Working for Families tax trap

NZ Herald Jan 30, 2010

Nearly 378,000 New Zealand households get a bit more money each week through Working for Families tax credits. But a system designed to help young families actually punishes them as extra income earned from hard work is taxed at rates as high as 90c in the dollar. For some families, the dole is a better option.
David Hall and Anne Mason opted to put Ryan, 5, and Sophia, 3, before their careers, a decision with economic implications. The first reason is, ironically, because the Government helps them with $125 a week in tax credits through Working for Families. Although the credits are reducing as Hall moves up the teaching salary scale, they will not disappear completely until the couple’s joint income reaches $90,457. “Right now those benefits are great,” says Mason. But clawing back those credits takes 20c out of every extra dollar that either Hall or Mason earns. Piled on top of the standard tax scale, that means Hall ends up keeping less than half of any extra dollar. That “tax trap” was identified by the Government’s tax working group last week as a key factor holding back New Zealand’s economic growth. Three-quarters of all our families with children, 377,800 families at last count, receive Working for Families tax credits.

And the second reason Mason and Hall pay a price for their choice to keep one parent mainly at home is that the tax system treats their incomes as completely separate. Hall pays tax at the second-to-top rate of 33c in the dollar just as if he was single, even though his income is shared with his wife and children. Mason has joined a lobby group, Parents as Partners, which sees this as a kind of “tax trap” too. The group wants to let two-income families split their incomes for tax purposes. For Mason and Hall this would mean paying tax on $31,000 each, lowering Hall’s tax rate sharply to just 21c in the dollar.

The tax working group found that the combination of tax rates and welfare clawbacks, especially for Working for Families, doesn’t just hold back thousands of people from increasing their incomes. It also diverts their efforts into finding ways to hide whatever they do earn. “Expansion of the Working for Families tax credits in 2005 has increased the incentives for people to shelter or split income, undermining the integrity of the system,” it said. Economist Gareth Morgan, a member of the group, is blunter. “The thing is completely broken,” he says. “Many people with low taxable incomes are actually rich people who are getting benefits just by spreading their incomes across different entities. The system works like a sieve.”