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Executive Summary
- This paper provides estimates for New Zealand of the extent to which taxable incomes change as a result of people responding to changes in the marginal tax rate they face.
- The measure used to summarise behavioural responses is the 'elasticity of taxable income'. This measures the proportional change in taxable income resulting from a proportional change of one per cent in the net-of-tax marginal tax rate (the latter is defined as one minus the marginal tax rate).
- Results were obtained using a special dataset constructed from a large random sample of New Zealand taxpayers. The data covered the changes in the income tax structure which came into effect in 2001, in particular the introduction of a new 'top' income tax bracket.
- Two approaches were used to estimate elasticity values for different groups of taxpayers. First, the introduction of an additional top marginal tax rate bracket provided a useful policy change as a natural experiment. Secondly, the stability of the tax structure over more recent years enables the effect of fiscal drag, in shifting some individuals into a higher marginal tax rate bracket, to be considered.
- In examining changes in taxable income, it was found that some responses to tax changes involve the timing, rather than the total amount, of taxable income declared, particularly in anticipation of announced changes taking effect.
- The estimated elasticity of taxable income is substantially higher for the highest income groups. Indeed for lower deciles of the income distribution, the elasticity was found to be negligible.
- Generally the elasticity was higher for men than for women, but this is largely because the taxable incomes of men are systematically above those of women.
- The marginal welfare costs (the excess burden of the tax per extra dollar of revenue raised) of personal income taxation were consistent across years, being relatively small for all but the higher tax brackets. For the top marginal rate bracket of 39 per cent, the welfare cost of raising an extra dollar of tax revenue was found to be well in excess of a dollar.
- The elasticity, of around 0.5, has important implications for revenue raising. In a non-proportional tax structure, an elasticity well below 1 can result in a reduction in revenue.
- Further work will examine the potential revenue effects of tax changes as well as using alternative estimation techniques.
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