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New Zealand’s tax system: weak at reducing inequality

How well does New Zealand’s tax system perform in reducing inequality? What would be the effect of some likely changes to it discussed in the interim report of the Tax Working Group, released last week?

New Zealand’s personal income tax system is very weak in reducing inequality compared to other OECD countries. So is our transfer (income support) system. Together they’re near the bottom of the OECD. Each system is about half as effective as the most effective in the OECD. The inequality-reducing power of the tax and transfer system on market income inequality has steadily declined for New Zealand over the last three decades, says the MSD’s Household Incomes Report.
GST is regressive: the lowest income tenth of households pay about twice the proportion of their income in GST as the highest income households. That is mainly because low income people are able to save proportionately less. GST is a tax on labour income and the combination of GST and personal income tax does little to reduce income inequality. The effective tax rate on the incomes of the lowest income households averages 26% compared to 31% for the highest income households. Only benefits and Working for Families tax credits make the tax and transfer system progressive. While reducing the GST rate would improve the situation, it comes at a high cost in lost revenue. Reducing the lowest tax rate or introducing a zero-tax threshold would be more effective in redistributing income to low and middle income families.

Most of the public focus has been on taxing capital gains – the increase in value of assets such as housing (excluding the family home) and shares – which most high income countries already tax. The gain in the value of an asset is, in economic terms, just another form of income so the proposal is that it should be taxed like any other form of income. Fairness is the strongest argument in favour of taxing capital gains. There is no reason why income as a capital gain should be tax-free when the same income earned in wages or salaries is taxed.

Those paying it are likely to be highly concentrated in the wealthiest households. A huge 82% of the assets whose capital gains are likely to be subject to tax are owned by the top 20% of households by wealth. Taxing this form of income would therefore be a useful step towards making New Zealand’s tax system more effective at reducing inequality, though in relative terms probably small in the average year. In addition, it could close some tax loopholes. Some wealthy individuals use closely-held companies to convert taxable income into untaxed capital gains. A well-designed tax on capital gains would make this practice pointless.

Much needs to be done to make our tax and transfer systems more capable of reducing New Zealand’s high level of income inequality. The Tax Working Group could recommend some useful options.

Download the full bulletin: CTU Economic Bulletin 203 – September 2018