Modelling approach

The projections of tax revenue break the tax system into three components:

source deduction of benefits and New Zealand Superannuation

source deductions of other income from employment

all other taxes.

Source deductions on benefits is projected as follows:

T^b_t = T^b_t-1 x (1+β)

where T_t = tax and β = growth of benefit payments, including New Zealand Superannuation.

Benefits here include New Zealand Superannuation, Unemployment Benefit, Domestic Purposes Benefit, Invalids Benefit and Sickness Benefit.

Source deductions on all other income sources is:

T^o_t = T^o_t-1 x (1+ g),

where g = growth of nominal GDP.

Total source deductions is the sum of these two:

T_t = T^b_t + T^o_{t .}

All other tax types (such as corporate tax and GST) are modelled as follows:

T_t = T_t-1 x (1+ g),

where g = growth of nominal GDP. In other words, the tax-to-GDP ratio for all taxes other than source deductions on benefits remains constant from 2011 onwards.

The revenue-to-GDP ratio does move up slightly through the projection period, because of taxation on the growing payout for New Zealand Superannuation (and other benefits).

Sensitivity to assumption changes

Because of the structure of Treasury’s Long-Term Fiscal Model, it is not possible simply to alter the tax scales, because taxes are estimated at too high a level of aggregation. It is possible, however, to use proxies to get an impression of the size of the effect of assuming no fiscal drag on the fiscal position.

Sensitivity to assumption changes

These scenarios use tax elasticities to illustrate the effects of different tax scales. The first scenario (full fiscal drag) assumes an elasticity of personal taxes to income of 1.3; a 1.0% increase in incomes results in a 1.3% increase in taxes.[36] This estimate comes from taking the incomes from a sample of taxpayers and working out each one’s tax liability based on today’s personal income tax scale. All incomes are then raised by 1% and the tax liabilities recalculated using the same scale (ie, no indexation). The result is a 1.3% increase in personal tax. All other taxes are assumed to have an elasticity of 1.0 (a 1.0% increase in income increases tax revenue by 1.0%).

Under this fiscal drag scenario, the tax-to-GDP ratio is 2.4 percentage points higher than in the base case.

Source: The Treasury

The second scenario shows the impact of adjusting the brackets in the personal tax scale from 2011 onwards by the assumed rate of inflation: 2% a year. The tax elasticity estimated in this case is 1.14 for personal income, which, when weighted up with the flat taxes, gives a total tax elasticity of 1.06. The result is a tax-to-GDP ratio between the no-indexation ratio (full fiscal drag) and the largely flat ratio. In 2050, the tax-to-GDP ratio for the inflation-indexed case is 1.1 percentage points higher than the base case.

Non-tax revenue

On the non-tax side, the Government also earns revenue from its commercial and other operations. Some examples are the profits from state-owned enterprises, the investment income of funds operated by Crown entities such as the Accident Compensation Corporation and the Earthquake Commission, and income on its foreign reserves.

Source: The Treasury

Increasingly, the largest source of income for the Crown is the earnings of the New Zealand Superannuation Fund. While these earnings are retained in the Fund and will be used for the purpose of paying future New Zealand Superannuation benefits, they are, legally, the income of the Crown and so are included in the Crown’s accounts.