The Cost of Working More: Understanding Effective Marginal Tax Rates in New Zealand's Tax and Transfer System

This Analytical Note examines how New Zealand’s tax and transfer system affects financial incentives to work, using Effective Marginal Tax Rates (EMTRs) as the main measure. EMTRs show how much of each additional dollar earned is lost through taxes and benefit reductions. High EMTRs are an unavoidable feature of any targeted welfare system that aims to support those most in need while managing government costs. Key findings include: (1) Most New Zealanders (94%) face EMTRs below 50%, with only 6% experiencing EMTRs over 50%. However, the distribution of EMTRs varies significantly across different family types. (2) Families without children generally experience lower EMTRs and therefore higher work incentives, as they are less likely to receive government support payments that reduce with increases to income. Around 90% of these families have EMTRs at their marginal tax rate. (3) In contrast, many families with children face much higher EMTRs and lower work incentives, particularly single-parent families. These high EMTRs come from a combination of factors including income tax and reductions in benefit, Working for Families tax credits, and Accommodation Supplement. 13% of couple-parent families and 30% of single-parent families have EMTRs greater than 50%. (4) A small number of families have EMTRs higher than 100%, and these are all families with children. This analysis highlights the complex interplay between various elements of the tax and transfer system in New Zealand. It demonstrates that most people keep a reasonable amount of their additional earnings when they work more hours, but parents - especially single parents - often face significant financial penalties for working more. These findings provide valuable insights into the structure of New Zealand's welfare system and its potential impacts on labour market participation across different demographic groups.