Estimates of Revenue Effects of Small Tax Rate and Tax Base Changes

Page updated 30 May 2008

• Introduction
• Major Assumptions and Caveats
• Estimates:
• Revenue Effect of Changes to Key Tax Rates, Bases and Thresholds for 2008/09
• Total Personal Taxable Income Contributed To Each Income Band

Note: For a personal income tax calculator visit the Inland Revenue website's Tax on annual income calculator.

Introduction

The estimated revenue changes depend on the size of the tax bases. These estimates have been updated to incorporate the latest economic outlook presented in the 2008 Budget Economic and Fiscal Update (BEFU) and on-going development of Taxmod [1].

For the 2008 BEFU, the major changes to the tax regime have been made to the personal income tax rates and thresholds.  The estimated revenue changes of the movements in the tax rates and thresholds are discussed in detail on page 6 of the Executive Summary.

These pages also include a table showing the total amount of taxable income contributed to each income band by all individuals [2]. This table enables readers to do their own estimates of the impact of changing tax rates, or thresholds, or both, on personal tax revenue using the method described in the examples. A much wider range of personal tax regimes can be modelled, with reasonable accuracy, using this table than can be achieved from the limited number of options given in Revenue Effect of Changes to Key Tax Rates, Bases and Thresholds for 2008/09.

Two examples in the Total Personal Taxable Income Contributed To Each Income Band page showing how the table on that page can be used to estimate the effect on total tax revenue resulting from a tax rate or a threshold change are provided below the table. These examples include explanations of the necessary calculations, which involve effective tax rates. The footnotes below the tables give more details about effective and statutory tax rates.

These income and tax tables have been updated based on the 2003/04 Statistics New Zealand Household Economic Survey, with population, income, tax and benefits adjusted to the 2008/09 tax (March) year by Taxmod [1].

Major Assumptions and Caveats

The estimates tables attached show the full-year revenue effects of each change. However, it is likely there would be a delay before these effects show up in tax revenue and receipts.

These estimates are subject to forecasting error and are dependent on sampled information.

The revenue estimates do not allow for second-round macroeconomic effects on growth and employment. For example, they do not make allowance for:

• the short-run aggregate labour-market response to changes to the personal tax rates;
• changes in investment spending due to changes in the company tax rate.

These are difficult to estimate without an extensive review of the macroeconomic forecasts. As a result, any effect of tax changes on economic growth is not included in the estimates.

The estimates only include the effect on gross revenue. The overall effect on the Government’s operating balance is unlikely to be the same as these estimates.
The estimates allow for direct inter-linkages between taxes at the individual and/or firm level. For example, changes in personal income taxes have a direct effect on consumption and thus on GST collections. The changes would also affect business profits and hence company tax.

Changing a single tax rate in isolation may indirectly affect tax revenue from other tax types. For example, raising personal tax rates while leaving the fringe benefit tax rates unchanged could encourage employees to elect to receive a larger portion of their compensation in non-monetary terms. This would allow them to reduce their tax liability. The levels of induced tax planning activities would depend on the magnitude of the differences in tax rates. These indirect linkages between tax types are not included in the table.

Proposals involving large changes in tax rates or proposals involving more than one change of rate generally have different revenue effects from the estimates presented because of interaction between tax types and greater behavioural responses.