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6 Conclusions

This paper has reported estimates of welfare changes and the marginal welfare cost of income taxation for a wide range of income and demographic groups in New Zealand, using an enhanced version of the Treasury's behavioural tax microsimulation model, TaxWell-B. The tax change context was one in which all marginal income tax rates were increased by five percentage points, and calculations were based on the 2011/12 Household Economic Survey.

Previous estimates for New Zealand have been at a high level of aggregation, using either a general equilibrium model or aggregate estimates of the elasticity of taxable income, or have been based on a standard approximation for the excess burden of an income tax. The present approach computes 'exact' welfare changes, making full allowance for the complex nonlinear nature of the budget set facing each individual or family. It also uses an approach, developed by Creedy, Herault and Kalb (2011), to deal with the fact that a discrete-hours structural approach is used to model preferences, in which individuals and families have preference functions containing both deterministic and stochastic components.

The paper has also demonstrated the use of a money metric utility measure in a social welfare function evaluation of the policy change. It was found that a smaller reduction in 'social welfare' is obtained, compared with the use of net incomes.

The results suggested that the marginal welfare cost of income taxation varies substantially among household types. They range from only about 5 cents for most single men to over six dollars for low-income single parents. However, single parents in aggregate have a marginal welfare cost of about three dollars and fifty cents, for each additional dollar in tax revenue. Single women also face high marginal welfare costs, which are as high as 90 cents per dollar for those in the higher age groups. For all single women combined, the marginal welfare cost was found to be 34 cents. Couples face a welfare cost of about 10 cents overall, but this conceals large variations. Those with children in the middle quintile income groups have costs of about 23 cents, while high-income couples have lower costs, of 10 cents. Low-income couples without children have a marginal welfare cost of about 50 cents, which higher-income couples face a cost of about 20 cents per extra dollar of revenue.

These results therefore display considerable variation around the aggregate marginal welfare cost of 12 cents per extra dollar of revenue raised. In considering these results it should also be borne in mind that they are specific to the particular tax policy change considered. Comparisons with earlier results are therefore extremely difficult. It was mentioned that Diewert and Lawrence (1994), using a general equilibrium model with a representative household, found a marginal welfare cost for income taxation of 18 cents, while McKeown and Woodfield (1995), using an approximation (along with an assumed compensated labour supply elasticity of between 0.2 and 0.6) found values for income tax and GST combined of between 25 and 45 cents. The considerable heterogeneity revealed by the present results is similar to that obtained for Australia by Creedy, Herault and Kalb (2011), although their aggregate marginal welfare cost is higher, at 25 cents. In comparing this with the present aggregate value, it must be remembered that the Australian tax and welfare system is very different from that in NZ, and in particular the income tax structure displays a higher degree of rate progression, along with higher top marginal rates.

In view of the large variation in marginal welfare costs faced by different individuals and families, it would be of interest to explore particular tax and benefit reforms that are capable of reducing the higher excess burdens observed in some cases. This is a potential benefit of this kind of behavioural microsimulation model that can be used to obtain welfare changes for selected demographic and income groups.

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