Why average earners' tax bill keeps growing

Are you paying more tax, but no better off?

Fiscal drag, or bracket creep, is the process by which taxpayers move up through the marginal tax bands as they get pay increases, and end up paying higher proportions of their income in tax, even if they have only kept pace with inflation.

It is something that the Australian opposition has said this week it wants to tackle by indexing tax bands to inflation.

Opposition leader Angus Taylor has been reported as saying it could deliver workers an extra A$1000 a year, four years into the policy but would cost the government about A$22 billion.

Infometrics chief forecaster Gareth Kiernan said there were similar concerns here.

His data showed that someone on the average wage would have been paying about 17 percent of their income in tax in 2010 and 2011, compared to 22 percent now.

"When GST was raised to 15 percent in 2010 and income tax rates were cut, the average wage earner was actually paying the lowest proportion of their income in tax since at least 1984. Bracket creep now means that they're paying the highest percentage since at least 1984, and by some margin."

A joint report from Inland Revenue and Treasury in December last year showed that if income tax thresholds had been adjusted for inflation between 2010 and 2024, the bottom rate of 10.5 percent would apply to income up to $19,323, not $15,600 at present. The next rate would apply to income up to $66,249 - not $53,500.

People would earning between $66,250 and $96,614 would pay 30 percent, people earning between $96,615 and $212,939 would pay 33 percent and only those earning over $212,940 would pay 39 percent.

It said people who were earning between $70,000 and $90,000 had experienced the biggest impact of the bracket creep because inflation had shifted more of their income into the 30 percent tax bracket.

The median full-time wage and salary worker earned $48,024 in the year ended June 2011 and paid $7427 in personal income tax.

In the year ended June 2023, the median full-time wage and salary worker earned $73,417 and paid $15,148 in personal income tax.

In the year to March 2024, an additional almost $800 million was collected from people with taxable income in the $70,000 to $80,000 band because of the impact of fiscal drag, and people earning $80,000 to $90,000 also paid almost as much in additional tax.

Government changes to the tax settings in 2024 helped - but didn't address the full story.

"Without Budget 2024 changes, we estimate that fiscal drag from inflation would have increased tax revenue by approximately 1.6 percentage points of GDP. Including Budget 2024 changes, we estimate that fiscal drag from inflation has increased tax revenue by approximately one percentage point of GDP," the IRD and Treasury paper said.

Constant issue

Tax specialist Robyn Walker at Deloitte said fiscal drag was a constant issue.

"Essentially it is the collection of more personal income tax by default as incomes increase but tax rate thresholds remain the same. Fiscal drag has been a problem in New Zealand because of the long gaps between personal tax rate changes. There was a long stretch from 2010 to 2024 where thresholds were not adjusted - the only change was the addition of the 39 percent top tax rate in 2020.

"When personal tax rates were adjusted as part of Budget 2024, this went part of the way toward addressing fiscal drag but didn't fully correct it due to the fiscal cost.

"Indexation of personal tax rates is a popular policy, and occasionally comes up in election tax policies, but hasn't been implemented because of the fiscal challenges of actually doing it. Ultimately it is a decision for the Government of the day and it's not possible to bind future Governments to changing tax rates and thresholds when they may have other policies and priorities."

Westpac chief economist Kelly Eckhold said it was tricky for the government to tackle.

"That has been longstanding issue in the New Zealand system. And it's something, obviously, the Australians are trying to correct with the current proposals…if you tried to do that in New Zealand, it would be pretty expensive."

Kiernan agreed but said the country also needed the revenue.

"Where do you put your historical benchmarks, is a little bit of it, because, you know, people have often gone on about 2010 as being a time when since then we've hardly adjusted the tax brackets, which is all well and good. But … with a little bit of the benefit of hindsight, you'd argue that we've been under investing in an infrastructure, for example, and in various aspects around that.

"It could well be that we were able to have lower tax rates then because we were not doing some of the spending that maybe we needed to be doing on a more sustainable basis. You've also got the additional issue looking forward around health expenses and superannuation expenses, which are only going to increase over time as well.

"We need better productivity growth throughout the economy, which is not an easy fix, of course. But if we were growing to the point that our incomes were higher, then we wouldn't have to be paying such a high percentage of them in tax to pay for superannuation or health or infrastructure or whatever it might be."

John Cuthbertson, Chartered Accountants ANZ tax leader, said the organisation had consistently supported adjusting tax thresholds to address bracket crept.

"Inflation shouldn't push average earners into higher marginal tax rates without any real increase in their purchasing power.

"Indexation is one way to manage that, but it doesn't have to be automatic or annual. We've previously suggested regular, periodic adjustments every few years could strike a more practical balance."

Sign up for Money with Susan Edmunds, a weekly newsletter covering all the things that affect how we make and spend money