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Can Automatic Tax Increases Pay for the Public Spending Effects of Population Ageing in New Zealand?

4  Historical evidence of aggregate marginal and average tax rates

This section places the simulated average tax rates in historical context. The current New Zealand system of PIT and GST involves marginal PIT rates of 10.5% to 33% and a marginal tax exclusive GST rate of 15% on expenditure (equivalent to a 13% tax-inclusive rate). Like marginal rates, average PIT rates rise with taxable incomes and in aggregate across all income taxpayers were around 21% in 2010, while the aggregate average rate of GST as a proportion of taxable income was almost 12%.[9]

McAlister et al. (2012) reported various marginal personal income tax rates for the New Zealand income tax since 1907, and calculated the associated income-weighted average marginal tax rate (AMTR) based on annual income distribution data. The AMTR provides a population-wide measure of the marginal rates faced by income taxpayers. Being income-weighted, it is a measure of the extent to which personal incomes face different effective marginal tax rates (EMTRs). The EMTRs were estimated from statutory marginal rates of income tax (MTRs) plus any additional explicit or implicit additional tax payable (or receivable in the form of subsidies) at the margin. Figure 14, adapted from McAlister et al. (2012), shows the top statutory income tax rate (top MTR), the top effective marginal tax rate (top EMTR) and the income-weighted AMTR, from 1922-2010.[10]

Figure 14 – Personal marginal tax rates in New Zealand since 1922
Figure 14 – Personal marginal tax rates in New Zealand since 1922

This shows the sharp rise in both statutory and effective top MTRs leading up to World War II (WWII) and the gradual decline in these from the mid-1940s in the case of the top EMTR. The top statutory rate of income tax remained around 60% from 1940 to the late 1980s before falling to the 33%-39% range since the major 1980s tax reforms. However, the AMTR provides a better measure of the marginal rate across all taxpayers. This can be seen to have risen steadily since 1922 (and especially during WWII) until the early 1980s, reaching around 40% in the mid-1980s. Reforms thereafter have steadily reduced that value to the current AMTR of about 24%.

This decline in marginal rates of income tax in New Zealand since the 1980s is a common phenomenon across OECD countries, especially for the top rate; see Loretz (2008). It is often thought to reflect economists' arguments, and policy-makers' concerns, about the adverse economic effects of high marginal tax rates. In considering historical evidence on ATRs and AMTRs, and how these may compare with future projections, it is not necessarily the case that high rates regarded as feasible and/or desirable in the past are feasible and/or desirable in future. This aspect is discussed further in Section 5.

Estimating historical aggregate average rates of income tax and GST for New Zealand is not straightforward, owing to limited data in disparate sources. However, using data assembled from a variety of sources (such as Goldsmith, 2008, for 20th century data, and Inland Revenue/Treasury for more recent years), we can construct implicit average PIT and GST rates from data on tax revenues, aggregate taxable income and GDP.

Figure 15 shows the resulting estimates for PIT and GST revenue/GDP ratios at 10-yearly intervals from 1920 to 2010. Based on the model simulations described above, Figure 15 also shows the equivalent projected ratios for 2060. GST is shown from 1990 (after its introduction in 1986); clearly other similar indirect (usually sales) taxes prior to the introduction GST could be added to the PIT/GDP ratios for earlier years, but suitable and comparable data are not readily available.[11]

Figure 14 shows that, like the AMTR series for personal income taxes, average PIT rates increased from the 1920s to 1980s (from 7% in 1920, to 15% in 1970 and 22% in 1980) and especially during the 1940s and 1970s. The major change by 1990 was the replacement of a fraction of income tax revenue by GST, with a slight increase in the overall average, from 22% in 1980 to 24% in 1990. In addition to the years 2000 and 2010, Figure 15 shows the tax ratios for 2007. 2010 partially reflects the aftermath of the relatively large effects of the global recession on tax revenues, whereas 2007 is the most recent pre-recession year in New Zealand. This confirms that during the 2000s, the combined average tax ratio to GDP remained around the 1990 level of 23-24%, with a drop to 20% in 2010.

Figure 15 also shows the projected change in the tax/GDP ratios to 2060, based on the projected increases in average tax rates from the BC model discussed earlier.[12] These are converted from ratios of taxable income to ratios of GDP using the 2010 taxable income/GDP ratio of 0.625, and added to the 2010 tax/GDP ratios in Figure 15 to arrive at the 2060 values shown. The resulting projected rise in PIT revenue/GDP is just over 3 percentage points by 2060 and a fall in the equivalent GST ratio of about 0.5 percentage points. Overall, therefore, the expected ratio of combined revenue to GDP, at 23-24% in 2060, is similar to the ratios observed over the 1990s and 2000s, but with slightly greater PIT and smaller GST contributions.

Figure 15 – Historical and projected tax revenue/GDP ratios
Figure 15 – Historical and projected tax revenue/GDP ratios

One important factor in considering whether such automatic future tax increases via fiscal drag could finance increase social expenditures that is not considered here is the issue of timing. In particular, the CM model projections suggest upward pressures on spending over the 2020-2040 period with a levelling-off thereafter. This contrasts with the Treasury fiscal model projections. Under the same conditions (for example, constant GDP growth rates), fiscal drag-related increases in average tax rates occur smoothly. As a result, even if increased average tax rates over the whole 2010-60 period could feasibly fund spending increases over this period, there may be funding issues over the near-term to be resolved with tax revenues growing more slowly relative to social spending.

Nevertheless, these results do not suggest future income tax and GST revenue to GDP ratios that are wildly different from those experienced historically. As discussed below, that does not mean that these average rate increases are to be recommended since, for example, past high income tax rates in particular have been criticised. Howeve it does suggest that future funding of public spending increases based on these automatic PIT and GST rate changes are worthy of discussion as possible revenue sources since they are clearly not unprecedented.

Notes

  • [9]This is based on GST revenue in the LTFM spreadsheet of $13,708 million for 2010/11, and IRD-sourced taxable income for 2010 of $118,051 million.
  • [10]Due to lack of consistent data these effective tax rates do not include an allowance for the abatement of social welfare payments where relevant; see McAlister et al. (2012; pp. 2, 24-25).
  • [11]Goldsmith (2008), for example, records revenue from indirect taxes, but this includes revenue from excises, such as on tobacco and alcohol, which remained after GST was introduced, and for consistency are not included in the tax rates shown for any year.
  • [12]From Table 1, the BC model projects a 4.4 percentage point increase in the combined PIT + GST average tax rate (as a percentage of taxable income, including capital income) over 50 years from 2011. This is composed of a +5.2 and -0.8 percentage point change for PIT and GST respectively.
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