6.4 Who Responded to the 2001 Reform?
The above results suggest that taxpayers in receipt of non-wage and salary income responded especially strongly to the 2001 reform and, in particular, by altering the declared 'other income' component of their taxable income. This subsection considers whether these were exclusively, or mainly, those on higher incomes facing the 33 to 39 per cent tax rate change, or whether this response applied more generally.
Furthermore, the 2001 New Zealand tax reform involved a combination of constant, increasing and decreasing tax rates, so it is possible to identify the categories of taxpayer shown in Table 4 who contributed most to the observed responses. Table 4 shows that it was mainly taxpayers in categories 3, 6, 7, 15 and 16 whose incomes responded in the expected direction. These categories account for 75 per cent of all taxpayers in the sample. From the combinations of Δy, Δτ, and Δτ* which each category represents, it is possible to identify those tax brackets within the New Zealand tax system in which those taxpayers are located.
Figure 4 shows the tax schedules for 1999 and 2002, with tax rates rising for incomes above $60,000, remaining constant between $38,000 and $60,000 and falling for taxpayers between $14,000 and $38,000. The Figure also shows the five categories of taxpayer of interest. The unbroken arrows indicate the observed movement in those taxpayers’ incomes and marginal tax rates between 1999 and 2002; the broken arrows indicate the predicted movement in their 'expected tax rate’ in the absence of reform based on the income dynamics described earlier.
- Figure 4: Tax Categories
For example, consider category 16, involving 152,000 taxpayers. Those taxpayers experienced a fall in their income and actual tax rate, while their predicted tax rate rose. This included two groups: taxpayers between $38k and $60k in 1999 whose incomes fell to below the $38k threshold in 2002 but who were (in the absence of the reform) expected to move above the $60k threshold. It also includes taxpayers with incomes above $60k in 1999 whose 2002 income fell to less than $38k. Their responses are discussed further below.
Category 7 is another large sub-set of 194,000 taxpayers. The experienced income increases took them towards the $34.2k (1999) or $38k (1999 and 2002) thresholds, but their predicted tax rate increase implies that they were expected to experience an income increase to above the $38k threshold. Thus the higher jump in marginal rates at $38k after 2001 (from 21 to 33 per cent instead of from 24 to 33 per cent) may have persuaded some taxpayers to declare lower income than otherwise expected, keeping their 2002 declared income below $38k.
In addition to the categories listed above, category 1 in Table 4 captures a large number of taxpayers (122,000) where Δy, Δτ, and Δτ* are all positive. This includes taxpayers for whom their 'no reform' predicted income increase exceeds their actual income increase; that is, their response is consistent with a smaller declared income increase in response to the tax rate change from 33 to 39 per cent. This includes taxpayers below $60k in 1999 and 2002 who would otherwise have crossed that threshold by 2002, and those above the $60k threshold in both years, as shown in Figure 4. The standard instrument cannot account for the former group (below $60k in 1999 and 2002) because of the restriction that the instrumented tax rate is based on unchanged income levels (Δτ* = 0 for incomes in the range $38k and $60k).
In summary, actual and expected taxpayer income movements, as depicted in Figure 4, suggest a large amount of crossing, and bunching around, the $38k and $60k thresholds. This is confirmed by an examination of the distribution of taxable income in 1999 and 2002. Figure 5 shows the two distributions of aggregate taxable income by $1000 income band over the $16k to $100k range (the range relevant to the analysis here). In addition to the general tendency for taxable incomes to rise over the three years (the 2002 profile generally lies above the 1999 version), a large spike can be seen to emerge around $60k in 2002 which did not exist in 1999. Further, the small spike evident around $38k in 1999 is considerable larger by 2002.
- Figure 5: Distribution of Taxable Income
Figure 5 also suggests an increased concentration of taxable income in the $38k to $60k range in 2002 compared with 1999. The percentage of taxpayers and taxable income in this range rose from respectively 12 and 23 per cent to 15 and 26 per cent. Almost all of this reflected a net movement out of the $9.5k to $38k bracket. While the marginal tax rate in this bracket remained unchanged at 33 per cent before and after reform, the increased concentration here is consistent with expected behavioural responses to the combination of a reduced tax rate in the bracket below (24 to 21 per cent) and the increased rate in the bracket above (33 to 39 per cent). By itself, the increased bunching of taxable income around the two thresholds in Figure 5, and income growth within the $38k to $60k bracket, might be considered merely suggestive of responses to the 2001 reform. However, the regression evidence and the income movements identified in Table 4 offer strong confirmation that this reflects the predicted causal behavioural responses to tax reform when those predictions are based on modelling income changes that occur both with and without that reform.
