5 Empirical Results: Fiscal Drag
This section, reports estimates of taxpayers' responsiveness to changes in marginal tax rates by examining the behaviour of earners whose marginal tax rate increased because they moved into a higher tax bracket as a result of fiscal drag. The period 2001 to 2008 is considered, as during this time no threshold or marginal rate changes were made to the lower income tax brackets. Elasticities of taxable income are derived for all taxpayers and for females and males separately. The assumption is made that people are fully aware of the effects on their marginal tax rate of bracket creep.
The effects of fiscal drag can be examined by using the difference-in-difference estimator in (7). In previous studies this has been used by taking as the control group those individuals within a tax bracket who remain in the same bracket from one period to the next, despite a general upward movement in incomes. The treatment group consists of those who were in the same tax bracket but moved into a higher bracket and thus experience an increase in their marginal tax rate. However, in the present context, it was found that there are significant variations in income movements. For example, there are many individuals who move from the second highest tax bracket, often into a lower tax bracket, while others move into the highest income range. This type of income dynamics produces a substantial bias if (7) is directly applied. Hence the following approach was used instead.
The calculations are based on people who were in the same tax bracket in period t, where some of those taxpayers moved into a higher income tax bracket in period t+1. The difference-in-difference elasticity compares the change in taxable income of these income recipients between periods t+1 and t+2. Taxable income may have changed because taxpayers adjusted how much they work or save, because of tax planning or because they exited paid market employment or emigrated from New Zealand and hence dropped out of the sample.
