Fair Personal Tax Reform

1. Fair Personal Tax Reform An Economic Assessment April 2008

2. 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

3. 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

4. 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

5. 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

6. 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)

7. Integrity of Personal Tax Base Source: IRD (2005) Briefing to Incoming Minister

8. Integrity of Personal Tax Base Source: NZIER (2007) December Quarterly Predictions

9. Integrity of Personal Tax Base Source: IRD (2005) Briefing to Incoming Minister

10. Integrity of Personal Tax Base

11. Poverty Traps and Marriage Penalties

12. Poverty Traps and Marriage Penalties

13. 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)

14. 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?

15. Personal Tax Options • Broad approaches include • Income splitting • Tax-free threshold • Threshold change • Rate change • Some combination of threshold and rate changes

16. 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

17. 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

18. Threshold Change

19. Rate Change

20. 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

21. Recommended Approach • A calculator for modelling detailed options for personal tax reform is available at www.nzier.org.nz/Site/Publications/reports/2007_Reports.aspx

22. 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

23. 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 early-2009 • 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)

24. Recommendations • 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 tax-benefit 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

25. Recommendations • 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

26. Recommendations • Undertake consultation as required by the Generic Tax Policy Process • Report on approaches for longer-term reform to the tax-benefit system

27. Annex One: Income Splitting • Horizontal equity: single income couples pay same tax as dual-income 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?

28. 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