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There are growing signs of an interest in introducing income splitting for families that have at least one dependent. It is the policy of the One Nation party, and it is rumoured that other parties are considering the proposal.

Income splitting is a type of family tax policy that treats the family, rather than the individual, as the basis of taxation. It allows couples to pool and then split their incomes for tax purposes, thus reducing the tax paid on the highest earning partner. All couples would be eligible.

Important here is the concept of horizontal equity. It means “equal treatment of equals”, or, in more concrete terms, that people with the same capacity to pay taxes should pay the same amount of tax.

Equal capacity to pay tax is the key concept. It is not the amount of gross income, because people who have the same income but differ in the amount of unavoidable expenditures incurred due to differing circumstance clearly do not have the same capacity to pay tax. Families need more income than singles.

In some countries, the pooled family income can be split between parents and dependent children (those under 18 years), further leaving more earned income with the family. This gives families greater autonomy, making them more independent of the welfare state.

The family payments and childcare system is based on the needs of families, so why is the taxation system based on individual income and not the family?

Uncertain Financial Outcomes

According to a policy costing requested by former senator Gerard Rennick, implementing income splitting for families would decrease the fiscal and underlying cash balances by $12.4 billion a year, due to reduced income tax revenue. This estimate is considered “uncertain”, in fact very uncertain, because it is not known how many families would be eligible or what will be the “behavioural responses of the impacted individuals”.

Look a little closer, and it emerges that the only certainty is that the financial outcomes are uncertain.

There may be very strong social reasons to implement the change, but the fiscal picture is murky because there are so many moving parts.

The Parliamentary Budget Office estimate is based on two assumptions, one crude and the other unknowable. The first is a belief that 26 per cent of tax filers would engage in income splitting “in line with the share of the national adult population that is both part of a couple and has a dependent child aged 18 or under or a dependent with a severe disability”.

This is far too simplistic. For one thing, the couples’ incomes may be similar, so it would make only a small difference to split incomes. There is already significant profit sharing – effectively the same as income splitting – when the main earner in a family is either a small business owner or a sole trader. It is very common, and legal, for sole traders, and small business owners, to employ their spouse and there are over 1.5 million sole traders in Australia and about 2.5 million small businesses.

The second assumption is that “there would be no significant behavioural impact on labour supply or resultant impact on taxable income under the proposal, including no reduction in work associated with higher effective marginal tax rates for secondary earners”. The point of introducing income splitting is precisely to encourage a behavioural change: making it easier for one parent to stay at home to perform a child-caring role. The costing thus ignores the very thing the policy is supposed to achieve.

Reviewing Family Payments

To develop a persuasive financial argument for the proposal, there would inevitably need to be a parallel examination of all family payments, which cost $34.9 billion in 2024-25. Most are means-tested and costly to administer.

It includes the Family Tax Benefit (FTB) program, administered by the Department of Social Services, which cost $17.2 billion in 2024-25 ($13.4 billion for Part A and $3.8 billion for Part B). Part A has an income threshold of $80,000 per year.

Another outlay is Paid Parental Leave, which is biased towards parents who work. It cost $3.3 billion in 2024-25.

The Child Care Subsidy, which is administered by the Department of Education, cost $14.3 billion over the same period, and there are other small one-off payments like the Newborn Upfront Payment and Newborn Supplement.

The FTB payments are unlikely to change substantially. The Paid Parental Leave payment may be slightly affected because there could be fewer parents in the workforce, but it is a relatively small cost. But the Child Care Subsidy, which costs more than the Budget Office’s estimate of the fall in tax revenue from income splitting, could be substantially reduced if there are more parents providing home care.

This suggests that not only is the Budget Office’s estimate of $12.4 billion an overstatement of the impact, the net effect may be much lower because one parent is not using institutional childcare.

There may also be administrative efficiencies. The late Stephen Smith, formerly a lecturer in accounting at Monash University, said that simplifying the tax transfer system will “reduce the amount of what is known as ‘fiscal churning’, a mutually offsetting tax and expenditure flow, or in plain terms, spending tax revenues from someone to provide income and government-funded services ‘back’ to that same person”.

Smith pointed to many other shortcomings in the current system.

One is “the development of a welfare mindset that lowers self-esteem and individual responsibility”, which does not happen with reducing tax payments.

Another is an unintended consequence of means testing, whereby the use of large penalties for people earning extra income discourages people to work and may actually increase poverty rather than alleviating it. The extreme complexity is not only difficult for families to deal with, it is expensive.

Family as Society’s Foundation

Income splitting is neither a new nor an especially radical idea. The National Civic Council has been urging this change for decades. As far back as 1975, the Asprey committee urged that the government prepare, for public examination and discussion, a detailed scheme for elective family unit taxation.

Many countries allow different ways for couples to shift income between them, although the picture is mixed. Variants of family-based taxation currently apply in many OECD nations: the United States, Canada, France, Germany, Belgium, Greece, Luxembourg, Portugal, Switzerland, Iceland, Ireland, Norway, Poland, Spain and the Netherlands.

Few would argue against income splitting for families on the grounds that it leads to socially undesirable outcomes. It is stating the blindingly obvious that the basis of any society is the family, and it would be a family-friendly policy. Having a parent look after their children in their early years in most cases is clearly preferable.

But it is going in the other direction. According to the Australian Institute of Family Studies (AIFS), women are increasingly remaining employed after they take time off to have a baby: 32 per cent of mothers with babies aged under one year were employed but away from work in 2021, compared to just 5 per cent in 1991, a six-fold increase in 30 years. There was virtually no change in the proportion employed and working some hours: 25 per cent.

The study also found an increasing trend for both parents of young children to be working:

“In 2022, both parents were employed in 71 per cent of couple families with children under 15 years. This compares with 56 per cent in 2000, and 40 per cent in 1979.

“This is supported by the availability of parental leave, with some mothers having access to paid leave through work provisions or through the Australian Government’s Paid Parental Leave. We know, too, that families are under increasing financial stress, through larger mortgages, (creating) impetus for women to remain employed when taking time off to care for a baby.”

From the perspective of the political parties, the overriding imperative will be to win elections. One Nation’s rising popularity may also be capturing the LNP’s attention.

But for income splitting for families to have a chance of becoming policy, there needs to be a rigorous costing of the likely implications and because there are so many factors to consider, it is a major undertaking.

Another element to consider is, if some parents leave the paid workforce, how much will that affect tax receipts? On the other hand, how much is saved from reduced fiscal churning and seeing some parents seek more hours of work because they are no longer constrained from working due to a poverty trap?

A somewhat perverse outcome might be that economic “growth” would slow, because GDP, a record of the total value of transactions, has been bolstered by getting carers into the workforce rather than having them do child rearing for free.

As the economist Mariana Mazzucato wryly commented: “If you marry your babysitter, GDP will go down. So, do not be tempted to do this, okay? Because an activity that perhaps was before being paid for is still being done, but is no longer paid.”

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Republished with thanks to News Weekly. Image courtesy of Adobe.