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Wednesday, 8 October 2014

New Zealand's income tax rates over time

During the election campaign it was often asserted by the opposition that New Zealand was a more equal society in the past simply because our personal income tax rates were higher. The pinnacle of this argument was the comparison of John Key's childhood in the 1960s, where it was claimed the welfare state was in a much better state - i.e. it provided more support for those at the bottom - as a result of the alleged higher tax rates. Was this actually the case?

On income tax rates, The Treasury has a fascinating paper from September 2012 looking at ways in which an "Average Marginal Tax Rate" (AMTR) could be calculated for New Zealand's personal income taxes. AMTRs come from a paper by Robert Barro and Chaipat Sahasakul at Harvard University 1983. They are:
..income-weighted average of individual-level marginal tax rates, having first accounted for various factors that allow effective, rather than statutory, marginal tax rates to be estimated.
The critical part of this definition is that the average is an income-weighted average, not simply an average across all taxpayers of the percentage of the all the income tax collected.

Here's what New Zealand's top effective marginal tax rates looked like from 1907-2009:

Top marginal tax rates, 1907-2009
As you can see, the top personal income tax rates appear to validate the claim that income taxes were higher in the past. After all, it's pretty clear from the graph that our top tax rate today is down to about where it was in the 1940s. But this ignores people's incomes and more specifically whether they would actually pay the higher tax rate.

This is where income distribution data comes in. Treasury uses the New Zealand Official Year Book (NZOYB) data up until the early 80s, and IRD data from then on. The factors they look at are:
  1. how income is distributed across the tax brackets/rates for which we have tax schedule information;
  2. how exemptions against tax are distributed across income levels and tax brackets; and
  3. how far NZOYB income distribution data, generally only available for tax filers until the PAYE regime from 1958, can be supplemented to capture non-filers’ incomes.
So what does that mean over time? Does it show that income taxes that people actually paid were higher in the 60s? Here's the paper's key graph:

New Zealand's Average Marginal Tax Rates (AMTR) 1907-2009 Source:
The Treasury
As you can see. AMTRs rouse slowly from the 1920s then rapidly during World War II, but didn't drop substantially. In the 1960s - when John Key was growing up - they dipped substantially and then increased slowly again up to the early 1970s. The 70s saw a rapid rise in AMTRs, largely driven by income tax brackets not being adjusted. The peak was 1982, when the AMTR hit 44%. From then onwards it was sharply down again, bottoming out in the early 1990s and staying at about the 30% mark.

Clearly, the income tax rates people actually pay today are not substantially greater than they were in the 1960s. So it is a myth that when John Key was growing up people paid more income tax. We should bear this in mind whenever it's claimed that a higher rate of income tax means lower inequality and a better welfare state.