Taxation and Basic Income


This page looks at taxation issues associated with Basic Income.

  • 1 Apr 2022 Jobseeker Support and New Zealand taxation figures are used on this page

List of questions answered here.

The following questions are answered here. Scroll down to see the answers.

  • What is the Effective Tax Rate (ETR)?
     

  • What is the Marginal Tax Rate (MTR)?
     

  • What is the Effective Marginal Tax Rate (EMTR)?
     

  • What is a progressive tax?
     

  • What is a proportional tax?
     

  • Why use a proportional tax?
     

  • How does the New Zealand Income tax system work at present?
     

  • How do tax cuts work and who benefits the most?
     

  • What happens with a change from a progressive tax to a proportional tax?
     

  • Which is the best way to combine a Basic Income with a tax scheme?
     

  • How do incomes change with a Basic Income?
     

  • Should a Basic Income be paid as a taxable or tax-free amount and with a progressive or proportional tax?
     

  • Will everyone have to change to a proportional tax?
     

  • What about people on temporary work permits?
     

  • Will existing computer systems be able to handle a Basic Income and a proportional tax?
     

  • What is a two-stage tax and why use it?
     

  • What is the Ulmer Model?
     

  • Will additional taxation be necessary and how will this be raised?
     

______________________________

What is the Effective Tax Rate (ETR)?

The Effective Tax Rate (ETR) is the rate that tax is paid on total annual income. With a progressive income tax, the Effective Tax Rate paid on total income may be significantly lower than the Marginal Tax Rate paid on the last dollar earned.

When a tax-free Basic Income is paid, the Effective Tax rate will be lower than the Marginal Tax Rate paid on the last dollar earned.

 
What is the Marginal Tax Rate (MTR)?
The Marginal Tax Rate (MTR) is the rate that tax is paid on the last dollar earned.

What is the Effective Marginal Tax Rate (EMTR)?
The Effective Marginal Tax Rate (EMTR) is the effective tax rate paid on the last dollar earned when other deductions or abatement of state grants are considered as equivalent to additional tax paid.

The Effective Marginal Tax Rate will be higher than the Marginal Tax Rate when there are other deductions and may in some cases exceed 100%. When the EMTR exceeds 100%, earning extra income will result in a reduction in net income. This is a poverty trap.

 
What is a progressive tax?
A
Progressive tax is a tax where the tax rate increases progressively as income increases. The increases are usually in steps so each time income exceeds a predetermined threshold, the tax will increase to the next tax rate. 

What is a proportional tax?
A Proportional tax is a tax where the tax paid is at a fixed rate so the total tax is directly proportional to the income earned. A proportional tax is also known as a uniform tax or flat tax.

Why use a proportional tax?

Basic Income advocates recommend that those who receive a Basic Income are taxed at a rate that is proportional to their income. This is known as a proportional tax.

There are three types of tax, regressive, proportional, and progressive.

  • With a regressive tax, tax rates reduce as income increases.
  • With a proportional tax, the total tax paid increases in direct proportion to income. All income is taxed at the same tax rate.
  • With a progressive tax, tax rates increase as income increases. 
     
A proportional tax rather than a progressive tax is used because a proportional tax reduces the total cost of providing a Basic Income and provides better targeting of a Basic Income to those on low incomes.
 
  • A proportional tax provides better targeting of a Basic Income to those with low incomes than can be achieved with a progressive tax. 
  • See: "How do incomes change with a Basic Income?" below for worked examples that show how the combination of a Basic Income with a proportional tax provides the best targeting and lowest overall cost.
  • Tax-free thresholds and progressive tax systems are intended to give people on low incomes an effective discount tax rate on their low incomes, but they also give the maximum value of the discount to those on high incomes. The people who need the discount the least get the maximum value of the discount.
  • To overcome the discounts that a progressive tax gives it is necessary to tax higher incomes at a significantly higher marginal rate. High marginal tax rates encourage tax avoidance and are a disincentive to work.  
  • A better solution is to pay a Basic Income and tax all other income with a proportional tax.
A regressive tax is not recommended as it accelerates the transfer of wealth from the poor to the wealthy
How does the New Zealand Income tax system work at present?

New Zealand has a progressive tax system with tax rates that increase progressively as income increases. There are five steps.
  • The first tax rate of 10.5% applies to all income up to $13,999
  • The second tax rate of 17.5% applies to all income from $14,000 to $47,999
  • The third tax rate of 30.0% applies to all income from $48,000 to $69,999
  • The fourth tax rate of 33% applies to income from $70,000 to $179,999
  • The fifth tax rate of 39% applies to all income above $180,000 
 
A person with an income greater than $180,000 will have:
  • the first $14,000 of their earnings taxed at 10.5% and 
  • the next $34,000 at 17.5%,
  • the next $22,000 taxed at 30%,
  • the next $110,000 taxed at 33%, and
  • all income over $180,000 taxed at 39%.
These are the marginal tax rates.
 
A marginal tax rate is the rate at which the last dollar earned is taxed.
  • A person's marginal tax rate maybe 10.5%, 17.5%, 30%, 33% or 39% depending on a persons income
  • Thus, for a person earning more than $48,000 but less than $70,000, the marginal tax rate is 30%
  • for a person earning more than $70,000 but less than $180,000, the marginal tax rate is 33%,
  • for a person earning more than $180,000, the marginal tax rate is 39%.
The average tax paid is often considerably lower than the marginal tax rate, perhaps less than 25%.
How do tax cuts work and who benefits the most?
People's incomes and pay rates tend to increase with time due to inflation. If the tax margins are not increased in line with inflation, people will end up paying a greater percentage of their income in taxation. Real incomes after tax will reduce.
  • When the economy is doing well, governments, even when they increase expenditure in line with inflation, may end up with surpluses.
  • One reaction is to talk of tax cuts but Basic Income is a better alternative.
  • In difficult times, governments may run a deficit. 
  • Again, some people call for tax cuts to boost the economy, but a Basic Income is a better alternative because it will boost the economy and government revenue.
  • A Basic Income is a better alternative because, when applied correctly, it will target the money toward those most in need of income while maximising the boost to the economy.
 
There are two ways tax may be cut.
 
  • The first method is to increase the margins, the point where the tax rate changes from one tax rate to another, while leaving the rates unchanged.
    • This method is usually justified as being necessitated by inflation or as a way of reducing a surplus.
       
  • The second method is to reduce the tax rates.​
    • This may occur if the government still has an annual surplus after the first method has been applied.​
       
  • Whichever method is applied, those with no income will receive no benefit and the benefit will progressively increase until income reaches $180,000.
    • Those who receive the greatest tax reduction in total dollars will be those with incomes greater than $180,000.
       
  • With a progressive tax system, tax cuts, even when restricted to the lower margins and rates for the lowest incomes, are not a good method of targeting the benefit of the cuts at those on the lowest incomes.
    • This is because those on lower incomes will receive only part of the benefit of the tax cuts while those on higher incomes will always receive the full benefit. Tax cuts invariably favour those on high incomes or the wealthy.
  • A Basic Income is a more efficient way of distributing value to those with the lowest incomes, as explained in more detail below.
What happens with a change from a progressive tax to a proportional tax?
 
  • As the progressive tax system gives an effective tax discount on the first $180,000 of income, converting to a proportional tax usually involves removing the discounted or lower tax rates so that all income is taxed at a higher marginal tax rate. In New Zealand, this may be a proportional tax in the range of 33% to 39%. 
     

  • Changing to a proportional tax of either 33% or 39% without some form of compensation will significantly hurt those on low incomes.

    • With a 33% proportional tax, those with low incomes will have a 22.5% tax rate increase, from 10.5% to 33%. 

    • With a 39% proportional tax, those with low incomes will have a 28.5% tax rate increase, from 10.5% to 39%.

    • This increased tax can be offset by providing a Basic Income. 
       

  • Reducing the proportional tax rate to less than 33%, to say 30% in an attempt to benefit those on low incomes will, however, give those with incomes over $70,000 but less than $180,000 a 3% marginal tax cut, and those with incomes over $180,000 a 9% tax cut while still significantly increasing the tax on those with the lowest incomes.

    • With a 30% proportional tax, those on an income of $180,000 or greater at present will receive a 9% cut in their marginal tax rate.

    • Changing to a proportional tax without a Basic Income will hurt those on low incomes and will benefit people on high incomes.
       

  • Changing to a proportional tax of 33% will result in a person on the minimum income of $21.20 per hour (p.h.),  $44,247 per annum (p.a.), paying an additional $7,838 p.a. (18%) in tax while a person with an income of $70,000 or greater will pay an additional $9,080 in tax (13% for those on $70,000 and 5% for those on $180,000).

    • As a percentage, the tax increase declines as income increases so the greatest negative impact is on those with the lowest incomes. Those on the lowest incomes are hit the hardest.
       

  • A change to a proportional tax will give the greatest percentage increase in tax to those on the lowest incomes while making very little difference in total taxation as a percentage to those on very high incomes.

    • Without a Basic Income, a change to a proportional tax favours the wealthy while driving those on low incomes into poverty. Without a Basic Income, this is a regressive change as it hits those on lower incomes harder than those on higher incomes.
       

  • Because a change to a proportional tax hits those on the lowest incomes hard while having little impact on the wealthy, a change to a proportional tax without a Basic income should not be contemplated.
     

  • However, with a Basic Income, a desirable outcome is achieved. This will be demonstrated in more detail below.

Which is the best way to combine a Basic Income with a tax scheme?

A Basic Income might be paid as a taxable amount or as a tax-free amount and taxation might be either proportional or progressive. This gives four possible combinations. We examine these possibilities below to determine the best combination.
 

  • To provide a fair comparison of the different possibilities, the net or after-tax value of the Basic Income, which is the actual cost to the government, must be the same in all cases.
     

  • Two of the combinations, a taxable Basic income or a tax-free Basic Income, paid in combination with a proportional tax on other income, produce exactly the same results.

    • This occurs because, with a proportional tax, the tax rate on a taxable Basic Income is the same as on other income and is constant and does not vary with income.

    • This leaves just three combinations to compare.
       

  1. Of the three, a Basic Income, either taxable or tax-free, paid with a proportional tax:

    • is the simplest option to implement,

    • provides a Basic Income that is best targeted at those with the lowest incomes, and

    • gives a scheme that provides the most value with the lowest overall cost.
       

  2. Of the remaining two, a taxable Basic Income with a progressive tax provides better targeting and lower cost than a tax-free Basic Income with a progressive tax, but

    • is more complicated than the first option above,

    • is not as well-targeted to those on lower incomes, and

    • is significantly more expensive than the option of a Basic Income paid with a proportional tax.
       

  3. A tax-free Basic Income with a progressive tax 

    • is the least targeted at those on the lowest incomes,

    • is the most expensive option and

    • should not be contemplated for any Basic Income scheme.  
       

  • Consequently, Basic Income advocates invariably recommend that those who receive a Basic Income will have all other income taxed at a proportional rate

    • An exception to this is when a two-stage tax is used, such as the Ulmer Model. For further discussion on a two-stage tax and the Ulmer Model see below.   ​
       

How do incomes change with a Basic Income?


Here we show, using examples, how incomes will vary with a Basic Income of different values.

Example 1. A net Basic Income of $174.02 per week tax-free, $9,080 pa.

 

A net Basic Income of $174.02 p.w. is just enough to offset the $9,080 pa extra tax paid by those with incomes greater than $70,000 but less than $180,000 when the present progressive tax is replaced with a 33% proportional tax.

Some Basic Income advocates suggest the alternative of a net Basic Income of $175 p.w., $9,131 pa. be paid with a 33% proportional tax as this will give everyone, including those with incomes over $70,000, a small increase in net income.

For comparison purposes, three incomes levels are used in the examples below:

  • No income,

  • minimum income of $21.20 ph., $848 p.w., or $44,247 pa., and

  • $70,000 p.a. to $180,000 p.a.

All increases in income shown below are net or after-tax values.

  1. A net Basic Income of $174.02 p.w. with a proportional tax.

    • A person with no income will receive the full $174.02 p.w., or $9,080 p.a. 

    • A person on the minimum income will receive an extra $23.80 p.w., $1,241.72 p.a.

    • A person with an income of $70,000 p.a. or greater income will receive no additional income.
       

  2. A taxable Basic Income that gives a net Basic income of $174.02 with a progressive tax.

    The taxable or gross value of the Basic Income will be $194.44.

    • A person with no income will receive the full $174.02 p.w., or $9,080 p.a. net

    • A person on the minimum income will receive an extra $145.10 p.w., $7,571 p.a.

    • A person on $70,000 p.a. will receive an extra $130.27 pw., $6,797 p.a.

    • A person on $180,000 p.a. will receive an extra $118.61 pw., $6,189 p.a.
       

  3. A tax-free Basic Income with a progressive tax.

    • A person with no income will receive the full $174.02 p.w., or $9,080 p.a.

    • A person on the minimum income will receive the full $174.02 p.w., or $9,080 p.a

    • A person on $70,000 or greater will receive the full $174.02 p.w., or $9,080 p.a

Note: with a proportional tax, for every dollar that a net Basic Income increases over $174.02 p.w., everyone, including those with incomes over $70,000, will receive an additional dollar. Similarly, for those receiving a tax-free Basic Income, their net incomes will increase by a dollar for every dollar the Basic Income increases.

Example 2. ​A net Basic Income of $315 per week or  $16,436 per annum (from 1 April 2022).

  • This rate is the same as the adult jobseeker rate from 1 Apr 2022.

  • The gross value of the Basic Income is $358.97 per week or 18,730.16 per annum.

The minimum income for 2022 is $21.20 per hour before tax.

  • A person working 40 hours per week will receive $848.00 per week or $44,247 p.a. gross or before-tax income.

  • After-tax figures are $718.38 per week or $37,483.38 per annum with the current progressive tax.

  • After-tax figures are $568.16 per week or $29,645.17 per annum with a proportional tax of 33%.

  1. A net Basic Income with a proportional tax of 33% - 2022.

    • A person with no income will receive the full $315 p.w., or $16,436 p.a.

    • A person on the minimum income will receive an extra $165 p.w., or $8,598 p.a.

    • A person on $70,000 or more but less than $180,000 will receive an extra $141 p.w., $7,356 p.a. 
       

  2. A taxable Basic Income with a progressive tax - 2022. 

    The taxable or gross value of the Basic Income will be $359 p.w., or $18,730 p.a. 

    • A person with no income will receive the full net or after-tax payment of $315.00 p.w., or $14,532 p.a.

    • A person on the minimum income will receive an extra $260 p.w., $13,580 p.a.

    • A person on $70,000 will receive an extra $241 p.w., $12,549 p.a.

    • A person on $180,000 will receive an extra $219 p.w. or $11,425 p.a.
       

  3. A tax-free Basic Income with a progressive tax - 2022.

    • A person with no income will receive the full $315 p.w., or $16,436 p.a.

    • A person on the minimum income will receive the full $$315 p.w., or $16,436 p.a.

    • A person on $70,000 or greater will receive the full $$315 p.w., or $16,436 p.a.

An examination of these figures shows:

  • all three options deliver the same net amount to a person with no other income

  • of the three options, option 3, a tax-free Basic Income with a progressive tax on other income, pays the greatest net amount to those on higher incomes

  • the first option of a Basic Income paid in conjunction with a proportional tax on all other income is the best means of targeting the Basic Income to those on low incomes keeping the overall cost of a Basic Income scheme down.

  • Option 3, a tax-free Basic Income with a progressive tax, is the least targeted and the most expensive option, increasing the incomes of those who do not need additional income.

 

Should a Basic Income be paid as a taxable or tax-free amount and with a progressive or proportional tax?

The figures in the examples above show that the best targeted and lowest cost Basic Income scheme is achieved when a Basic Income, either taxable or tax-free, is combined with a proportional tax.

  • New Zealand welfare payments such as jobseeker support are as a general rule considered to be taxable income.

    • The cost to the government of deducting tax at source is negligible.

    • Consequently, when a Basic Income is paid with a proportional tax on all other income it makes little or no difference to the total net cost of the scheme if a Basic Income designed to give the same net value is paid as a taxable or tax-free amount.

Will everyone have to change to a proportional tax?

No. Only those receiving a Basic Income.

  • A feature of a Basic Income scheme paid in conjunction with a proportional tax is that only those receiving a Basic Income will be required to have their income taxed at the proportional rate. This enables a Basic Income to be introduced voluntarily and progressively.
     

  • The combination of a Basic Income with a proportional tax enables trials to be set up if thought desirable, and for these trials to be localised or for those on the trial to be dispersed throughout the country.
     

What about people on temporary work permits?

As a Basic Income is normally restricted to citizens or those with permanent residency this needs to be considered to ensure that people on temporary work permits are not unduly disadvantaged or discriminated against. There are several options.
 

  • The first option is to not pay these people a Basic Income and tax them using the present progressive tax system.
     

  • A second option is to pay those in full-time employment a Basic Income and tax them at the proportional tax rate or to let them choose between the two options of receiving a Basic Income with a proportional tax or no Basic Income and the progressive tax system.
     

  • The situation is more complicated for those in part-time employment. A full Basic Income payment for such people would not be appropriate so these people are likely to be taxed using the progressive system and receive no Basic Income.

Will existing computer systems be able to handle a Basic Income and a proportional tax?

 

Yes. Existing computer systems are designed to handle a number of different tax systems and rates simultaneously.
 

  • People undertaking work must indicate if they are in primary or secondary employment and are taxed at different rates. Those on contract are taxed at another rate. Those on a Basic Income will be taxed at the proportional tax rate.
     

  • Inland revenue computers handle many different tax rates. Incorporating a proportional tax rate for those on Basic Income will not be difficult.
     

  • Computer systems already exist to pay New Zealand Superannuation and various welfare payments such as jobseeker support. It will not be difficult to include Basic Income payments.
     

What is a two-stage tax and why use it?

  • Some Basic Income proposals use a two-stage tax taxation system. With a two-stage tax system, the tax rate may either increase or decrease above a threshold income level.
     

  • Using a two-stage tax gives the designers of a Basic Income more flexibility. Tax rates on net recipients and net payers can be adjusted independently to ensure that payments to recipients are balanced by extra tax raised or to maximise the benefits achieved with a Basic Income.  
     

  • When a uniform tax is combined with a Basic Income, the Effective Tax Rate (ETR) is progressive. That is, the ETR progressively increases as gross income from other sources increases.

    This is because the Basic Income may be considered to be a negative tax payment and when the negative Basic Income and the positive tax are added the net result is negative for those on low incomes so the ETR is negative.

    As the gross income from other sources increases, taxation on other income increases, and the tax payment will eventually exceed the Basic Income received so the ETR progressively becomes less negative and eventually becomes positive.

    While the tax rate on other income has not changed, the ETR on all income is progressive.

     

  • Changing the tax rate on income above a threshold changes the rate that the ETR increases but the increase in ETR with other income will remain progressive, except for some very unusual cases. 
     

  • There are two possible ways that the tax rate can change: a tax rate that increases when other income exceeds the threshold or a tax rate that decreases when other income exceeds the threshold.

    1. In the first case, a tax rate that increases above a threshold results in lower marginal tax rates on extra income earned by those taking up part-time work, lowering the disincentive to work, but tends to increase the overall cost of a Basic Income scheme resulting in higher tax rates on those above the threshold.​

    2. In the second case, a higher initial tax rate, and a lower rate above the threshold will reduce the overall cost of a Basic Income scheme and limit those who benefit from it but will have the disadvantage of higher marginal tax rates for those on lower incomes taking up part-time work. A special case of a tax rate that decreases beyond a threshold is the Ulmer Model. 

What is the Ulm Model?

  • The Ulm Model (Ulmer Modell) was developed at the University of Ulm in Germany. It is a special case of a Basic Income combined with a two-stage taxation system where the tax rate reduces above a threshold.
     

  • With the Ulm Model, the threshold is set at the Transfer Limit, the point where the Basic Income received equals the taxation raised on other income. As a result, the net income received at the Transfer Limit is equal to the Gross Income.
     

  • When other income is less than the Transfer Limit, the Basic Income will be greater than the taxes paid. When other income is greater than the Transfer Limit, the taxes paid will be greater than the Basic Income received.
     

  • The advantage of the Ulmer Model with a higher initial tax rate is that it reduces the cost of a Basic Income scheme by targeting the net payments toward those with the lowest incomes.
     

  • A disadvantage is slightly higher marginal tax rates for those on the lowest incomes.

Further information

Will additional taxation be necessary and how will this be raised? 

To a large extent, a Basic Income is self-funding but a small amount of additional taxation may be necessary.
 

  • With a Basic Income, savings are made by eliminating welfare payments of the same or less value and partially replacing welfare payments of greater value.
     

  • Additional tax revenue is generated by taxing those receiving a Basic Income at the proportional tax rate.
     

  • The extra money in the economy will increase expenditure and economic activity increasing the GST collected and increasing income tax, profit tax, and tax on interest and dividends. Modelling shows that after a two-year introductory period a Basic Income will return 99% of the money paid out as taxes. The additional money required from other sources to fund a Basic Income is, therefore, less than 1% of the total money required to pay a Basic Income. 
     

  • If there is a tax revenue shortfall, various advocates have suggested alternative methods of increasing tax revenue. BINZ does not support any particular additional tax and suggests that all alternatives be carefully considered. Spreading tax increases over a number of different possibilities may be a way of avoiding distortions to the economy and unintended consequences. Some suggestions follow but there are other possibilities.
     

  • Increasing GST has been suggested as one way of increasing tax revenue. GST increases will result, however, in increases in the cost of goods requiring those on low incomes to spend more for essential goods, so the value of the Basic Income needs to be increased to compensate. Unduly high GST rates may result in more goods being purchased online from foreign countries so this loophole must be closed and kept closed. Others may travel to foreign countries to purchase goods. High GST rates also tend to target those on lower incomes more as people on lower incomes spend a greater proportion of their incomes on goods and services. This adds to the flow of wealth from the poor to the wealthy. 
     

  • A special property tax has been suggested as another alternative, perhaps as an additional levy on rates. New Zealanders already pay GST on rates so this would be an additional charge. While some see no need for exemptions, others consider that this will also impact those on lower incomes and suggest that either the family home or perhaps the first $750,000 dollars of property should be exempted from this new tax. 
     

  • A comprehensive wealth tax has also been suggested. This will tax all accumulated wealth including property, bank accounts, and investments.
     

  • Taxes on bank transactions, either within New Zealand or on foreign transactions have also been suggested.

END

Revised. 7 Oct 2020, 6 Oct 2021, 21 June 2022, 21 Aug 2022, 26 Aug 2022