Microsimulation Analysis of Optimal Income Tax Reforms: An Application to New Zealand

35 Pages Posted: 25 May 2018

See all articles by John Creedy

John Creedy

Victoria University of Wellington

Norman Gemmell

Victoria University of Wellington - Victoria Business School

Nicolas Herault

University of Melbourne - Melbourne Institute: Applied Economic & Social Research

Penny Mok

Government of New Zealand - Ministry of Business, Innovation & Employment

Date Written: May 24, 2018

Abstract

This paper examines the optimal direction of marginal income tax reform in the context of New Zealand, which recently reduced its top marginal income tax rate to one of the lowest in the OECD. A behavioural microsimulation model is used, in which social welfare functions are defined in terms of either money metric utility or net income. The model allows for labour supply responses to tax changes, in which a high degree of population heterogeneity is represented along with all the details of the highly complex income tax and transfer system. The implications of the results for specific combinations of tax rate or threshold changes, that are both revenue neutral and welfare improving, are explored in detail, recognising the role of distributional value judgements in determining an optimal reform. The potential impact of additional income responses is also examined, using the concept of the elasticity of taxable income. Results suggest, under a wide range of parameter values and assumptions, that raising the highest income tax rate and/or threshold, would be part of an optimal reform package.

Keywords: optimal taxation, tax reform, behavioural microsimulation, social welfare function, money metric utility

JEL Classification: D63, H21, H31, I31, J22

Suggested Citation

Creedy, John and Gemmell, Norman and Herault, Nicolas and Mok, Penny, Microsimulation Analysis of Optimal Income Tax Reforms: An Application to New Zealand (May 24, 2018). Melbourne Institute Working Paper No. 7/18, Available at SSRN: https://ssrn.com/abstract=3184654 or http://dx.doi.org/10.2139/ssrn.3184654

John Creedy

Victoria University of Wellington ( email )

P.O. Box 600
Wellington, 6140
New Zealand

Norman Gemmell

Victoria University of Wellington - Victoria Business School ( email )

PO Box 600
Wellington 6140
New Zealand

Nicolas Herault (Contact Author)

University of Melbourne - Melbourne Institute: Applied Economic & Social Research ( email )

Level 5, FBE Building, 111 Barry Street
Parkville, Victoria 3010
Australia

HOME PAGE: http://www.findanexpert.unimelb.edu.au/researcher/person125238.html

Penny Mok

Government of New Zealand - Ministry of Business, Innovation & Employment ( email )

15 Stout St
Wellington, 6011
New Zealand

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