Evaluating the fiscal cost of tax cuts

As reported in the New Zealand Herald today, the Taxpayers' Union released a new report today titled "5 Options for Tax Relief in 2017". I haven't had a chance to read the report in great detail, but here's what the Herald had to say:

The average New Zealand worker is paying $483 a year more in tax because income brackets have not been adjusted with inflation, a new report by a right-wing lobby group claims...

In an effort to put pressure on the National-led Government ahead of May's Budget, the report assumes $3 billion is available for tax relief in 2017/18.

The report outlines five different options for how those tax cuts could be divvied out.

They are:

• A tax-free threshold of up to $13,000. The report states this would save taxpayers $1295 a year, for those earning more than $13,000.

• Cutting the marginal tax rate for earnings between $48,001 and $70,000 to 17.5 per cent, and increasing the 10.5 per cent threshold from $12,000 to $24,000.

The report says this would particularly benefit middle income earners, giving the example of a $4000 a year saving for a dual-income household with a combined income of $100,000.

• Cutting tax rates for high income earners by eliminating the top tax bracket and reducing the rate above $48,001 to 26 per cent, and slashing company and trust tax rates to 26 per cent.

Those measures would save a person earning a $120,000 salary more than $4300 a year. A low income earner would get no benefit, while the average earner would save just $360 a year.

• Increasing the income thresholds of each tax bracket without adjusting any of the tax rates.

• Reducing the company tax rate from 28 per cent to 13 per cent, at a cost of $2.88 billion.

The report stated that an "average worker" on $57,000 is paying $483 a year more in tax than they would had income tax thresholds been adjusted for inflation since 2010.

Back in February in another article about tax cuts, Brian Fallow pointed us to this handy tool on the Treasury website: The Personal Income Tax Revenue Estimate Tool. It's an Excel-based tool (it would be even cooler if it were fully online) that allows us to evaluate the impact of changes in the tax brackets or marginal income tax rates (the proportion of the next dollar that would be paid in income tax) on total tax revenue (from personal income tax).

I had a bit of a play with the tool and the assumptions above, and here's what it came up with:

• The tax-free threshold of up to $13,000 would reduce personal income tax revenue by $3.35 billion
• Cutting the marginal tax rate for earnings between $48,001 and $70,000 to 17.5 per cent, and increasing the 10.5 per cent threshold from $12,000 to $24,000 would reduce personal income tax revenue by $3.46 billion
• Eliminating the top tax bracket and reducing the rate above $48,001 to 26 per cent would reduce personal income tax revenue by $2.49 billion (and reducing company and trust tax rates to 26 percent would reduce taxes paid by those entities as well) 
• Increasing the income thresholds of each tax bracket without adjusting any of the tax rates (as per their report) would reduce personal income tax revenue by $3.46 billion
• Reducing the company tax rate can't be evaluated using the PITRE tool.

I leave it up to you to decide whether these different tax changes, each costing around $3-3.5 billion according to the PITRE tool, are affordable and worthwhile. The estimates should be taken with some caution however (and the PITRE tool even warns against making large changes to the tax rates and bracket thresholds). Whenever marginal tax rates change there are a raft of effective marginal tax rate changes that affect incentives to work (or not work), that cannot easily be evaluated with a simple tool such as this. However, I do encourage you to download and play around with the tool, especially if you want to see how marginal and average tax rates work, and the effects of changing them (slightly!).