Personal tax cuts from 1 April 2018
A modest dividend for middle-income New Zealand
Finance Minister Steven Joyce has announced tax cuts – widely signalled in advance - to apply from 1 April 2018.
The cuts will make a difference to millions of hard-working New Zealanders. Could they have been brought in sooner – say 1 October? When challenged on that point, Joyce cited Inland Revenue’s current transformation as a reason for delay.
Middle income tax cuts
From 1 April 2018, the $14,000 income tax threshold will increase to $22,000, and the $48,000 threshold to $52,000.
- The change above means anyone earning more than $22,000 annually will receive a tax reduction of at least $10.77 a week, and anyone earning more than $52,000 will receive a tax reduction of $20.38 per week.
- The independent earner tax credit of up to $10 per week will be discontinued. Individuals who currently receive the tax credit will be fully compensated by the increase in the $14,000 tax threshold to $22,000.
Table 1: Current and new personal income tax thresholds
These are tightly targeted, relatively small changes. It is seven years since National changed personal tax rates. Over that time the average wage has risen from $49,500 to $58,900. Many middle income earners are now faced with a marginal tax rate of 30 per cent.
Julia, an IT professional, earns $60,000 per annum, just over the average wage of $1,133 per week. She will see an extra $20.32 per week in her hand from 1 April 2018.
The saving is smaller for the median earner. Take Kyle, a newly qualified primary school teacher on the 2016 starting base salary of $47,039, a little under the June 2016 median wage of $937 per week (or around $49,000 annually). He will gain a net $8.37 per week from 1 April 2018 - $10.77 as a weekly tax reduction, but losing $2.40 from the abolition of the independent earner tax credit.
And for hospitality worker Laura, on the minimum adult wage of $15.75 per hour, pulling in $24,570 per annum from a 30 hour week, the weekly gain will be $10.77.
Higher earners will receive no more than those on middle incomes as the top threshold remains unchanged. Everyone with an income in excess of $52,000 will receive the maximum weekly cut of $20. 38.
Tax and fairness
Joyce has worked hard to prevent criticism on fairness grounds for delivering tax cuts for the rich. Higher earners will inevitably receive the maximum tax cut as they pay more tax. Short of increasing the top rate of tax, it is hard to see how Joyce could have delivered a different outcome given the funds available. As it is, the top tax rate will now cut in at a mere 1.2 times the average full time wages – one of the lowest ratios in the OECD.
Today’s Budget statistics show that in 2017, taxpayers on incomes over $70,000 paying the top tax rate of 33% (the top 19 percent of taxpayers) already pay $20.5 billion in income tax, that is, 62 percent of all income tax. The bottom 49 percent, with income of $30,000 or under, paid $3.0 billion, or 9 percent of the total. (Note these figures cover all individuals over 16 years of age – not just those in employment.)
Today’s announcements will skew this pattern further towards income tax being largely paid by higher earners. With a progressive tax system, higher income taxpayers will always pay more tax – both in absolute terms and as a percentage of their total income.
Fiscal drag has hit middle incomes hard
Joyce has worked hard to target the cuts for maximum impact at middle income levels. The case for targeting is strong: it is people on middle incomes who have seen the biggest proportionate increase in their tax burdens since the last tax cut in 2010.
For the tax year ended 31 March 2017 the average full time worker paid almost $2,000 more in income tax than they did in 2012: $10,701 compared to $8,719. That’s around $38 per week more. Even inflating the 2012 payment to today’s prices, that’s nearly $30 per week more.
That is due to fiscal drag: the combined impact of wage growth and inflation dragging people into higher tax brackets. The chart below shows the way in which the tax liability for the average full time earner has increased over time.
Income tax paid by the average full time employee over time
The $48,000 question
Back in October 2010, $48,000 was the magic tax number. Ignoring the independent earner tax credit1, the marginal tax rate below $48,000 was 17.5 percent. With the mean wage a little over $48,000, the median wage around $40,000 and three-quarters of all adults reporting incomes of under $48,000, most people paid only 17.5 cents of tax for every additional dollar earned.
In 2010 that was smart tax design. Low marginal tax rates were targeted at middle income New Zealand. With tax rates unchanged since 2010, the downside of that targeting becomes apparent. The majority of full time workers now face a marginal tax rate of 30 percent.
Each year more taxpayers face marginal tax rate of at least 30 percent. The chart below shows how tax rates for the average earner have been drifting upwards. For the 2012 income year (the first full year following the cuts applied from 1 October 2010, a full time worker on the average wage faced an average tax rate of 16.7%. This year, that same worker pays an average 18.2%.
Average tax rates since 2000
Why is the Independent Earner Tax Credit being discontinued?
Individuals who receive the independent earner tax credit will be fully compensated by the increase in the $14,000 tax threshold. Since being introduced, the independent earner tax credit has had less uptake than expected. Only 32 per cent of eligible recipients claim it during the year they are eligible. Removing the tax credit will also help simplify the system, as individuals will not have to file a tax return at year-end or use a different tax code to claim it.
We think that’s a good call and congratulate Joyce on removing a measure which did not meet it aims.
Has Joyce delivered meaningful personal tax reform
While Joyce will have had the impact on people like Julia, Kyle and Laura in his mind, he has to balance the Government’s books. The increasing personal tax take has gone a long way towards meeting debt targets and shoring up New Zealand’s credit rating.
The chart below shows the increase in income tax receipts over the last few years, both in dollar terms and as a proportion of gross domestic product.
Personal tax revenue since 2007
The steeply rising tax take tells its own story – tax relief had become inevitable. At a cost of almost $2 billion per annum it’s a significant package but still leaves the average earner on a 30% marginal tax rate. Is that enough to stifle the calls for more?
Tax cuts, combined with family assistance, were a central part of Budget 2017’s Family Incomes Package. Improving economic conditions and forecasts, along with fiscal drag, have given the Government real choice this year. This is a well thought out tax package which will make a difference to many middle income New Zealanders.
1 The independent earner tax credit abates at 13 cents in the dollar for incomes between $44,000 and $48,000.
Government to target relief towards low- and middle-income families
Policies evolve as circumstances change. That’s the lesson we draw from today’s reset around working for families tax credits.
Tighter targeting, but help for younger families
From 1 April 2018
- Increases to the family tax credit rates for children aged 0 to 15, to align with the rates for children aged 16 to 18 years – the existing five rates of family tax credit will reduce to two
- Abatement rate to increase from 22.5 percent to 25 percent
- Abatement threshold to drop to $35,000
Jo is a single parent with a 12-year old daughter. She earns $36,350 per annum. Right now Jo receives family tax credit ($92 per week) and the in-work tax credit $72.50 per week), therefore receives a total of $164.50 per week or $8,554 per annum. For each dollar Jo earns over $36,350, her credit reduces by 22.5 cents. Once Jo earns over $74,367, her working for families tax credit finally disappears.
Following the changes Jo will now receive an extra $2.76 per week from the family tax credit. She gains from the increased rate for her daughter, but loses from tighter abatement rules.
Jo will of course also benefit from the cut in income taxes of $10.77. So in net terms she gains by $13.53.
In total the Government will spend an extra $300 to $400 million each year on working for families, up from the current $2.4 billion. That’s significant but many commentators had predicted more.
Supporting families through tax credits
Governments from both left and right have for many years seen supporting families as important. Most recently, a package aimed at alleviating child poverty was at the heart of Budget 2015. That budget included an extra $25 a week, after tax, for beneficiary families with children.
For Budget 2017, Joyce sees that working families are the group in greatest need, with a boost for working for families tax credits. The working for families package has been a political football for much of its existence.
Working for families expands through the 2000s
Working for families was the centrepiece of Labour’s 2004 Budget. Then Finance Minister Michael Cullen projected the total cost to be $1.1 billion a year.
At that time, abatement started for annual incomes as low as $25,000, with the credit abating at 30 cents in the dollar.
John Key, then in opposition as National’s Deputy Finance Spokesperson, derided the programme as “communism by stealth”. He argued the package would discourage higher income recipients from working overtime and weekends given the high abatement rates for families over a wide range of middle incomes.
Election 2005 honed in on this ideological difference. Labour lifted the abatement threshold to $35,000 and dropped the abatement rate to 20 cents in the dollar. Credits now extended well into middle, and - for large families – even six figure incomes.
Targeting in order following the Global Financial Crisis
In 2011, anti-avoidance measures removed the ability for families to use investment losses, including losses from rental properties, to reduce their income and therefore become eligible for working for families payments, from 1 April 2011. Automatic adjustment to the abatement threshold was removed.
Even so, by 2011, annual costs had grown to $2.8 billion each year, far above Cullen’s original $1.1 billion costing for the more targeted original scheme. Changes announced gradually over four years to lower the abatement threshold back to $35,000, and increase the abatement rate to 25 cents in the dollar, compared to the previous 20 cents in the dollar.
These changes had still been working through the system. Thus far the abatement rate has increased to 22.5 cents in the dollars (not 25 cents), with the increase applying from 1 April 2016.
Joyce has chosen to bring forward the tougher abatement and eligibility rules that would otherwise have progressively occurred by 2025.
Confused? That’s not surprising. Some reports suggest that working for families is so complex that a third of payments made under it are "inaccurate", that is, more than 20 percent away from the correct credit entitlement.
Time to press refresh – Working for Families 2.0
Have we come full circle? Targeting is now tighter than since the mid 2000s. Working for families appears engrained in our tax system for a generation, no longer communism by stealth, but instead redistribution loud and proud.
Working for families is a complex scheme. Its annual focus does not sit well with the ever changing requirements of today’s working world and shifting family structures. Could the Government have done a more thorough review of indexation rules, work requirements, payment mechanisms and impact on child poverty? Only time will tell.