DECEMBER 3, 2008 5:16PM

Income smoothing and happy families

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Like any country, mine has had its share of policy successes and failures. On balance, we are justifiably proud of our system of universal healthcare and our subsidised pharmaceutical scheme that gives us all affordable access to necessary medicines. Like unemployment benefits, these forms of state welfare work, for the most part, to moderate those vicissitudes of life that can assail any one of us, through no fault of our own. And while they help the less fortunate, we can support them even with purely selfish motives: partly because we may need them one day, but also because a community with too many destitute or chronically ill citizens who cannot afford healthcare is hardly a nice place to live or raise a family.

Perhaps my favourite Australian policy success, though, is HECS, or the higher education contribution scheme. From the 1940s on, and with major growth in the 1960s and early 1970s, the tertiary education system in Australia grew dramatically, as successive governments realised that, (a) a more educated population was essential for our long-term economic competitiveness, and (b) a system enabling young people from disadvantaged backgrounds to be educated on the basis of merit, rather than private wealth, would promote social fairness – though different governments prioritised (a) and (b) quite differently.

In 1974, the newly elected Whitlam government abolished university fees entirely, turning instead to funding from general revenue – that is, taxes. At the time, most students were still from more privileged backgrounds, because enduring employment patterns made it sensible enough for a poorer student to leave school and begin work prior to completing secondary school.

By the late 1980s, though, the growth in high school retention rates and university entry rates resulted in a university system that was becoming too expensive. The government of the day, in what I regard as a rather rare and exceptional display of administrative competence, stripped the issue back to its basics and came up with what was, at the time, a fairly novel solution. (I think it is worth mentioning the architects of this solution by name: Bruce Chapman, an economist at the Australian National University, and John Dawkins, then the federal Education Minister.)

The new scheme, HECS, took into account the important issue of social equity: able students who happen to be poor should nonetheless be able to go to university. However, the scheme also took into account the fact that people with degrees typically obtain a private benefit as a result: once qualified, they earn a lot more. Since they are accruing a private benefit, it is not fair for that benefit to be obtained at no expense to themselves. But university education also confers a public benefit on society as a whole, albeit one that is hard to quantify; educated people are good citizens to have in any community, because they improve that community’s economic and administrative performance, share their knowledge, train others, and so on. In other words, university education confers both private and public benefits, and so it should be paid for by both its immediate beneficiaries (the students), and its less direct beneficiaries, the community as a whole.

The initial scheme, introduced in 1989, imposed only a modest fee as the “private” part of this equation, with the remainder of education expenses continuing to be paid out of general revenue. But rather than simply requiring the private portion of the fee to be paid, the scheme gave students the option of deferring payment. That repayment was to be made on a sliding scale linked to a student’s (or graduate’s) income; the repayment scale kicked in at a moderate income level and was deducted along with income tax. Graduates would pay back all of their HECS, but some would pay it back faster than others because they earned more money sooner. Interest was applied to the debt only at the rate of inflation.

Subsequent review, under a new (right-leaning) government in the mid-1990s, increased the private component of the fees, while maintaining the deferred repayment scheme, and renamed it to “HECS-HELP” – the extra bit standing for “higher education loan programme.”

But while it is true that the simplest way to look at the scheme may be as a student loan, I think the name change spoiled things a bit. It’s not just because I think that it conceals the desirable social equity aspect of the programme. It’s also that I prefer to see it not merely as an ordinary loan, but as a form of income smoothing.*

By income smoothing, I mean utilising lifetime earnings “out of sequence”, in a way that maximises utility. Thus, knowing that a university graduate will, generally speaking, earn significantly more than someone without a degree, a government scheme like HECS-HELP can allow a young person to get some of the benefit of their future earnings sooner, in a context that is good for both the young person and the community as a whole. An approach like this isn’t merely a hand-out, because it will be paid back later. Nor does it encourage waste in the way that simple government hand-outs can, because the fees accrue to the student and warrant a rational assessment of the costs and benefits of university study.

The idea of income smoothing is really predicated on a few simple observations:

- we have a lifetime savings capacity

- the timing of our access to savings is not always optimal in a way that is most efficient

- access to "future savings" can smooth our income in a way that maximises lifetime income

- many of us do not have access to private means of income smoothing such as sufficient credit, family or personal wealth

- there is a public benefit, as well as a private benefit, to some forms of income smoothing, including university education

People who have considerable assets or investments routinely smooth their income, drawing on savings or liquidating assets so that they can live a certain way at a certain time in their life, rather than having to tie their activities to their immediate income. They replenish the expenditure later, from future income. It is a powerful method by which to have a more productive and rewarding life. Those who are less well-off can’t ordinarily do the same, but a scheme like HECS-HELP gives them access to this powerful “life optimising” strategy while still ultimately requiring them to pay for those things that benefit them.

Considering that, overall, the scheme has been quite successful and has few serious critics, it’s perhaps surprising that it hasn’t been used viewed as a model for income smoothing in other areas where private and public benefits coincide. To some degree, our superannuation scheme has elements in common with it, particularly if you take the “income smoothing” rather than the “deferred repayment loan” view that I prefer. But the one I am thinking of is parental leave. We currently have a debate underway about the level of maternity leave – time off work after having a child – that is desirable here. How long should it be? Should any of it be paid leave? How much? How long must a job be held open by an employer? (I should mention that most of these kinds of rules, in this country, apply only to larger employers and not the smaller ones).

To date, the debate has not included a discussion of the combination of private and public benefits that parental leave can confer. There is a clear private benefit to parents who are able to stay at home with their children. There is a clear public benefit for communities in enabling parents to care for their children more closely. And there is even the same kind of equity issue that arises with access to a university education: costs aside, it would be a fairer world if the poor as well as the wealthy could afford to take time off work to look after their young children.

An income smoothing model seems like a great one to explore for this kind of problem, and has been raised by at least one think tank, the right-leaning Centre for Independent Studies (at this point, I must acknowledge that a newspaper article by one of their policy analysts, Jessica Brown, was my source for the idea of drawing a link between HECS and parental leave policy).

Having a child is, of course, expensive – what a terrible time to lose family income! And yet, people who give up work to look after young children are not bowing out of the workforce forever – most look forward to returning to employment in a relatively short timeframe. Meanwhile, placing the whole burden of a private choice to have children on taxpayers or employers is manifestly unfair, because it doesn’t strike the right balance between private benefits and private costs. Nonetheless, recognising that there is also a public benefit to more flexible working arrangements for parents of young children (happier communities and more well adjusted kids), it is by no means inappropriate for government to play a role. A big part of that role could be a HECS-like scheme to enable parents to smooth their income – drawing, while their children require the most time-intensive care, not only on their past savings (if they have any), but on their anticipated future savings as well.

I realise that most of the people who read my posts here on Open Salon are Americans, and that for the United States, the gap between current policy and the kind of policy I’ve talked about here is much larger than it is for Australia. Still, I thought it might be of interest to hear how we have approached some universal problems down here. One thing to note is that, while this kind of approach looks and smells a little like that terrible “socialism”, that “taking from the rich and giving to the poor” that everyone fears so much, for the vast majority of those who participate the “rich” and “poor” in that cliché are the exact same people, but at different stages of life.

 

*I should mention that the term “income smoothing” is also commonly used to describe a business accounting methodology, which is not related to the income smoothing I have been talking about.

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We need more of this type of thinking and discussion in the U.S. I just read where the increased cost of college education here is outstripping increases in family incomes by a factor of three (see http://www.nytimes.com/2008/12/03/education/03college.html?em). This is going to have a major detrimental impact on the U.S. economy.

Please keep the posts from Down Under coming.
Thanks Mike.

Obviously not everything is rosy down here either, but it can only be good to think about different ways of looking at things.
Jason, thanks for this insight. You're right, we need ideas like these in the U.S.
I didn't know that it was possible, but your post just lowered my approval of the terrible U.S. Congresses that I have witnessed in my lifetime.
Great article. The only thing that surprises me about it is that this is not the common sense wisdom applied everywhere. I've been suggesting similar ideas for years only because they seem obvious. I don't even think it's necessarily unreasonable to do it percentagewise, that is, to say that the cost of education should simply be a percentage (even possibly a progressive percentage) of future income. So, for example, if you go to college and it never gets you more than minimum wage for the rest of your life, you pay nothing later on, thereby not detracting from your need to pay basic bills. But if you go to college and it gets you a modest "targeted" income, you pay a percentage of that income back to the school system. If you get rich, it's presumably at least partly owing to your education, and you pay at least a straight percentage if not a larger percentage in thanks for the extraodinary benefit you got. But then, seeing those percentages, it seems a lot like just something that could be factored into the tax system. So, rather than just rates for married and single, there could be tax rates for college-educated or not, etc.