7  Capital Income Tax Revenue

This section adds income tax revenue from capital income to the projection model. In view of the systematic increase in capital income over the life cycle, population ageing is expected to result in more revenue from this source, in addition to the consequent increase in indirect tax revenue. However, capital income tax is complicated by the existence of a range of sources (such as different types of investment, rental and interest income), where different rates apply. It is not possible here to model the changing distribution of different sources over the life cycle at the individual level. Hence, the present analysis of capital income taxation necessarily has to rely on strong assumptions and a high level of aggregation.

It is important to consider the changing proportion of people with positive investment income over the life cycle, so that appropriate allowance can be made for the changing demographic structure over time. The approach taken here is to use cross-sectional information from the Treasury's model, Taxwell, to obtain the arithmetic mean of investment income for each year of age, by gender, conditional on receiving some (positive) investment income. This is combined with corresponding information on the proportion of people receiving investment income, by gender and single year of age. [14] In obtaining projections, the changing age distribution of the population over time can therefore be used in conjunction with the appropriate proportions, and conditional average capital incomes, to obtain the required aggregate values for each age and gender. It is then necessary to apply a single tax rate to the aggregate capital income. In the following simulations, a rate of 30 per cent was applied to all investment income. The aggregate net capital income was then added to aggregate disposable income from employment, in order (after allowing for saving and dis-saving behaviour) to obtain the base on which to apply GST.

Examination of the Taxwell data showed that both average (positive) investment income and the proportion receiving some capital income grow approximately linearly with age. Table 5 reports regression results. [15] In the case of male investment income, there is considerable variability with age, as seen by the lower value of R² compared with that of females. To allow for cross-sectional and cohort differences, it was assumed that (nominal) investment income grows at 5 per cent per year: this means, for example, that a 20 year old in 2020 obtains 5 per cent more than a 20 year old obtained in 2019. This growth rate is thus slightly higher than the growth assumed above for labour incomes.

Figure 20 shows the projected total capital income tax revenue for each year under several assumptions. The only variations that affect the growth of capital income relate to the assumed growth of investment income over time. Corresponding to the assumed variations in productivity and hence wage growth when considering tax revenue from employment income, the figure shows the effects of 4 and 6 per cent growth rates, in addition to the benchmark 5 per cent. Figure 21 decomposes, for the benchmark assumptions, the growth of investment income for the case where there is no population aging. The variation in labour force participation has no effect in the present model because the variation in investment income is not linked directly to an individual model of capital accumulation over the life cycle. As suggested above, the effect of population ageing is to raise capital income tax revenue in view of the systematic increase in capital income, and the proportion of people receiving capital income, with age.

Figure 20: Total Capital Income Tax Revenue

Figure 21: Decomposition of Total Capital Income Tax Revenue

Figure 22 shows projections of the time path of the ratio of private source deductions (that is, personal income tax plus capital income tax revenue) to private GST revenue for the benchmark assumptions. In this case the projected variations in labour force participation do have an influence in view of their role in generating labour income. Total nominal tax revenue, from males and females and from all private income and consumption sources, is shown in Figure 23 for a range of assumptions, as described earlier when discussing labour incomes. The corresponding ratio of private source deductions to GST revenue, for the different projection assumptions, are shown in Figure 24.

Figure 22: Decomposition of Ratio of Source Deductions to Private Consumption GST

Figure 23: Total Tax Revenue

Figure 24: Ratio of Private Source Deductions to Private Consumption GST Revenue