Introduction

The distributional consequences of tax reform are prominent in current policy debates in New Zealand. As a reflection of the importance attached to this aspect, the Finance Minister has announced, in advance of his 2008 Budget, that his proposed tax reforms would be required to meet an ‘inequality test’, namely that the reform should not worsen current inequality.[1] However, the precise interpretation given to ‘inequality’ also raises complex issues. In addition, in evaluating a tax reform, inequality is just one of the criteria which may be applied. It is also necessary to consider the consequences for efficiency in order to ensure that redistributive aims are achieved at minimum acceptable costs.

Concepts of both efficiency and equity are therefore central to analyses of taxation reform. A variety of previous studies have attempted to measure the efficiency and redistributive properties of actual and hypothetical reforms in New Zealand.[2] Furthermore, the New Zealand Treasury maintains a tax microsimulation model constructed to examine the effects on individuals and households of the direct tax system. The evaluation of tax policies is complicated by the fact that they frequently involve both losers and winners, and any judgements cannot avoid subjective ‘value judgements’ regarding the weight attached to changes affecting different groups in society. Economic analysis can make a valuable contribution to policy debate and decision making by examining and presenting the consequences, in as succinct a form as possible, of adopting a range of clearly stated value judgements.

This paper examines summary measures of the distributional and efficiency properties of the New Zealand personal income tax and transfer system in order to shed some light on the trade-offs involved. Section 2 discusses some of the measurement issues involved and the way value judgements can be specified in the context of an ‘evaluation function’. Section 3 briefly summarises some inequality indices and tax ‘efficiency’ measures. Section 4 examines some indices of inequality for pre- and post-tax-and-transfer incomes in New Zealand using the Treasury tax microsimulation model, TaxWell, applied to 2006-07 Household Expenditure Survey (HES) data.[3] This section also considers sensitivity to the income units used: individual incomes, household incomes, and adult-equivalent household incomes.

Section 5 compares the inequality outcomes for a number of policy scenarios including alternative tax reforms designed to be approximately revenue-neutral. In the absence of a full behavioural model, we are unable to construct ‘welfare’ measures such as excess burdens of taxes and transfers, but section 6 provides some clues to possible equity-efficiency trade-offs by examining effective tax rates facing different taxpayers. Section 7 focuses on data for low-income earners, arguing that at least in New Zealand, using the tax system to redistribute towards individuals with low taxable income would represent poor targeting of social assistance. Section 8 concludes.