Thursday 1 August 2024

New Zealand's new average and marginal tax rates

This week my ECONS102 class covered taxes, and as luck would have it, today the Government's new tax changes come into effect. As the New Zealand Herald reported yesterday:

The tax cuts the National Party campaigned on will officially take effect tomorrow, with around 3.5 million New Zealanders benefitting, according to Finance Minister Nicola Willis.

Changes from July 31 include an increase in personal income tax thresholds, the extension of the independent earner tax credit (IETC) and an increase to the in-work tax credit and the minimum family tax credit.

I'm going to focus  purely on the changes in personal income tax thresholds, and update a figure I posted back in 2022, which showed the marginal tax rate and the average tax rate, for taxpayers on different annual incomes. The marginal tax rate is the amount of the next dollar earned that is paid in tax. The proportion of income that a taxpayer pays in tax is called the average tax rate. The marginal tax rate is what people often think about when they think of tax rates. However, for a country that has a progressive income tax, such as New Zealand, the average tax rate is always lower than the marginal tax rate. That's because people on high incomes, with a high marginal tax rate, nevertheless have paid a low marginal tax rate on their first dollars of income.

Anyway, here's the picture of those marginal tax rates and average tax rates. The rates that applied up to yesterday are shown in blue (marginal tax rate) and red (average tax rate). Those are the same lines from my 2022 post. Notice that the marginal tax rate is always higher than the average tax rate (except for very low incomes below $14,000, where they are the same). The new rates applying from today are shown in green (marginal tax rate) and orange (average tax rate).

Notice that changing the personal income tax thresholds shifts the vertical parts of the marginal tax rate schedule to the right (comparing the blue and green lines). That's because the higher rates now kick in at slightly higher incomes.

However, what most people are probably interested in is the change in average tax rates, not the change in marginal tax rates. This is shown by the difference between the red and orange lines. The difference is imperceptible at low incomes, as well as pretty small and decreasing at the highest incomes. It is largest in the middle of the income distribution, which is why the government has sold these changes as helping the 'squeezed middle'.

In fact, the decrease in the average tax rate is largest for those on an annual income of $55,000, [*] where the average tax rate has decreased from 17.31% to 15.86%, a decrease of 1.45 percentage points, or $799.50 per year. That isn't the largest absolute difference in tax paid, which happens at all annual incomes above $78,100, and is equal to $1,042.50 per year. Of course, as a percentage of income, that $1,042.50 is smaller at higher annual incomes, which is why the gap between the red and orange lines gets smaller for higher incomes.

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[*] I only looked at incomes in steps of $2500, and this is closest to the threshold with the biggest step up in the marginal tax rate schedule, which is now $53,500.

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