Tax relief need not break the bank

Delivering tax relief in 2024 is part of the coalition Government’s policy platform. A range of commentators have suggested that to deliver tax cuts now would be inflationary and unaffordable. Let's take a closer look to see if that is indeed the case – and consider the consequence of not adjusting tax brackets in more than a decade.

Let’s start with a typical minimum-wage worker, working 40 hours a week. As of April 1 they have just graduated to a new tax bracket, and instead of paying the previous 17.5% in tax, they’ve now been tipped to pay 30% on anything over $48,000. If you thought it was an April Fool’s Day prank, I have some bad news for you.

This is what economists call fiscal drag in action – it changes the real value of tax thresholds. The fact that a minimum wage worker is eligible for the third-highest tax rate in this country demonstrates how we’ve managed to get it wrong.

When New Zealand’s tax brackets were last adjusted, back in 2010, a person earning minimum wage would have to work 71 hours a week before being pushed into the next tax bracket – today that happens after just 40.

Advice from Treasury to the previous Government mentioned this tax bracket issue and pointed out that for someone earning $179,000 the marginal rate would be 33% - clearly a reduction in progressivity (a tax rate that increases or progresses as taxable income increases), which is one of the objectives of our tax system.

Treasury also advised implementing tax relief would improve the progressivity of the tax system, help address cost of living issues, help address fiscal drag, and improve labour supply. But won’t any sort of tax cut simply add to inflation?

The conversation around tax cuts in recent years has centred around a belief that any relief would be inflationary, because it would increase demand for goods and services. But this argument fails to take into account the bigger picture. Readjusting our tax brackets would be a way to ensure more money stays in Kiwis’ pockets at a time when every dollar counts. Some may choose to offset their higher cost of living or save the difference.

Most New Zealanders with a mortgage are simply trying to satisfy their regular interest payments, and if it were used to pay down debt or add to savings, many economists say the inflationary risk is minor. Likewise, spending on utilities and household costs like rates and power (which are already out of step with wages) is on the rise, so in many cases, any tax relief would likely go towards these costs.

When it comes to productivity, lower taxes afford households a better return for their work, and therefore a greater incentive to work. A healthier net pay packet makes working a few extra hours more appealing to employees. A lower tax rate also makes it easier for a business to attract talent from abroad, and could prevent local talent from looking elsewhere overseas.

Is it the right time to adjust tax brackets? There’s no doubt they’re well overdue for a correction and would benefit in the long term by being regularly reviewed to ensure any bracket creep is kept to a minimum. If they’re not, governments end up with snowballing tax gains and, as has been the case, poor spending outcomes that don’t increase core service delivery to taxpayers.

The likelihood of large cuts or threshold adjustments in this year’s Budget is slim, given the extremely tight fiscal position the Government finds itself in. So if we’re being realistic any adjustments to New Zealand’s tax brackets would likely be modest.

Likewise, any relief would be diminished, but it would be relief nonetheless.