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Bracket Creep: time to fix a broken system

Bracket creep. It sounds vaguely like an unpleasant medical problem no one talks about, but as an issue that disproportionately affects New Zealanders on lower incomes, it deserves higher public awareness. 

Time to read: 3 mins

With tax and the forthcoming Budget in the spotlight right now, this is our opportunity to address a significant problem on the horizon.

The growing disparity between New Zealanders, assets and average incomes is concerning in a fair society, with the median house price rising more than a fifth in the year to February 2021.

This is creating a situation where many are getting steadily richer (on paper) as house prices rise, while others are left behind with little hope of catching up.

Measures aimed at slowing our runaway property market have captured headlines, such as the abolition of tax deductibility for residential rental properties and the extension to the bright-line test, but it is unlikely these will have a significant long term effect.

However, the best opportunity to increase fairness in the tax system and support those at the bottom of the ladder is to shift our tax brackets. The guiding philosophy in New Zealand's tax system for many years has been "broad base/low rate" but, while the base is being broadened the effective tax rate for earners has gone up.

 

Living wage

Since 2010, when the last major tax bracket overhaul occurred, wages have been steadily rising. The median weekly income a decade ago was $778. By June 2020, it was $1,060.

What that means is that more New Zealanders on relatively low incomes have crept into what used to be high brackets, with the 30% rate starting on the proportion of income earned over $48,000 a year. The average wage earner pays as much on their top slice of income as someone on $70,000. 

Working for Families tax credits changes the picture significantly, but only applies to those with children, and is partly designed to selectively patch over the tax rate problem.

Consider that someone working full-time on the minimum wage earns $42,000.

Its concerning that those who are earning a "living wage" are close to paying 30 per cent tax on their top slice of earnings.

While a new 39 per cent threshold was introduced this year, it only affects those earning more than $180,000, or two per cent of earners, having no effect on taxes at the lower end of the spectrum.

 

Bottom tier earners

We know that poverty and inequality are issues the government is particularly keen to solve, and the most effective way to put more money back in the pockets of lower income earners is to tackle bracket creep It's great to see National MP Simon Bridges raising this as an important issue.

We should introduce annual changes to the tax brackets based on inflation and go further and introduce a 0% tax band for the bottom tier of earners, as many other countries do.

 

Tax Freedom Day

We celebrate Tax Freedom Day this May 11, the day Baker Tilly Staples Rodway calculates New Zealanders have paid their full tax obligations to the government and can earn every dollar for themselves for the rest of the year.

That's two days earlier than it would have fallen in 2020, and just two days later than in 2019. After a year of staggering upheaval and uncertainty, that's something to be proud of, and shows the resilience of the underlying economy and the effectiveness of the wage subsidy in avoiding a jobs apocalypse.

Businesses are about to undergo a tsunami of regulatory measures which will only add to their costs, reduce their willingness to take business risks to grow the economy, and reduce their profitability and taxes they pay.

At the same time, the COVID-19 economic support to New Zealanders has been provided by borrowed money, which must be paid back over time. This is the time to ensure that burden doesn't fall too heavily on those earning just above minimum wage, and make our tax settings fairer for everyone.

DISCLAIMER No liability is assumed by Baker Tilly Staples Rodway for any losses suffered by any person relying directly or indirectly upon any article within this website. It is recommended that you consult your advisor before acting on this information.

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