Executive Summary
This paper presents a framework for projecting income tax revenue, along with revenue from a broad-based goods and services tax. The major components of the model include a method of projecting the changing distribution of labour income with age for each cohort alive at each calendar date, for males and females. A simplified projection model of aggregate capital income is also used, based on the age-profile of the proportion of people receiving positive investment income and the (conditional) average of that investment income. Information about average benefits received (net of tax) over the life cycle are then combined with information about the changing propensity to consume with age, in order to project revenue both from personal income taxation and the Goods and Services Tax (GST) over the period 2011-2062.
Total revenue at each date is obtained by aggregating over the cross-section of all cohorts existing at that date. The components are estimated for males and females in New Zealand. The projections are in nominal terms in view of the taxation of nominal incomes in the NZ multi-rate structure.
The model can be used to examine the implications of alternative assumptions about population ageing, labour force participation, the general growth of incomes and the adjustment to tax thresholds.
It is found that as the baby-boomers move into retirement the burden of taxation is projected to have a compositional shift, from the current male modal age of 48 in 2010/11 to 43 in 2051/52. During the middle of the transition to retirement for the baby-boomers, the male modal age (in the distribution of tax revenue by age) is projected to fall to 40 in 2030/31. The distribution of the proportion of tax paid by females follows a similar pattern.
The projections of income tax revenue are also decomposed into ‘pure ageing' and ‘pure labour force participation' changes: for example, in the former case only the projected age composition of the population is allowed to change, while participation rates remain constant at their 2010/11 values. Ageing is found to reduce aggregate income tax revenue below the base model case. However, changing participation rates, particularly among women, imply higher tax revenue. The projected changes in the age distribution (with fixed labour force participation rates) reduce total tax revenue, below the base model case, by 2.4 per cent by the year 2061. However, the effect of changes in participation rates (with an unchanged age distribution) are projected to increase aggregate revenue above the base model case by 5.7 per cent.
The projected demographic and labour force participation changes are thus small, though not trivial. However, these effects are dwarfed by the much larger changes generated by income growth. Aggregate revenue projections are highly sensitive to changes in the overall rate of change in wages and capital income (affecting all cohorts), which is a major determinant of tax revenue growth, along with the assumption regarding indexation of income tax thresholds. The use of fiscal drag, which arises from not adjusting the thresholds, may not be sustained for long periods, otherwise a very large proportion of the population would move into the top income tax rate bracket. Hence the effect of periodic threshold adjustments was therefore examined.
