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5.4 Earned vs. Unearned Income

As noted above, throughout the period from 1922 to 1949 a distinction was made between earned and unearned income and these were taxed at different rates. Figure 10 shows the AMTRs for earned and unearned income, as well as the total AMTR. Up until 1930 the tax rate on earned income was reduced by 10% (relative to that for unearned income) for the first £2000 of income. During this period the AMTRs for the two types of income tracked each other fairly closely, with the AMTR for unearned income generally at 2% to 5% above that on earned income.

From 1931 to 1949 the distinction was changed such that the tax on unearned income was increased by 33.3% relative to that on earned income. From 1939 the gap between the unearned AMTR and earned AMTR begins to increase, reaching its greatest divergence in 1945 with a gap of 24 percentage points. This widening gap is due exclusively to the changing relative income distributions of earned and unearned income. The proportion of unearned income at the top end of the income distribution increased dramatically during this period. For example, the proportion of unearned income in the top bracket (>£4000) increased from 2% in 1940 to 17% in 1945, while the proportion of earned income in this top bracket remained fairly constant at around 1%.

Unsurprisingly, the overall AMTR is driven mostly by the AMTR for earned income reflecting the low share of unearned income in total income. Moreover, this proportion decreased substantially over the period, such that the very large AMTRs for unearned income in the mid 1940s did not have such a large impact on the overall figure. Unearned income made up around 40% of all filers' income in the early 1920s, but had dropped to around 4% by 1949, the last year in which the two were taxed at different rates. Indeed the drop in (declared) unearned income in the 1940s may in part reflect responses to the very high marginal tax rates applied to it.

Figure 10 - AMTRs for earned and unearned income, 1922-1956
Figure 10 - AMTRs for earned and unearned income, 1922-1956   .

From 1950-56 the earned/unearned distinction was no longer relevant for tax purposes, but Statistics New Zealand continued to collect the data separately. For this period the difference between the two AMTRs - of the order of 5 to 6% - solely reflects the different income distribution of earned and unearned income.

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