4.3 Income Tax Revenue Growth in NZ

When using the above method to project tax revenues, it is necessary to obtain population and labour force projections by single year and gender. The population projections by gender and single year of age were obtained from Statistics New Zealand,[11] along with the labour force projections.[12] Figures 3 and 4 show the variations with age in the male and female populations, labour force participation rates and labour force in 2011. These clearly show the rapid decline in participation rates after 65, the age of entitlement to New Zealand Superannuation. The projected patterns show, in addition to some smoothing of the age profiles, slight increases in participation rates in the higher age groups.

Figure 3: Male Population, Participation and Labour Force by Age: 2011

Figure 4: Female Population, Participation and Labour Force by Age: 2011

The growth parameter, β = 0.035, has been chosen to be consistent with the long-term stable wage growth assumed in the Treasury Long-Term Fiscal Model.[13] This consists of inflation of 2 per cent and real wage growth of 1.5 per cent per year. These assumptions, along with the income profile estimates reported earlier, were used to obtain the ‘base model' results, in which the income thresholds are not adjusted over time. Hence ‘fiscal drag' operates over the whole period. In addition, some sensitivity analyses were carried out as follows.

1. A ‘no ageing' case holds the population age structure for males and females constant at 2010/11 proportions of population, for males and females respectively. The same aggregate male and female populations apply in the year, as do the same labour force participation rates.
2. A ‘constant labour force participation' case holds the labour force participation rates frozen at the 2010/11 values.
3. A ‘wage indexation' case adjusts the income thresholds of the tax function every year according to wage growth, starting in 2010/11.
4. A ‘sawtooth' case allows fiscal drag to operate for 10 year periods, when the income thresholds are adjusted to the wage indexation values, allowing fiscal drag to occur between the adjustments.
5. In ‘base model +1%' and ‘base model -1%', the overall rate of wage growth is set at 1 per cent higher, and lower, than the long-term assumed rate of 3.5 per cent.

First, the base model is compared with the no-ageing and constant labour force participation cases in Figures 5 and 6, for females and males respectively. These demonstrate the small effect on income tax revenues of anticipated increases in labour force participation rates. Furthermore, population ageing reduces the revenue slightly, in view of the relatively larger number of males who are beyond their peak income-earning age groups. However, the effect is relatively small. Figures 7 and 8 show the profiles of the proportion of tax paid by each age group in three selected years, for females and males respectively. Relatively more tax is paid in the higher age groups in later years because of the increased labour force participation in those groups, the effect being larger for females. Clearly, relatively less tax is paid by those around 50 years of age in the later projection years. The nature of the changing labour force can also be seen from Figure 9, which shows the projected variation over time in the average age of male and female taxpayers. The role of female labour force participation changes is clearly evident in the early years. The very slight decline for males arises from the retirement of the baby-boom generation.

Figure 5: Decomposition of Growth of Income Tax Revenue: Females

Figure 6: Decomposition of Growth of Income Tax: Males

Figure 7: Proportion of Tax Paid by Age: Females

Figure 8: Proportion of Tax Paid by Age: Males

Figure 9: Average Age of Taxpayers

Figures 10 and 11 show the effects of alternative assumptions. The growth rate clearly has the most substantial impact on revenue. Indexing thresholds for wage growth reduces revenue substantially below the base case (of no adjustment). The periodic adjustment of thresholds, to bring revenue down to the full wage indexation profile every decade, leads not surprisingly to projections that are closer to the full indexation case than when fiscal drag is allowed to operate over the whole period.

Figure 10: Growth of Income Tax Revenues for Alternative Scenarios: Females

Figure 11: Growth of Income Tax Revenue for Alternative Scenarios: Males