Labour supply in New Zealand and the 2010 tax and transfer changes

Abstract

This paper examines the simulated labour supply responses to the personal tax and transfer policy changes introduced in New Zealand in 2010, and the implications for revenue and income distribution. The main changes examined are the increase in the Goods and Services Tax (GST) rate from 12.5% to 15%, along with reductions in personal income tax rates and increases in the main benefit payments and assistance to families with children, to compensate for the rise in the GST. The simulated labour supply responses were obtained using the Treasury's behavioural microsimulation model, TaxWell-B. The 2009/10 Household Economic Survey was used. The combined effect of all policy changes is to increase average labour supply slightly for all demographic groups, with a weighted average increase of 0.10 hours per person. The average hours increase is the largest for single parents, at 0.33 hours per person. Labour force participation of sole parents is simulated to increase by 0.86 percentage points. In considering separate components, the change in income tax rates is found to have the largest effect on labour supply. This is not surprising, given that it affected a large proportion of the population while the changes to the benefit system and assistance to families with children apply only to certain groups. The reforms are found to be approximately distribution neutral, in terms of the Gini inequality measure of after-tax income per adult equivalent person.

Keywords:

• Taxes and transfers
• labour supply
• discrete choice model
• microsimulation
• New Zealand

JEL Classification:

• C25
• J22

Acknowledgements

We would like to thank Norman Gemmell, Michelle Harding, Angela Mellish, Joseph Mercante, Suzy Morrissey, Hemant Passi and a referee for their comments on an earlier version of this paper. We have also benefited from comments by participants at NZAE July 2015 and a seminar in NZ Treasury.

Disclosure statement

The views, opinions, findings, and conclusions or recommendations expressed in this Working Paper are strictly those of the authors. They do not necessarily reflect the views of the New Zealand Treasury or the New Zealand Government. The New Zealand Treasury and the New Zealand Government take no responsibility for any errors or omissions in, or for the correctness of, the information contained in these working papers. The paper is presented not as policy, but with a view to inform and stimulate wider debate. Access to the data used in this paper was provided by Statistics New Zealand in accordance with security and confidentiality provisions of the Statistics Act 1975. The results presented in this study are the work of the authors, not that of Statistics New Zealand.

Notes

1 The Hon. Bill English, Minister of Finance, stated (2010) that ‘Tax reform is a centrepiece of this budget’. For a summary of the budget, see http://www.treasury.govt.nz/budget/2010/execsumm/10.htm

2 The influence of the report is underscored by the statement (2010) of the Hon. John Key, Prime Minister, that ‘the Tax Working Group discussed a broad range of options for tax reform. The Government has considered all of these options closely ... While the Government has ruled out some of the proposals ... most of the options discussed by the group still remain on the table’. For reflections on the review process, see Buckle (2010, 2015).

3 The time between the announcement of the changes and their implementation is likely to have induced some income shifting of non-wage income in order to benefit from the future reduction in the top income tax rate. However, this would not affect labour supply over the survey period.

4 For details of minimum wages in New Zealand, see http://employment.govt.nz/er/pay/minimumwage/previousminimum.asp

5 This random component should be distinguished from ‘optimising frictions’ associated with adjustment costs, discussed by Chetty (2012). He argued that these are more important at the intensive margin, and may bias microeconometric estimates of labour supply responses.

6 The specification does not include any components relating to the number of jobs available at the various discrete hours levels. It must therefore be acknowledged that the estimation of preferences may be affected by the state of the labour market following the global financial crisis of 2008.

7 For discussion of small differences between TaxWell and TaxWell-B in the no-response setting, see Mok and Mercante (2014, Appendix B).

8 This was obtained using the same sample weights as the previous report.