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Average Marginal Income Tax Rates for New Zealand, 1907-2009 WP 12/04

2.3 The New Zealand Personal Income Tax

When the New Zealand income tax was first introduced it took the standard multi-step structure in which a set of statutory MTRs are applied across ranges of income covering hundreds or thousands of pounds.[8] Between 1914 and 1939 various other elements were added to the tax schedule whereby, in addition to these ‘steps’, tax rates were increased - by tiny fractions of a pound - for every additional pound earned. This had a substantial impact on effective MTRs. We discuss each system in turn below.

2.3.1 The early years: 1892-1913

Income tax was introduced in New Zealand in 1892 with a simple three rate structure: 0% for incomes below £300, 2.5% for incomes in the range £300-1,000 and 5% for incomes in excess of £1,000.[9] This simplicity lasted until 1909; as Table 1 shows, complexity soon set in with a set of ten marginal rates introduced in 1910 including a top rate of 5.8%.

Table 1 - Income tax rates, 1910-1912
Annual Income range
(in £)
Tax rate
(%)*
Less than 300 0
301 - 400 2.5
401 - 600 2.9
601 - 700 3.3
701 - 800 3.8
801 - 900 4.2
901 - 1,000 4.6
1,001 - 1,250 5
1,250 - 2,000 5.4
Over 2,000 5.8

*Quoted in the tax code in shillings and pence per pound of income

This structure involves the now familiar ‘multi-step tax function’ in which the marginal tax rate (MTR) is changed in discrete ‘steps’ at a set of thresholds covering ranges of income levels - usually, as here, involving progressively rising steps at higher income ranges - but is constant between thresholds. Formally, the multi-step income tax function, with a tax-free income exemption, can be written as:

T(y) = 0                                          0< y a1

        = t1(y a1)                             a1< y a2

        = t1(a2a1) +t2 (y a2)         a2< y a3         (3)

and so on, where t and a are the statutory tax rates and income thresholds respectively.

2.3.2 The multi-slope tax system: 1914-1939

The structure in (3) was the structure of the NZ personal income tax system prior to 1914 and from 1940. However, from 1914-1939 the tax schedule involved an increasing tax rate for every additional pound of income. To distinguish it, we refer to this below as a ‘multi-slope tax function’ since it involves an upwardly sloping marginal rate function between different income thresholds. In New Zealand it typically applied to incomes in excess of an initial threshold income level (ie, a1 in (3) above) and, as an individual's income increased, the higher rate applied to all income (above an initial exemption where applicable), not just the increment; see Vosslamber (2009, p. 304). Thus the apparent marginal rate in the schedule did not specify the ‘effective’ marginal rate since an additional pound of income brought with it an additional tax liability on that pound and all previous pounds above the initial exemption level. In addition, from 1917, this initial exemption level was abated (withdrawn) at £1 for every additional £1 of income in excess of £600, further adding to the ‘true’ marginal rate over this income range.[10] This system is described in more detail in Appendix 1.

2.3.3 Other aspects of New Zealand's income tax structure

It is not possible here to catalogue the numerous changes to the income tax system from 1907 to the present, but a number of milestones in the evolution of the New Zealand income tax structure are worth noting. Those of relevance to AMTR estimates include:

  1. The introduction of various exemptions in addition to the ‘general exemption’. These included exemptions for children and other dependents and a life insurance exemption (see Appendix 3 for details).
  2. The distinction made between earned and unearned income from 1921 to 1950.[11] A 10% discount on earned income (up to £2000) was in place until 1930, followed subsequently by a one-third tax surcharge on unearned income.
  3. A drop in tax rates in the mid-1920s after the WWI ‘temporary’ increases (see Figure 2).
  4. The introduction of a social security tax in 1931 at 1.25%, rising to 12.5% in 1943, then reduced to 7.5% in 1947 and abolished in 1970.
  5. The introduction, also in 1931, of an ‘additional tax’ levy, at 30% of the individual’s income tax liability. The additional tax was removed in 1936 but re-introduced for 1939-1953. Over the latter period the rate varied subsequently between 2.5% and 33.3%.[12]
  6. The large increase in EMTRs during WWII with the top rate statutory rate rising to 60%, and a top EMTR approaching 100% (inclusive of social security and special war taxes).
  7. The replacement of the multi-slope income tax schedule with a multi-step function of MTRs in 1940 but with 40 separate rates/steps and a maximum statutory rate of 60%.
  8. Generally lower top statutory rates after WWII until the mid-1970s.
  9. Rises in top statutory MTRs to the mid-1980s followed by the sharp drop associated with the 1980s reforms.

Figure 2 illustrates the decomposition of the top effective marginal tax rate over the period, including the statutory top personal income tax rate plus the ‘additional tax' component and the social security tax. For the period where the multi-slope function applied, its impact on EMTRs is also shown.

The impact of the ‘additional' and social security taxes on individual EMTRs is rather different. The relevant expression for an individual's tax liability can be written as:

T(y) = τ(y - a) + βTI(y) = τ(1 + β)(y - a)         (4)

Where τ is the statutory or effective marginal income tax rate, b is the rate of 'additional tax' which is applied to the income tax liability, TI, where TI(y) = τ(y - a). The effective marginal tax rate on income therefore becomes τ(1 + β). Letting the marginal social security tax rate be s, the effective marginal tax rate, EMTR, of all taxes combined is composed as follows:

EMTR = s + τ + βτ         (5)

Here βτ captures the EMTR impact of the ‘additional tax' levied on the overall income tax liability.

Figure 2 shows how both the social security tax and the additional tax substantially increased effective rates around the WWII period with the additional tax being phased out in the mid-1950s. The social security tax was retained till the late-1960s. For four years during WWII the combined effect of all three taxes produces a top EMTR in excess of 90%: a top IT = 60%; additional tax = 20% (ie, legislation set β = 0.33 in those years) and SST = 12.5%.

During the 1920s-30s, the impact of the multi-slope tax schedule on top EMTRs was also substantial, often adding around 15-20 percentage points to those specified in the tax schedule. These high effective rates typically applied at high, but not the highest, income levels (see Appendix 1). In 1923 and 1924 there was a 20% discount on the tax bill, resulting in net a top EMTR of 44%.

Figure 2 - Top effective marginal tax rates for New Zealand, 1907-2009*
Figure 2 - Top effective marginal tax rates for New Zealand, 1907-2009.

* Tax rates shown include social security taxes and relate to earned income where relevant.

Finally, for much of the period studied the amount of tax that individuals paid was also dependent on the amount of exemptions received, which reduced their average tax rates. These can affect individuals' effective marginal tax rates directly when they are abated with rising incomes, as discussed above, and indirectly by affecting the number of income earners liable to tax, their assessable income and hence the statutory marginal tax rates applicable for a given gross income. They therefore would shift some individuals across tax brackets and affect economy-wide AMTRs as discussed in section 4.

Notes

  • [8]The New Zealand currency was the NZ Pound till 1967; thereafter the NZ Dollar (converted at $2=£1). The Pound (£) was composed of 20 Shillings (s), with each shilling equal to 12 Pence (d); ie, £1 = 240d.
  • [9]Tax rates were expressed as shillings (s) and pence (p) per pound (£) of income, where there were 12 pence per shilling and 20 shillings per pound. Hence 2.5% = 6p/£ and 5% = 1s/£. New Zealand’s currency was decimalised (to the NZ dollar) in 1967.
  • [10]This abatement regime operated from 1917 to 1926. Two other abatement regimes were in place from 1927-1930 and 1931-1935. More details are in Appendix 3. A supplementary ‘special war tax’ was also introduced during 1917-20 which effectively applied a multiplier of 1.3333 to all tax rates (eg, 6% becomes 8%).
  • [11]Earned income was defined as income earned by a taxpayer through physical exertion (largely salary and wage income), whereas, unearned income relates to passive sources of income such as interest, or rental income.
  • [12]There had also been a similarly calculated ‘discount' during 1923-24 at 20%.
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