Empirical insights into Australia’s labour market
: Examining the impact of the tax and transfer systems on workforce participation across two decades

  • Nhung Nguyen

    Student thesis: Doctoral Thesis

    Abstract

    Tax and transfer systems are critical and essential instruments for redistributing income and encouraging work incentives (Joumard et al., 2013). Like most OECD countries, Australia has a progressive income tax system where the nominal marginal tax rate increases as income grows. Personal income tax accounts for the most significant portion of tax revenue. Benefits are entitlements financed from general revenue and are either income- or asset-tested (Whiteford, 2010). The tax and transfer system aims to provide both adequate social welfare and to encourage labour participation. However, these can sometimes conflict (Adam et al., 2006; Blundell, 2002). For instance, while a tax cut may encourage work, the overall incentive to work, combined with complex changes in transfer systems such as family benefits and public pensions, may create unexpected disincentives for low-income workers to enter the labour market. Building upon these foundational issues, economists have developed several labour supply models based on the prevailing utility theory in an attempt to explain the influences of tax and transfer systems on heterogeneous groups of families and, therefore, on their labour participation decisions (Blundell, 2003; Callan et al., 2012; Meghir & Phillips, 2010). However, the standard method has several theoretical and empirical challenges as it requires assumptions about complex human behaviour rationales which may be unfounded, especially when adding tax and benefits into the model (Keane, 2010; Manski, 2014). Additionally, it is challenging to completely account for unobserved heterogeneity because, strict numeric utility maximisation may fail to obtain convergence when relaxing the distributional assumption on parameters and model specifications. Using data from nearly the past two decades, this thesis empirically investigates how financial incentives are distributed and have evolved in the Australian labour market and presents empirical evidence on how such incentives interact with people’s labour supply decisions. The findings suggests heterogeneities in behaviour are underestimated in the previous literature and are conditional on the current labour market environment. Specifically, the thesis focuses on answering the following questions: What are the main determinants and the distribution of monetary work incentives provided by the tax and transfer system in Australia, and how have these evolved in the past two decades? (2) Do different population groups respond differently in their labour participation decisions when facing the same financial incentives? (3) Do the financial incentives from different sources (e.g., childcare subsidy vs income tax) have the same effect on labour force participation for mothers with young children? To study these questions, this thesis examines the changes in the labour force transitions through participation tax rate (PTR), a key indicator reflecting financial incentives offered by the tax and welfare system and illustrate the disincentives for specific family situations to enter the workforce. Additionally, the chapter uses a semi-parametric approach to estimate the relationship between the variations in the incentivise and the labour force outcome taking into account both observed characteristics directly and unobserved traits indirectly by grouping individuals with similar attributes. This methodology allows for a more nuanced examination of behavioural response heterogeneity and offers estimates on the less-explored asymmetric effects of incentives on labour supply (Bartels & Pestel, 2016). These estimations help analyse the income consequences of transitions between employment and non-employment in different population subgroups. In addition to incorporating flexible controls for age, education, and family characteristics, I conduct the analysis in smaller population cells segmented by age, gender, and marital status. This analysis aims both to capture heterogeneity and to mitigate potential bias in the estimation due to unobserved factors. Such an estimation strategy challenges the commonly disputed rationality assumption and empirically derives behavioural responses to the tax system through PTRs. Moreover, the thesis disaggregates PTRs into two components - PTR tax-benefit and PTR childcare - to exploit policy variation over time and examine both cross-sectional and longitudinal effects of different financial incentives on participation decisions, particularly for women with young children. To provide a comprehensive view, the thesis also explores the factors that dominate changes in PTRs over time using population-wide counterfactual simulation and a Shapley–Owen decomposition model. This method contrasts with those that focus on "typical" individuals and households, capturing the actual utilisation of personal income tax and deductions in various family circumstances with differing incomes and demographic characteristics. Thus, it presents the distribution of PTRs more extensively than previous studies. The findings indicate that Australia's tax and transfer system from 2001 to 2019 enhanced work incentives, especially for low- and middle-income earners. Overall, the majority of people aged between 25 and 60 have PTRs ranging from 35% to 45%. Workers aged 40–55 have lower PTRs compared to younger workers, suggesting increased monetary incentives to work as they approach retirement age. Empirical results from a Shapley–Owen model reveal that family status is the primary factor dominating the monetary incentives imposed by Australia's tax and transfer system. This suggests that support for specific families, particularly those with children or secondary earners, plays a pivotal role in boosting labour force participation. Further, the semi-parametric estimations reveal that responses to taxation changes are highly heterogeneous, even within a group of population with similar observed characteristics, and vary based on age, income, and current PTR. This challenges the assumption underlying some policies that people within the same group will have homogenous responses. Women show greater responsiveness than men, indicating a higher elasticity of labour force participation concerning PTRs. Additionally, young people—both single and in couples—in Australia are most sensitive to changes in PTRs, which directly influence disposable income. The efficacy of PTRs in promoting labour force participation varies depending on one's current employment status. Finally, the research shows that increases in direct taxation and cash transfers have greater impact on reducing the labour supply of mothers than childcare subsidies, which are administered as consumption subsidies. Interestingly, single mothers are less responsive to changes in both transfers and childcare subsidies. These observations suggest distinct effect of monetary support through different welfare channels and underscore the need for policymakers to recalibrate benefit structures carefully to balance financial assistance with workforce engagement incentives. They also suggest that interventions targeting childcare subsidies may offer greater potential to enhance women's labour market engagement.
    Date of Award2023
    Original languageEnglish
    SupervisorJinjing Li (Supervisor) & Hai Anh La (Supervisor)

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