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Taxation

Individual income tax is likely to vary by age and by gender of the taxpayer, but for simplicity we assume here that tax revenue largely remains a constant proportion of nominal GDP throughout the projection period.

We have chosen in these long-term projections not to model fiscal drag on individual income tax (fiscal drag is the rise in the average tax rate as income spills into higher brackets) as the government has announced it intends to index personal tax rate thresholds every three years from April 2008 onwards. In addition, fiscal drag is not modelled in this type of long-term work by other finance ministries, and the LTFM does not have the level of detail to model it properly.

The revenue-to-GDP ratio does move up slightly through the projection period, but that is because of taxation on the growing payout for NZ Superannuation.

Source deductions tax (or PAYE, tax on individual income) has the following form for tax on benefits:

where Tt= tax and β = growth of benefit payments. In aggregate, this rises through the projection period, driven by payments of NZS.

Benefits here include NZS, unemployment benefit, domestic purposes benefit, invalids benefit and sickness benefit.

Source deductions tax on all other income sources is

where g = growth of nominal GDP. Then, total source deductions tax is the sum of these two:

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

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 2010 onwards.

Although the base case does not include fiscal drag, we show the estimated effects of fiscal drag in the figure below, where a tax elasticity of 1.13 produces the lighter line,[35] which grows to a 2.4 percentage point difference with the baseline tax-to-GDP ratio.

Figure 25: Tax revenue as a share of GDP rises only slightly through the projection period
Figure 25: Tax revenue as a share of GDP rises only slightly through the projection period.
Source: Treasury projections

Effect of changing productivity growth

In the above modelling, we have assumed a constant real labour productivity (or real wage) growth of 1.5% from 2011 onwards. For benefit payments, this additional growth above inflation could be assumed on the grounds that the same gains enjoyed by workers should also apply to benefits (but as mentioned at the start of section 5, we are assuming the current policy of CPI indexation). Otherwise, a growing gap would open up between workers and beneficiaries. For spending without a strong demographic linkage (such as defence or core government services), we have assumed that annual spending would grow overall by 1.5% in real terms (this is the wage growth of people providing those services).

If most spending programmes are indexed to labour productivity, then changing the productivity growth assumption will have only a small effect on the share of total spending to GDP.

This assumption, therefore, pervades most of the modelling. It is used to construct projections of GDP and shows up in most, but not all, of the spending categories. It is not surprising, then, that having a larger productivity growth of, say, 2% per annum makes only a little difference to the ratios to GDP. With a higher growth in productivity, as a society we would be wealthier (nominal GDP would be larger by 22% in 2050), and so have a larger tax base, but on the other hand we assume we would be paying larger benefits and more in wages, and the costs of other non-demographic programmes would also rise. This alternative assumption is illustrated below for the core Crown social security and welfare benefits where the rise in GDP largely matches the rise in expenditure.

So while labour productivity growth is important for many reasons (such as lifting the living standards of New Zealanders), if most spending programmes were indexed to labour productivity (or equivalently to real wages), then changing the productivity growth assumption will have only a small effect on the share of total spending to GDP.

Figure 26: Higher labour productivity growth has little effect on the ratio of social security and welfare payments to GDP
Figure 26: Higher labour productivity growth has little effect on the ratio of social security and welfare payments to GDP.
Source: The Treasury
Table 5: Summary of major modelling approaches
Model type Example Drivers
Parametric NZ Superannuation
  • Demographics: 65 and over
  • Wage growth
Non-parametric Education (by level)
  • Demographics: appropriate age groups
  • Cost per student (driven by teaching staff wage growth)
Non-parametric Core government services
  • The equivalent of GDP
Non-parametric Health (by service group, such as public health and disability support)
  • Demographics
  • Age-dependent cost curves shifting to reflect contraction of morbidity and falling disability prevalence
  • Demand (GDP via income elasticity)
  • Residual growth (historical to capture technology, input cost growth)

Notes

  • [35]In other words, a 1% growth in personal income produces a 1.13% increase in tax on that income. This comes from an estimate of the tax elasticity on personal income using a microsimulation model.
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