Demographics will force tax changes
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Tax payers, age band , New Zealand

Demographics will force tax changes

It’s well documented that high-income earners pay substantial amounts of income tax. According to Treasury estimates, 42% of the projected income tax payable for the year ended 31st March 2020 will be paid by those with annual income of over $100,000. That group is about 341,000 taxpayers or roughly 9% of all taxpayers.

But how much tax is paid by each age group?  To find out, I asked Inland Revenue for details of the total PAYE paid for each of the five years ended 31st March 2018, broken down by 10-year age bands together with details of the number of taxpayers within each age band.

The results give an insight into why the recent Tax Working Group in its Future of Tax: Submissions Background Paper warned:

“If the Government is to continue providing healthcare and superannuation at current levels, then the level of taxation will need to increase, or spending on other transfers or publicly provided goods and services will need to fall.”

Paye , New Zealand, tax

Paye paid by year to 31 March in New Zealand

As you might expect the percentage of tax payable by each age band represents a typical Bell Curve: it rises as each group moves into their prime earning years, before declining after age 55 as older taxpayers move into retirement.

tax paid, age band, tax demographics

Tax percentage paid by age band

What is of particular note is that the proportion of PAYE paid by the 36 to 55 age bands has fallen quite sharply over the past five years. In the 2013/14 year those two age groups paid 49.4% of all PAYE.  By the 2017/18 year the proportion had dropped to 46.8%, a 5.2% decrease.

On the other hand, the proportion of PAYE paid by the 16-35 age groups (Millennials and Generation Z) rose by 5.9% over the same period to 26.2%. However, this probably reflects the effect of 170,000 additional taxpayers in those age groups over the five-year period. The rise in the numbers of 16-35-year-olds is more than five times greater than the increase of 30,400 in the 36 to 55 age groups.

The implication is that on a per-capita basis the growth in income for the two youngest groups has not been as significant as that of the older cohorts.  The average PAYE paid by a taxpayer in the 16-35 age groups rose by 18.3% over the period compared with an 18.6% rise for the 36-55 age groups. (Tax rates and thresholds were unchanged throughout this period).

PAYE tax payers, age band, tax,

Number of PAYE tax payers 

What’s also noticeable is the rapid growth in the size of the over 65 age group.  It outstrips the total rise in the 36-55 age groups. This illustrates the effect of the Baby-Boomer generation reaching retirement.

Tax payers, age band , New Zealand

Growth in tax payers by age band in New Zealand

These statistics reinforce a message of the TWG that a demographic tax crunch is coming. The TWG’s Submissions Background Paper included the following projections for government expenditure and revenue (per cent of GDP) based on historical spending patterns:

Government expenditure, New ZEaland, projections

Government expenditure projections

A deficit of 1.2% of GDP represents about $3.5 billion in current terms. Based on the estimated tax take of $84.7 billion for the year to 30 June 2019, this implies that taxes might have to rise by between 4% and 5% from present levels.

Furthermore, this demographic crunch is coming much more quickly than people realise.  Budgets work on a four-year cycle, with each Budget projecting the fiscal position for the coming four financial years. Within the next four or five years the projections will start showing deficits towards the end of each four-year period. This will happen regardless of which party is in government.

As the TWG warned these deficits can only be closed either by increasing taxes, reducing benefits or some combination of the two. Neither option will appeal to voters or politicians.

There is also likely to be a growing intergenerational tension as older taxpayers moving into retirement will expect younger taxpayers to continue to support present levels of superannuation and health care with no guarantee that the younger age groups will enjoy the same benefits. The amount of New Zealand Superannuation paid rose more than 25% from $10.9 billion to $13.7 billion between June 2014 and June 2018. According to the latest Budget forecasts it will total $17.4 billion in the June 2022 year – an increase of 59.6% since the June 2014 year.

The inevitable conclusion from this demographic change is that the tax base will need to be expanded in some form. The decision in April not to impose a capital gains tax simply deferred the point at which this will happen.

So, what would be the most appropriate means of raising additional revenue?  An increase in the GST rate is unlikely because as the TWG noted, GST represents the most regressive tax for low income earners. Increases in income tax rates look more likely and could potentially also improve what the TWG described as a “not particularly progressive” tax system.

Increased environmental taxes were mooted as a longer-term option.  However, the TWG’s suggestion was that over the short-term such taxes should be used to “help fund the transition to a more sustainable economy”. The OECD’s Base Erosion and Profit Shifting initiative might over time mean multinationals do pay more but overall the TWG didn’t see the company income tax take rising substantially.

An obvious candidate for immediately expanding the tax base would be a widespread capital gains tax. However, quite apart from the fact that the Prime Minister ruled out a CGT for the duration of her time as leader of the Labour Party, a CGT would largely leave the substantial gains of the last 30 years untaxed.  This would favour the older generations who enjoyed tax free capital gains tax. Instead the burden of a CGT would fall on the younger generations, a group which is struggling to build wealth at the moment. Viewed this way it’s a recipe for exacerbating inter-generational tensions.

So perhaps the answer might be not a CGT but some form of capital asset tax such as that proposed by The Opportunities Party, or maybe a transfer tax on death.

The youth wing of the Andrea Tax Party proposed charging GST on estates above a certain threshold, maybe $500,000. The theory is that the value of the estate represents untaxed consumption which should be taxed on death.

Another option might be to look again at a low-rate land tax, something which the majority of the 2010 Tax Working Group supported. This might need to include exemptions for Māori-held land, but it would at least have the merit of taxing much of the growth in land values over the past 20-odd years which has largely gone untaxed. (The move would also tax land-banking and land held by non-residents so therefore would address one of the issues around housing supply and house-prices).

Politicians come and go.  Even Winston Peters will eventually leave the political stage, but the demographics are inexorable.  At some point, and much sooner than any politician would probably like to acknowledge, the tax consequences of the coming demographic crunch will have to be addressed. The only question is who will be brave enough to do so.

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