New Working Papers on Impact of 2008/09 Recession on Households, Tax Smoothing, and Elasticity of Taxable Income
Three Treasury Working Papers published today examine the impact of the 2008/09 recession on New Zealand households, tax smoothing, and the elasticity of taxable income.

New Zealand Households and the 2008/09 Recession (WP 13/05) was written by Christopher Ball and Michael Ryan. This paper studies the changes in three metrics: income, expenditure and equivalent variation between 2006/07 and 2009/10 for different types of households in New Zealand. The period between 2006/07 and 2009/10 is an interesting period to study as it includes the 2008/09 recession. The equivalent variation is a measure of utility changes owing to price changes.

Tax Policy with Uncertain Future Costs: Some Simple Models (WP 13/07)
was written by Christopher Ball and John Creedy. This paper considers how uncertainty about the extent of future public expenditure affects decisions regarding ‘tax smoothing’, that is, the use of higher current taxes to build up a fund so that future taxes do not need to be as high as otherwise. It is not clear whether governments should act immediately or wait until more information becomes available. The paper uses simplified models to clarify the different influences on policy decisions. Illustrative examples show that the potential future expenditure must be relatively large (as a proportion of income) before it is worth pre-funding, though not completely smoothing tax rates over time. Attitudes to risk were found to have a small effect. The size of the potential future tax-financed cost and its associated probability were found to be the major determinants of the optimal policy.

Regression Estimates of the Elasticity of Taxable Income and the Choice of Instrument (WP 13/08) was written by Simon Carey, John Creedy, Norman Gemmell and Josh Teng. This paper examines estimation of the elasticity of taxable income using instrumental variable regression methods (The ‘elasticity of taxable income’ measures the response of taxable income to variations in the net-of-tax rate. It captures the combined impact of various economic responses to marginal income tax rates, so is a crucial component of any investigation of the potential revenue effects of proposed income tax changes.). Two alternative tax rate instruments are proposed, using estimates of the dynamics of taxable income from a panel of taxpayers over a period that involves no tax changes. When applied to the 2001 tax reform in New Zealand, (which involved a mix of marginal tax rate increases, decreases and no change across a wide range of incomes), it was found the proposed new instruments significantly outperform an instrument based on the standard approach of assuming unchanged income levels after reform.

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