NZ tax system is fairer than you think despite big earners rorting top rate, rejected report finds

A new report has found high-income earners are shouldering a greater proportion of the national tax burden - and that the system is also unfair for most ordinary Kiwi workers.

The finding that those with the biggest pay packets pay more of the national tax take than they earn in taxable income could aid calls to axe the top tax rate, something National and Act have both said they would like to do, but not this term.

The finding only relates to people’s taxable income.

Another IRD report, published last year, found New Zealand’s wealthiest people paid an average tax rate of 9.4 per cent on their “economic income”, compared to a 20.2 per cent rate paid by a “middle-wealth” New Zealander. The distinction is that top earners earn income in ways less likely to be taxed at high rates.

It also warned that the amount of money IRD spends on tax investigations has fallen significantly during the last Government’s term, a fact the new Government has said in its coalition agreement with NZ First that it would remedy.

A notable number of people began declaring income close to but not above the top tax rate threshold. Photo / IRD

The irony is that the report was written up under the Labour Government’s Tax Principles Act, which required IRD to regularly publish reports on things like the fairness of the tax system.

At the time, then-Revenue Minister David Parker said the law would continue “the good work of shining a light on the fairness of our tax system”.

“The public deserves to have this information, so people can use it to assess claims made by politicians about tax fairness.

“Successive governments have made changes to the tax system in the name of fairness – but without facts, the idea of fairness can be subjective, and manipulated to suit political arguments,” Parker said.

Despite that, the new Government swiftly repealed that bill before IRD could deliver the first report.

The Herald has obtained a copy of the hitherto unpublished report released by IRD after it was requested under the Official Information Act.

The report said people’s average income tax rate was increasing.

“Over time, as incomes grow through inflation or real increases, average tax rates increase unless the marginal tax rate structure is changed.”

It said this made the system less progressive “unless thresholds are adjusted upwards”, which is what the new Government proposes to do”.

“From 2012 to 2017, the average tax rate of the most common income of a regularly employed worker increased by 0.1 percentage points. But from 2017 to 2022 it increased by 1.2 percentage points.

“The significant increase is because the peak that includes the most common regularly employed worker shifts to the higher marginal tax rate of 30 per cent. The average tax rate then increases rapidly as incomes rise from there and marginal income is taxed at 30 per cent instead of 17.5 per cent,” the report said.

The report found the top 10 per cent of income earners paid 44 per cent of personal taxes, despite earning 33 per cent of taxable income. In other words, that part of the tax system is progressive because high-income earners contribute a higher proportion of their income in tax take.

The report nodded to the debate on what constituted income.

It noted the tax base “could be altered to better reflect taxpayers’ actual ability to pay”. If this were done, “the system’s progressivity might be more effectively realised”.

“In New Zealand, the major debate relevant here is whether realised capital gains should be included in the tax base,” it said.

The report found there was large uptake of the Government’s R&D tax credit scheme, which offers firms tax credits for spending on research and development.

High-income earners pay a larger share of tax than they receive in taxable income. However, high-wealth people pay a lower effective tax rate. Image / IRD

Just $40 million was spent on the scheme in 2018/19. This rose to $473m by 2021/22.

The report raised an eyebrow at the curious phenomenon of income “bunching” around $180,000.

After the new top tax rate was introduced for incomes above $180,000, there was a dramatic bunching of people declaring incomes around that income level. The suspicion is people do this to avoid having much, if any, of their income taxed at the top rate.

Labour’s revenue spokeswoman Deborah Russell posted to X, formerly Twitter, that the bunching was “curious”.

The report noted the amount of money spent on tax investigations had fallen under the last Government, although “some of this has been the temporary shift in effort from back-end compliance activities to support Covid-19 and cost-of-living initiatives”.

Nevertheless, spending on investigations fell from about $160m in 2017 to $113.2m in 2022.

Thomas Coughlan is Deputy Political Editor and covers politics from Parliament. He has worked for the Herald since 2021 and has worked in the press gallery since 2018.