Keith Ng: Four tax myths that might pop up this year

While bracket creep is rightly characterised as "a tax increase by stealth", successive governments – left and right – ...
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While bracket creep is rightly characterised as "a tax increase by stealth", successive governments – left and right – have kept it as a handy political tool, says Keith Ng.

Keith Ng discusses four popular tax myths, in an extract from a new PSA booklet on topics in tax policy and practice

OPINION: Myth 1: "40% of households pay no 'net taxes'"

Since 2011, Bill English has been pushing the idea that around 40 per cent of NZ households don't pay any "net tax".

In its first iteration, the claim was very technical and specific. English said that these households "receive more in income support than they pay in income tax" [emphasis added]. But by 2016, it's mutated into a wildly inaccurate claim in the media that these households are "contributing nothing to New Zealand's tax take" and that the whole tax system is propped up by "a small number of taxpayers [who] bear the brunt of New Zealand tax bill".

The problem with "net taxes" is that it excludes GST, which accounts for 32 per cent of all taxes. Not quite as much as income tax (38 per cent of all taxes), but it's a whopping big heap not to count. It also only counts cash transfers – so if you get cash from the government, that gets counted, but if you get a service from the government (such as education, or healthcare) that does not.

"Net tax" is an arbitrary and meaningless way to count who is "contributing" and who isn't. It exists as a political tool. Although it is produced by Treasury, Treasury themselves have never published it. It has only ever been  released by the minister of finance's office, and usually its first public appearance is on David Farrar's blog.

Myth 2: The top 10% of taxpayers paying 46% of taxes proves they're overtaxed

It's true, the top 10 per cent of taxpayers pay 46 per cent of all income tax – but that's only half the picture.

How much tax you pay depends on two things: a) the tax rate, and b) your income. It's pretty straightforward, so it's incredible how often people blame "high amount of tax paid" on the tax rate being too high, and completely ignore the income effect.

The top 10 per cent of taxpayers make around 34 per cent of all taxable income, nearly as much as the bottom 70 per cent combined. So while they pay a lot of tax, they also make a lot of money.

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But the critical part is that they pay a higher tax rate, and that's where any debate about tax fairness ought to start. The top 10 per cent of taxpayers have an average income of $140,000 per year, and pay 26.5 per cent of that in income tax. The next 10 per cent down from them have an average income of $73,000, and pay 20.4 per cent of that in income tax.

The defining factor of a progressive income tax system is that people on higher incomes pay a greater percentage of their income in taxes.

Whether you think that's fair is a matter of values, not fact. But looking at the "total tax paid" or "proportion of tax paid" without looking at income or tax rate is just plain misleading, and tells us nothing about progressiveness or fairness.

Myth 3: Bracket creep has reversed the effects of the 2010 tax cuts

Bracket creep refers to the effect of inflation on the tax rate. As our incomes grow (due to inflation), we move into higher tax brackets and a pay higher tax rate, even though the growth due to inflation isn't really

making us richer.

Before the 2010 tax cut, the average tax rate for all taxable income was 21.4 per cent. Immediately after the tax cut kicked in, at its lowest point in 2012, the average tax rate fell to 18.9 per cent.

That's the impact of the tax cuts.

By 2015 (the latest year for which data is publicly available), it crept back up to 19.5 per cent. That 0.6 per cent increase is partly the result of bracket creep. It's not nothing – and it disproportionately affects people earning around $50,000 per year – but people are still paying less income tax than they did in 2010.

While bracket creep is rightly characterised as "a tax increase by stealth", successive governments – left and right – have kept it as a handy political tool. It's a mechanism that automatically raises taxes a tiny bit each year; over time, it gives governments the option to increase spending or to tweak the tax system.

Myth 4: Tax cuts pay for themselves

Here's an idea: If everyone gave the government less money, the government would receive more money. This is not a joke. The 2010 tax cuts were estimated to cost around $1.1b over four years. But by 2014, the tax cut was supposed to result in the government receiving an extra $175m a year in taxes.

The magical part is a single line in the budget called "Adjustment for macroeconomic effects". Treasury includes this because they believe that tax cuts will help the economy grow faster, and a bigger economy means more taxes.

It's a sound idea in theory, except it's a bit like a rain-dance. If it rains more than average after I do a rain-dance, then clearly it was very effective. If it rains less than average after I do a rain-dance, then you're lucky I did it, because it would've been much worse if I didn't!

And that's what happened. By the time 2014 rolled around, the economy grew slower than expected and tax revenue was $4b less than the 2010 forecast. Did the tax cut fail to stimulate growth? Or was the economy worse because of the Christchurch earthquake and other factors, and the tax cut helped soften the blow?

Even with the benefit of hindsight, it's impossible to prove or disprove.

That's a pretty lousy way for an "evidence-based" government to justify spending a billion dollars.

The PSA's "Progressive Thinking: Ten Perspectives on Tax" booklet features 10 authors, academics and campaigners writing journalistically on a broad range of topics in tax policy and practice. It is being released on Monday 22nd May in advance of the Government's Budget, and will be available to read online at the PSA's website from Monday 22nd onwards.

Keith Ng is a data visualisation consultant by day and data journalist by night, using data to understand and explain complex issues and policies.

 - The Dominion Post

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