Fair Personal Tax Reform
An Economic Assessment
April 2008
Preliminary Issues
► NZIER
has undertaken this work independently
of government or any other institution
► Focus
is on personal tax and benefit reform. A
reduction in GST is not considered to be a valid
option
2
The Four Tests
► No
borrowing or cuts in services (1 and 2)
– Elasticity of tax revenue (may be a ‘cheap lunch’),
distinguish capital from operating expenditure,
establish the counterfactual expenditure level
► Avoid
exacerbating inflationary pressures
– Real issue the inflationary effect of fiscal policy –
poorly targeted spending likely to be more inflationary
than personal tax reductions
► Not
leading to greater inequality
– Better expressed in terms of fairness
3
Fairness
► Support
for progressive taxation (varying tax
liability according to ability to pay) does not equal
envy. This can be read in two ways
– Arguments for progressive taxation are more robust
than simply being based on envy
– Arguments for progressive taxation do not justify envy
(need to consider change in proportion of income
paid, not dollar reduction)
► Consistent
treatment is important
4
Problem Definition
► The
four tests do not give reasons for personal
tax relief
► It is necessary to identify the policy problem (c.f.
political problem)
► Changes should be kept in context (the personal
tax scale collects $23 billion from 3.3 million
taxpayers)
► Changes should be right and not rushed
5
Integrity of Personal Tax Base
►
►
The personal income
tax scale has
remained unchanged
since 1999
Income growth has
pushed more
taxpayers into higher
tax brackets (fiscal
drag)
Current Personal Income Tax Scale (Including
Low Income Earner Rebate)
39%
33%
21%
15%
$9,500
$38,000
$60,000
Note: Not drawn to scale
6
Integrity of Personal Tax Base
Source: IRD (2005) Briefing to Incoming Minister
7
Integrity of Personal Tax Base
Source: NZIER (2007) December Quarterly Predictions
8
Integrity of Personal Tax Base
Source: IRD (2005) Briefing to Incoming Minister
9
Integrity of Personal Tax Base
Growth in average hourly wages 2000 to 2006
Cumulative Wage
Growth
40%
35%
30%
25%
20%
15%
10%
5%
0%
2000
2001
2002
NZ Gross
2003
AU Gross
2004
2005
NZ Net
AU Net
2006
Source: NZIER, based on 40 hours work per-week, incomes net of personal
income taxes
10
Poverty Traps and Marriage Penalties
Key areas of family income assistance (2007-08)
Recipients
$ Billion
Total tax revenue
49.6
Total social assistance
16.3
Key areas of social assistance:
New Zealand Superannuation
505,900
7.3
Working for Families Tax Credits
350,000 (1)
2.6
Domestic Purposes Benefit
96,400
1.5
Unemployment Benefit
41,400
0.5
Invalid’s Benefit
81,100
1.2
Accommodation Supplement
251,500
0.9
Notes: (1) Approximate figure based on MSD Statement of Intent
Sources: Estimates of Appropriations (2007), Vote: Social Development, Vote:
Revenue, Ministry of Social Development (2007), Statement of Intent
11
Poverty Traps and Marriage Penalties
Making work pay for a sole parent (2007-08)
EMTR
Net Income
$800
110%
100%
$700
90%
$600
80%
70%
$500
60%
$400
50%
$300
40%
30%
$200
20%
$100
10%
$-
0%
0.0
10.
20.
30.
40.
50.
60.
Hours of Work
Market Income
Domestic Purposes Benefit
Family Assistance
EMTRs
Note: Assumes two children under 12, minimum wage
Source: NZIER
12
Poverty Traps and Marriage Penalties
► Major
contributor main benefit abatement
– DPB relatively strong incentives for part-time, poor
full-time incentives
– UB poor part-time incentives, easier to earn income
above ‘welfare wall’
► WFTC
– MFTC creates high ‘EMTRs’, which mostly face sole
parents
– Trade-off between lowering abatement rate (30 → 20)
and poverty traps (lower rate shifts disincentives
higher)
13
Poverty Traps and Marriage Penalties
► Marriage
penalties (before accounting for cost
differences and child support liability)
– Highest for (largely) single income families on around
$50,000 to $60,000 with multiple children and
receiving Accommodation Supplement
– Followed by beneficiary families with multiple children
and receiving Accommodation Supplement
► Key
Qn: which disincentives should we be
concerned about?
14
Personal Tax Options
► Broad
–
–
–
–
–
approaches include
Income splitting
Tax-free threshold
Threshold change
Rate change
Some combination of threshold and rate changes
15
Income Splitting
► Couples
would be allowed to ‘split’ their income
for tax purposes (e.g., a single-income family on
$100,000 would be taxed as a family with two
earners on $50,000)
► These families would benefit due to the
progressive income tax scale (they would face
lower rates twice)
► Everyone else would face the individual personal
income tax scale
16
Tax-Free Threshold
► No
personal income taxes would be levied on
incomes below a particular threshold (say,
$5,000)
► E.g., all people with total incomes below $5,000
would pay no income tax, people with incomes
above $5,000 would only pay income tax on
income above the threshold
17
Threshold Change
Adjusting Thresholds for Fiscal Drag
Marginal
Tax Rate
39%
33%
21%
15%
$9,500 $11,875
$38,000
New Thresholds
Current Personal Scale
$47,500
$60,000
$75,000
Gross Individual
Income
Note: Not drawn to scale
18
Rate Change
General Reduction in Rates
Marginal
Tax Rate
39%
37%
33%
31%
21%
19%
15%
13%
$38,000
$9,500
New Rates
Current Personal Scale
$60,000
Gross Individual
Income
Note: Not drawn to scale
19
Recommended Approach
► A simple
policy is a good policy
► Income splitting and tax-free thresholds are
unfair, inefficient and not cost-effective (detailed
slides on these options are included as annexes
to this presentation)
► The appropriate approach would be to shift
thresholds, lower rates or undertake some
combination of both
► The appropriate approach should be considered
within a longer-term revenue strategy
20
Recommended Approach
Hypothetical Rate and Threshold Changes
Option
Fiscal Cost Static Distributional Effect
($b)
Raising Thresholds for Fiscal
Drag
1.4
Largest reduction in ATRs from $40,000 to $50,000
2% All Rate Reduction
1.9
All ATRs fall by 2%
37% Top Rate
0.3
Largest reduction in ATRs above $100,000
31% Upper Middle Rate
0.3
Largest reduction in ATRs from $50,000 to $60,000
19% Lower Middle Rate
0.9
Largest reduction in ATRs for $25,000 to $40,000
13% Bottom Rate
0.5
Largest reduction in ATRs below $10,000
33% Top Rate
0.8
Largest reduction in ATRs above $100,000
Note: Due to data limitations all figures should be seen as indicative only
Source:
►
NZIER
A calculator for modelling detailed options for personal tax reform
is available at www.nzier.org.nz/Site/Publications/reports/2007_Reports.aspx
21
Broader Tax-Benefit Interface Issues
► Unit
of assessment
► Definition of income and means
► Time period for assessment
► Abatement rates
► Provision to breadwinners or caregivers, and
addressing shared custody arrangements
► The
combination of these issues leads to
much complexity
22
Timing
►
Timing is a major issue
– Inflationary expectations increasing. Market
commentators do not expect inflation to fall back
within the RBNZ target band until late-2008 or early2009
– Administrative systems stretched. A change to
personal rates has implications for other taxes (e.g.,
FBT, RWT)
– Employers facing fast growing non-wage labour
costs (including KiwiSaver obligations)
23
Recommendations
1.
2.
3.
Note the need for a clear definition of the policy
(c.f. political) problem
Note the need to consider personal tax
changes within the context of a broader taxbenefit and revenue system
Note that market commentators do not expect
inflation to fall back within the RBNZ target
band until late-2008 or early-2009
24
Recommendations
4.
5.
6.
7.
Report on a range of options for changes to
personal tax thresholds and/or rates
Rule out income splitting and tax free
thresholds as options
Report on changes to other taxes required as a
result of personal rate changes
Report on compliance implications of tax policy
changes
25
Recommendations
8.
9.
Undertake consultation as required by the
Generic Tax Policy Process
Report on approaches for longer-term reform to
the tax-benefit system
26
Annex One: Income Splitting
►
Horizontal equity: single income couples pay same tax as dualincome couples → is this treating ‘same’ as the ‘same’?
►
Vertical equity: tax relief increases with household income (due to
progressivity) → is this basing liability on ‘ability to pay’?
►
Efficiency: reduce EMTRs and ATRs of primary earners, increase
those of secondary earners → would this increase labour
participation and/or increased work effort?
►
Fiscal cost: every dollar in tax revenue foregone requires a tax dollar
elsewhere, a reduction in spending, or increase in government debt
(all else being equal) → does the reduction in revenue justify the
opportunity cost?
►
Administration and compliance: how would the boundary between
couples/non-couples be policed, and are there better policy tools
(e.g., family tax credits) available?
27
Annex Two: Tax-Free Threshold
►
Horizontal equity: most individuals would be treated the same,
however some households may benefit from the change more than
once
►
Vertical equity: the level of tax relief would rise with income up to
$5,000 gross, but then would remain unchanged. Tax relief would be
limited to $750 per-individual per-year ($5,000 x 15%), but some
relief would be received by most personal income taxpayers (except
for people who rely solely on a main benefit)
►
Efficiency: average tax rates for all people above $5,000 would fall
(no change in their marginal rates), marginal and average rates for
people below $5,000 would fall
►
Fiscal cost: fiscally costly policy as received by almost all personal
income taxpayers
►
Administration and compliance: increased incentives for reallocating
income within households to avoid income taxes
28