percent of the generation. That difference cannot be explained by the kids in the street being naturally stupid. Rather they were poor, and that limited their life opportunities.
Or consider health status (albeit with the caveat that the majority of the poor are healthy on the measure I am going to use). Suzie Carson and I looked at the health of children by their household income (adjusted for family size). We found that a child in a bottom quintile household were three times as likely to be in fair or poor health as a child in a top quintile household.
Why are poor children more likely to be sick? Their parents arnt nearly as prone to sickness, so we cant attribute it to family background. Rather childhood is period when individuals are more vulnerable to sickness – especially because of their living situation. The circumstances of the poor include less access to health care (including transport cost as a hindrance), poorer nutrition, and inferior housing, all of which are likely to be detrimental to a child’s health.
You may think that such outcomes are unfortunate or unfair. But they can also be socially damaging. How many adult New Zealanders with poor health are precipitated there by childhood conditions? How many miss out on life path opportunities indirectly because of poor childhood health, or directly because of financial limitations. We dont know the exact number, but it is likely to be large. From a child’s perceptive, the earliest years are the happiest days of one’s life – or they may not be. But from society’s perspective children are a social investment. Each generation’s quality of life is dependent upon the success of that social investment in younger generations. This becomes especially true when the generation retires because their welfare depends almost entirely on the younger generations. .
That so many children are in poverty suggests we are under-investing in them, even though we know that human capital is one of the keys to economic and social progress. The comparison with most other OECD countries supports the conclusion.
Investing in Children
If we decide to increase the investment, what should we do. The big investment areas are education, health services, housing, and income assistance.
The record is that the parental contribution to schooling has been increasing. There is a system of public funding which favours lower decile schools – the ones which tend to have more children in poverty. Even so, higher decile (and family income) schools are better funded overall, and the children benefit as a result.
The government has been increasing the subsidies for children visiting a general practitioner, and has also put a lot of effort into better public health for children. Those concerned with poverty should give the government credit for that poverty relief.
The government has also increased housing assistance, although I dont know how much of the funds go into the pockets of landlords and in higher house prices, rather than relieve the long term financial stress of poor families. There is still not a coherent approach to housing, although that was even more true in the 1990s.
However, today I want to spend most of the time available exploring the issue of income assistance. Basically people are poor because they have not enough money. We can alleviate their poverty by giving them more. Of course, that wont solve it all, for there are other contributors to poverty. But without more income the other contributors will compound an already unsatisfactory situation. Income assistance is effective.
The catch about this strategy – of addressing the problem directly rather than through some partial and misunderstood interpretation of the real problem – is that it is expensive. The ideal situation would be a universal family benefit – one for every child related to age and the other children in the house – of sufficient value to take the poor out of poverty. But because the rich would get the same supplement it would be very expensive. Given that we only have a certain about of government support to give away, unless we raise taxes substantially, that which is available has to be targeted on the poor.
But it cant all be targeted only on the poor. Those who are just above the poverty line also have to have some income supplementation, for otherwise they would have no incentive to better themselves. Those just above them also need some assistance, for the same reason. So the support has to taper out.
Typically what happens is that as the income of the assisted rises, as well as paying income tax they also experience a reduction in the amount of assistance. For instance, if they earn a dollar, the government might take 20 cents in tax, but also reduce their family assistance by 50 cents. So at the end of the day they have only 30 cents in the hand despite having earned a dollar. We call the 70 cents in the dollar the ‘effective marginal tax rate’ or EMTR.
The Treasury estimates of the EMTRs on the second earner of two groups of households, are published as Figure 4.5 in the OECD Review of New Zealand. There are various other assumptions but for our purposes we dont need to detail them because the conclusion we are after is quite general and apply to other households.
What is instructive is that the effective marginal tax rates are very high on the left hand side of the graph, when the second earner is earning a low income, but much lower on the left, when the earner is a high income. The rising on the right from 21 to 39 percent is the progression in the income tax system. On the right, among the poor, the levels are higher: over 50 percent and even over 70 percent.
So the poor face higher marginal tax rates than the rich. Politicians bemoan their rich clients facing marginal tax rates of 39 percent. But the poor, who have very few politicians to speak on their behalf, face rates which are almost double the so-called ‘iniquitous’ rate on the rich.
The Treasury also provides estimates of EMTR for some beneficiary households. (Figure 4.4) They face even higher marginal tax rates, even tax rates of 100 percent, which means that if they earn anything extra they experience no rise in their income. That is what we mean by the ‘poverty trap’. Extra effort gives no extra reward. There being no incentive to make an extra effort, the family is trapped into a low income level. That is no only detrimental to them, but it is detrimental to us because if they are not working they are not contributing to national income, while they remain a burden on the tax system.
It is important to understand why this happens. The mathematical model is simple, but I’ll try to explain it in words.
Suppose we decided there was a minimum standard of living to which everyone is entitled. I’ll ignore here that we may say some people should earn it – a difficult direction when there is unemployment. Now I want you to decide what proportion of the average income that minimum should be. My experience is that people usually propose a minimum in the range of 50 to 60 percent of the average. So let’s say 55 percent. The theorem says that in order to guarantee a minimum income for everyone of 55 percent, there has to be somewhere along the income distribution an effective marginal tax rats a rate of 55 percent or more.
If you prefer a 60 percent minimum, then somewhere the EMTR will have to be 60 percent to more. And so on.
The theorem does not say where this high rate has to be exactly. It could be put on those with highest incomes in which case the system would be progressive. Or it could be put on those with lowest incomes and the system would be regressive in places. In practice we make the latter choice.
There is a nice little illustration of the theorem in the Treasury graphs. They show the rates before and after the working for families package. The effect of the package was to raise the minimum income for working families. The theorem predicts that somewhere there will be a hike in the EMTRs and, sure enough, the graphs show one.
At the time of the working for families package was introduced, there were some politicians who waxed indignant about the high EMTRs, observing that a family could substantially increase its earnings and yet have little increase in take home pay. Some, I’m regret, were hypocritical, for they did not draw the conclusion that the EMTRs on families with children could be reduced by raising the general level of income taxes. Or perhaps they are going to reduce EMTRs by reducing the minimum income that families are entitled to.
That was a major factor in the justification for the benefit cuts of 1991, and it was likely to be a factor as to why the working for families package did not raise the income of beneficiaries. A major concern was that there is not enough difference between the income of non-working beneficiaries and the income they would receive if they worked, it being argued that when the gap was small there was no incentive for beneficiaries to go out and find a job.
It is a complicated area. We face the uncomfortable tradeoff of being only to choose two out of the following three objectives:
– high minimum incomes;
– low tax rates on those in receipt of government assistance;
– low general tax rates.
Even so, the designers of the current system have not covered themselves with glory.
To give the government a little credit, it did its best with the ‘working for families’ package last year. The package is the tax cut we are demanding. What the government did was calculate the largest possible tax cut that could be phased in over the next three years, and instead of cutting general tax rates, they gave all the money available to low income families with a working parent. That may not have been many people’s priority, but child poverty reduction was the government’s, even though those without children did not get a tax cut. .
The package was too ad hoc, and it was hamstrung by having to ensure no one was worse off. A better strategy would have been to have started from zero and ask how the available funds going to families could be best spent. I look forward to the day such an exercise occurs. In the interim we have the working for families package.
Can Our Children Afford Tax Cuts?
Given the quantity of child poverty, you may think the package is too meagre. The government spent every penny it had left on the package, after its other commitments. That is why it had to phase it in over a number of years: there was not the revenue stream to introduce it in one hit. In a typical year the government has only an extra billion dollars or so to allocate on spending and tax cuts. About half has been going on education and health. So it is out of this smaller pot that the tax cuts in the working for family package has been funded.
‘But’, you may ask, ‘isnt the government running an enormous fiscal surplus’? The answer is no, it is not. Total Crown liabilities are projected to rise by $1.7b in the year to next June. ‘What about’, you may ask. ‘the enormous OBERAC surplus?’ But OBERAC, the operating balance after revaluation and accounting changes’, is an accounting measure and not the true fiscal surplus, because it does not include the various capital outlays of the government. OBERAC is not large enough to cover all the capital outlays. That is why the government has to borrow.
Regrettably, those unfamiliar with the fiscal matters focus on the OBERAC measure, including alas far too many journalists and politicians. It is unfortunate their misunderstandings – one might say ‘ignorance’ – misleads the public. However rather than go through the intricacies of the fiscal theory, which I did at a St Andrews presentation In Praise of Fiscal Sustainability a couple of weeks ago, let me give that paper’s summary of why we cannot afford a tax cut unless we cut government expenditure:
1. The government is already borrowing – $1.7b this year.
2.Consumer spending has grown faster than incomes – 17.7 percent against 13.3 percent. We have already spent the proceeds from the growing economy
3. Cullen has spent it all – just like every other Minister of Finance in election year. Of course he has. He would be stupid not to.
In the 1980s the Labour government borrowed to fund its tax cuts for the rich. The government account did not get back to fiscal balance until the early 1990s, when the incoming National Government made savage reductions on government spending, eliminating the fiscal deficit by increasing the social deficit. Poverty levels rose. Among those most heavily hit were the nation’s children.
Tax cuts funded by borrowing will raise interest rates and the exchange rate, and stagnate the economy, just as they did in the 1980s when there were six years of economic stagnation. Children born after those events never benefited from the tax cuts of the time and now suffer from them: from the long term effects of cutbacks in social expenditure and because they have to fund the debt servicing from the higher borrowing. Tax cuts in current circumstances are about getting today’s children and those yet to be born, to pay for our consumption splurge. We keep them in poverty to fund our greed.
Poor economic performance of the last twenty years is one of the limitations on our ability to give bigger tax cuts – to children, or anyone. In turn we will suffer from the inferior deal we gave to the nations children: we may already be suffering in high crime, more expensive social policy, and lower national income from less productive workers.
It is easy to say ‘child poverty does not affect me, and so it does not matter’. It affects all of us. At issue is whether we are willing to make the sacrifices to invest in the nation’s children now, to give the nation and each of us a long term benefit.
Is New Zealand the best place in the world to bring up children? For many children, the answer is still ‘yes’. For too many others the answer is a sad but firm ‘NO’. We are not going to make that slogan true by endlessly repeating it, We make it true by committing ourselves to the goal. The first commitment has to be address child poverty.