Susan St John wants to see the problem of the 'effective marginal tax rate' on the incomes of the poor come out of the too-hard basket

Susan St John wants to see the problem of the 'effective marginal tax rate' on the incomes of the poor come out of the too-hard basket

This is the ninth of ten articles in the Public Service Association's "Ten perspectives on tax" series.*


By Susan St. John*

One of the least tractable concepts in tax is that of the effective marginal tax rate (EMTR). The official income tax rate applied to each dollar earned is not the only payment a family will make on that dollar.

There may be other losses and government imposts that look and feel like taxes. Families with children are particularly affected. The overall effect is a high EMTR that leaves a parent little to show for the effort of earning that extra dollar, constituting a strong disincentive to earn it in the first place.  It is one of the major reasons that child poverty rates are high in low income working families.

Let’s take the example of a parent on the minimum wage of $15.75 per hour, earning $36,350 per annum. There are some Working for Families and rent subsidies but increasingly this family relies on foodbanks and loan sharks.

Let’s say there is an opportunity to earn another $10,000. Once tax and ACC are paid (18.71%), Working for Families is abated (22.5%), student loan repayments are made (12%), Accommodation Supplement is reduced (25%) and KiwiSaver extracted (3%), the $10,000 has been effectively taxed at 81.21%.

Furthermore, there may be a sudden drop in child care subsidies and child support payments of between 18-30%. Every family is in a different set of circumstances, and few will understand what is actually happening. They will know that at the end of the year despite their extra work effort they are no better off, may actually be worse off and will undoubtedly feel despair.

The EMTR effect, arising from the tax-transfer interface, is always in the too hard basket. In 2010 the Tax Working Group felt it was outside their brief and passed the buck to a welfare working group. But when the Welfare Working Group (2011) was established, it was explicitly forbidden to examine this issue. Yet it is this interface that impacts intensely on the well-being of families with children, and their ability to work their way out of poverty.

It is important to understand how this debilitating problem has arisen. The high tax rates of the early 1980s were thought by economists to reduce the incentives of high income people to earn and save.

Enter Rogernomics and the low flat-tax broad base solution of the late 1980s. However, a comprehensive view of income was not achieved because the capital gains part of the package did not eventuate.

Nor did flat tax solve the high EMTR problem; it merely shifted it from the top end to low and middle income earners. Low flat tax under the ideology of the day was to be accompanied by more user pays of social provision. However a three-way iron rule applies.

The greater the amount of social assistance to be reduced as income rises, the longer the range of income before all assistance has been bled out unless a higher rate of abatement is imposed. Reducing the amount of assistance acts to intensify poverty, a long income range defeats the purpose of welfare only for the poor, while a high rate of abatement imposes severe disincentive effects.

In advice to the incoming government in 1990, Treasury warned:

As a general rule, the more people facing higher effective marginal tax rates over longer ranges of potential income, the greater the costs to society and the greater the probable loss of output.1

Treasury identified high levels of benefits as a major factor preventing a more gradual abatement system and benefits were cut significantly in 1991. The Change Team on Targeting Social Assistance in 1991 was tasked with designing a new ‘integrated’ system of targeted social assistance. Thus the 1991 budget announced a complex system of Family accounts based on aggregated family assistance and a constant bleed-out or abatement rate. 2

Unfortunately, while aggregating assistance onto a family-based smart card, abating at one rate worked in theory, but the technocrats could not make it work in practice. One of the problems was that the typical modern family did not resemble the assumed nuclear family model.

Another was that the scale of assistance to be targeted, even with the 1991 welfare benefit cuts, meant assistance would be paid well up the income scale even with a very high single rate of abatement.

The integrated solution that had been used to justify the low flat-tax user-pays approach had quietly disintegrated. Now all that was left was the welfare mess of a plethora of high and overlapping abatements.

While one might have expected a re-examination of the wisdom of the 1990s reforms, instead the welfare morass has been intensified

in the name of target efficiency. 3 Welfare ‘only for the poor’ and low top tax rates has been the means of achieving an implicit, if not explicit, objective: more wealth and income for the top earners and an ever-immiseration and indebtedness of low-income families.

An alarming part of this picture is way tax credits for children are treated. One of the requirements to moderate the regressivity of a flattish income tax system with a notably high GST on everything, is a well-designed set of family-based tax credits.

The New Zealand system, known as Working for Families (WFF) operates to offset taxes paid by the family, thus improving horizontal equity – at least for low income families – by acknowledging that children reduce the ability to pay tax. The progressivity of the overall tax structure is further enhanced because tax credits are ‘refundable’ when they exceed the taxes paid by a low income family.

WFF tax credits are a major mechanism to alleviate and prevent child poverty. Just as older people need tax-funded support, so do families, especially when on a low income. It is critical such child tax credits are understood, supported and enhanced. When policy confines the tax credits ever more closely to low income families the EMTR problems are intensified.

If there is no will to revisit the ideology that drove the 1991 changes of flat low tax and user pays, then mitigation of high EMTRs is the urgent task. Unfortunately, current policy, based on increasing target efficiency, is going in quite the wrong direction.

For WFF, this sees the threshold for abatement heading back to $35,000 – where it was in 2005 – and the rate of abatement going up to 25% over time. Student loans are replacing student allowances, so repayment of larger student loans applies for long periods of time, especially for women. The thresholds for loan repayment have been frozen, as has the threshold for the parental income test and the cap for the Accommodation Supplement.

An innovative set of policies that reverse the recent cuts and enhance the programmes that help families, including a debt forgiveness programme is urgently required. Better still, a revisiting of the low flat-tax broad-based dogma is
well overdue.


[1] The Treasury (1990). Briefing to the incoming government. Wellington, The New Zealand Treasury: https://goo.gl/YACrXO

[2] Shipley, J. (1991). Social assistance: welfare that works. Wellington, Government Printer

[3] St John, S. and K. Rankin (2002). Entrenching the welfare mess. Auckland, Economics Department Auckland University: https://goo.gl/JxNjs

 


* Susan St John is an Honorary Associate Professor in the Department of Economics University of Auckland where she directs the Retirement Policy and Research Centre. This is the ninth article in the PSA's "Progressive thinking series, Ten perspectives on tax."

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42 Comments

Taxing personal income exclusively through GST would mitigate some of the perceived EMTR.

And grossly favour the very wealthy

Wealthy people spend more and as such would pay more GST. Affected people would literally see more money in their bank accounts effective from their next pay packet.

Also keep in mind that there is not normally any GST on rent which is an expense that affects the poorer disproportionately.

"Affected people would literally see more money in their bank accounts effective from their next pay packet."
Your point being?
They are still going to have to consume a larger proportion of that money, than the wealthy.

Hence, the wealthy are favoured..

Debatable at best. If you spend 50% of your income on GST exempt residential accomodation, someone who owns their own house would need to "not spend" a lot of money to catch up to your effective tax savings ratio.

Perhaps convert just the bottom threshold into GST and have tax bands above $20,000 that reflect the GST raise.

Rubbish.

I'll do a schoolboy exercise for you.

Labour4Life nets $700 (essentially min wage).
He has rent (GST free) of $200.
He is left with $500 of disposable income.
His other expenses are $450 - of which all is liable for GST.
He benefits the $50 (treat the rent as sunk).
His proportion of (disposable) tax free income is 5/70 = 1/14

Sadr001 nets $2000
He has a mortgage of $750
Expenses of $450
He benefits from $800 of tax free income.
His proportion of tax free income is 2/5

Sadr001 is taxed at a much lower rate than Labour4Life.

"Perhaps convert just the bottom threshold into GST and have tax bands above $20,000 that reflect the GST raise."
The whole idea was to suppose a condition to simplify the tax system - proposing bands just recomplicates it.

If I ever decide to spend any of that $800 (get a benefit from it) I'd pay GST on it.

in your example above I paid GST to build a house (factored into mortgage) so my income affected by GST is $1,200. Or 60% immediately and if I ever spend the remaining 40% I'd pay GST on that too. Total 100% of income affected.

Labour would only pay GST on 500 because the 200 is GST free. Essentially he is only taxed on 70% of his income.

Do you pay any GST when you buy a preexisting house?

Wrong, again.
You assume consumption is going to occur. That is incorrect.
A 100% GST system disincentivises non essential consumption - that is why the poor suffer.

"If I ever decide to spend any of that $800 (get a benefit from it) I'd pay GST on it."
You wouldn't pay a tax component on investing that money, if it was a completely user pays system until it was transacted for consumption - this gives the wealthy a huge advantage in wealth accumulation.
Nor would you pay tax on it for consumption outside of NZ.
Things get very messy at this point.

"in your example above I paid GST to build a house (factored into mortgage) so my income affected by GST is $1,200. Or 60% immediately and if I ever spend the remaining 40% I'd pay GST on that too. Total 100% of income affected.

Labour would only pay GST on 500 because the 200 is GST free. Essentially he is only taxed on 70% of his income."

Exactly how is it that you are paying an effective GST component through your mortgage, and Labour (renter) is not through rents?
Given that rents are a function of cost..
That's why I said to ignore/sink those costs.

I wish I got $700. Sadr001 is a greedy fella who needs to get more tax.

Disagree with your comments and without going into the detail why not just remove the GST component on vegetables/bread/milk eggs our staple foods.Other countries have done this successfully eg Denmark

Just my experience after being in sales for 30 years. Your statement should read

Wealthy people are mostly tight and look for wholesale and cash deals to minimise any potential nasty tax payments.

Debt forgiveness of the first $100,000 of every new mortgage would disproportionately benefit people with smaller mortgages because 100,000 is a greater percent of a small mortgage than a big one.

There used to be a 10% debt forgiveness of your student loan if you paid it back early.

Also don't forget that when frozen tax related thresholds are adjusted for inflation,it is the poor who complain!

Important article. But it's hard to yet see the way out of this trap we have wandered into. A real tarbaby. It's government participation via convoluted tax that got us into it, so less tax interventions methinks. Government taking a role of referee would be better.
Strategically, if we become a high income country for citizens, it could eliminate the need for the tax convolution we have created. Unfortunately high incomes for locals does not seem to be a policy objective of recent governments.

The current system of Working for families is utter bollocks taking the money away from working folk and then giving their own money back to them .

What does the Government take people for ?

Fools ?

Its a hopelessly complicated money-go round that costs a fortune to administer all the the name of some sort of leftist redistributive social engineering

It would be far simpler to have tax tables giving rebates or reduced taxes to families with kids as follows :-

Table M for no kids
Table M+1 for 1 child
Table M+2 for 2 children
up to M+5 and after that you are probably on the benefit anyway

Taking money from working folk? You do realise working (hint) for families is targeted at working families right? They then give this money not to working people, but slum lords benefiting not from their hard work but from debt created by a bygone era of real estate ponzi.

But its actually not, It favours the people who work less (less income) or work lower paid jobs. It does not favour people who work hard to earn a higher wage. Me and my partner both work, we don't get a cent from the government for our child. If my partner was to not work? we still don't earn a cent. If I was to bail out of my job and got work at pack and save... watch the money roll in!!!

And yet your not going to quit your job and work at pak n save anytime soon are you? It's hardly big money, it's literally the difference between being able to pay your power bills and not.

Working harder is a bit disingenuous, working smarter yes... there are a lot of businesses benefiting disproportionately from lower paid workers.

> there are a lot of businesses benefiting disproportionately from lower paid workers.

Yep - it's these businesses who benefit from Working for Families and the Accommodation Supplement, because they don't have to pay the wages that would otherwise be required to attract workers to where they are.

Yes - the benefits are a subsidy to employers paying poor wages

You are going off track, The specific point made was it benefits family's who work. It doesn't. It benefits those families who work less or work in lower paying jobs.

Lower paying jobs are still jobs. Has there been any evidence working for families is subsidizing low wages? Are we seriously coming to the conclusion these people would be getting paid more if working for families wasn't in existence?

It couldn't be perhaps a recent influx of chef and retail managers to the tune of 70k per annum limiting lower end wage growth could it?

agree totally and have had many argruments on this.
its like the difference between donating to a charity where a portion of it is gobbled up by admin costs and donate to a give a little page (before the fees were introduced). one got cents on the dollar the other got the whole dollar

When Helen Clark introduced Working for Families she created a constituency of voters for Labour. Very good move for the party's interest and destructive of every thing else.
Make people dependent on the government giving them back their own money - anybody who wants to rethink that in the future creates votes for Labour - brilliant but cynical.

National has increased it, after calling it communism by stealth.

Looks like National has abandoned their ideological routes...although perhaps the fact they're giving more subsidies to businesses, farmers and property investors means they're still the "business" party?

Doesn't matter how you tax, just raise the benefit somewhat and I will be happy.

How about you just upskill yourself, instead?
Increasing the benefit won't make you richer in the long run.

No jobs with good pay. I'll work any job that pays $50/hr

You could work my job for that rate. It would be a discount, but regardless, you wouldn't be able to do the required tasks.

Essentially, you get paid what you are worth.
If you are unhappy about that, you need to up-skill yourself. Not rely on the redistribution of other people's wealth.

You should aim higher ;P

Quite funny that the far right commentators do not notice the satirical poster. Because the satirical poster is true to what they believe the left wing are.

I was being satirical, doubt Labor was.

As a person who has voted National most of my life (not any more) I object to your lack of a sense of humour. You're making us all look bad.

You are satirical poster

Funnily enough, you resemble Ralph's stereotypes of the left.

One wonders.

Shhh...

Pretty sure Labour4Life is a false flag, don't let them wind you up nymad.

Exactly what I have been saying for a while now. Our welfare system is set up as a poverty trap that prevents people from ever saving the deposit for a home while enriching landlords and adding fuel to ever increasing house prices.

True Chris, but as long as we have people who only want to work for $50/h then no money or system in the universe can help the situation - some of our issues are attitude related rather than money !
I am yet to see a government bold enough to reduce benefits to those who are able to work but cannot be bothered - the majority of which are on sickness benefit ...!! Oh and they want to own a house too - go figure

everybody deserves money

I don't buy this effective marginal tax rate being unfair.
And I don't buy that there is no incentive for people to come off welfare.
First point: To say it is unfair that you don't continue to receive benefits when you start earning enough income is dishonest at best, and mean-spirited at worst.
Second point: the disincentives that apply when you are earning in the top tax bracket are vastly different to the disincentives when you are in the lowest tax bracket, especially if you are just breaking out of welfare. There is an incentive firstly just to get off welfare (I would assume). Secondly there is an incentive to get experience in a well-paying job that could further your career. Thirdly, your net benefit for working those 'extra' hours is probably still a big percentage of your net income during welfare.