By ABC's Michael Janda Updated Fri 2 May 2014

Photo: Lowering the minimum wage would arguably make the return to surplus more difficult. (AAP: Lukas Coch)

The Commission of Audit has proposed controversial changes to the age pension and minimum wage despite the fact they won't help the budget get back in the black, writes Michael Janda.

The Commission of Audit was primarily tasked in its terms of reference with examining the sustainability and efficiency of Commonwealth expenditure, with a view towards returning the budget to surplus.

In its report, the commission was targeting a budget surplus equivalent to 1 per cent of gross domestic product (GDP) within a decade.

Since the report's release, there has been extensive coverage of many of the cuts the commission recommends to put Australia on that path.

However, two of the most controversial recommendations don't appear to contribute to that mandate and one, arguably, would make the return to surplus more difficult.

Those recommendations are changes to the age pension and altering the way the minimum wage is calculated in order to lower it.

The proposed change to the minimum wage, given that it does not directly relate to public expenditure, must surely have been included in the report under the term of reference allowing the commissioners to consider "other savings or matters that the Commission considers should be brought to the Government's attention".

The proposal is to benchmark the minimum wage to 44 per cent of average weekly earnings over 10 years, by increasing the pay of Australia's poorest workers by the inflation rate minus 1 per cent over that period.

The commission notes that "under this arrangement the minimum wage would continue to grow over time in nominal terms". What it doesn't expressly articulate is the logical corollary that it will fall in real terms - Australia's lowest paid workers will have less purchasing power than they do currently; they will become poorer.

To put it in context, the wage cut the commission is talking about, if implemented immediately, would result in the minimum pay rate sliding from just over $32,000 a year to just over $25,000 - roughly a 20 per cent cut.

What is the commission's rationale for this recommendation? The report explains:

A minimum wage that is too high prevents groups, such as young job seekers, from entering the labour market, inhibiting the development of workplace skills and experience that could increase their wages over time.

This is an orthodox economic argument that lowering the minimum wage would encourage employers to take on more low paid workers, and that this would boost employment (and thus tax collections) while lowering unemployment (and thus dole payments).

However, there are two serious problems with this line of reasoning.

The first is that it may be wrong. The commission references no evidence to support its assertion that lowering the minimum wage will increase the employment of low paid workers.

As it turns out, the academic literature is mixed - while many economists do believe lowering the minimum wage will substantially increase demand for low-skilled workers, a large number of these analysts also predict that the impact on total employment will be low.

Other empirical studies, many looking at minimum wage rises in some US states, have found that a lift in the base rate of pay has had no effect on employment levels, or have even detected a small positive impact.

One potential reason for this is the propensity of low income earners to spend most of their earnings, meaning that any extra money they receive is likely to be cycled through the consumer economy, such as retail, creating more work.

On a local anecdotal level, discounted youth wages clearly don't have enough of an incentive effect for employers to rush out and hire young people, with the commission itself noting that youth unemployment is twice the general rate for older people on full pay.

In short, the jury is still out on whether a lower minimum wage would boost employment at all and, if it did, by how much.

Heed the warning

The 86-point hit list outlined by the Commission of Audit yesterday is a lopsided affair, but it shouldn't be dismissed out of hand, writes Ian Verrender.

 

The second problem with the commission's reasoning is that, even if a lower minimum wage created more jobs, they would be substantially lower paid, and therefore pay less income tax.

Given the propensity of low income people to spend almost all of their incomes, a wage cut would likely lower consumption and therefore GST revenue.

All in all, the minimum wage cut would have to create a lot of employment, much more than most of the economics suggests it would, for the job creation effects to offset the lower tax revenue collected from each employee.

Another other seemingly incoherent proposal is the flagged change to the pension eligibility age and assets test.

Many economists agree that these things may need to be changed to cope with an ageing population, particularly the bulge of older Australians from the baby boomer generation that are now retiring.

The incoherent part of the proposal is when these changes would take effect.

The commission suggested 2053 for the pension age to rise to 70; the Treasurer is talking about 2035.

The commission is saying that tightening the assets test and other changes to reduce the growth of pension payments should kick in for people applying for pensions from 2027 onwards, but not apply to people already on pensions.

But applying these changes then does nothing to address the biggest budget challenge, which is not so much that we are all living longer, but that the largest demographic group in Australian history is living longer and retiring now.

By the time these changes would be introduced, a substantial number of baby boomers would have started shuffling off this mortal coil, taking some of the budget challenges their generation is creating with them.

Once the baby boomer bulge has passed through retirement into death over the next 20-40 years, the spread of ages becomes smoother again.

While longer lifespans will still present a challenge of fewer workers to each retiree, the problem will not be as acute.

Exempting baby boomers from the pension cut backs defeats the raison d'etre for making them in the first place.

Michael Janda has been the ABC’s Online Business Reporter since 2009. View his full profile here.

The Audit proposals that won't help the budget - The Drum (Australian Broadcasting Corporation)