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Today, the first round of the National Government's personal tax cuts became effective, along with the raised employee ACC employee levies.

There are three main areas of controversy.

First, taxpayers with children will need to be earning at least $41,025 annually before they see any increase in their after-tax earnings. This is because the reductions in the statutory tax rates only affect persons earning over $40,000. At incomes between $40,000 and $41,025, the extra ACC payments will exceed the tax cut. This is controversial because it both discriminates against most taxpayers with children - who are now classed as 'dependent' because they receive Family Tax Credits - and because it ignores lower income recipients.

Second, all employed tax-payers (ie with or without children) earning less than $24,000 will pay extra ACC levies while gaining no tax cut.

The third and most significant change is the introduction of an Independent Earners Tax Credit (IETC) of $520 per year ($10 per week) which, as well as discriminating against families, also discriminates against persons who earn less than $24,000.

The discrimination against low-middle income taxpayers with children is intended to offset a perceived discrimination in favour of low-middle income taxpayers with children that Labour implemented after the 2005 election. (Labour's programme at that time was known as Working-for-Families, and continues to pay a range of tax credits to families. Some of these tax credits - the infamous In-Work Tax Credits - will be withdrawn from many working families whose hours of work are reduced in the present recession.)

There was another way this perceived imbalance could have been redressed. Instead of creating two classes of taxpayer - 'independent' and 'dependent' - the new government could have saved money by paying the In-Work Tax Credits on a per child basis. That would mean paying $15 or $20 per week per child instead of paying $60 per week for families with 1 - 3 children, and $15 per child after that.

Having gone down the route, however, of creating a special additional tax cut for 'independent' persons only (the IETC), the most egregious error of National's personal tax package was the imposition of a lower qualification limit of $24,000.

What this lower limit means is that, from today, persons earning between $14,000 and $23,999 pay 12.5% tax on their first $14,000 of income, and 21% on their remaining income.

An 'independent' person earning $24,000 per year, however, will, by virtue of the IECT, pay 12.5% tax on their first $14,000 of income, and 15.8% on their remaining income. This means a person on $24,000 pays $3,330 of tax (plus $408 ACC), whereas a person on $23,999 pays $3,850 of tax (plus $408 ACC).

This goes against all the normal principles of taxation, which require persons of lesser means to pay no more than persons of greater means.

There is a very simple solution to this problem. It is to abolish the IETC, and to replace it with an independent earner tax rate of 15.8% for the $14,000 to $24,000 income bracket. And, once the full programme of tax cuts is completed in 2011, the government could further lower taxes on the first $24,000 of income by replacing the extended $780 IETC ($15 per week) by a tax rate of 12.375% for the first $24,000 of income.

The tables below show the currently legislated rates for 2009 and 2011 (Tables 1 and 3) and my proposed modification of rates for 'independent' earners (Tables 2 and 4) that would make the IETC redundant.

Table 1
National's Tax Scale: 2009-10

Table 2
Independent Earner Scale: 2009-10

Table 3
National's Tax Scale: 2011-12

Table 4
Independent Earner Scale: 2011-12

We can see from Tables 1 and 2 that a simple trade off between the rates for the $14,000-$24,000 income bracket and the $44,000-$48,000 income bracket can yield all of the benefits arising from the IETC, while also giving some tax relief to independent persons earning between $14,000 and $24,000.

Two examples:
• under Table 1 (the current regime) independent workers earning $30,000 pay $5,110 in tax, and get an IETC of $520, equivalent to $4,590 income tax payable. Under the tax scale in Table 2, the tax payable is $4,590, the same.
• under Table 1 independent workers earning $20,000 pay $3,010 in tax, and get no IETC. Under the tax scale in Table 2, the tax payable is $2,698, equivalent to a partial IETC of $312 ($6 per week).

This matter is especially important in times of recession, because a common response to recession is for workers to have their hours of work reduced. In many cases, a reduction of work hours will take a person's income from above the $24,000 qualifying threshold for the IETC, to below the threshold. National should not want to be seen to be abandoning lowly-paid workers at a time when they, most of all, need assistance.

I suggest that the Government legislates to replace the IETC in April 2010 with the tax scale shown in Table 2, and in April 2011 with the tax scale shown in Table 4.

In addition to the above suggestion, I would like to see, sooner rather than later, an end to the discrimination between 'independent' and 'dependent' taxpayers. A simple and fair way to achieve this aim would be to extend the suggested 'independent earner' tax scales to all taxpayers, and to recoup much of that cost by replacing the In-Work Tax Credit for low-middle income families ($60+ per week) with a universal family benefit of $15-$20 per week per child.

The suggestions that I have made can be implemented by the government at little cost, and will substantially increase the fairness of the tax system, while also decreasing its administration costs.

Keith Rankin
Lecturer in Economics
Department of Accounting and Finance
Faculty of Creative Industries and Business
Unitec Institute of Technology

Keith Rankin is the author of "Personal Tax Cuts and Recession Assistance Policies: 2009 - 2011", published in the March 2009 edition of the New Zealand Journal of Taxation Law and Policy. He is also co-author (with Susan St John) of Escaping the Welfare Mess, Working Paper 267, Economics Department, Business School, University of Auckland.

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