Like many developed economies, New Zealand faces difficult choices about how to finance public spending. Among the various policies on offer ahead of next week's general election are promises to raise the top income tax rate.
Authors
- Peer Ebbesen Skov
Associate Professor of Economics, Auckland University of Technology
- Norman Gemmell
Chair in Public Finance, Te Herenga Waka — Victoria University of Wellington
The Green Party and Te Pāti Māori use different income thresholds, but propose raising the rate from its current 39% to 45% or 48% respectively.
New Zealand's top personal income tax rate (which applies to earnings over NZ$180,000) is relatively low by international standards. It's possible that rate could be higher - maybe up to 56% - and therefore raise more revenue.
But simply raising the rate isn't as straightforward as it might seem.
Because taxpayers change their behaviour in response to higher tax rates, those higher rates may raise less revenue than expected.
So, the questions we need to ask about proposals to raise tax rates are: how much revenue would a higher rate actually raise, what would it cost the economy, and who would gain or lose?
How much revenue?
People can respond to higher income taxes by changing when or how their income is taxed, or by changing their economic activity.
An employee might arrange with their employer to receive a bonus before a tax increase, or a business owner might change how income is reported. Such responses can involve costs - such as time and resources spent on tax planning - but need not reduce productive activity.
Others might take on less work, put less effort into securing a promotion, or turn down a better-paid job requiring relocation. In the longer run, career and education choices may change. These responses can reduce economic activity itself.
Economists summarise both types of responses using what's known as "elasticity of taxable income" ( ETI ), which measures how strongly reported taxable income responds to changes in tax incentives.
Consider a simple example. A 30% tax on $100 of income raises $30. Increasing the rate to 40% would raise $40 if income remained unchanged. But if taxable income falls to $95, the government collects $38 instead.
This is the intuition behind the Laffer curve, named after economist Arthur Laffer who famously sketched it on a restaurant napkin in Washington DC in 1974.
As tax rates rise, behavioural responses increasingly offset the desired additional revenue. Eventually, further increases cease to raise more revenue and may even reduce it.
In our recent study published in New Zealand Economic Papers, we use Inland Revenue data for 2024 to illustrate the revenue effects of changing the top tax rate while keeping the $180,000 threshold fixed. (It's important to note, these are not forecasts or costings of election proposals).
The revenue effects depend on how strongly taxpayers respond to changes in tax rates, as measured by the ETI. A previous New Zealand study estimated ETIs of around 0.25, meaning a 1% fall in the amount taxpayers keep from an extra dollar earned would lead to a 0.25% fall in reported taxable income.
For example, raising the top tax rate from 39% to 45% reduces the amount taxpayers keep from 61 to 55 cents for each dollar earned above $180,000 (a fall of around 10%). That would translate into reported taxable income falling by approximately 2.5%.
Raising the top rate from 39% to 45%, while retaining the $180,000 threshold, would mechanically raise around $1.1 billion annually if taxable incomes remained unchanged.
But accounting for taxpayers earning or reporting less income reduces the estimated additional revenue to around $560 million. Because higher tax payments and lower incomes also reduce household spending and GST receipts, the estimated gain in total public revenue falls to around $300 million.
Raising the top tax rate increases public revenue only up to a peak, beyond which further increases reduce it. Our calculations put this revenue-maximising rate for New Zealand at around 56%.
But stronger responses by higher-income taxpayers, as some international evidence suggests can happen, could bring that peak much closer to today's 39%.
The type of response also matters. If half the reduction in personal taxable income were instead shifted into family trusts that remained taxed at 39%, the government would still collect tax on that income rather than lose it entirely.
Under this scenario, the top personal income tax rate that maximises total public revenue would increase from around 56% to 66%.
Assessing the overall revenue consequences therefore also requires accounting for taxes collected elsewhere in the system or in other years.
What does it cost the economy?
Even when higher taxes raise additional revenue, they can impose economic costs.
Suppose taking on some additional work produces $100 of value, but the worker needs at least $58 in take-home pay to make giving up their free time worthwhile.
At a 39% tax rate, the worker keeps $61 and takes on the work. At 45%, they keep only $55 and decline it. Society loses $100 in production but the worker gains free time valued at $58, leaving a net economic loss of $42.
At the current 39% top rate, we estimate that raising an additional dollar of net public revenue generates around $1.20 in economic efficiency losses. At a 45% top rate, this cost rises to approximately $2 per dollar raised. These costs must be weighed against the benefits of the additional revenue.
Who benefits?
Raising the top rate places a greater direct tax burden on higher-income taxpayers. But its overall effect on inequality depends on how the additional revenue is spent.
Transfers to low-income families could reduce inequality, whereas spending that disproportionately benefits higher-income households would do less.
The social value of public spending also matters. Additional revenue might improve healthcare, education or other public services, creating benefits that cannot be assessed simply by counting dollars transferred.
Evaluating tax proposals
Our calculations suggest raising New Zealand's current 39% top income tax rate would generate additional revenue.
A higher rate would also impose economic efficiency costs, while the additional revenue could fund valuable public services or redistribution of wealth. Whether these benefits justify the costs is ultimately a political judgement.
Looking at the tax proposals on offer in this election, it's important we also ask three key questions. How much revenue will the change raise? What economic costs will it impose? And who will ultimately gain or lose, including from how the additional revenue is spent?
From the cost of living and a health system under extreme pressure to how best to tackle climate change, the coming election involves some big choices.
This article is part of The Conversation's Election 2026 series : expert analysis of the major policy debates and the big challenges New Zealand's next government will face.
The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.
