1  Introduction

Much attention has been given to the potential effects on government social expenditure of population ageing, in view of the fact that many items of social expenditure are systematically and positively related to age.[1] However, less attention has been devoted to investigating the possible effects on income and consumption tax revenue. This is likely to be influenced by population ageing in view of the systematic variation in income and consumption over the life cycle and among cohorts. Furthermore, population ageing is expected to be accompanied by changes in age-specific labour force participation rates, especially by women.

The aim of this paper is to present a framework for projecting income tax revenue, along with revenue from a broad-based goods and services tax. The model allows for the changing age-income profile over time, and hence among cohorts, for income from employment. The major components of the tax revenue model include a method of projecting the parameters of the distribution of labour income (namely the mean and variance of log-income) for each cohort alive at each calendar date, for males and females. A simplified projection model of aggregate capital income is used, based on the age-profile of the proportion of people receiving positive investment income and the (conditional) average of that investment income. Then the tax system is applied and total revenue at each date is obtained by aggregating over the cross-section of all cohorts existing at that date. The effect on the overall effective average tax rate of population ageing can thereby be calculated. The age-income profiles models are estimated for males and females in New Zealand. With additional information about the changing propensity to consume over the life cycle, the model is used to project revenue both from personal income taxation and the Goods and Services Tax (GST) over the period 2011-2062. The approach may be seen as an alternative to ‘ageing' a microsimulation model or using a highly aggregative time series projection model. The present approach specifies the structural components using relatively few estimated parameters, along with population and labour force projections by age and gender.

The basic way in which population ageing can affect tax revenue growth, and the components of the model used here, are introduced in Section 2. Section 3 presents the specification of the age-income profiles model and reports the estimates for New Zealand males and females. The method used to generate personal income tax revenue arising from wage and salary income, in the context of a multi-rate structure, is described in Section 4. The framework of analysis makes use of the distribution of income in each time period for each cohort, where it is necessary only to specify the form of the distributions and the relevant parameters. Here it is assumed that incomes can be approximated by the two-parameter lognormal distribution. This section also presents the projections for New Zealand under a variety of assumptions regarding indexation and the general growth of incomes. The model is extended in Section 5 to include GST revenue projections. In this case, in order to project changes in disposable incomes over time, it is necessary to estimate an additional age-income profiles model to allow for consumption financed from income arising from government benefits (net of any tax, as in the case of New Zealand Superannuation) other than wage, salary and self-employment income. The variation in average effective tax rates over time is considered in section 6. The model is extended in Section 7 to deal with capital income. In view of the complexities of dealing with capital income from a variety of sources, and the range of possible effective tax rates, a more aggregative approach is used here. Brief conclusions are in Section 8.