A common criticism of tax indexation is that it reduces government revenue, which may negatively impact the services the central government provides. A reduction in revenue would require spending cuts; if those cuts are too substantial, there is a risk of plunging the country into austerity. Another criticism is that tax indexation can be complex and administratively burdensome for both taxpayers and the government, with constantly changing tax brackets requiring systems and software updates as well as increasing the risk of errors. There is also something nice about having tax thresholds with easy-to-remember round numbers rather than thresholds that would evolve from the application of a formulaic approach.

If tax indexation ever does see the light of day, the implementation of the policy would need to be carefully considered. Some tax policies, such as the Use of Money Interest rates and the Fringe Benefit Tax prescribed rate, are set by formulas linked to movements in Reserve Bank interest rates, so they are effectively indexed to inflation. Inland Revenue has already had to increase these rates several times in the past year to attempt to keep pace with inflation (and will continue to need to do so if interest rates continue to move). Policymakers would not want personal tax thresholds moving more than once per income year, and ideally less often than this.

Tax indexation takes up a peculiar political position. Tax indexation every three years was legislated by the Helen Clark Government following Budget 2005, however, the policy never came to fruition as it was replaced with different tax cuts before the rules took effect. More recently, the National Party has proposed a one-off tax indexation policy, however, with the caveat that automatic indexation as part of that policy is still an idea that the National will need to “give some thought”. Other political parties don’t currently include indexation as a priority. It is also notable that in 1981, the last time inflation was at current levels, the Reserve Bank explored tax indexation as a possible solution. In that instance, the policy was not adopted by the Muldoon government.

To date tax indexation has not been a focus of the current government.

Compared to other OECD countries, the statistics tell us that overall, New Zealanders currently pay a low proportion of personal income tax. The tax wedge is a measure used by the OECD to determine what level of tax a country imposes on labour income. This measure includes the tax paid by both the employee and employers as social security contributions. New Zealand currently ranks 36th out of the 38 OECD member countries, with a tax wedge of 19.4% in 2021 compared to the OECD average of 34.6%. However, to contextualise the below average taxes on labour, it’s worth noting that OECD analysis also indicates New Zealanders pay a higher proportion of taxes through GST than the OECD average; and New Zealanders also pay more than the OECD average to purchase consumer goods and housing.

There is an unfortunate tendency to look at tax policies in a vacuum. But individual tax policies are only a cog in a much larger economic machine; therefore, it is important to look at tax indexation in context. The decision to maintain or index tax thresholds will have to be weighed against other considerations, such as wages. Although methodology difficulties are well documented with wage comparisons between multiple countries, some indexes, such as the International Comparison Program, suggest that New Zealand wages are trailing behind comparable countries such as Norway, Ireland, and Singapore. Low wages in New Zealand may be a part of the cost-of-living crisis, and the worry is that maintaining the current tax thresholds might only worsen things.

Not only does bracket creep tighten the cost-of-living squeeze, but the impacts of inflation can also be seen across the economy. Inflation can increase inequality, as those who own assets that benefit significantly from inflation (such as housing) receive an advantage, whilst those reliant on fixed incomes suffer. Inflation also creates significant uncertainty for investors, businesses and individuals, as unpredictable prices and values make it difficult to plan for the future. Finally, rising interest rates can be an expensive impediment to borrowing.

As noted, tax indexation is a treatment but not a cure for inflation. Indexation may only be a temporary relief for taxpayers as it could fuel more inflation, resulting in a vicious cycle. Other economic policies will always be necessary. The Reserve Bank is fighting inflation through monetary policy as it raises the Official Cash Rate to reduce economic activity. Government fiscal policy (i.e., reducing government spending) is another important tool that can be used. Finally, reducing consumer spending or increasing market competition can also help.

Tax indexation has pros and cons, and all elements of any potential tax indexation policy would need to be carefully considered. That being said, there remains a possibility that tax indexation could be introduced at some point in the future and would be a significant change to our current tax system.

Your usual Deloitte advisor would be happy to help if you have any questions.