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Population ageing and taxation

Obviously, an ageing population means more people will be dependent on NZS and private pensions for their income; and older and younger people tend to differ in the amount of their income they spend and what they spend it on. This could affect both the amount and type of tax revenue they pay.

A recent Treasury study focused on this demographic change.[9] While it might be expected that this analysis would show a fall in income, as older people on lower incomes like NZS replace younger earners with higher incomes, this does not appear to be what will happen. Most people's incomes rise from when they first enter the labour force until they reach 45 to 55 years of age, and then tend to decline towards and into retirement. With the average age of the New Zealand adult population expected to rise from around 45 currently to 51 by 2050, it turns out that rising incomes for those currently under 50 are expected to approximately balance the declining incomes of those currently over 50.

An important change, however, is that more income, and therefore more income tax, GST and excise revenue, will be dependent on NZS payments. Because the number of people aged 65 and over is expected to double by 2050, the effect of ageing doubles (from around 6% to 12%) the share of income tax and GST that will be raised from NZS payments. As this redistribution of the overall tax take occurs because of higher spending on NZS, it will not result in a more favourable revenue to expenditure balance. An increased contribution from a source of tax revenue not linked to any government spending will do much more to help balance future budgets.

Personal income tax rates are also important when demographic change means we will want increased labour market participation - whether by encouraging immigration, discouraging emigration or by having more New Zealanders enter the workforce or stay in paid work longer; for example, by delaying full-time retirement. For this reason, it is especially important that the future tax system encourages rather than discourages paid work, particularly among older age groups. As high average and marginal income tax rates discourage participation, the process of population ageing is likely to require a shift away from a reliance on such income taxes.

The prospect of higher taxes to pay for increased spending raises a different issue. Today's workers pay taxes to fund current public services, including superannuation. This is sometimes referred to as a social contract between younger and older generations. As younger people age, they will expect their retirement pensions to be funded by the next generations of workers. This kind of social contract would be put under greater pressure if young workers face rising tax rates to pay for other people's pensions, while other publicly-provided services diminish.

The future tax system

As discussed earlier, in the historic trends scenario, the tax-to-GDP ratio is projected to increase steadily (largely due to fiscal drag) from a trough of 28.4% in 2011 to around 31% by 2023, before returning to a more average 30% thereafter. Because this is not large enough to cover the projected increase in government spending, net debt is projected to grow indefinitely. Figure 5.1 shows the increase in tax that would be required to finance the increased government spending and stabilise net debt at around 20% in the long run. The long-run tax-to-GDP ratio would need to increase by more than 3 percentage points.

This would mean for individuals that, if this tax increase were to be achieved via increased personal tax, there would be across-the-board tax rate rises of 5.5 percentage points - ie, instead of someone on the average wage paying an average tax rate of around 19% now, they would face an average rate of 24.5%. Alternatively, if the increase were funded entirely through raising the rate of GST, it would need to increase from its current 12.5% to about 20%.

This increase in the overall tax take would also likely result in lower GDP. This would mean lower incomes overall and less money for individuals to spend. If other countries were also increasing tax to finance increased government spending, or if our taxes are really targeted at less mobile factors like land, then the effect could be less. Nevertheless, it would be unlikely that such a shift would help achieve the Government's objective of closing the income gap with Australia by 2025.

Figure 5.1 - Tax revenue
Figure 5.1 - Tax revenue.
Source: The Treasury

Irrespective of the role that taxes play in achieving a sustainable long-term fiscal position, New Zealand's future tax system should:

  • encourage economic growth
  • enhance New Zealand's competitiveness, and
  • raise the necessary revenue in the most cost-effective way by minimising avoidance; minimising transfers that increase the economic cost of tax; and ensuring the coherence of the system – ie, that people with similar income share a similar tax burden.


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