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Prepared by Nick Johnson, July 2005
with funding from the sponsors of the Ian Axford (New Zealand) Fellowships in Public Policy
About the author
Nicholas Johnson is Vice President of the Center on Budget and Policy Priorities’ State Fiscal Project in Washington, DC. Nicholas has been with the Center on Budget and Policy Priorities, which is among the nation’s pre-eminent policy institutes, since 1996. He now serves as Director of the State Fiscal Project, which works to develop strategies for long-term structural reform of state budget and tax systems, encourage low-income tax relief, and improve the way states prioritize funding. Previously he worked for the US Senate Committee on Agriculture, Nutrition and Forestry, and as a newspaper and wire-service journalist. He has an MPP degree from Duke University and a BA in American Studies from Yale University.
During Nicholas’ Ian Axford Fellowship exchange to New Zealand he was based at The Treasury and the Ministry of Social Development, where he researched tax and welfare reform.
Executive Summary
New Zealand’s simple tax system has few deductions, exemptions, or credits. Income is taxed from the first dollar, on a simple four-tiered rate structure that is one of the flattest among developed countries. Where the United States and other countries frequently adapt the income tax system to accomplish social (or other) policy objectives, New Zealand generally keeps its social policy tools separate.
But when New Zealand decided in 2002 to pursue a set of social policy goals – reducing poverty, strengthening work incentives for unemployed parents, and improving the delivery of assistance – it did so using a tax-based system. Family Assistance is a set of means-tested tax credits for families with children. Under the Working for Families legislation enacted in 2004 Family Assistance is doubling in size over a four-year period to total 4.4 percent of total government spending. By 2008, when the current changes are phased in, an estimated 61 percent of New Zealand families with children will receive Family Assistance.
This report finds that the Working for Families package is likely to achieve its goals of reducing poverty, making work pay, and improving utilization of family supports by extending tax-based aid.
- The expansion of Family Assistance is likely to reduce poverty and boost the incomes of families with children. The biggest boosts to income will go to working families with relatively low incomes. Middle-income families will also receive income boosts.
- Working for Families will improve incentives for unemployed families now on a benefit to get jobs.
- Working for Families will likely improve utilization of Family Support programmes, as the agencies that administer Family Assistance change how they do business to better serve eligible families.
This report also finds that the expansion of Family Assistance to an increasing proportion of New Zealand’s middle-income, two-parent families could have unintended and undesirable consequences for some families with two working parents: high effective marginal tax rates and ‘partner penalties’.
- Working for Families increases the incomes of many two-parent families by thousands of dollars per year.
- At the same time, the steep abatement rates in Family Assistance create high ‘effective marginal tax rates’, or EMTRs, for families that didn’t face them before. Unlike New Zealand’s standard tax code, which is based on individual income, these EMTRs are based on family income.
- The result is that Working for Families will likely encourage some two-earner households to become one-earner households.
- In addition, it will worsen penalties for parents who become or remain partnered.
The report begins with some comparisons between New Zealand and the United States and concludes with policy recommendations and suggestions for further research.
An American perspective on New Zealand’s tax and transfer system
This report is not a formal comparison of U.S. and New Zealand policies, but it is informed by my familiarity with the U.S. tax and transfer system. One significant difference is that in the United States, the tax code has many provisions intended for social policy purposes. By contrast, New Zealand’s income tax system is simple, relatively flat, and rarely used for social policy other than Family Assistance.
Another contrast is that means-tested benefits such as the Domestic Purposes Benefit (DPB) in New Zealand for an unemployed parent come closer to meeting actual costs of living than their U.S. counterparts. On the other hand the United States subsidizes the wages of low-income working parents at least as much as New Zealand does. Wages also tend to be higher in the United States. The net result is stronger work incentives.
Working for Families: achieving social policy objectives through tax-based assistance
The goals of the Working for Families legislative package are social policy goals. Working for Families seeks to reduce child poverty which has been higher than in other developed countries despite low unemployment. It seeks to improve the incomes of working families struggling to make ends meet on New Zealand’s relatively low wages. It seeks to ensure that paid jobs are more financially attractive than the dole. And it seeks to make it easier for families to access financial assistance.
The designers of the Working for Families package have chosen to increase tax-based assistance through the pre-existing Family Assistance tax credits instead of increasing welfare benefits. However, benefit expenditures are declining slightly while expenditures on Family Assistance are projected to double. By 2008 Family Assistance will outstrip the Domestic Purposes Benefit as New Zealand’s largest single programme of means-tested cash aid to families.
Reducing poverty through increased tax-based aid. In 2001, New Zealand’s child poverty rate was the 10th highest among the 26 nations of the OECD. By increasing the incomes of most families with low incomes through increased Family Assistance, Working for Families is projected to reduce poverty rates by one-third to two-thirds.
Increasing incomes and improving tax progressivity. Poor families only receive a portion of the increased assistance from Working for Families. The largest per-child increases in family incomes under Working for Families are likely to accrue to families with incomes somewhat above the poverty line. Indeed, by one calculation, some 41 percent of the benefits from Working for Families are estimated to go to the one-fifth of families with incomes in the middle of the income distribution. Still, as a share of income, the biggest benefits accrue to families with below-average incomes.
Making work more financially attractive than welfare benefits. Working for Families boosts the income of a prototypical non-working sole parent with two children by 8 percent. A comparable working parent in a low-wage job receives an 18 percent income boost.
Improving utilization of public assistance. No programme of income assistance can work if families lack access to it. The Ministry of Social Development (New Zealand’s welfare agency) and the Inland Revenue Department (the tax agency) are taking steps to increase Family Assistance take-up, particularly among families that are not receiving a benefit.
The unintended consequences of Working for Families: High effective tax rates and ‘partner penalties’ for families with two working parents
Under Working for Families, the number of two-parent families with children who qualify for Family Assistance – both legally married couples and those living together as if married – is on the rise. Partnered couples represent about two-thirds of New Zealand families with children, but prior to Working for Families, they represented only about one-third of Family Assistance recipients. The rest were sole parents. By 2008 the MSD estimates that the ratio will be closer to 50-50.
Partnered couples that receive Family Assistance will have higher incomes. However Family Assistance is means-tested with the amount of entitlement declining as total family income rises. So when families increase their income their Family Assistance may decline, an effect that is equivalent to a 30 percent increase in marginal tax rates.
These rising marginal tax rates for couples with children pose at least two causes for concern:
- Some parents may work less in order to maximize eligibility for Family Assistance. This is particularly likely to affect partnered mothers with young children. Working for Families may be expected to increase the number of non-working parents but the increase will be small – perhaps a few thousand.
- Partner penalties’ – the difference between Family Assistance received by a partnered couple relative to if they were single – will rise by several thousands of dollars for many families under Working for Families. Besides appearing unfair, the penalties may discourage some working parents from marrying or partnering, or encourage them to separate. The impact will probably be small, perhaps a few thousand, although such effects are difficult to predict. They may also encourage some couples to lie to the tax authorities regarding their partnered status, balancing the risk of getting caught against the heightened reward for deception.
There are policy options to reduce these marginal tax rates, but they are expensive relative to the number of families whose behaviour may be influenced.
Findings and recommendations
The findings in this report have implications both for New Zealand and the United States. Among the key recommendations for New Zealand policymakers:
- Start considering improvements to Family Assistance now. Working for Families included a substantial evaluation component and data is expected to emerge from that evaluation in the coming months. It is not too soon now to begin including that data in a formal process of re-evaluation that focuses on two questions: whether Working for Families is meeting its intended goals, and what unintended consequences may be resulting.
- Monitor carefully impacts on two-parent families. Fixing the high-EMTR problem for secondary earners and the partner-penalty problem would be costly. The deciding factor should probably be whether there is evidence that the behavioural impacts predicted in this paper do in fact occur.
- Bring social policy considerations into tax policy decisions. The distribution of the tax burden has a range of social implications. More careful consideration of exactly how tax decisions affect social policy does not have to undermine the ‘broad-base, low rates’ philosophy, but could enrich it.
Among the key lessons for U.S. policymakers:
- Policy choices can reduce child poverty without undermining work incentives. Working for Families increased incomes for working and non-working families while also strengthening the relative attractiveness of work.
- Tax simplicity and a tax system that distributes aid to families with children are not inconsistent. As the United States contemplates fundamental tax reform, protecting existing systems of tax-based assistance to poor families will be a priority. New Zealand’s experience shows the two can coexist.
- Make use of emerging New Zealand data. The Working for Families reforms are expected to yield data that could help researchers from the United States and other countries better understand behavioural responses to changes in tax policy and social policy.
The Introduction to this report describes some of the similarities and differences between the U.S. and New Zealand tax and transfer systems, including a comparison of benefit levels.
Chapter One explains how the initial goals of simultaneously reducing poverty and increasing incentives to work led to the expansion of Family Assistance to many middle-income families, and concludes that this was a reasonable policy approach. It also explores some of the implications of that expansion, for family incomes and for the tax/benefit system as a whole, as well as for the agencies that administer it.
Chapters Two and Three look at the specific implications of Family Assistance for partnered couples with children – the improved incomes as well as the changes in financial incentives. Chapter Two focuses on the employment decisions of partnered couples, in particular ‘secondary earners’ with children. Chapter Three focuses on the partnering decisions of those couples.
Chapter Four concludes and offers policy recommendations and suggestions for further research.
Table of contents
Acknowledgments
Executive Summary
Introduction
- Supporting Incomes Through the Tax System and the Benefit System: Changes and Implications
- Working for Families and the Work of Two-parent Families
- Partnering Penalties in the Tax and Benefit Systems
- Conclusions and Recommendations
Bibliography
Appendix: Data on Effective Marginal Tax Rates
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