Tax system means, for some, it's not worth going out to work

Tuesday, 13 August 2019

There are ways to fix 'bracket creep' without squeezing public services.

Some New Zealanders are being trapped by a tax and welfare system that means it doesn't make sense for them to earn more, commentators say.

While they might earn a few extra dollars, in some cases almost three-quarters is taken back before it even hits their bank accounts.

How does it happen? One of the biggest culprits, experts say, is Working for Families.

The scheme was introduced 15 years ago as a way to give some tax back to households with kids. About 345,000 families receive a tax credit from this scheme, according to the Welfare Expert Advisory Group.

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But tax commentator Terry Baucher said the way it was structured meant that some people could end up paying an effective tax rate of about 50 per cent on any extra money they earnt.

An 'effective marginal tax rate' is different to the tax rate you see going out of your pay each fortnight. It's not only tax, but also how a rise in wages can mean you miss out on means-tested Government assistance, like Working For Families.

Have you been affected? Email susan.edmunds@stuff.co.nz

Once your household's income exceeds $42,700, you lose Working for Families tax credits at a rate of 25 per cent.

Terry Baucher said tax brackets should be higher to help reduce the disincentive to work.

Baucher said that meant someone who was a sole earner being paid $42,700 would pay an effective marginal tax rate of 42.5 per cent on each extra dollar earnt - broken down, this is the combination of their 17.5 per cent tax rate, and the loss of 25 per cent of their Working for Families credits.

If they had a pay increase that pushed them into the 30 per cent tax bracket, the extra money earnt (and the loss of Working for Families) would have an effective tax rate of 55 per cent.

With ACC payments, KiwiSaver contributions and student loan repayments, they could end up losing more than 70 per cent of any new earning.

Baucher said the tax thresholds were too low and people should be able to earn more before they were pushed on to higher tax rates.

Infometrics chief forecaster Gareth Kiernan said it was most acutely an issue for a household's primary earner moving from a benefit to paid employment.

Someone on sole parent support who earns more than $200 a week loses 70c in the dollar of benefits.

But he said it could also be an issue for secondary earners.

He said many could feasibly expect to pay 17.5 per cent tax, 1.4 per cent ACC, 12 per cent for a student loan and a 25 per cent Working for Families abatement, adding up to a 55.9 per cent effective marginal tax rate.

'Although this seems like it would still be worthwhile working, we haven't taken account of other costs associated with working such as travel and childcare. A person earning $25 an hour and working part-time for two eight-hour days per week would earn $400 gross, $240.89 after deductions. If we assume $65 a day for childcare for a child under three and $10 a day for travel, they would get to keep $90.89.

'If the same person was offered another day's work they would earn $600 gross, $329.11 after deductions. Making the same childcare and travel cost assumptions, they would get to keep $104.11 or, in other words, $13.22 for working an extra day.'

He said this was always going to be an issue at some point along the income scale with a targeted benefit system.

'Arguably the problem with Working for Families is that it has pushed the problem quite a long way up the income scale in certain circumstances, meaning that the decision to work more or not is a very real choice, because you can get by with the money you're already earning.

'In contrast, when the high effective marginal tax rates are towards the bottom of the income scale, once you get past the initial hurdle of working a minimum number of hours, it's relatively easy to do better by working than the subsistence lifestyle provided for by the benefit system.

'The introduction of Working for Families by the Labour Government last decade tried to address rising living costs that were squeezing budgets for lower-middle class households, and was also a convenient vote-capturing exercise.

'Unfortunately it didn't try to address the fundamental problems, such as soaring house prices, that were actually causing the squeeze. Working for Families has effectively created an additional layer of beneficiaries who are dependent on the government for some of their income and, depending on their circumstances, don't have an easy way of getting out of that dependency given the incentives of the system. This dependency also makes it very difficult for any incoming government to substantially change or remove the system.'

Researcher Jess Beretson-Shaw of The Workshop, said Working for Families was also problematic because single parents had to work 20 hours to get the in-work tax credit.

Many people would try to be contracted for more than 20 hours so that they were not at risk of losing the credit if their hours dropped on a certain week. But the childcare subsidy for three- and four-year-olds is only available for 20 hours a week.

She said unconditional payments to families would be better. 'It would be a positive thing to think about going back to the family benefit.'

Another option would be to extend the in-work payment to all families.

Baucher said a universal basic income was another solution, although that would need to come with a major recalibration of the benefit system.

'It's all well and good to say people on a benefit should go out and work but the impact on them from trying to do that… it's very hard for them to break through.'