Parliament is urgently debating a bill that will make law a new top tax rate of 39 per cent – one of Labour’s key campaign promises.
The tax hike will only apply to the top 2 per cent of income earners.
But a regulatory impact assessment from IRD has said that the tax will only have a tiny impact on inequality in New Zealand.
The paper cites a Treasury analysis saying that the tax “will reduce the Gini coefficient for individual after-tax income by an estimated 0.2 percentage points (from 0.493 to 0.491)”.
The Gini coefficient is a measure of inequality.
“The small impact reflects the relatively small impact this tax increase has on the overall income distribution.”
The impact could be even smaller if, as IRD fears, people try to dodge the tax by shifting money into other entities that pay less tax.
“This is a very imprecise impact as it assumes no behavioural response and does not account for shifting of income into other (lower-taxed) entities,” the IRD report said.
This could include trusts, which are taxed at 33 per cent. When the new top income rate takes effect in April next year, it will open up a large gap between the top income tax rate and the trust rate – creating an incentive for people to use trusts to reduce the amount of tax that they pay.
This happened under the previous Labour Government, which also opened up a gap between the top income tax rate and the trust rate. The number of trusts almost doubled between 2000 and 2008 to nearly 250,000.
IRD estimated it was losing $300m a year in revenue by 2007.
Green Party Finance spokesperson Julie Anne Genter said that the tax changes could actually make inequality worse by encouraging people to shift their income to reduce their tax bill.
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She said the IRD's estimates didn't take into account the potential to shift income "even further to property, which would likely increase inequality".
"We think, based on previous research done by Westpac economist Dominick Stephens that there is a significant risk that the lack of a capital gains tax that these income tax changes will actually exacerbate inequality," Genter said.
The Greens will abstain from voting on the tax changes.
The gap between the two rates remains a concern so IRD actually recommended the Government put the trust rate up to 39 per cent to avoid abuse. It made five recommendations for how best to roll-out the tax change (although one recommendation was to leave both rates at 33 per cent).
IRD’s preferred option was to put the trust rate to 39 per cent, as it “will reduce opportunities to avoid the 39 per cent income tax rate through the use of trusts”.
Upping the trust rate would give the Government a hefty $1.5b in revenue over the next four years, raising the amount of money earned from the tax changes to $3.7b from $2.2b.
Labour’s election manifesto promised it would not put up the trust rate, but after questions from Stuff on Tuesday, Revenue Minister David Parker said the Government would consider raising the trust rate if there was evidence of abuse.
Finance Minister Grant Robertson said that behaviour would be monitored to ensure the tax wasn’t being abused.
“In the campaign we were very clear we weren’t going to do that [raise the trust rate],” Robertson said.
“If we do see a spike in the use of trusts then we will be prepared to act to align the trust rate,” he said.
Robertson said he’d be watching for a spike in the creation of trusts, like the spike that occurred under the Clark government.