Effective marginal tax rates, and work incentives for older people

Tax rates matter for work incentives. When tax rates are high, there is less incentive for people to work. They may pass up additional work and choose leisure time instead. However, it isn't just taxes that matter. It is the loss of other entitlements as well. All of these are bound up in what is called the effective marginal tax rate (EMTR), which is the amount of the next dollar of income a taxpayer earns that would be lost to taxation, decreases in rebates or subsidies, and decreases in government transfers (such as benefits, allowances, pensions, etc.) or other entitlements.

Because they relate not just to tax rates, but to the loss of other entitlements, EMTRs can get very high (sometimes over 100 percent), and present a strong disincentive for work. This article in The Conversation this week, by Peter Martin (Australian National University) presents one example for Australia:

Pensioners who do go over the $227 per week limit lose half of every extra dollar they earn in a cut to their pension.

Plus tax, this means they lose a total of 69% of what they earn over the limit where their tax rate is 19%, and 82.5% on the portion of earnings taxed at 32.5%.

And this is after the boost designed to “incentivise pensioners into the workforce”.

So, the EMTR for older people in Australia could be as high as 82.5 percent. And the consequence of this, in comparison with New Zealand (where there is no reduction in national superannuation for older people who work):

In Australia, 15.1% of the population aged 65 and older are in some kind of paid work, up from 14.7% a year earlier.

In contrast, in New Zealand the proportion has just hit 26%. That’s right: more than one-quarter of New Zealanders aged 65 and older are employed.

That's a substantial difference, that is almost certainly explained in part by the difference in EMTRs between New Zealand and Australia. Now, sometimes government may have a good reason for high EMTRs and the work disincentives they create. For example, tertiary students in New Zealand who receive a student allowance face an EMTRs of 100 percent beyond the first $258.08 of additional work earnings. That ensures that students don't spend so much time working that they can't concentrate on their studies. However, it's hard to make a similar argument for older people. Would the Australian government want a high EMTR on older people who that they don't spend so much time working that they can't concentrate on their retirement?

Most governments want older people to work more, not less, in order to mitigate labour force shortages (e.g. see the Older Workers Employment Action Plan for New Zealand). Australia seems to be getting this wrong. As Martin concludes:

...New Zealand is certainly making it easier for retirees to work legitimately, rather than stay at home or accept cash in hand.