Susan St John: Level of inequality just not acceptable

New Zealand once enjoyed a reputation in tax as an international leader. As the Tax Working Group has explained, we have lost that edge. The tax system now falls woefully short on the standard criteria of equity, efficiency and administrative simplicity.

The group did recommend a tax on property to help tax those in similar positions more equitably, but they were unable to address the broader aspect of equity as measured by the fairness of the overall post-taxes and transfer of income distribution.

While they modelled the impact of different scenarios of tax cuts and base broadening on child poverty and inequality, their concern was limited to ensuring that these did not get noticeably worse.

The question not asked was "is the current level of inequality and poverty acceptable?".

New Zealand's after-tax distribution is one of the most unequal in the OECD, and child poverty rates are a national disgrace.

The Ministry of Social Development's just released 2008 survey of living standards, reports 19 per cent of children are experiencing "serious hardship" and "unacceptably severe restrictions on their living standards".

The design of the income tax system, including tax credits for children, is a crucial influence on these outcomes.

To address distributional questions the tax/transfer system needed to be considered as a whole.

The Tax Working Group could not undertake the needed integrated review as it was neither set up nor funded to do so.

It noted however the convoluted interface between the tax and benefit system and called for a comprehensive review of the tax/welfare system.

The problem is the plethora of social assistance that impacts on how much income can be retained when an extra dollar is earned (the effective marginal tax rate).

For example, some of the key ones are welfare benefits, family assistance, student loan repayments, child support, student allowances, childcare subsidies and the accommodation supplement.

While claiming most of these were outside its brief, the Tax Working Group had to take Working for Families (WFF) into account as it is the key way taxes are adjusted for family size.

It is a very complex package made up of the Family Tax Credit, the Parental Tax Credit, the In Work Tax Credit and the Minimum Family Tax Credit.

The group highlighted the 53-58 per cent effective marginal tax rates that middle and higher income parents can face. They also modelled the welfare - like the poverty-trapping Minimum Family Tax Credit with its extraordinary 100 per cent abatement for extra income and rigid number of work hours requirement. But the plight of people who earn extra income while on a partial welfare benefit was ignored.

Welfare advocates are continually confronted with cases where no matter how hard beneficiaries try, they fall further behind.

A couple on the unemployment or sickness benefit can have only an extra taxable $80 between them before they lose almost dollar for dollar of extra earnings.

Families go further into debt just to meet the basic costs of food, rent, and electricity. For many, the escape of full-time work is a total impossibility. Perhaps this should be regarded as more serious than the modest disincentives faced by some higher income families who are caught in the Working for Families net.

The Tax Working Group did not ask whether the purpose of the various parts of Working for Families was achieved.

For example, the In Work Tax Credit has two objectives - to encourage sole parents to work and to reduce child poverty.

It is exceptionally expensive at $590 million annually, and is paid not just to those earning the minimum wage but way up the income scale to those earning over $100,000 annually. Yet the design of this expensive package excludes the poorest 200,000 children whose poverty has been left to deepen.

Because the tax group did not analyse the detail of Working For Families their suggested changes to reduce effective marginal tax rates are problematic. For example, one scenario modelled universalising the last $2000 a child of the Families Tax Credit. At a further cost of $700 million annually, this would pay the In Work Tax Credit to the very wealthiest working families, who clearly don't need an incentive to keep off a benefit.

Remarkably, this extra $700 million expenditure would not increase family payments at all at the lower end where they are so desperately needed.

Other examples of the layers of evolving complexity wrought by the Families package are the Independent Earner's Tax Credit and the Restart package. The first was introduced so that childless low income people did not feel left out. This tax credit is both badly designed and hard to administer.

If you earn one dollar less than $24,000 per annum you miss out on the lot. The Restart package is not much better, allowing some families, but not others, to keep the In Work Tax Credit during the first 16 weeks of unemployment.

The tax/welfare interface is a mess. The system is inequitable, inefficient, and administratively complex. It requires much more attention than the Tax Working Group could give it. Let's hope that the Government listens to the group's call for an adequate and comprehensive review.

Susan St John is associate professor at the economics department, Business School, University of Auckland.