Answer Happy

1 Background On 30 November 2020, the New Zealand government enacted a new top personal income tax rate of 39% on annual income exceeding $180,000 for the year ending 31 March 2022 (2022 tax year) and later income years. Part of the reason behind this new higher marginal tax rate was a revenue objective (The Government needed to reduce the fiscal impact of higher operating allowances).1 Table 1 below shows the tax schedule for each of the two tax years 2021 (column 2) and 2022 (column 3). The 2021 tax schedule includes four brackets with the lowest tax rate 10.5% applied to income below $14,000 and the highest 33% tax rate applied to income above $70,000. The 2020 reform introduced a new, fifth, income bracket and tax rate whereby income above $180.000 is taxed at 39%. Tax Rates by Income Bracket for 2021 and 2022 Income Bracket Tax Rate 2021 Tax Year 2022 Tax Year $0 - $14,000 ti 10.5% 10.5% $14,001 - $48,000 t2 17.5% 17.5% $48,001 - $70,000 t3 30% 30% $70,001 - $180,000 t4 33% 33% $180,001 - ts %39 In the following case study, you are part of a small consultancy group that are asked to predict the revenue implications of this new tax bracket and rate: how much (extra) revenue will the Government collect.
Part A: Stylised Illustration of a Tax Reform a Consider a simple two-bracket tax system with a marginal tax rate tı on pre-tax income (2) below a threshold K and a marginal tax rate t2 > ti on the income exceeding K. Illustrate in a diagram (with pre-tax income (z) on the x-axis and after-tax income (c) on the y-axis) the budget set created by the tax system. Show how the budget set changes when the top tax rate (t2) is increased and explain the link between the marginal tax rate and the slope of the budget line. Discuss how the increase in t2 could affect individuals' labour supply decisions.
Part B: Tax Revenue Impact The tax revenue from the new 39% top income tax (t5) is given by: R=t5(Z – K)N where z is the average pre-tax income for the individuals above the threshold K (NZD 180,000) and N is the number of top threshold taxpayers. The associated excel data includes the 2019 taxable income distribution, use those data to find N and calculate z. Predict the total revenue collected from this new tax rate and bracket. How much additional tax revenue is collected as a result of the new tax rate and bracket?
Part C: Revenue Effects from Marginal Tax Changes The effect of a marginal increase in (ts) on the government's revenue can be expressed as?: dR la mat) t5 1-t5 E NZ, Z where a = 2 – K dto Estimates of the elasticity of taxable income ε suggest this parameter is equal to 0.15 (NB. previous version incorrectly gave the ε as -0.15). Use your data set to calculate a and find dR (dt5) (i.e. plug in all the parameters in the above formula and report the resulting dollar amount). Provide an interpretation of a and comment on how (dt5) depends on a. Compare and contrast the revenue consequences calculated in Part C with those in Part B. dR