The Elasticity of Taxable Income in New Zealand

Authors


  • Submitted February 2011.

  • The authors are grateful to the Royal Society of New Zealand for funding support from the Cross Departmental Research Pool from Government, and to Matt Benge, Viv Hall, Leo Krippner, Wayne Tan and Sandra Watson for valuable comments. They have also benefited from suggestions by participants at seminars at the Asian Development Bank, the New Zealand Inland Revenue, the New Zealand Treasury and the New Zealand Association of Economists 2010 conference. The views expressed in this paper are the authors' own and not necessarily those of Inland Revenue or Treasury. The authors are particularly grateful to two referees and Hamish Low for their detailed comments and suggestions.

Abstract

This paper reports estimates of the elasticity of taxable income with respect to the net-of-tax rate for New Zealand taxpayers. The relative stability of the New Zealand personal income tax system, in terms of marginal rates, thresholds and the tax base, provides helpful conditions for deriving these estimates. The elasticity of taxable income was estimated to be substantially higher for the highest income groups. Changes in the timing of income flows for the higher income recipients were found to be an important response to the announcement of a new higher rate bracket. The marginal welfare costs of personal income taxation were consistent across years, being relatively small for all but the higher tax brackets. For the top marginal rate bracket of 39 per cent, the welfare cost of raising an extra dollar of tax revenue was estimated to be well in excess of a dollar. Implications of the findings are that: disincentive effects of high top marginal rates can be substantial even when labour supply responses are small; the welfare costs of increases in top marginal tax rates can be high; and announcement effects of tax policy changes can lead to considerable income shifting between time periods.

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