6 Applications: The 2001 Tax Change

Table 3 in section 4 shows the New Zealand income tax structure reforms in 2001. After a period with relatively few changes, the 2001 reforms represented a significant policy change, involving a number of tax rate changes, but especially an increase in the top marginal rate from 0.33 to 0.39 above $60,000. This policy change is examined using comparisons of top income shares by Claus et al. (2012). They show that the announcement of the tax changes led to a certain amount of income shifting between periods, so that a comparison between incomes in 2000 and those immediately after the change gives highly misleading results. Using a longer interval allows for these inter-temporal shifts in income to settle down.

The income dynamics model discussed above allows for the possible effect of regression towards the mean in generating relative income changes that are independent of tax changes, along with serially correlated changes. In examining the 2001 New Zealand tax change, period 2 refers to 2002. Period 1 refers to 1999, so that the use of lagged income terms requires information on incomes in 1998.

In addition to the age terms and income terms in the regression, a dummy variable to allow for the composition of income was set equal to zero if the individual received only wage or salary income in 1998, 1999 and 2002, the three years used in the regressions. The dummy was set equal to 1 if the individual received, either in addition to or instead of wage and salary income, any 'other income'.[16] Subsections 6.1 and 6.2 respectively describe the special dataset used here and the econometric properties of the instruments. Subsection 6.3 presents the regression results, while subsection 6.4 considers in further detail the characteristics of those who responded to the tax changes.

6.1 The Data

The database used here was constructed by randomly sampling the Inland Revenue Department's individual taxpayer population, and covers the period 1994-2009. The number of taxpayers in the random sample rises from 138,464 in 1999 to 139,420 in 2002. The sample is weighted to match the individual taxpayer population, which increased from 2,800,528 taxpayers in 1999 to 2,962,200 in 2002. The database is not constructed on a household basis. It contains welfare benefits data administered to individual taxpayers and family assistance provided to a nominated parent but not both parents. It is not possible to obtain estimates for households with different composition and income due to the lack of linking information.

For the regressions outlined below, various restrictions are imposed on the data. Age restrictions are imposed in order to remove those taxpayers likely to be in the very early stages of their careers as well as those becoming eligible for New Zealand superannuation. Only taxpayers aged 25-64 across the entire period are included. Income restrictions are also imposed, in order to remove very high income earners (over $1 million in 1999) and low-income earners under $16,000. The latter face benefit abatements rates which mean that their effective marginal tax rates differ significantly from those of a standard taxpayer.[17] Finally, those without sufficient income data across all relevant years (1998, 1999, 2002, 2003, 2004 and 2005) are necessarily excluded. As a result, the sample size is reduced to 38,744, which, when weighted up to reflect the population, represents 803,920 individual taxpayers. Further details of the data, the restrictions and the sampling process are given in Appendix B.