Getting the Incentives Right on Welfare

If the entire policy-making mindset of the Liberal Party could be reduced to a single underlying principle, I believe it would be the fundamental importance of incentives in determining outcomes. This principle informs our views on everything from economics to welfare policy, our support for capitalism, low taxes, small government, free markets and our strident opposition to socialism. Reward for effort, individual responsibility, border protection and rule of law are all in large part matters of incentive. Good policy means the right incentives. Bad policy usually means good intentions but the wrong incentives.

The fundamental problem of welfare is one of incentives. Take for instance the question of social housing. People in social housing have usually waited years to get it, they pay well below market rent and are strongly incentivised to stay. The problem is that when they earn too much they are forced to leave; they are therefore strongly incentivised to remain unemployed. We need better solutions to the problems of housing affordability and homelessness, and the productivity commission has concluded this as well, recommending a stronger emphasis on rent assistance over social housing.

Over 100,000 people sleep homeless each night. For a country as prosperous as Australia, this is neither acceptable nor inevitable. There is an opportunity for the Liberal Party to develop solutions to this problem that set us apart from Labor and the Greens, who are spending big on social and affordable housing. With 150,000 households on the public housing waitlist, they are barely making a dent.

As Liberals, we should be advocating for solutions that leverage private investment, provide greater choice and fairness for tenants and incentivise self-reliance. If we truly believe that markets not governments provide the best solutions, then we should be spending less on housing projects, and putting that money into rent assistance where the tenant can decide what accommodation suits them best. We should also be focussed on solutions to the core problem of rental affordability: namely an imbalance in supply and demand. Immigration must be drastically reduced and housing supply boosted, as I have written about here.

For many Liberals (including our leaders), discussion about welfare starts from the wrong premise. Slogans such as “Lifters not leaners”, “If you have a go, you get a go”, etc. all stem from a view that unemployed people are generally dole bludgers who don’t want to work.

This claim is easily disproven. Dole bludgers (except for freshly minted ones) are by definition long-term unemployed. The current rate of long-term unemployment is less than 1.5%. Allowing for the fact that some people are basically unemployable, the total number of dole bludgers who simply choose not to work can’t be much more than 1%. Therefore, if unemployment were at its long-term average of 6.5%, we would do well to remember that more than 80% of unemployed are not dole bludgers, they are hard and willing workers just like us – only they’ve had the misfortune of being sacked. Once we acknowledge this crucial point, we can proceed from a place of compassion and respect for the unemployed, instead of suspicion and contempt.

The core challenge when setting the rate of the dole is one of incentives. I believe that as a society, we should judge ourselves by how we treat our poor, sick and elderly. Yet this does not mean making unemployment comfortable. It should be uncomfortable, but not impoverishing. I feel the current rate is about right in striking this balance, but there are two major issues that need reform.

Firstly, there is a continuing risk, given the large gap between the minimum wage ($880/w) and the dole ($375/w), that a short-term setback will spiral into a vicious cycle of unemployment. For example, a person living paycheque to paycheque on the minimum wage who goes on the dole can usually no longer afford their current rent and bills. They may be forced to sell their possessions or go in to debt just to pay for basic necessities. They may be unable to pay school fees. Within months they will likely fall behind on rent and be evicted. All of this seriously impairs a person’s ability to find work, especially when there aren’t many job vacancies. They may be rushed into an ill-suited job for the sake of finding any work, rather than taking the necessary time to retrain or find a job that matches their skill set. The remedy for this situation is simple: the dole should be increased for the first 2-3 months of unemployment to provide a relatively secure position from which people can look for work. 2-3 months is short enough that there is still immense urgency to find a job, but the onset of financial stress is crucially delayed to give the person the best chance of bouncing back.

Secondly, the rate at which the unemployed lose benefits when they earn money from work is far too high, and a massive disincentive to finding work. Liberals rightly protest against Labor’s changes to the Stage 3 tax cuts, because they recognise that a tax rate of 37c in the dollar disincentives hard work. How can we possibly accept that a person on the dole being docked 60c (+19c income tax) for every dollar earned is anything other than the same thing but much worse. One might argue that the difference is the taxpayer is losing their own hard-earned money, whereas the welfare recipient is merely losing money they didn’t earn, which is technically true but misses the point. In terms of the psychology of incentives, the two are equivalent: If I work more, I lose X% of what I earn. What we should do is decrease the falloff rate for the dole to 42c in the dollar, for the first year of unemployment. This rate is calculated such that their welfare payments reach zero when they are employed full-time at the minimum wage.

Contrary to what our opponents claim, being Liberal doesn’t mean being indifferent to the suffering of unemployed people. In fact, compassion and a sense of fairness and equity, so characteristically Australian, are our political assets, especially when we bring our distinctly Liberal values to bear to find lasting policy solutions that get the incentives right.